Prospects for the World Economy after September 11th

Joseph E. StiglitzAndorra

June 6th, 2002

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Views before September 11, Enron, Argentina:

Globalization• increased openness to trade and capital flows• provided the best promise for growth

Free markets• American style• provided the best economic system

The New Economy brought unprecedented prosperity

End of the Business Cycle

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The Bursting of the Bubble (I)The Bursting of the Bubble (I)

American recession and global slowdown:• Business cycle had not been repealed

Bursting of Tech Bubble• The New Economy had been partly hype

Enron Scandal• America had preached good “accounting” but practice deficient• Corporate Governance was a problem everywhere• Political interference in setting standards, bail-outs (LTCM)• Without good information, resources misallocated

California Electricity Scandal• Deregulation again failed• Markets had been manipulated

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The Bursting of the Bubble (II)The Bursting of the Bubble (II)

September 11• Globalization had facilitated not only the flow of goods and services across borders• US policy on secret offshore banking centers had facilitated financing terrorists

Argentina• Failure of sixth major bail-out• IMF hadn’t learned the lessons of East Asia—contractionary policies worsen

economic downturns• Privatization had contributed to crisis• Fixed exchange rate system had contributed to crisis• Throughout the region, countries are asking

Why does U.S. advocate expansionary fiscal policy when it has recession, but contractionary fiscal policies in developing countries?

Has globalization failed us? Has reform failed?

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The Bursting of the Bubble (III)The Bursting of the Bubble (III)

More general dissatisfaction with globalization• IMF failed to fulfill its mandates• Trade Agenda imbalanced • Rules of the game set by North for North –or for special interests in the North

Problems are exacerbating American Unilateralism Incongruity between America’s free trade—free market rhetoric and practice

• Steel tariffs• New farm bill• Airline bail-out

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Global EconomyGlobal Economy

US continues to play key role

Europe, Japan, and Emerging Markets not playing role of “engine of growth”

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Whence the US Economy? (I)Whence the US Economy? (I)

The wrong question is being asked:

– Not whether the recession is over

– But when will robust growth resume

– Enormous shortfall between economy potential and actual

– Loss of $300 to $500 billion annually

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Whence the US Economy? (II)Whence the US Economy? (II)

– Recession was combination of inventory and investment cycle

– Inventory cycle over

– Not so for investment cycle

– Good news: Force of obsolescence

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Forces Limiting Recovery (I)Forces Limiting Recovery (I)

Consumption

– Given limited decline, hard to get large increase.

– Temporary forces leading it to be sustained Lowering of interest rates led to refinancing

mortgages Special auto deals

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Forces Limiting Recovery (II)Forces Limiting Recovery (II)

– Longer term forces suggesting even more limited growth

Savings rate already very low Had been sustained by high capital gains Those capital gains not likely to be sustained Huge debt overhang

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Forces Limiting Recovery (III)Forces Limiting Recovery (III)

Investment

– Irrational exuberance lead to irrational investment

– Overhang will not be eliminated quickly

– Confidence further eroded by valuation uncertainty

– Higher long term interest rates

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Forces Limiting Recovery (IV)Forces Limiting Recovery (IV)

 Exports

– Limited growth, given worldwide slowdown

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Forces Limiting Recovery (V)Forces Limiting Recovery (V)

Public Sector

– Military expenditures are one source of short term expansion

– But these expenditures do not lead to increased strength of US economy

– Tax cut not designed either to be short term stimulus or enhance long term growth, for example by encouraging investment in new economy Benefits upper income and old economy firms

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Forces Limiting Recovery (VI)Forces Limiting Recovery (VI)

– Marked change in fiscal position helps account for why long term interest rates have not fallen in tandem with short

– Worsened by uncertainty

– Underinvestment in productivity enhancing activities

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Lessons (I)Lessons (I)

Important to understand source of downturn and to learn lessons

East Asia: Excessively rapid financial and capital market liberalization

1991 US Recession: Financial sector deregulation

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Lessons (II)Lessons (II)

This Recession – Deregulation in telecom and financial sector

– Conflicts of interest

– Inadequate information systems

– Bubble of the standard kind

– East Asia crisis helped US Lower commodity prices U.S. seen as safe haven for capital Lower interest rates

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Lessons (III)Lessons (III)

Major fundamentals of US economy strong

But there are problems – Low savings rate– Huge trade deficit– Long term social security and medicare problem– Huge energy dependence, with no commitment to conservation– Huge inequality

 Would be foolhardy to ignore problems

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Challenges facing EuropeChallenges facing Europe

Maintaining full employment• Cannot rely on US recovery to restore its own economy• How to restructure institutions created to avoid inflation to deal with problems of

downturns

Restructuring economies• Getting right balance –role of government• “Flexibility” with “security” –security can promote growth• Importance of competition

Making globalization work• How to counteract American Unilateralism• How should it deal with the US: role of global consensus building versus hard

bargaining• How can it present a united front to counterbalance US while respecting diversity of

views and interests.

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Guarded Optimism (I)Guarded Optimism (I)

New Economy may have been overblown, but it was real

– But downturn is slowing down investment in new technology

 A new balanced perspective on the role of government

– Unregulated markets by themselves will not work

– There is a role for government, e.g., in air safety

– And in regulating financial markets, setting accounting standards

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Guarded Optimism (II)Guarded Optimism (II)

New approach to globalization

– Recognition that we had lost balance

Drugs and patents IMF and capital market liberalization

– Worry that WTO may limit ability of us to revise accounting standards

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Guarded Optimism (III)Guarded Optimism (III)

– Rethinking off shore bank secrecy

– Doha and the development round

– New emphasis of poverty and social justice

– Increasing recognition that unilateralism will not work

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AspirationAspiration

Global system which works, and not only for the few in the more advanced countries, but for everyone in all of the countries.