Brazil, China, Commodities, Corporate Finance, Economics, Emerging Markets, global economy, IMF, International Trade, Latin America, Long term finance, Uncategorized, World Bank

Articles of January-June 2017

 

Global Economy and Finance

 

  1. Matchmaking Finance and Infrastructure Capital Finance International, summer 2017 (w/ Aleksandra Liaplina)

The world economy – and emerging market and developing economies in particular – display a gap between their infrastructure needs and the available finance. On the one hand, infrastructure investment has fallen far short from of what would be required to support potential growth. On the other, abundant financial resources in world markets have been facing very low and decreasing interest rates, whereas opportunities of higher return from potential infrastructure assets are missed. We approach here how a better match between private sector finance and infrastructure can be obtained if properly structured projects are developed, with risks and returns distributed in accordance with different incentives of stakeholders.

(.pdf version here from OCPPC)

 

  1. Bloated central bank balance sheetsCapital Finance International, spring 2017 (w/ Matheus Cavallari)

Central banks of large advanced and many emerging market economies have recently gone through a period of extraordinary expansion of balance sheets and are all now possibly facing a transition to less abnormal times. However, the fact that one group is comprised by global reserve issuers and the other by bystanders receiving impacts of the former’s policies carries substantively different implications. Furthermore, using Brazil and the U.S. as examples, we also illustrate how the relationships between central bank and public sector balance sheets have acquired higher levels of complexity, risks and opacity.

(.pdf version here from OCPPC)

 

  1. Global Imbalances on the Rise Capital Finance International, winter 2017

Signs of a possible resurgence of rising global current-account imbalances have returned attention to the issue. We argue here that, while not a threat to global financial stability, the resurgence of these imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment, i.e. a post-crisis global economic recovery below its potential. In addition, we approach how the re-orientation of the US economic policy already announced by president Trump suggests risks of new bouts of tension around global current account imbalances.

 

  1. NAFTA at the Crossroads Huffington Post, May 19 (w/ Michael McKeon and Samuel George)

The U.S. Senate voted to confirm Robert Lighthizer as United States Trade Representative last week, rounding out President Donald Trump’s cabinet and giving momentum to his trade agenda. At his swearing-in ceremony on May 15, Ambassador Lighthizer predicted that President Trump would permanently reverse “the dangerous trajectory of American trade,” and in turn make “U.S. farmers, ranchers and workers richer and the country safer.” This policy shift will begin in earnest in the coming weeks, when Lighthizer meets with congressional trade leaders to discuss the administration’s plan to renegotiate the North American Free Trade Agreement (NAFTA).

 

Brazil

 

  1. Does Brazil’s Sector Structure Explain Its Productivity Anemia? Huffington Post, June 20 (w/ Fernanda De Negri)

Brazil’s labor and total-factor productivity (TFP) have featured anemic increases in the last decades. As we illustrate here, contrary to common view, sector structures of the Brazilian GDP and employment cannot be singled out as major determinants of productivity performance. Horizontal, cross-sector factors hampering productivity increases seem to carry more weight.

 

  1. Long-term finance and BNDES tapering in Brazil Huffington Post, June 6 (w/ Matheus Cavallari)

One major policy issue in Brazil is how to boost productivity, while following a path of fiscal consolidation that will take at least a decade to bring the public-debt-to-GDP ratio back to 2000 levels. The productivity-boosting agenda includes not only the implementation of a full range of structural reforms, but also recovering and upgrading the national infrastructure and other long-term investments. Given that fiscal consolidation has already been leading to less transfer of funds—in fact, the reversal—from the Treasury to the National Economic and Social Development Bank (BNDES) and a consequent downsizing of the latter’s operations, pursuing the double objective of raising productivity and adjusting fiscal accounts will require an expansion of alternative sources of long-term asset finance.

 

  1. Brazil’s Pension Reform Proposal is Necessary and Socially Balanced Huffington Post, April 17

Last week the World Bank released a Staff Note analyzing the pension reform proposal sent last December by Brazil’s Federal Government to Congress. It concludes that:

“… the proposed pension reform in Brazil is necessary, urgent if Brazil is to meet its spending rule, and socially balanced in that the proposal mostly eliminates subsidies received under the current rules by formal sector workers and civil servants who belong to the top 60 percent of households by income distribution.”

With the help of some charts extracted from the note, we summarize here some of the reasons for such a statement.

 

  1. The Brazilian debt hangoverHuffington Post, January 22

With the help of five charts, we approach the Brazilian credit cycle, the downward phase of which helps understand why the post-crisis recovery has been so hard to obtain. In our view, the profile of such a credit cycle in effect points to it as a special chapter of our previously approached determinants of the Brazilian economic crisis.

 

  1. The Brazilian productivity anemiaColumbia Global Centers – Rio de Janeiro

Brazil has been suffering from “anemic productivity growth”. This is a major challenge because in the long run, sustained productivity increases are necessary to underpin inclusive economic growth. Without them, increases in real labor earnings tend to conflict with global competitiveness; collecting taxes in order to fund government expenditures on infrastructure and social policies becomes a heavy burden; returns to private investment becomes harder to achieve; and ultimately citizens will have less access to high-quality goods and services at affordable prices. The focus on urgent fiscal reforms adopted by the new government– public spending cap, social security reform – must be accompanied by action on the productivity front.

