GLOBALIZATION AND THE GLOBAL ECONOMY:PERSPECTIVES AND PROSPECTS FOR THE SHORT RUN AND LONG RUN JOSEPH E. STIGLITZ

VALENCIAJUNE 2006

MAJOR CHANGES IN THE GLOBAL ECONOMY

GLOBALIZATION THE EMERGENCE OF THE

EMERGING MARKETS RISING OIL (ENERGY) PRICES INCREASING GLOBAL FINANCIAL

INSTABILITY A NEW GEOPOLITICS?

GLOBALIZATION

The closer integration of the countries of the world As a result of lowering of transportation and

communication costs and the reduction of man-made barriers to the movement of goods, services, people, capital

So that the world has become more interdependent Successes and failures in one locale have global

ramifications China’s rapid growth has driven up commodity prices America’s war in Iraq has driven up oil prices What will be the consequences of a downturn in the U.S.?

THE EMERGENCE OFTHE EMERGING MARKETS

2.5 billion people in India, China, and other countries in Asia Were formerly excluded and marginalized As a legacy of colonialism

Are now being integrated into the global economy

This is an event of historical proportions

And so is their unprecedented success

GLOBAL SUCCESS AND CHINA Previous economic revolutions—like the

industrial revolution of the nineteenth century—had seen growth rates peak at around 2 to 3%

The golden age of growth in America in the 1950s and 1960s saw similar growth rates

China’s growth rates have been three times this Even faster than Asia’s miracle countries Its success has been not only in increasing GDP The fraction of China’s population living on less than

$1 a day fell from 63.8% in 1981 to 16.6% twenty years later

INDIA’S IMPRESSIVE GROWTH India has also had enormous economic success

Over two decades of 5-6% growth, now approaching 8% A crucial element has been India’s commitment

to investment in education, particularly in technology Created an educated middle class able to take advantage of

the changes brought about by globalization Now wealthier countries outsource technology work to

India In Bangalore, Infosys has built the world’s largest

corporate residential education center, can train 4,500 employees at once

Not quite as successful as China at fighting poverty In 2000, 35% were still living on less than $1 a day

IS THE WORLD FLAT? Thomas Friedman has suggested “the world is flat”

Poor countries are finally competing on a level playing field But the world is not flat

Disparities between the haves and have-nots have increased Importance of research gives enormous advantage to those

who have the resources and skills to undertake it The Uruguay Round made the world less flat, especially

TRIPs Power of entrenched monopolies, like Microsoft, is probably

greater than ever before The nature of competition is enormously changed

Cannot simply rest on laurels These changes will affect everyone

CHINA AND INDIA UNDERSTAND That what separates developed from less

developed countries is not only a gap in resources but also a gap in knowledge

And are working hard – and successfully – to narrow that gap

Education and technology are also the basis of success of other high growth economies, like Brazil Brazil’s Embraer airplane Energy independence through research Huge growth of exports

CHALLENGES FACING ADVANCED INDUSTRIAL COUNTRIES To find new “comparative advantage” –

market niche – which may require considerable restructuring

To invest more in education and research In the U.S., expenditures on research are

declining As a percentage of GDP, federal funding has

declined 37% since 1970 Reflected in part in share of worldwide patents Since 1980, Japan’s share of worldwide patents

increased from 12% to 21%, mostly at the expense of the U.S., whose share declined by 8 percentage points

EDUCATION STATISTICS ARE EQUALLY DISMAL

Of the 2.8 million 1st university degrees in science and engineering issued annually worldwide 1,200,000 are issued in Asia 830,000 are issued in Europe 400,000 are issued in U.S.

Asia produces 8 times more engineers than the U.S. Since 1993, the number of Americans in graduate

science programs has fallen by nearly 25% while the global supply of science Ph.D.s increased 25% - mostly in Asia

Nearly half of all U.S. doctorate degrees in engineering and computer science are earned by foreign students, many of whom have had serious visa problems since 9/11

PROBLEMS START EARLIER

In elementary and secondary schools Evidenced by performance in standardized

tests in science and math. For example, on 8th grade exams

44% of Singapore students performed at the highest level

38% of Taiwanese students performed at the highest level

7% of U.S. students performed at the highest level

THREATS TO GLOBAL ECONOMIC STABILITY High oil prices Global financial instability

Including increase in interest rates Or risk premia

US economic downturn Enormous transfer of wealth Dampening effect on growth Little leeway

HIGH OIL PRICES

Enormous wealth transfer to oil producing countries To parts of world marked by high political

instability and Dampening global growth

Result of imbalance of supply and demand Demand increase largely anticipated Major “disturbance” to global market result of Iraq

invasion Middle East remains low cost producer

Instability means that investments in Middle East are not forthcoming

But long term investments in supply alternatives are also not forthcoming

AN ALTERNATIVE GLOBAL STRATEGY IS NEEDED

More conservation Bio-fuels

Brazil has shown viability Would have enormous geo-political and

environmental benefits Europe needs to pressure U.S. to join Kyoto

protocol If necessary using trade sanctions

Low energy price constitutes an unfair trade subsidy

GLOBAL FINANCIAL INSTABILITY Underlying force – huge U.S. trade and fiscal deficits The U.S. borrows close to $3 billion a day from rest of world

Twin deficit – huge U.S. fiscal deficit Structural problem compounded by low household savings –

negative! Result of tax cut well beyond country’s ability to afford

And unbridled spending – including corporate welfare No evidence of fiscal restraint Overall cost of Iraq war now estimated in excess of $1 trillion Abandoned rules that had been used to maintain discipline

