State of the World Economy

1
State of the World Economy
A research programme

IDEAs Shanghai August 2006
Cambridge Endowment for Research in Finance (CERF)
Alphametrics Ltd.
2
What we want to know about the world economy

• Growth and distribution ...
• What outcomes can we expect ?
• Can policies make a difference ?

3
Changing the direction

• Globalization makes countries and regions
  inter-dependent
• Global policies require coalitions
• Coalitions require common understanding

4
How we can understand such a huge and complex
system ?

• Preconceptions - are they correct ?
• Data - does it tell us what we need to know ?
• Models - how complicated ?
• Scenarios - can they answer our questions ?
• Finally - some data and a scenario

5
Preconception

• Global development is a historical process
• political power
• markets
• technology
• environment and resources
• social change

6
Can we measure the historical process with
statistical data ?

• The statistical data are incomplete and imperfect
• BUT ... we have much more data than ever before
• SO ... let's try

7
The best data ?

• Commodity trade
• Balance of payments
• National accounts
• Population and demography
• Energy
• Financial markets

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Problem 1 So many countries

• UN statistics cover over 200 territories but
  coverage is uneven and territories change over
  time (eg former USSR)
• Some are very huge (China, India) and others are
  tiny (island states)
• Solution A world regions (blocs)
• Solution B 80 countries and groups
• Solution C variable geometry ?

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Problem 2 Gaps inconsistencies

• Missing history
• Recent figures
• Errors ...
• Solution A estimation
• Solution B filtering and reconciliation

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Problem 3 Specifying models

• How much detail ?
• How much regularity ?
• Structural relationships ...
• Things that are very difficult to model
• financial markets
• the price of oil
• politics and 'confidence'
• longer-term trends

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Problem 4 How good is the model ?

• Is it relevant to the questions we want to answer
  ?
• Is it consistent with what we know about
  institutions ?
• Is it consistent with results of detailed studies
  ?
• Does it have plausible dynamics ?
• Are the residuals plausible in the light of
• the data generation process ?
• known structural changes and historical events ?

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Problem 5 Defining scenarios

• Q1 what outcomes can we expect ?
• baseline projection
• alternatives
• Q2 can policies make a difference ?
• targets
• instruments

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Work in progress the data
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Work in progress the model
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Terms of trade primary products and energy
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Income growth rates
17
Trade balances as of income
18
Energy supply
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Now for your entertainment ...

• Some facts (history) and a scenario

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Who succeeds in the global market today ?

of world exports of world population
30 3
80 20
95 56
remaining 5 remaining 44

• Global markets are dominated by large companies
  and production is concentrated in specific
  regions
• 5 of the market is shared by countries with
  almost half the world's population

Nigeria, Indonesia, Pakistan, India,
Bangladesh and many other countries in Asia,
Africa and America
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Industrial exports
Exports of manufactures, billion US at 2004
prices

• The market has been dominated by Western Europe,
  the USA, Japan and the rest of Asia
• China attracts attention as a new entrant

excluding intra-bloc trade
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The world market for manufactures
Imports of manufactures, billion US at 2004
prices

• The USA and Western Europe provide the main
  markets although Asian imports are growing
• The rest of the world exchanges energy and raw
  material exports for manufactures

excluding intra-bloc trade
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Underconstruction
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Harder times ahead ?

• Growth of world trade relies on growth in the US
• With rising interest rates and the high price of
  oil, will US growth continue ?
• And, longer term, we have to consider energy use
  and climate change

25
The growth engine ...

• Debt of US households is now one-and-a-half times
  income
• To sustain the current growth pattern, debt may
  have to rise to about two-and-a-half times income
  ten years from now

Debt of the personal sector as of disposable
income
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Asset appreciation
Asset prices in real terms

• Accumulating debt has been backed by ever-rising
  asset prices
• If this continues, equities and houses should be
  priced at one-and-a-half times their (already
  high) value ten years from now ?

House price index
SP 500 index
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If U.S. spending slows down
( p.a.)

• If household spending reaches a plateau relative
  to income, growth will slow down

Average growth of the U.S. (1970-2004) 2.8
Continuing the pattern
Slowdown
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Could the slowdown result in a recession ?
( p.a.)
Average growth of the U.S. (1970-2004) 2.8

• Weakening sentiment may affect
• - asset prices
• - credit expansion
• - household spending
• - jobs
• - tax revenue
• How will governments and monetary authorities
  respond ?

Slowdown
Recession
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What can the rest of the world do to reduce the
risk ?

• A more balanced and sustainable growth process in
  each world region
• Less dependence on the USA
• Less reliance on high-cost imported energy
• Closer regional integration
• Growth sustained by domestic spending as well as
  exports

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A scenario ...

• Can Asian countries bring about a reduction of
  the US trade deficit by relying more on domestic
  spending ?

Trade surplus (billion)
Rest of world
China
Japan
Rest of Asia
31
Increased energy efficiency

• Energy saving will reduce damage to the
  environment and facilitate a more balanced
  pattern of trade

Energy consumption (tons of oil equivalent per
million income)
Rest of Asia
Japan
China
32
Growth generalized
Per capita income, 2005 - 2015
Former USSR 7.1
Africa 6.1
Eastern Europe 5.5
Middle East 5.1
Other America 4.5
Other Developed 3.0
Western Europe 2.7
USA 2.2
China 7.6
Rest of Asia 7.3
Japan 4.6