 

Emerging Markets

 

  1. Beyond the Ballot: Turkey’s Economy at the Crossroads Huffington Post, March 26 (w/ Sam George)

In the current environment, Erdogan is no longer striving to prove Turkey is ready for the EU and many believe that this course has rendered Turkish accession extremely unlikely, at least in the near term. From a purely economic standpoint, a political falling out would be a shame. The European Union is the most important trading partner for Turkey, and 40 percent of Turkey’s exports are destined for European countries. Turkey has increasingly become a part of European production chains for manufacturing as well. If political ties are not deepened, these economic links may not reach their full potential.

In the meantime Turkey’s economy continues to grow, and the country maintains its momentum. But as Turks prepare to take to the polls to address a political crossroads, they must not lose track of the economic crossroads bearing down on them from beyond the bend.

 

  1. Colombia: getting growth, getting peaceHuffington Post, March 3 (w/ Diana Quintero)

The Santos administration has delivered on two of its main promises: sign a peace agreement with the FARC guerrilla and get approved a significant structural tax reform. We approach here why both are expected to become strong pillars to help keep the growth-cum-poverty-reduction momentum of the last decades.

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Brazil, China, Commodities, Corporate Finance, Economics, Emerging Markets, Emerging markets, global economy, International Trade, Latin America, Long term finance, Uncategorized

Global Imbalances on the Rise

Capital Finance International, winter 2016-2017 

Discussions around large current account imbalances among systemically relevant economies as a direct threat to the stability of the global economy vanished in the aftermath of the global financial crisis. As the crisis originated in the U.S. financial system – followed by a second dip in the Eurozone – and global imbalances diminished in following years the issue has faded into the background.

More recently, some signs of a possible resurgence of rising imbalances have returned attention to the issue. We argue here that, while not a threat to global financial stability, the resurgence of these imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment, i.e. a post-crisis global economic recovery below its potential. In addition, we approach how the re-orientation of the U.S. economic policy already announced by president-elect Trump suggests risks of new bouts of tension around global current account imbalances.

Are global imbalances rising again?

For five years now, the International Monetary Fund (IMF) has produced an annual report on the evolution of global external imbalances – current account surpluses and deficits – and the external positions – stocks of foreign assets minus liabilities – of 29 systemically significant economies. Results for 2015 have pointed out a moderate increase of global imbalances, after they had narrowed in the aftermath of the global financial crisis (GFC) and stabilized later (IMF, 2016a) – see Chart 1.

The evolution of imbalances in 2015 depicted in Chart 1 as explained by the IMF is reflective of three major drivers:

First, the recovery among advanced economies proceeded in an asymmetric fashion. Stronger recoveries in the U.S. and the U.K. relative to the euro area and Japan led to divergence in expected paths for monetary policies and appreciation of the dollar and sterling (pre-Brexit). The deficits of the U.S. and U.K. widened, together with increased surpluses in Japan and both debtor and creditor countries of the euro area (Chart 2).

Second, the fall of commodity prices – especially oil – transferred income from commodity exporters to importers. Overall however, it made only a moderate contribution to the narrowing of imbalances.

Third, prospects of monetary policy normalization in the U.S., as well as bouts of fears about the softness of China’s rebalancing, contributed to a slowdown of capital inflows and depreciation pressures in emerging markets (Canuto, 2016a).

All in all, larger U.S. deficits and augmented surpluses in Japan, the Euro area and China more than compensated for smaller surpluses in oil exporters and smaller deficits in deficit emerging markets and Euro area debtor countries. Hence, global current account imbalances widened last year, even if “moderately”.

However, a picture of higher global imbalances emerges if one focuses on the rising surpluses of two systemically relevant groups of economies. Chart 2 exhibits how in the euro area deficits in debtor countries have shrunk in tandem with the maintenance of surpluses in creditor countries (slightly increasing in the case of Germany). While the net foreign asset position (liabilities) of debtors has not diminished as much, their current account adjustment has added to the soaring surpluses the euro area as a whole runs with the rest of the world. Setser (2016) in turn has called attention to how the six major East Asian surplus economies – China, Japan, South Korea, Taiwan (China), Hong Kong (China), and Singapore – have reverted their post-GFC decline of surpluses and are currently topping even the euro area (Chart 3).

Such double trajectory of rising surpluses gives credence to those who have expressed concerns about a revival of rising current account imbalances as a source of risks to the global economy. While Eichengreen (2014) had declared “the era of global imbalances” to be over, more recently others believe they are “back” and claim that “rising global imbalances should be ringing alarm bells” (HSBC, according to Verma and Kawa (2016). To address this issue, however, it is worth first reviewing how the profile of current imbalances differs from the one prior to the GFC.

Global imbalances have evolved

The “era of global imbalances” up to the GFC (Chart 1) had two distinctive-yet-combined processes at its core:

On the one hand, credit-driven, asset bubble-led growth in the U.S., along with wealth effects, intensified the existing trend of domestic absorption (particularly consumption) growing faster than GDP. This resulted in falling personal saving rates and increasing current account deficits (Chart 4) (Canuto, 2009; 2010).

On the other hand, the accelerated structural transformation and rapid growth in China, led to high and rising savings and investments and producing ever larger current account surpluses (Chart 5) (Canuto, 2013a).

Two caveats about these distinctive-yet-combined processes are needed. First, the bilateral U.S. deficit with China in the period decreases by a third when measured in terms of value added,  as China became a “hub or a stroke” of value chains with intermediate stages supplied from abroad  (Canuto, 2013b). The U.S.-China bilateral imbalance therefore constituted outlets for production beyond China.

