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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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…
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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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Economics

Secular Stagnation: A Working Pair of Scissors Needs Two Blades

Scissors

The role of asset bubbles as an unsustainable pillar of pre-2007 world economic growth has been widely recognized. Simultaneously, analysts worry that a secular stagnation, though momentarily offset by asset bubbles, may have been already at play in major advanced economies, leading to the ongoing sluggish and feeble recovery. Still, there is a core divergence among some “Keynesian” and “Schumpeterian” economists who have proposed such stagnation hypotheses; each camp points to different underlying factors for continued anemic levels of growth. “Keynesians” argue from the demand side, and believe that proactive fiscal policies are needed for a strong recovery, while “Schumpeterians” believe that the necessary force of creative destruction has continually been stymied by such policies. 

 

Bubble-led growth had feet of clay

 

It has now been widely acknowledged that the long period of economic growth in advanced economies prior to the crisis was largely dependent on asset bubbles. Consider the case of the US:

(…) the liquidity-generating machine inflated US asset values and fed the exuberant growth of US household spending. US consumers have accounted for more than one-third of the growth in global private consumption since 1990. Increasingly, their spending was made possible by the wealth effect generated by the rising prices of housing and household financial assets and stocks, whose values were in turn expected to more than outstrip those of household debt. It was this upswing in consumption by US households, and others as debt-based consumers-of-last-resort in the global economy that essentially made possible the extraordinary structural transformation and productivity increases experienced by some manufacturing exporters and commodity producers among developing economies.” (Canuto, 2009)

A similar bubble-led growth process could be found inside the Eurozone, starting with the downward convergence of both perceived risks and interest rates toward levels in Germany and France throughout the zone after the introduction of the new common currency. The Eurozone countries under stress today were formerly able to sustain domestic absorption far above domestic production capacities over a long period, easily financing the difference through sudden domestic asset value appreciation. The underestimation of fiscal risks was another manifestation of such euphoria.

Asset-price dynamics has now been mainstreamed as an important subject to be addressed by policy makers, and macroprudential policies have become a component of the macroeconomic stabilization toolkit (Canuto, 2013a). However, enhancing the policy framework through improved financial regulation and articulated monetary and prudential policies, in order to ensure both financial and macroeconomic stability may not be enough if some underlying trend of stagnation is at play. If the pre-crisis growth trend was inextricably dependent on the overspending induced by the financial frenzy – credit and house bubbles –  avoiding future asset price booms and busts might simply lead to stability around low growth rates.

 

Keynesians: it’s aggregate demand, stupid!

 

Such a view underlies the possibility of a “secular stagnation” as discussed by economists like Krugman (2013) and Summers (2013):  

“Manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade, along with very easy money, were sufficient to drive only moderate economic growth. (…) short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment.” Summers (2013)

They and other –  “Keynesian” – economists have suggested an array of possible causes for the US economy and others to display a propensity of aggregate demand shortfalls, in the sense that, as a result of structural conditions, aggregate spending would be enough to ensure full employment and use of potential output capacity only in the presence of negative real interest rates. Such an “investment drought” – or, as a flipside, a “savings glut” as measured by levels of non-consumption expenditures required to sustain income at full employment – could be seen as underlying the evolution depicted in Chart 1, obtained from Fatas (2013).

Beyond the legacies of the crisis – including higher risk aversion, increased savings by states and consumers, increased costs of financial intermediation and major debt overhangs – several long-standing factors would have contributed to dampening investment. Among them, I  single out two as the most significant:

First, rising income concentration – rising shares of income accruing to capital and the very wealthy – would be leading to overall under-consumption, only occasionally countervailed with unsustainable over-indebtedness by the poor. Second, technological evolution might also be contributing to an investment drought. Steep declines in the costs of durable goods – especially those associated with information and communication technology and/or outsourcing – means reduced spending on investment plans out of corporate savings. Furthermore, the trajectories of technological evolution currently unfolding would not carry as many high-return investment opportunities as past periods of innovation.

Chart 1

US – Private Nonresidential Investment and Real Interest Rates

Secular Stagnation chart 1

                                                        Source: Fatas (2013)

 

Summers (2014) argues that “(…) our economy is held back by lack of demand rather than lack of supply. Increasing capacity to produce will not translate into increased output unless there is more demand for goods and services.” He strongly recommends establishing “a commitment to raising the level of demand at any given level of interest rates through policies that restore a situation where reasonable growth and reasonable interest rates can coincide.”

It follows from this view that the policy mix that has prevailed since the aftermath of the crisis has been inappropriate. Instead of relying single-handedly on ultra-loose monetary policy, public spending – on infrastructure, energy and other sectors – should be rescued from the retrenchment to which it has been submitted. As long as credible medium-to-long-term adjustment programs are announced, there would be scope for fiscal stimulus despite current public debt levels. By the same token, pro-active public policies to ignite private investment spending should also be implemented.

 

Schumpeterians: it’s all about “creative destruction”, folks!

