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The shift and the shocks:prospects for the world economyMartin Wolf, Associate Editor & ChiefEconomics Commentator, Financial Times

Global Policy Dialogue

23rd January

London School of Economics

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The shift and the shocks

Shift

Shocks

Prospects

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1. The shift

In the 19th century, there occurred the greatdivergence

In the second half of the 20th century, convergencebegan, notably with Japan and the east Asian tigereconomies

In the late 20th and early 21st centuries convergencespread to the Asian giants

Divergent growth is mirror image of convergingincomes

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1. The shift

EMERGING COUNTRIES OUTPERFORM HUGELY

GDP SINCE THE CRISIS

90

100

110

120

130

140

150

160

170

2007 2008 2009 2010 2011 2012

Advanced economies Emerging and developing economies China India

Source: IMF, WEO database

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1. The shift

DEVELOPED COUNTRIES FALL, ASIA RISES

SHARES IN WORLD OUTPUT

(at PPP, per cent)

29 25 20 18

2524

2018

4

7 1418

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1990 2000 2010 2016

European Union United States Other advanced economies China

India Other developing Asia Other emerging economies

Source: IMF WEO database, October 2011

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1. The shift

The great convergence has had powerfulconsequences:

An ongoing labour-supply shock, which lowered relativewages of the relatively unskilled in high-income countries;

Initially, a dis-inflationary shock, as China lowered world

prices for manufactures;

An increase in the surplus of desired savings and so the riseof the global imbalances;

Then an inflationary shock, as demand for raw materialssoared; and throughout

Ongoing shift in global economic activity

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2. The shocks

The economic collapse was large and enduring

The rescue was also dramatic:

Liabilities of the core financial system were nationalised;

Monetary policy is unprecedented; and

Fiscal policy has been put on a war-time footing.

This then is a contained depression.

According to Carmen Reinhart and Kenneth Rogoff, This Timeis Different, it could take three years, to return to normality.

Given the scale of affected economies, it could be longer. Conventional fiscal and monetary firepower is used up.

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2. The shocks: global

THE LEGACY OF THE DEBT EXPLOSION

HOUSEHOLD DEBT TO INCOME RATIO

60

80

100

120

140

160

180

2000

Q1

2000Q3

2001

Q1

2001Q3

2002Q1

2002

Q3

2003Q1

2003

Q3

2004

Q1

2004Q3

2005

Q1

2005Q3

2006

Q1

2006Q3

2007Q1

2007

Q3

2008Q1

2008

Q3

2009

Q1

2009Q3

2010

Q1

2010Q3

2011Q1

United States Euro area United Kingdom Japan

Source: IMF WEO, September 2011

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A LONG DEPRESSION

GDP IN THE GREAT RECESSION

90.0

92.0

94.0

96.0

98.0

100.0

102.0

104.0

Q1

2008

Q2

2008

Q3

2008

Q4

2008

Q1

2009

Q2

2009

Q3

2009

Q4

2009

Q1

2010

Q2

2010

Q3

2010

Q4

2010

Q1

2011

Q2

2011

Q3

2011

US UK CANADA JAPAN ITALY FRANCE GERMANY

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THE SOVEREIGN DEBT CRISIS

NET PUBLIC DEBT OVER GDP (per cent)

0

20

40

60

80

100

120

140

160

180

Japan Italy United States France United Kingdom Germany Canada

2006

2009

2012

2015

Source: IMF WEO, October 2011

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STRUCTURAL FISCAL DEFICIT(as per cent of GDP)

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

Canada France Germany Italy Japan United Kingdom United States

2008 2009 2010 2011 2012

THE AGE OF PREMATURE RETRENCHMENT

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2.The

shocks:

global

FISCA

LROOM

?YES

TEN-YEA

RGOVERN

MENTBON

DYIELDS

0 1 2 3 4 5 6 7 8

30/10/2009

30/11/2009

30/12/2009

30/01/2010

28/02/2010

30/03/2010

30/04/2010

30/05/2010

30/06/2010

30/07/2010

30/08/2010

30/09/2010

30/10/2010

30/11/2010

30/12/2010

30/01/2011

28/02/2011

30/03/2011

30/04/2011

30/05/2011

30/06/2011

US

UK

Japa

n

Germany

France

Italy

Canad

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2. The shocks - eurozone

The eurozone crisis is the world, in miniature

The core of the eurozone financial crisis is not afiscal crisis

It is the interaction of balance of payments with

financial crises, though huge debt stocks played apart in creating liquidity problems for sovereigns

