Economic Prospects: Implications of the Eurozone Crisis

Economic Prospects: Implications of the Eurozone Crisis Carlos A. Primo Braga Special Representative and Director for Europe, External Affairs VicePre...
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Economic Prospects: Implications of the Eurozone Crisis Carlos A. Primo Braga Special Representative and Director for Europe, External Affairs VicePresidency, The World Bank

The views expressed here are those of the author and do not necessarily reflect the views of the World Bank, or those of its Executive Directors or the governments they represent.

Outline • The impact of the Great Recession • The sovereign debt crisis: additional sources of tension • Implications for ECA, MENA and SSA • Changes in the global economic map • The Doing Business agenda

The Great Recession: A Perfect Storm

3

Impact of the Great Recession •

A financial crisis originating in the advanced, not the developing, world (synchronized recession across advanced countries (2008/9) and a weak recovery in 2010/11)



Developing countries have shown significant resilience so far, but uncertainties about recovery in industrialized countries are increasing and potential impacts via trade and financial flows (including Official Development Assistance, ODA) require close monitoring



Increased perceptions of risk across the spectrum of trade and investment activities

– The crisis is fostering a significant rethinking – not necessarily of the overall merits of globalization – but of how to better harness it for development ends – Notably, there has not yet been a significant turning away from globalization by developing countries



Significant changes in the roles and regulation of financial market participants



Government s are expected to play a much larger role in the global economy



Is this a “Hubble” moment for economics (Edwin Hubble and the implications of his observations supporting the concept of an expanding universe and the Big Bang theory, revolutionizing astrophysics, 1929)?

“Theory is when you understand everything, but nothing works. Practice is when everything works, but nobody understands why. At this station, theory and practice are united, so nothing works and nobody understands why.” (Source: Fisher, 2011)

The near future: a mix of good and bad news… • • •

Commodity prices increase has moderated and inflationary pressures are down Recovery of natural disasters (Japan, Thailand…) is proceeding well Emerging markets growth remains strong (and developing countries are expected to grow around 5.4% in 2012) and so far no signs of systemic debt problems BUT • Eurozone strains continue • Political uncertainty about US fiscal position • Weaker underlying growth momentum in High Income Countries (2012 growth forecast reduced to 1.4% versus 2.2% forecast of mid-year; with the euro area expected to contract: -0.3%) • Major global stock market correction (more than $6 trillion since July) • Even though developing countries fundamentals remain strong, contagion is generating significant headwinds and major capital outflows • Moreover, developing countries have now a more restricted fiscal space compared to 2008 In short: downside risks have increased

Commodity prices have stabilized or are falling

Sources: Datastream and World Bank DEC Prospects Group

2011 GDP compares well with 2007, in most cases •

For example, GDP is below its 2007 level in only 8 out of 30 ECA countries

Deviations of 2011 real GDP from the 2007 level 40 30 20 10 0 -10

CHN TKM UZB IND AZE TJK BLR KSV ALB KAZ BRA KGZ POL KOR MDA TUR GEO MKD SRB MNE RUS BIH MEX CAN BGR SVK DEU CZE ROM USA FRA SVN HUN GBR ARM JPN HRV ITA UKR LTU EST LVA

-20

BUT…

Global economic environment has become much more precarious • Turmoil since August has affected financial conditions in developing countries and economic activity worldwide • Slow growth in large-middle-income countries and high-income Europe makes recovery fragile • Developing countries expected to grow in 2012 by 5.4 %, highincome countries by 1.4% (vs June forecast of 6.2 and 2.7%) • Baseline assumes no serious deterioration of conditions, should this materialize impacts for developing countries could be much worse • Developing countries are vulnerable because of: – – – – –

Reduced fiscal space Maturing short-term and long-term debt Potential deleveraging by banks in high-income world Weaker export demand and remittances flows Commodity prices

38% of developing countries had a government deficit greater than 4% of GDP in 2011 (18% in 2007) Percent of developing countries 40 35

2007

30

2011

25

20 15 10 5 0 -15

-10

-8

-6

-4

-2

0

2

4

More

Government balance (% of GDP) Source: World Bank, Global Economic Prospects, 2012A.

Message: Combination of weaker middle-income growth and fiscal crisis in Europe pose significant downside risks Projected and Simulated GDP growth 10 8 6 4 2 0 -2 -4

Revised baseline

Scenario 1 Scenario 2

2006

2007

Developing High-income World

-6 2005

2008

2009

Source: World Bank, Global Economic Prospects, 2012.