 

On the other side of the debate, there are those “Schumpeterian” economists who have offered supply-side based hypotheses of a long-run stagnation trend supposedly already in course for some time. Like Joseph A. Schumpeter, they lay emphasis on growth as a process of “creative destruction” in which obsolete forms of resource allocation and wealth – jobs, fixed-capital assets, technologies, and balance sheets – are replaced by higher-value ones. Although accepting an eventual role of monetary policies in avoiding systemic financial meltdowns, they tend – also like Schumpeter – to be more skeptical of fiscal or other types of countercyclical stimulus if these are designed in ways that retard the process of creative destruction. As for the post-crisis policy mix,  Schumpeterians believe that public policy which artificially props up aggregate demand cannot be a key component in the fight against stagnation. In other words, “If you are postulating a stagnation across the longer run, ultimately it will have to boil down to supply side deficiencies.(Cowen, 2013). The evolution of declining investments in tandem with lower interest rates shown in Chart 1 is seen as stemming from disadvantageous rates of return not related to the pace of aggregate demand expansion.

Technological evolution as a cause of stagnation has been put forth as a hypothesis by Gordon (2014). Nevertheless, his arguments focus on the limited ability of current technological trajectories to raise productivity, rather than their supposedly dampening effects on aggregate demand.

Cowen (2011) has in turn approached stagnation as an outcome of the exhaustion of a significant set of “low-hanging fruits” reaped in recent history, namely one-off supply-side opportunities associated with post-war reconstruction; trade opening; diffusion of new technologies in power, transport, and communications; and educational attainments, among others. Other recently-proposed causes for supply-side stagnation are associated with features of resource allocation, such as over-sizing of financial activities, as discussed by Canuto (2013b).

As Rajan proposed in 2012, such propositions about stagnation trends suggest that:

“(…) the advanced countries’ pre-crisis GDP was unsustainable, bolstered by borrowing and unproductive make-work jobs. More borrowed growth – the Keynesian formula – may create the illusion of normalcy, and may be useful in the immediate aftermath of a deep crisis to calm a panic, but it is no solution to a fundamental growth problem. If this diagnosis is correct, advanced countries need to focus on reviving innovation and productivity growth over the medium term, and on realigning welfare promises with revenue capacity, while alleviating the pain of the truly destitute in the short run.”

 

To be effective, a pair of scissors needs both blades

 

Keynesian and Schumpeterian hypotheses on stagnation trends are based on non-directly observable factors. Therefore, the struggle for hearts and minds of public opinion and policy makers will likely remain unsettled.

I, for one, lean in favor of the argument of insufficiency of aggregate demand throughout the ongoing recovery in advanced economies, as the behavior of the prices of goods and services seem to indicate (Chin, 2014). Nevertheless, one may acknowledge the possible negative effect on investment prospects caused by procrastination regarding “creative destruction.” This is clearly the case with sluggish balance-sheet adjustments and a debt overhang in the Eurozone.

Let me offer two key takeaways. First, regardless of the size of public outlays, public action and spending should be both designed in ways that maximize the “bang for their buck” in terms of overcoming obstacles to the process of creative destruction. Take the case of Japan: the success of the third arrow of Abenomics, which focuses on structural reforms in the services sector, will be a condition for successful results in its fiscal and monetary arrows. Likewise, in the Eurozone, quicker action to restructure/consolidate “zombie” balance sheets and companies, in line with a more pro-active stance taken by monetary and financial authorities, should also hasten their path out of the current stagnation.

Second, regardless of whether advanced economies are indeed facing demand- or supply-side stagnation trends,  the developing world’s economic transformation remains as a powerful source of growth for the global economy as a whole (Canuto, 2011). However, for such growth to continue, developing countries themselves will also need to pursue their own country-specific agendas of structural reform and, therefore, of “creative destruction” (Canuto, 2013c).

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Economics

Crisis recovery: flying on a single engine

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. These macroeconomic outcomes have to some extent been shaped by the policy mix predominantly adopted in those economies in response to the crisis, one in which very loose monetary policies have been combined with tight fiscal policies.

 

Actual GDP has lagged behind its potential along the recovery

 

The ongoing recovery in advanced economies has been sluggish and fragile when compared to the three previous ones (Kose et al, 2013). While real GDP per capita returned to positive trajectories soon after previous temporary downturns, this time it not only started decelerating well prior to the global recession year (2009), but has not yet fully recovered its peak levels. 

Chart 1– from Davies (2013) – depicts several key features of the ongoing recovery in the group formed by the US, Euro Area, Japan and UK. First, the aggregate growth trend exhibited prior to the crisis is no longer there, either because it was not really sustainable in the long run and/or as a legacy of the crisis. Second, a new “Great Depression” has been avoided but actual GDP has remained subpar relative to the latest IMF/OECD estimates for potential output. Finally, despite the possibility of catching-up with potential GDP in two years, as outlined in the central GDP projection, such an outcome remains subject to policymakers properly calibrating their responses to a wide range of idiosyncratic challenges ahead (Canuto, 2014).