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The difficulty is largely the result of the divergencesaccumulated in the years of excess

What made everything seem so good was creatingan acute long-term crisis

The failure of a true union stands revealed: neitherfinancing in a crisis nor workable adjustmentmechanisms

Too little, too confused and too late

The crisis is potentially terminal for the eurozone

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CURRENT ACCOUNT BALANCES

(per cent of GDP)

-12.0

-10.0

-8.0

-6.0

-4.0-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Finla

nd

Netherl

ands

Belgium

Germ

any

Austria

Fra

nce

Italy

Irelan

d

Spain

Greece

Portugal

Estonia

1999-2007 Average 2012

EUROZONE IMBALANCES

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ROAD TO THE EUROZONE FISCAL CRISES

NET PUBLIC DEBT

(relative to GDP)

0

20

40

60

80

100

120

140

160

180

Greece Italy Portugal Ireland Spain

2002

2003

2004

2005

20062007

2008

2009

2010

2011

20122015

Source: World Economic Outlook database April 2011

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2.The

shocks

-eurozon

e

ROAD

TOTHEEUROZONEFISCA

LCRISE

SPREADSO

VER

BUNDS

0

100

200

300

400

500

600

01/01/2007

01/03/2007

01/05/2007

01/07/2007

01/09/2007

01/11/2007

01/01/2008

01/03/2008

01/05/2008

01/07/2008

01/09/2008

01/11/2008

01/01/2009

01/03/2009

01/05/2009

01/07/2009

01/09/2009

01/11/2009

01/01/2010

01/03/2010

01/05/2010

01/07/2010

01/09/2010

01/11/2010

01/01/2011

01/03/2011

Belgium

Spain

Fr

ance

Italy

Nether

lands

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2.The

shocks

-eurozon

e

ROAD

TOTHEEUROZONEFISCA

LCRISE

SPREADS

O

VER

BUNDS

-500 0

500

1000

1500

2000

2500

3000

3500

4000

01/01/2007

01/03/2007

01/05/2007

01/07/2007

01/09/2007

01/11/2007

01/01/2008

01/03/2008

01/05/2008

01/07/2008

01/09/2008

01/11/2008

01/01/2009

01/03/2009

01/05/2009

01/07/2009

01/09/2009

01/11/2009

01/01/2010

01/03/2010

01/05/2010

01/07/2010

01/09/2010

01/11/2010

01/01/2011

01/03/2011

Greece

Ireland

Portugal

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3. Prospects

At the broadest level, we are watching theinteraction of two huge events:

A secular shift in the location of economic activity; and

The collapse of a generational expansion in private and, toa lesser extent, public sector leverage in high-incomecountries

The eurozone crisis falls at the intersection of theseprocesses

Imbalances are a vital symptom of economic stress

So how might it all play out?

We do not know. There are too many unknowns.

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2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012GROWTH FORECASTS FOR 2012

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

US

UK

Japan

Eurozone

Germany

France

Italy

Spain

Jun-11 Jan-12

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2. The prospects: global

GROWTH PROSPECTS DWINDLE FOR 2012GROWTH FORECASTS FOR 2012

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

China

India

Asia Pacific (without

Japan)

Russia

Eastern Europe

Brazil

Latin America

World

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3. Prospects: global

Here are salient elements of global challenges:

Accelerating de-leveraging in the private sectors ofoverleveraged countries;

Rebalancing the world economy, to give over-leveragedeconomies to enjoy export-led growth, necessary when

their private sectors run huge financial surpluses; Reducing fiscal deficits in high-income countries, without

killing the recovery; and

Avoiding excesses in emerging countries, despite easy

financial and monetary conditions.

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3. Prospects: eurozone

What is needed now in the eurozone are:

Financing while adjustment occurs, which will take at least 5years and possibly 10 years, or more;

Adjustment via structural reforms and divergent inflationacross the eurozone, with higher inflation in core countries

and low inflation in vulnerable countries; The big risk is a combination of premature fiscal tightening in

the periphery and the absence of adjustment in the core;

That will lead to further deep recessions;

And a possible break-up.

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3. Prospects

Some guesses:

Growth in high countries will remain weak for many years,

with a significant chance of a true depression;

Headline inflation rates will fall;

Short-term official interest rates will remain low;

Countries with their own central banks will have low long-term bond rates; many eurozone countries will not;

Eurozone break-up risk remains;

The US will be the fastest growing of big economies;

Emerging countries will grow quickly, but there is somechance of crises there, too.

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Documents

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