Deficits crowd out investments needed for competitiveness

Problems have become so deep they will be hard to reverse

THE ROLE OF CHINA Is China playing unfairly with an

undervalued exchange rate? The exchange rate is undervalued But the U.S. trade imbalance is more than 15 times

greater Appreciation of the yuan will not significantly affect

global imbalances It will simply change the countries with which

the U.S. has trade imbalances (import textiles from Bangladesh rather than China)

And these other countries would likely be less willing to lend to U.S. than China has been

Thus the risk is that global instability increases further

PROSPECTS FOR FINANCIAL MARKETS

Of instability continuing/increasing Particularly difficult for Europe – the

weakening dollar and strong euro will make exporting difficult Problem could get worse if ECB increases

interest rates in response to inflationary pressures

REFORMS NEEDED

ECB should focus more on growth and unemployment U.S. Fed’s mandate focuses on growth,

employment, and inflation Reform to global reserve system

The dollar has been the basis of the reserve system

But confidence in the dollar is eroding, so that it is no longer a good store of value

The system is fraying Alternative – Bancor or Global Greenbacks

U.S. ECONOMIC DOWNTURN Emerging markets have increasingly

become drivers of global growth But the U.S. is still the largest global

economy So a U.S. slowdown would have global

consequences Standard projections are that growth will

continue at just under the current rate But there are serious reasons for concern

WORRYING ABOUT THE U.S. ECONOMY The U.S. is heavily energy dependent

An increase in oil prices would have serious consequences

Weakening of the dollar and high oil prices would have inflationary consequences Fed, to show resolve, would continue to raise

interest rates Thus slowing the economy Lack of confidence in the dollar would induce

investors to pull money out of the U.S., including bond markets, driving up long run interest rates

Misconceived actions by politicians might make matters worse – discouraging China’s holding of bonds

RISING INTEREST RATES Rising interest rates could be a major problem

for U.S. For past 5 years, growth based on real estate

Withdrawal of equity from housing amounted to 7.5% of consumption

Even if real estate prices and interest rates stabilized, would have been hard to sustain consumption growth

Slowdown in real estate price increase will slow down consumption

Large number of American households with high level of indebtedness Median debtor household already spending close to 20%

of income servicing debt; significant increases in interest rate would impose severe strains, force cutbacks in consumption

Compounding effects of oil price increases Especially significant among lower income families (more

than a quarter with debt in excess of 40% of income) Beginning to be evident in slowdown in sales in Walmart

Investment in real estate will also slowdown

COMPENSATING FOR DROP IN DOMESTIC CONSUMPTION What will take up this slack and can do

so in a timely way? Government expenditures?

With huge deficit, there’s little scope Increases in other forms of investment?

Unlikely, if consumption is slowing down Exports?

But significant increase will require large depreciation

Significant disturbance to global economy

A NEW GEOPOLITICS? With globalization, geography is less

important than it previously was With the end of the cold war, the benefits

and costs of alliances changed dramatically Though Cold War patterns still predominate As does Cold War thinking, especially in U.S.

Who is the enemy against which the U.S. spends huge sums in defense, more than rest of the world combined?

Little of that money is fighting the war on terrorism

And who is the “enemy” in the war on terrorism?

IMPACT OF THE IRAQ WAR

With Iraq war, U.S. unilateralism The U.S. seems to show lack of commitment to

democratic approaches to solving global problems

But Iraq has shown the limits of military power The U.S. cannot establish stability in a

country a tenth of its population and one percent of its GDP

Emphasizes importance of “soft power” In much of world, the U.S. no longer perceived

as a model for democracy, human rights

THE U.S. TRADE AGENDA

In trade, the U.S. has pursued bilateral trade strategies, highly damaging to multilateral system (based on non-discrimination, most favored nation principle) Advanced industrial countries have

reneged on promises made in Doha for a Development Round

THE WORLD IN FLUX Latin America rethinking patterns of trade,

alliances Recent elections have shifted Latin American

political power farther left than in recent years New “Berlin” Wall between Mexico and U.S. of

enormous symbolic significance Asia source of global growth, new found

confidence, becoming increasingly focus of global attention American MBAs are beginning to spend summers in

India and China in order to gain valuable experience

Henry Paulson Jr., recently appointed U.S. Treasury Secretary: intimate knowledge of the Chinese economy viewed as major source of strength

New challenge for Europe: Finding its place in this world in flux Lowering unemployment, sustaining growth,

maintaining living standards—and not just for those at the top

Will require more flexible macro-economic policies Reforms in its “innovation” system New trade policies New global strategic vision

Making use of “soft power”—far more important that military power

Within Europe, there are some real successes Ireland, Nordic Countries Nordic countries have been so successful,

not only in growth, but in broader measures of success

Readjusted their “welfare state” model to new realities But still retained model—including high taxes

Required to finance investments in education and research, fund safety net

With better safety net, there can be more risk taking, entrepreneurship

Success in modern technology based economies requires risk taking

Lessons from these successes: Pragmatism and balance Success requires “balance” For countries—a balanced role of government and

the market Market is at the center of the economy But in every successful economy the government has

played a large role In science and technology (internet) In making markets work (sound banking and securities market

regulation In protecting the environment In maintaining social cohesion (income distribution, safety

nets)

Europe’s success is important not just for Europe But for the world as a whole The world needs a new balance of power

America’s Constitution based on checks and balances

But in the area of foreign policy, it was assumed that the checks and balances would be provided by those abroad

But this is no longer the case Europe can and must succeed