Second, while often linked as mirror images of each other – as in the hypothesis of an Asian “savings glut” causing low interest rates and asset price hikes in the U.S. (Bernanke, 2005) – the U.S. asset bubbles were more strongly associated to the “excess elasticity of the international monetary and financial system”, rather than to Asian current account surpluses (Borio and Disyatat,2011) (Borio, James, and Chin, 2014). Global current account imbalances cannot be blamed for the U.S.-originated GFC. As stressed by Eichengreen (2014):

“…the flows that mattered were not the net flows of capital from the rest of the world that financed America’s current-account deficit. Rather, they were the gross flows of finance from the US to Europe that allowed European banks to leverage their balance sheets, and the large, matching flows of money from European banks into toxic US subprime-linked securities.”

Asset bubbles in the U.S. to a large extent were blown by European banks through their balance sheets, by channeling U.S. money market funds into toxic assets. From the U.S.-Europe balance of payments standpoint, short-term outflows from the latter to the former were netted out by simultaneous long-term flows in the opposite direction. Close-to-zero net capital flows hid a lot of financial intermediation and asset-bubble blowing via banks’ balance sheets.

A parallel to that China-U.S. relationship can be traced within the euro area, including its later experience with a second dip of the GFC. The entry of the euro as a common currency was followed by a risk premium convergence toward German levels and to cross-border banking flows at extremely easy conditions. Consequent asset bubbles originated wealth effects and excess domestic absorption – besides inflated financial intermediation – in southern Europe and Ireland, leading to the subsequent debt crisis. The pattern of intra-euro area current account imbalances exhibited in Chart 2 was primarily a consequence of the euphoria taking place under conditions of “excess elasticity” of the euro area’s financial system.

The commodity super-cycle also helped shape global imbalances in this period seen in Chart 1. However, it was to a large extent a consequence of extraordinary global growth prior to the crisis, one in which commodity-intensive emerging market economies maintained growth trends above those of advanced economies (Canuto, 2010).

While such a pattern of global imbalances was unfolding prior to the GFC, much discussion took place about its potential to spark a crisis on its own when faced with a sudden stop. China’s current account surpluses were boosted by depreciated levels of the exchange rate sustained mainly by a piling up of foreign reserves. The same evolution was interpreted by some as an expression of a savings glut unmatched by enough domestic availability of safe-and-liquid assets like U.S. Treasuries.

Regardless of the emphasis of causality one might establish between export-led strategies and saving-glut-cum-safe-asset-scarcity, analysts were split into two camps, as described by Eichengreen (2014). Some analysts feared a possible crisis of confidence in the dollar bringing capital flows to a sudden halt, while others saw imbalances as an exchange of cheap Asian goods for safe and liquid U.S. assets. In the latter case, imbalances might gradually unwind as export-led strategies reached exhaustion and/or the desire for asset accumulation approached satiation.

In any case, the GFC happened before that dispute was settled and global imbalances started to unwind in its aftermath. U.S. personal saving rates began to climb, borrowers reduced leverage, the dollar devalued and the U.S. current account deficit shrank from almost 6% of GDP in 2006 to much lower levels from 2009 onwards. At the same time, as shown in Chart 5, China initiated its rebalancing from an exports and investment-led growth model towards higher domestic consumption and services, including an appreciation of the RMB and lower growth rate targets. This has not meant a straightforward change of trajectory, as caution against a post-GFC hard landing favored continued high investment in domestic housing and infrastructure as a component of the transition (Canuto, 2013a).

As we have already seen, deficits also diminished in the euro area in the aftermath of its debt crisis. The decline in commodity prices also helped global imbalances to shrink.

So, global imbalances did not spark a crisis and have returned in different configuration. Since current account balances are neither expected nor desired to be zero, how to make an assessment of whether the recent “moderate” uptick detected by the IMF might be a bad omen? Do those who have voiced concern over rising surpluses in East Asia and the euro area have a point? To answer these questions, it will be useful to look at the IMF exercise of judgement on whether global imbalances have been “in excess”, i.e. inconsistent with “fundamentals and desirable policies” (IMF, 2016a, Box 1).

How misaligned with fundamentals have current account imbalances been?

National economies are not expected to exhibit zero current-account balances and stocks of net foreign assets. At any period of time, domestic absorption – consumption and investment – can be larger or smaller than the local GDP, triggering inflows or outflows of capital, due to “fundamental” factors:

  • Differences in intertemporal preferences and age structures of their populations mean different ratios of domestic consumption to GDP;
  • Differences in opportunities for investment also tend to lead to capital flows;
  • Differences in institutional development levels, reserve currency statuses and other idiosyncratic features also generate capital flows and imbalances;
  • Cyclical factors – including fluctuations in commodity prices – may also cause transitory increases and declines in balances; and
  • Countries’ outstanding stocks of net foreign assets also have a counterpart in terms of service payments in their current accounts.

When global imbalances – and corresponding real effective exchange rates (REERs) – reflect such fundamentals, economies are in a better place than they would be in autarky (isolated with zero balances). There are situations, however, in which such imbalances may be gauged as in excess and countries should reduce them – as approached in Blanchard and Milesi-Ferretti (2010; 2011).

There is the straightforward case of imbalances being magnified by domestic distortions, the removal of which would directly benefit the economy. For instance, this is the case when deficits are higher because of lax financial regulation fueling unsustainable credit booms or excessively loose fiscal policies. It is also the case of surpluses that reflect extremely high private savings due to lack of social insurance or investments being curbed because of a lack of efficient financial intermediation. It is worth noticing that, while excessive deficits eventually face a shortage of external finance, surpluses suffer less automatic pressures to dissipate and can therefore persist for longer.

