GLOBALIZATION AND THE GLOBAL ECONOMY: PERSPECTIVES AND PROSPECTS FOR THE SHORT RUN AND LONG RUN

1. GLOBALIZATION AND THE GLOBAL ECONOMY:PERSPECTIVES AND PROSPECTS FOR THE SHORT RUN AND LONG RUN JOSEPH E. STIGLITZ VALENCIA JUNE 2006

2. MAJOR CHANGES IN THE GLOBAL ECONOMY • GLOBALIZATION • THE EMERGENCE OF THE EMERGING MARKETS • RISING OIL (ENERGY) PRICES • INCREASING GLOBAL FINANCIAL INSTABILITY • A NEW GEOPOLITICS?

3. 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.?

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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?

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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)

30. 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