 

Chart 1

Canuto March Chart 1

At first glance, this is not surprising, given the nature of the factors underlying the crisis: the pervasiveness and magnitude of asset booms and busts; design flaws of the Eurozone fully revealed as the crisis unfolded; the degree of synchronization of recessions; policy uncertainty associated with a loss of confidence on the sufficiency of established policy blueprints; and so on. Moreover, any such transition from a previously booming economy to a “new normal” would necessarily entail a significant reallocation of resources, with creation/destruction of jobs and productive assets. As remarked by Rajan (2013):

 “(…) the bust that follows years of a debt-fueled boom leaves behind an economy that supplies too much of the wrong kind of good relative to the changed demand. Unlike a normal cyclical recession, in which demand falls across the board and recovery requires merely rehiring laid-off workers to resume their old jobs, economic recovery following a lending bust typically requires workers to move across industries and to new locations.”

On the other hand, gauging by the size and persistence of the gap between actual and potential GDPs exhibited in Chart 1, one may question whether such a transition might have been made faster with appropriate macroeconomic policies. After all, while economists often assume that, no matter where potential GDP might be, actual GDP will eventually move to it, convergence can occur in the reverse direction. Losses associated with prolonged periods of significant output gaps – e.g., labor de-skilling, foregone R&D efforts, and resource idleness – then become permanent.

 

The crisis response has been single-handedly based on monetary policy

 

Kose et al (2013) point out how the recovery in advanced economies may have reflected peculiarities of the policy mix adopted as responses to the recent economic downturn, as compared to previous experiences. While both fiscal and monetary policies have been implemented in a countercyclical direction in the past, that has not been the case this time.

Monetary policy has been extremely accommodative. As policy interest rates approached the bottom – the lower zero bound – central banks went so far as to expand their balance sheets, in conjunction with other unconventional monetary policies (Canuto, 2013). Chart 2 illustrates that by matching short-term interest rates during previous and current (the “Great Recession”) experiences.

Conversely, while previous recovery experiences were supported by the expansion of public spending, fiscal policy has this time moved in the opposite direction (Chart 3). The fiscal stimulus implemented in the US at the outset of the downturn was reversed not long after, followed by fiscal contraction. In the Eurozone, in turn, fiscal austerity policies were implemented as financial havoc morphed into fiscal unsustainability of its crisis-ridden members. Austerity has also been favored in the UK.

  Chart 2

Short-term interest rate during global recessions and recoveries (percent)

Canuto March Chart 2

Note: Zero is the time of the global recession year. Each line shows the PPP-weighted average of the countries in the respective group.

Source: Kose et al (2013)

Chart 3

Real primary expenditure (index, PPP weighted)

Canuto March Chart 3

Notes: Dashed lines denote WEO forecasts. Figures are indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line shows the PPP-weighted average of the countries in the respective group.

Source: Kose et al (2013)

 

Why has the fiscal and monetary policy mix been so different? On the fiscal policy side, as shown by Kose et al (2013), public debt levels in advanced economies were much higher than in the past when the macroeconomic downturn took place. Public deficit levels had soared in the run-up to the recession, given the scale of financial support measures and substantial revenue losses. However, one may also say that a policy option for austerity was exercised. In the cases of the US and UK, financial markets were not imposing any substantial short-term fiscal retrenchment – especially if medium-to-long-term structural adjustment plans were to be announced. In the Eurozone, in turn, the intensity of fiscal adjustment in crisis-ridden members could have conceivably been lower provided that a correspondingly higher financial support from outside had been made available.

Unconventional monetary policies, in turn, came out of the urgency of halting potentially­ catastrophic processes of debt deflation and bank-credit freezes that threatened to transform solvent-but-illiquid balance sheets into insolvent ones. In the case of the Eurozone, such risks of financial meltdown were compounded by negative feedback loops between banks’ portfolios and rising risk premiums associated with crisis-ridden national public debts.

Very loose monetary policies smoothed the process of private-sector balance-sheet deleveraging by keeping yields at low levels and propping up asset values. In the Eurozone, risk premiums abated after the European Central Bank pledge to do “what it takes” to keep currency convertibility.

The phasing out of unconventional policies has been protracted as a reflection of the sluggishness and feebleness of the macroeconomic recovery and the absence of fiscal stimulus as an alternative. In the Eurozone, the debt overhang is still salient and balance-sheet deleveraging still has some way to go, but certainly in the case of the US, where debt deleveraging has already been substantial, fears regarding consequences of the unwinding of quantitative easing have made it a measured and paced process.

Can one point out the single-handed reliance on monetary policy to counter downturn as a factor underlying actual GDP tracking behind potential levels? After all, most analysts attribute an asymmetric capacity to monetary policy in economic downturns: the ability to countervail risks of asset-debt deflation is not accompanied by an equivalently strong capacity to induce agents to invest in new productive assets. As the saying goes, “one can pull a string, not push it!” Furthermore, after a certain point, ultra-loose monetary policy would only lead to a repeat of the bubble-blowing process seen before the crisis.

In this sense, countercyclical moves by policy makers might have reduced the length and size of the observed output gap had fiscal policy operated as a countercyclical tool complementary to monetary policy. Regardless of whether restrictive fiscal policies have been a necessity or an option, the fact is that they have constituted a major factor leading to a subpar recovery performance.

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