Furthermore, as pointed out by Blanchard and Milesi-Ferretti, there are also situations in which the multilateral interdependence of economies calls for restricting current-account deficits or surpluses. Unsustainable deficits of large, financially integrated economies are such a case, as a crisis associated to them may trigger cross-border effects.

Blanchard and Milesi-Ferretti additionally point out two conceivable situations in which surpluses can be deemed as in excess:

  • When current-account surpluses are the result of deliberate strategies of curbing domestic demand and deliberate exchange rate undervaluation, crowding out foreign competitors. On the other hand, given the simultaneous determination of savings and current account balances, it is always hard to disentangle such a strategy from other determinants of the current-account balance.
  • When an increase of one economy’s surplus takes place while others face difficulties to absorb it without suffering adverse, durable effects on their demand and output. This is the case when part of the world is caught in a “liquidity trap”, unable to resort to lowering domestic interest rates as an adjustment policy, or face obstacles to use countervailing fiscal policies.

The IMF “External Sector Report” aims to gauge to what extent current account balances and corresponding REERs are out of line with “fundamentals and desirable policies”, as well as whether stocks of net foreign assets are evolving within sustainable boundaries. What did the latest issue show?

Chart 6 displays its assessment of how intensively individual economies have exhibited current accounts – and REERs – that are out of line with their “fundamentals”, i.e. those features that would normally lead them to feature current account imbalances within certain estimated country-specific ranges. Stronger (weaker) corresponds to REER “undervaluation” (“overvaluation”). Stronger (weaker) also means that a current account balance is actually larger (smaller) than that “consistent with fundamentals and desirable policies” (IMF, 2016a, Box 1).

The report notices that the evolution toward less excess imbalances after the GFC has stopped and recent movements have given cause for concern (IMF, 2016a, p. 23):

First, those economies with external positions considered “substantially stronger” (Germany, Korea, Singapore) or “stronger” (Malaysia, Netherlands) have remained as such for the last 4 years. Also noticeable has been the shift toward stronger positions in the cases of Thailand and Japan.

Second, at the bottom of the distribution, while some countries reduced – or suppressed – degrees of “weakness” (Russia, Brazil, Indonesia, South Africa, and France), others remained (Spain, Turkey, United Kingdom) – with the addition of Saudi Arabia to this group after the oil price decline.

Third, on-going trends of current account imbalances are bound to lead to a further widening of some external stock imbalances accumulated since the GFC. While China’s external stock position is expected to stabilize, other large economies are projected to exacerbate their debtor (U.S., UK) and creditor (Japan, Germany, Netherlands) positions. Furthermore, the net foreign asset position of some euro-crisis countries remain highly negative despite years of flow adjustment with high unemployment and low growth.

In our view, although not giving ground to fears of a collapse in major financial flows, global imbalances have not gone away as an issue, as they reveal that the global economic recovery may have been sub-par because of asymmetric excess surpluses in some countries and output below potential in many others. The end of the “era of global imbalances” may have been called too early. Lord Keynes’ argument about the asymmetry of adjustments between deficit and surplus economies remains stronger than ever.

The IMF report has a point in calling for a “recalibration” of macroeconomic policies from demand-diverting to demand-supportive measures. This would be particularly the case for countries – or the Eurozone as a whole – currently able to resort to expansionary fiscal policies that have instead relied mainly on unconventional monetary policy – which has become increasingly ineffective at the margin. On the other hand, one must acknowledge that there are limits to which national fiscal policies can deliver cross-border demand-pull effects. Huge savings flows – like German or U.S. corporate profits – may also not be easy to redeploy.

Hence specific priority should be given to country-specific structural reforms addressing obstacles to growth and rebalancing. Which could be aided by cross-border dislocation of pools of savings currently parked in low-return assets. Paradoxically, global imbalances demand more globalization in a moment when the latter faces hurdles (Canuto, 2016b).

Implications of U.S. future trade and macroeconomic policies for global imbalances

Given the weight of the U.S. economy, global imbalances may undergo new shocks in the coming years as a result of the policy reorientation already announced by president-elect Donald Trump. Although at a preliminary stage, it is possible to devise two possible scenarios, the choice of which will depend on the options assumed by trade policies accompanying the macroeconomic reorientation.

President-elect Trump and his team have announced a macroeconomic platform with a likely strong potential impact: a major fiscal boost via infrastructure spending, corporate tax cuts, and a (financial and environmental) deregulation agenda (Canuto & Cavallari, 2016). Such platform underlies the announced goal of raising the U.S. economic growth to 4% a year, well above the potential 2% estimated by the IMF (IMF, 2016b).

Important details are yet to be filled out. For example, how much of the US$ 1 trillion of infrastructure investment pledged will be borne by the public sector or by public-private partnerships, and therefore how much of it will contribute to public sector deficits and debt. As suggested by different experiences around the world, including the United States, sudden increases in public investment are not easily implemented. The increase in investments in infrastructure will take some time to implement and there will be a lag in their effects, on both the demand and supply side.

Similarly, given that U.S. corporations currently display already high liquidity reserve buffers and low levels of acquisition of new fixed assets, the results of corporate tax reduction on their expenditures will depend significantly on the terms of conditions of local investment that may be attached. Such type of conditionality has already been alluded to in the case of profit repatriation.