2010

2011

2012

2013

13

The “elephant” in the room: the danger of a sovereign debt crisis in HICs

Contagion has increased sovereign credit default swap rates worldwide Change in 5-year sovereign credit-default swap, basis points (as of Jan. 6th, 2012)* 450 5,929

Developing countries

High-income countries

300

150

Ukraine Argentina Croatia Romania Bulgaria Lithuania Turkey Kazakhstan Russia South Africa Indonesia China Malaysia Thailand Chile Philippines Brazil Colombia Mexico Peru Venezuela Greece Portugal Italy Spain France Germany Japan USA Ireland

0

* Change since the beginning of July. Sources: Bloomberg and World Bank DEC Prospects Group

15

European banking-sector counterparty-risk concerns persist despite pledge to recapitalize Interbank overnight spreads, basis points 400 350

United States (LIBOR-OIS spread)

300 250

200 150

Europe (EURIBOR-EONIA spread)

Indications of rising concerns about counter-party risk in European banking system

(Latest reading, 93)

100 50 0 Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Sources: Datastream and World Bank DEC Prospects Group

Jul-10

Jan-11

Jul-11

Jan-12 16

The European sovereign debt crisis: some considerations • Signs of contagion with CDS spreads rising even in some core Euro Area countries • Banking-sector exposure to European sovereign debt is an issue of concern • Markets remain uncertain about commitment to adjustment; lack of consensus on the role of the ECB; moreover, the current debt overhang plus fiscal/financial imbalances, and limitations on the use of exchangerate policy constrain growth prospects • Uncertainty can transform temporary liquidity problems into solvency crises… • Sovereign debt crises: history suggests that growth (unlikely in the near future…), fiscal adjustment (growing political resistance…), inflation (the experience of the 1920s vs the reality of the 2010s), debt restructuring (financial engineering and real debt relief…) and financial repression are some of the usual channels to cope with unsustainable debt/GDP ratios

Message: Impact on developing countries can be significant if further deterioration of economic conditions in high-income countries materializes • Direct financial channel potentially important for Latin America & Caribbean and Europe & Central Asia regions (due to integrated bank ownership) • Should wealth effects and confidence be affected more markedly than growth could be weaker by two percent or more • If financial-sector solvency is affected or a market-induced credit event occurs more serious consequences could be envisaged (downside scenarios captured in the Global Economic Prospects forecasts’ slide) • Implications for world trade non-trivial (temptation to rely on protectionist measures will increase) • Growing reliance on capital controls: a new form of “beggar thy neighbor” policy?

The trade channel: MENA, ECA and SSA have the closest ties to high-spread European economies Percent of merchandise exports destined to Europe 45 40 9.5

35 30

7.3

25

6.2

20 15

16.3

4.2 4.8

10 5 0 Latin America & Caribbean

East Asia & Pacific

South Asia

Sub-Saharan Africa

Europe & Central Middle East & Asia North Africa

Arab spring events have affected investment, economic activity and labor markets Industrial production (% change, 3m/3m, seasonally adjusted annualized rates)

Source: World Bank based on data from Datastream

Tourist arrivals (% change over same period last year)

Unemployment rates (%)

Source: UNWTO.

Source: Government statistics.

Growth and unemployment Growth accelerated in response to reforms but not enough to address the key challenges facing the region (average, annual growth rates in %)

The MENA region has the highest youth unemployment rate in the world (%) 40

9 8

35

7

30

6 5

25

4

20

3 2 1

1990-99

15

2000-08

10

0

5

-1

0

-2

North Africa

MENA has the lowest participation rate, and also among women (% of working age population)

SSA ECA LAC SA female

MENA

0

20

40

60

80

SA

LAC

World

Sub South Saharan Asia Africa

The young population has been soaring in MENA

EAP

total

Middle East

100

East Asia

MENA’s job problem cannot be attributed solely to a slow pace of job creation relative to growth • Oil importers record a slow response of job creation to income growth • Oil exporters create jobs at a fast pace relative to growth so their main problem is low income growth • In all MENA countries, job quality is an issue Employment-growth elasticities, 2004-08

Source: ILO.

ECA: job losses remain a big concern • ECA: Unemployment increased significantly during the crisis; 1 in 8 are unemployed • Youth unemployment is a concern; 3 in 10 young adults are unemployed Youth unemployment rates in select ECA countries (percent, Q1 2011)

Unemployment rates (per cent, latest available) 50

60

40

50

30

40 30

20

ECA average

ECA average

20

10 10

Source: Employment Monitor-- http://go.worldbank.org/B8MMAI31I0

0 KAZ RUS CZE SVN MDA TUR EST ROM POL HUN BGR LVA SVK LTU HRV SRB MKD

BLR* TJK* KAZ¹ RUS¹ CZE‡ ROM** MDA‡ UKR** SVN‡ POL‡ TUR‡ HUN‡ BGR** HRV** EST‡ SVK‡ ALB** LTU‡ LVA** ARM* MNE* SRB* MKD** BIH*

0

Sub Saharan Africa GDP growth

GDP Growth - SSA

Oil countries the crisis

Average GDP growth rates 1998-2008

Liberia Mozambique Sierra Leone Rwanda Sao Tome and Princ. Ethiopia Tanzania Cape Verde Mali Burkina Faso 40% Botswana Ghana The Gambia Mauritius Namibia Senegal Niger Benin Zambia Madagascar

Percentage of total African population

SSA: A more inclusive and sustained growth

Equatorial Guinea Angola Chad Sudan 30% Nigeria Cameroon Congo, Rep. •Thanks to cfrom Gabon

Kenya Malawi South Africa Guinea Lesotho Swaziland Seychelles Burundi Congo, Dem. Rep. Comoros CAR Togo Côte d’Ivoire Eritrea Guinea-Bissau Zimbabwe

Growth 4% or higher

Growth less than 4%

30%

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Growth performance in SSA GDP growth in Sub-Saharan Africa by country groups

Source: World Development Indicators, World Bank.