There are also doubts as to the extent of the impacts of deregulation. In the case of finance, given the favorable climate in Congress and beyond to reforming the Dodd-Frank regulation, one can expect a relief from the regulatory burden that has been inhibiting bank credit in recent years. Environmental deregulation may also facilitate investment in the energy sector, particularly on shale oil and gas.

Assuming that, in fact, aggregate demand is stimulated, there remain doubts as to the current capacity of the response of domestic supply. After all, low rates of involuntary unemployment and upbeat levels of economic activity at the end of the Obama administration will be part of the latter’s legacy. In the event of binding supply limits, the macroeconomic effect will be largely directed to higher inflation and import growth. The frenetic appreciation of the dollar in the weeks following the initial announcements of Mr. Trump’s program reinforces the possibility of greater demand leaks via foreign purchases of goods and services.

In any case, a drastic change in the current regime of fiscal and monetary policies is likely to occur. The normalization of monetary policy by the Federal Reserve toward higher interest rates and smaller balance sheets tends to accelerate, while fiscal policy will definitely leave the consolidation path forced by Congress to the Obama administration in recent years. In effect, the U.S. is one of those cases in which the IMF – and others (Canuto, 2014) – have long advised a shift from monetary easing to expansionary fiscal policies. The appetite in the markets for Treasury bonds has been far from satiated and larger public deficits would be easily absorbed, for which it would suffice to issue signs of future reforms toward some smoothing of the public debt path.

It is in trade policy and in dealing with current account imbalances that two scenarios emerge: a “soft” scenario is the one in which the Trump government limits its campaign promises to occasional “arm twists” with corporations, like moral suasion and tax concessions in exchange for local investments or import substitution within value chains. The “hard” scenario would be to establish extraordinary tariffs and other restrictions on imports – China and Mexico were frequent targets of such threats during the election campaign.

In the “soft” scenario, there will be a demand stimulus for the rest of the world, albeit at the cost of greater current US imbalances which would not likely face financing difficulties. The “hard” scenario, in turn, contains high risks of substantial price increases in the domestic basket of goods and services, as well as of having a negative impact on the profitability of U.S. corporations. In addition, if followed by “trade wars” with countries directly affected, a “lose-lose” result in the global economy – as in the 1930s – could materialize (Canuto, 2016b). After all, the US economy nowadays has levels of trade and financial integration with the rest of the world sufficient to generate significant feedback loops.

Bottom line

Current account imbalances in the global economy have returned to the spotlight, albeit with a different configuration from the one that marked the trajectory prior to the global financial crisis. Not as a particular threat to global financial stability, but mainly because they reveal asymmetries in adjustment and post-crisis recovery between surplus and deficit economies and, in the coming years, for the risk of sparking waves of trade protectionism.

Otaviano Canuto is an Executive Director at the World Bank (WB). All opinions expressed here are his own and do not represent those of the institution or of those governments he represents at the WB Board.

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Brazil, China, Commodities, Economics, Emerging Markets, Latin America, Uncategorized

Has the global trade-development link peaked?

Trade has been a key driver of global growth, income convergence, and poverty reduction. Both developing countries and emerging market economies have benefited from opportunities to transfer technology from abroad and to undergo domestic structural transformation via trade integration in the last decades. Yet, more recently, concerns have been raised over whether the current pace and direction of world trade lead towards a lesser development-boosting potential.

What happened to world trade? Is it cyclical or structural?

World trade suffered another disappointing year in 2015, experiencing a contraction in merchandise trade during the first half and only low growth during the second half. This follows a similar pattern since the onset of the global financial crisis (GFC), in which world trade volumes have lagged behind GDP growth (Figure 1).

Figure 1

World Real GDP and Trade Volume

(Annualized quarterly percentage change)

Has Trade-Dev Peaked-Fig 1.

Source: IMF, World Economic Outlook, October 2015.

 

Economists have indicated some circumstantial factors to explain this post-GFC pattern (Dadush, 2015) (Didier et, 2015, p.18). For instance, world GDP and trade figures would be reflecting the fact that the highly open-trade countries of the Eurozone have had a sub-par growth performance relative to the rest of the world. Furthermore, the  weak recovery of fixed investments in advanced economies – Canuto (2014a) – has suppressed an important source of trade volume, given the higher-than-average cross-border exchanges that characterize such goods.

More disputed hypotheses have also been argued. More stringent capital requirements and financial regulations might be curbing the availability of trade finance. Additionally, rising “murky” trade-restrictive tax-cum-subsidy policy measures adopted in some key sectors by some countries may also have become more significant than usually perceived (Global Trade Alert 18, 2015).

While those post-crisis factors have certainly played a role, some structural trends seem also to be at play. As suggested by Figure 2, after steadily increasing between the mid-1980s and the mid-2000s, the trade elasticity to GDP has lost steam (though it remains above one, thus implying that trade is still rising faster than GDP). After jumping in previous decades, the world’s exports-to-GDP ratio seems to have started to approach some plateau (or a “peak trade”). Since 2008, world trade has been rising slower than GDP at around 0.8:1, leading to a fall in the share of exports in global GDP. However, even if post-GFC factors were partially reversed, the presence of a long-term trajectory of trade elasticity displaying a slowdown already prior to the recent pattern would suggest no automatic return to the heyday.

Figure 2

Trade-income elasticity and Exports-GDP ratio – global economy

Has Trade-Dev Peaked-Fig 2.

Source: Escaith and Miroudot, ch. 7 in Hoekman (2015).

Notes: Merchandise exports only; world GDP and trade at constant 2005 prices; dollar figures for GDP are converted from domestic currencies using official exchange rates. Long-term elasticity is based on 10-year rolling period from 1960-1970 to 2005-2015 (2015 is based on forecasts).

Hoekman (2015) brings a thorough examination of both “cyclical” (post-GFC) and “structural” hypotheses about the global trade slowdown. Regardless of the weight attributed to these factors in explaining recent developments, three processes stand out as relevant for the purpose of analyzing what lies ahead in terms of the link between global trade and development. Two of them were “transitional” – in the sense that they were “one shot” – the unfolding of which occurred behind the extraordinary ascent of the global export-GDP ratio. The third one has evolved more gradually and will likely carry a significant transformative role ahead.

A major wave of vertical and spatial fragmentation of production has passed

The period from the mid-1980s to the mid-2000s was peculiar in several aspects. For one, these decades featured a process of economic reforms that aimed to remove barriers to trade, a multilateral trading system that reduced uncertainty for traders, and technological advances that reduced trade and communications costs. Combined, these trends ushered in years of sustained trade expansion. Average tariffs moved to well below ten percent, and in many countries a significant share of trade became duty-free. Advances in transport (such as containerized shipping) and information and communications technologies greatly reduced the cost of shipping goods and of managing complex production networks. Together these developments led to two major changes in the structure of global trade: (a) the vertical and spatial cross-border fragmentation of manufacturing into highly integrated “global production networks” or “global value chains” (GVCs); and (b) (to a lesser extent) the rise of services trade (Canuto, Dutz & Reis, ch. 3 in Canuto & Giugale, 2010) (Canuto, 2012).

The full establishment of cross-border GVCs intrinsically raises trade measured as gross flows of exports and imports relative to GDP, a value-added measure, because of “double counting” of the former – although the ratio of trade to GDP still increases even when trade is measured on a value-added basis (Canuto, 2013a). Given the then-prevailing technological state of arts in production processes, the policy and enabling-technology breakthroughs above mentioned sparked a powerful cycle of fragmentation, especially in manufacturing, with a corresponding cross-border spread of GVCs.

The re-shaping of the economic geography might have kept the pace with global trade impacts via further dislocation of fragments of GVCs, depending on the evolution of country locational attributes. Technological changes might also have altered optimal spatial configurations of the various manufacturing activities, as well as extended fragmentation to other sectors. This may well be the case ahead, as technologies and country policies keep evolving – some analysts point to a greater reliance on regional production networks, while others refer even to a potential reversal of GVCs because of 3D printing (“additive manufacturing”) (see references in the introduction of Hoekman (2015)).

However, the wave of cross-border manufacturing fragmentation of mid-1980s through the mid-2000s was particularly intense and time-concentrated (Canuto, 2015a). Figure 3 – from Constantinescu et al (2015) – shows that the ratio of foreign value added to domestic value added in world gross exports increased by 2.5 percentage points from 2005 to2012, after having risen by 8.4 percentage points from 1995 to 2005.

Figure 3

Ratio of Foreign Value Added to Domestic Value Added

in World Gross Exports (%)

Has Trade-Dev Peaked-Fig 3.

                                    Source: Constantinescu et al (2015)

 

A major wave of trade-cum-structural-transformation has passed – with China as a special case

The wave of fragmentation of manufacturing activity benefited from the incorporation of large swaths of lower-wage workers from Asia and Eastern Europe into the global market economy (Canuto, 2015a). Conversely, the former facilitated a process of growth-cum-structural-transformation with substantial total factor productivity increases in these countries via transfer of population from low-value, low-productivity activities to the production of modern tradable goods, for which foreign trade was instrumental – with China as a special case both in terms of speed and magnitude (Canuto, 2013b) ((Gautier et al, ch. 5 in Hockman (2015)).

The transitional nature of such a lift of world trade relative to world real GDP, even as the latter grew substantially, stemmed from the inevitable tendency of both starting to rise more in line once the intense transformation approached completion. Its extraordinary intensity also reflected a peculiar – and transitory – combination of ultra-high investments-to-GDP and trade-surplus-to-GDP ratios in China with large current-account deficits of the U.S. (Canuto, 2009).

More recently, China has initiated a rebalancing toward a new growth pattern, one in which domestic consumption is to rise relative to investments and exports, while a drive toward consolidating local insertion in GVCs to move up the ladder of value added is also to take place. That rebalancing has been pointed out as one of the factors behind the recent global trade slowdown, given China’s weight in the world economy and a recent trend of “import substitution” as illustrated in Figure 4.

Figure 4 

China’s Share of Imports of Parts and Components

in Exports of Merchandise

Has Trade-Dev Peaked-Fig 4.

                            Source: (Constantinescu et al, ch. 2 in Hoekman (2015)

Advanced countries are becoming services economies

While both the GVCs’ rise and growth-cum-structural-transformation – especially in China – were taking place, with corresponding impacts on the landscape of foreign trade, advanced – or mature market – economies maintained a steady evolution toward becoming services economies – a trend maintained after the GFC. Lower GDP shares of the value added in manufacturing have accompanied rising shares of employment in services (Figure 5).

Figure 5

Global manufacturing and employment in services

Has Trade-Dev Peaked-Fig 5.

                  Source: Institute of International Finance, “The rise of services – what it       means for the global economy”, December 15, 2015.