Africa’s infrastructure deficit Infrastructure deficit (billion dollars/year) Total gap

$93

Current expenditures

$45

Potential efficiency gains

$17

________________________ Funding gap

$31

By 2025, major emerging economies are likely to become some of the largest economies in the world Source: World Bank (2011) $ Trillions

Eurozone

(Real US$2009) 30

United States

China (no appreciation) 25 Russia

United Kingdom

20

Japan 15

Brazil

Canada 10 India

Korea 5

0 2009

2011

2013

2015

2017

2019

2021

2023

2025

Message: the growth gap between developing and developed countries is becoming a structural feature of the world economy Source: World Bank, 2011 10

percent

8

6 4 2 0 -2 -4

Gap (Developing-HIC) Developing countries High income countries

-6

28

R&D Intensity R&D Intensity and Per Capita GDP (mid 1970s-early/mid 2000s)



Korea & China have R&D intensity increasing with per capita GDP at an accelerating pace Brazil and India have more volatile R&D intensity

5

y = 0.0009e0.7349x 4.5 4

Japan 3.5

U.S.

R&D (% of GDP)



3 2.5

Korea, Rep. 2

Brazil

Singapore

1.5

China

India

1

Thailand

Malaysia

0.5 0

6

7

8

9

GDP per capita (log) Source: Brahmbhatt and Hu, 2010

29

10

11

The current R&D input landscape (Scientists & Engineers/Million people versus R&D/GDP)

Message: number of innovating firms in emerging economies will continue to expand rapidly Source: World Bank, 2011 Top 1,000 firms by R&D spending, 2009

Top 1,000 firms by R&D spending, 2004

30

EM: 6% Japan

UK

UK

Swiss

Swiss Euro

Other

USA

12 Number of patents (left axis)

10 8

20

6 15

Sweden

Sweden Denmark

percent

25

Japan

Other

thousands 35

EM: 12%

Euro

Cross-border patents granted worldwide to EM residents

USA

Denmark

4

10 5

2

0

0

• In 2009, 114 firms from EMs among world’s top R&D 1,000 investors (twice as many as five years early) 31

Which regions have the most business-friendly environment in Doing Business? Source: WB/IFC (2011) Economies in Sub-Saharan Africa and South Asia are the most likely to have both weaker legal institutions and more complex regulatory processes

Ranking of European Union member states in the overall ease of doing business 2010/11 Source: WB/IFC (2011) Denmark United Kingdom Ireland Finland Sweden Germany Latvia Estonia Lithuania Belgium France Portugal Netherlands Austria Slovenia EU average Cyprus Spain Slovak Republic Luxembourg Hungary Bulgaria Poland Czech Republic Romania Italy Greece

5 7

10 11

14 19 21

24

27 28 29 30 31 32

37 39 40 44

48 50 51 59 62

64

72 87

33

100

Concluding remarks • The Great Recession has increased skepticism about the benefits of globalization: : the danger of trade and financial protectionism is rising • Recent turbulence in financial markets and uncertainty about future prospects is impacting growth in both high-income (HICs) and developing countries (DCs), but divergent growth trends between HICs and DCs are expected to continue; • In a multipolar world economy (in which several major emerging countries are attaining growth pole status), international relations will take on a much more complex pattern, with South-South trade, investment, and finance linkages requiring greater attention; • The global innovation map will continue to change: the BICs have “arrived”! • The Doing Business agenda is still quite relevant for many European countries.

References •

Battelle, 2010, “2011 Global R&D Funding Forecast.”



Brahmbhatt, M., and A. Hu, 2010, “Ideas and Innovation in East Asia,” World Bank Res Obs (2010) 25 (2): 177-207 Chandra, V., Osorio-Rodarte, I. and Primo Braga, C.A., 2009, “Korea and the BICs: catching-up experiences,” in V. Chandra, D. Erocal, P.C. Padoan, and C.A. Primo Braga, eds., Innovation and Growth: Chasing a Moving Frontier, Paris: OECD and The World Bank. Dahlman, C.J., 2012, The World Under Pressure, Stanford: Stanford University Press.



• • • • •

Fischer, R.W., 2011, “Explaining Dissent on the FOMC Vote for Operation Twist (with reference to Jan Mayen Island, Paul Volcker and Thor’s Hammer),” Dallas, Texas: Federal Reserve Bank of Dallas. IMF, World Economic Outlook, several years. Primo Braga, C.A., and G.A. Vincelette, eds, 2010, Sovereign Debt and the Financial Crisis: Will This Time Be Different?, Washington, D.C.: The World Bank. World Bank, 2011, Global Development Horizons 2011 -- Multipolarity: The New Global Economy, Washington, D.C.: The World Bank.



World Bank/IFC, 2011, Doing Business 2012, Washington, D.C.: The World Bank.



World Bank, 2012, Global Economic Prospects: Uncertainties and Vulnerabilities, Washington, D.C.: The World Bank.

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