Both supply and demand factors explain such trends in advanced economies. On the supply side, beyond the higher pace of increases of productivity in manufacturing than in services (with correspondingly different rhythms of reduction in labor requisites), not only did the relative prices of manufactured goods fall, but a substantial part of local production was also off-shored as a result of GVCs and the incorporation of cheaper labor from areas previously out of the market economy world. On the demand side, one may point out both a higher income-elasticity of demand for services – reinforced by aging of the population – and to technology trends favoring “software” vis-à­-vis “hardware” – or “intangible” relative to “tangible” assets – as leading to an increasing weight of services in GDP and employment (IIF, 2015).

Those evolutionary features of supply and demand would also be valid for emerging market and developing countries – even if, as suggested in the upper half of Figure 5, they were partially mitigated in China and other Asia/Pacific countries by sucking manufacturing activities from other emerging market and developing economies. In any case, given the state of current technological trajectories, rising shares of services throughout would imply an anti-trade bias, given a still higher trade-propensity of manufacturing.

IIF (2015) goes as far as to argue that this has already brought consequences for the global business cycle, rendering it less influenced by swings in manufacturing output, with shock transmission from advanced economies increasingly taking place via trade of services among themselves and more weakly to manufacturing-dependent emerging market and developing economies. This would be one of the factors behind the abrupt decline of the world trade elasticity and of the recent decoupling of growth between recovering advanced and decelerating emerging economies.

Has the window of opportunity of developing via trade integration narrowed?

World trade may well live through a new era of rise relative to GDP (Hoekman’s introduction in Hoekman (2015)): on-going technological trajectories may deepen the fragmentation and increase the tradability of services; new vintage trade agreements – including possible TPP and TTIP (Canuto, 2015b) – are giving special attention to restrictions on trade of services. In fact, the content of services in current foreign trade transactions has already been higher than what gross trade figures display (Canuto, 2014b).

Another question is what lies ahead in terms of growth opportunities for non-advanced economies through foreign trade given the lines of evolution of the latter along the lines here described, one in which the factors that led to the “peak trade” seem to have exhausted. The nature and height of domestic policy challenges have changed substantially in a three-fold way:

First, China is in a league of its own and its rebalancing-cum-upgrading will condition other emerging market and developing economies. If it lets low-skill labor-intensive manufacturing activities go, a new wave of further GVC dislocations may open opportunities for countries currently endowed with cheap and abundant labor. On the other hand, its densification of local parts of GVCs will represent a competitive challenge to medium-range manufactures produced in other middle-income countries. The net result will also depend on the leakages outward of its domestic demand as it rebalances toward a more consumption- and service-oriented economy.

Second, the directions taken by technological trajectories and aggregate demand in advanced economies seem to point toward a broad alteration of the balance of locational advantages for production fragments, decreasing the weight of labor costs and augmenting the relevance of local availability of other complementary intangible assets. A “double whammy” on production and exports of non-advanced economies may take place: a partial reversal of off-shoring and a slower growth of outlets for their typical exports.

Third, the bar, in terms of what it takes to countervail that double whammy (improvements of the local business environment and transaction costs, quality of economic governance and other conditions favorable to accumulation of intangible assets) has been raised. Nonetheless, provided that such bar is reached, the local provision of – embodied or disembodied – services complementary to those produced or used in advanced economies may flourish. This will be the case, e.g. of natural resource-rich countries that manage to develop related intangible assets in terms of applied-science capabilities.

The run-up to “peak trade” was one of primarily exploring complementarities within GVCs to substitute for existing producers. The post-peak trade era may well be one of building complementarities.

* Written from my notes for a presentation at “The role of the US in the world economy”, OMFIF, Federal Reserve Bank of Atlanta, 12-13 November 2015.

Otaviano Canuto is the executive director at the Board of the International Monetary Fund (IMF) for Brazil, Cabo Verde, Dominican Republic, Ecuador, Guyana, Haiti, Nicaragua, Panama, Suriname, Timor Leste and Trinidad and Tobago. The views expressed here are his own and do not necessarily reflect those of the IMF or any of the governments he represents.

Dr. Canuto has previously served as vice president, executive director and senior adviser on BRICS economies at the World Bank, as well as vice president at the Inter-American Development Bank. He has also served at the Government of Brazil where he was state secretary for international affairs at the ministry of finance. He has also an extensive academic background, serving as professor of economics at the University of São Paulo and University of Campinas (UNICAMP) in Brazil.

 

 

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Brazil, Corporate Finance, Emerging Markets, Emerging markets, Latin America, Long term finance

Latin American Corporate Finance: Is There a Dark Corner?

 

Since last year there has been much talk of possible financial stress stemming from increased debt leverage in non-financial corporates of emerging markets economies. A recent study has brought to light some key evidence on the Latin American case (Bastos et al, 2015).

Read here:

http://www.huffingtonpost.com/otaviano-canuto/latin-american-corporate_b_6627016.html

or here:

http://www.economonitor.com/blog/2015/02/latin-american-corporate-finance-is-there-a-dark-corner/

Best regards

OC

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Uncategorized

My Articles in 2014 (with links)

Bear and bull dancing

Global Economy – Crisis Recovery and Secular stagnation Hypotheses

1. Macroeconomics and Stagnation – Keynesian-Schumpeterian Wars
Policy makers in the advanced economies at the core of the global financial crisis can make the claim that they prevented a new “Great Depression”. However, recovery since the outbreak of the crisis more than five years ago has been sluggish and feeble. Since these macroeconomic outcomes have to some extent been shaped by policy […]
May 6, 2014 | By Capital Finance International

2. Sluggish Postcrisis Growth: Policies, Secular Stagnation, and Outlook

(with Raj Nallari, and Breda Griffith)
Economic Premise n.139, April 2014.

3. Calibrating 2014
 Huffington Post – Posted January 2, 2014 | 12:35 PM
The global economy looks poised to display better growth performance in 2014. Leading indicators are pointing upward — or at least to stability — in major growth poles. However, for this to translate into reality policymakers will need to be nimble enough to calibrate responses to idiosyncratic challenges.

Emerging Markets

4. Liquidity Glut, Infrastructure Finance Drought and Development Banks
The world economy faces huge infrastructure financing needs that are not being matched on the supply side. Emerging market economies, in particular, have had to deal with international long-term private debt financing options that are less supportive of infrastructure finance. While unconventional monetary policies in advanced countries in the aftermath of the global financial crisis […]
September 19, 2014 | By Capital Finance International

5. Long-Term Finance in EMEs: Navigating between Risks and Policy Choices
(with Anderson Caputo Silva, and Catiana García-Kilroy)
Economic Premise n. 152, June 2014
(Also as: Forward – THE EUROMONEY – EMERGING MARKETS HANDBOOK 2015)

6. China and Emerging Markets: Riding Wild Horses
Huffington Post Posted February 3, 2014 | 8:08 PM
One month ago, I discussed some major risks to a slight upturn in the global economic scenario for 2014. Among those risks, concerns with the growth slowdown and challenges with shadow banking in China have already come to the fore as the Chinese Year of the Horse approached…
Read Post

7. Sovereign Wealth Funds Are Coming Home
Huffington Post Posted January 15, 2014 | 5:30 PM
Followers of this blog have read several recent pieces on the changing landscape of investment finance in developing countries, particularly in natural resource-rich countries. We have approached the rise of development banks partially filling the void left by the retrenchment of international banking. We have also highlighted how…
Read Post

8. Commodity Super Cycle to Stick Around a Bit Longer
Some analysts have predicted that the commodity price boom has played itself out. However, natural resource-based commodity prices (with the exception of shale gas and its downward pressure on US natural gas prices) have remained relatively high over the last few years, despite the feeble global economic recovery (Canuto, 2014). The commodity price spike that […]
August 22, 2014 | By Capital Finance International

Brazil

9. The High Density of Brazilian Production Chains
Huffington Post Posted November 13, 2014 | 12:50 PM
International trade has undergone a radical transformation in the past decades as production processes have fragmented along cross-border value chains. The Brazilian economy has remained on the fringes of this production revolution, maintaining a very high density of local supply chains. This article calls attention to the rising opportunity costs…
Read Post

10. Navigating Brazil’s Path to Growth
Huffington Post Posted November 9, 2014 | 10:01 PM
Brazil’s macroeconomic management will face four major immediate challenges in the near future. The response to them will be strengthened if we could have some indication of how to steer the Brazilian economy back to a growth route.
A first major challenge will be the upward realignment of domestic regulated…
Read Post

11. Three Perspectives on Brazilian Growth Pessimism
(with Philip Schellekens)
Economic Premise n.148, June 2014
It has become increasingly evident over the last two years that the growth engine of the Brazilian economy has run out of steam. Despite relative resilience during the global financial crisis and following a quick recovery, economic growth registered just 1 percent in 2012 and…

12. What’s Holding Back Brazil?

Project Syndicate,February 21, 2014

One often hears that Brazil’s economy is stuck in the “middle-income trap,” having failed to revive the structural transformation and per capita income growth that it enjoyed before the debt crisis…

13. Clogged Metropolitan Arteries
Huffington Post Posted February 10, 2014 | 3:45 PM
Bad conditions of mobility and accessibility to jobs and services in most metropolitan regions in developing countries are a key development issue. Besides the negative effects on the wellbeing of their populations associated with traffic congestion and time spent on transportation, the latter mean economic losses in terms of waste…

Middle-Income Trap

14. Access to Finance, Product Innovation and Middle-Income Traps
(with Pierre-Richard Agenor)
World Bank Policy Research Working Paper Series 6767, February 2014

15.  Access to Finance, Product Innovation, and Middle-Income Growth Traps

(with Pierre-Richard Agenor and Michael Jelenic)

Economic Premise n.137, March 2014.)

Debt Restructuring

16. Orderly Sovereign Debt Restructuring: Missing in Action! (And Likely To Remain So)
(with Brian Pinto and Mona Prasad)
The World Bank Research Observer 01/2014; 29:109-135.
(Accessible in Academia.edu and ResearchGate.net)

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Brazil, Emerging Markets, Uncategorized

Navigating Brazil’s Path to Growth

Brazil’s macroeconomic management will face four major immediate challenges in the near future. The response to them will be strengthened if we could have some indication of how to steer the Brazilian economy back to a growth route.

Read here:

Navigating Brazil’s Path to Growth

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Economics, Emerging Markets, Emerging markets, Long term finance

Long-Term Finance in Emerging Market Economies: Navigating between Risks and Policy Choices

Emerging market economies (EMEs) are making important strides in developing long-term finance capital market vehicles to support investment in strategic areas such as infrastructure. However, since last year, EMEs have suffered from big shifts in terms of market sentiment. While EMEs’ prospects were clearly overhyped in the wake of the crisis, the bleak forecasts that dominated headlines in the second half of last year were similarly exaggerated. There are still a number of factors indicating that EMEs’ role in the global economy will continue to grow—just not as rapidly or dramatically as previously thought.

Click here: Economic Premise 152

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