THE ECONOMIC AND SOCIAL COUNCIL
SOFIA, 23-30 JULY 2016
TOPIC A: LOW OIL PRICES AND THEIR IMPACT ON THE GLOBAL ECONOMY
prepared prepared by Alexand Alexander er Sohl
TOPIC B: IMPLICATIONS OF SLOWING GLOBAL GROWTH FOR THE GLOBAL ECONOMY
prepared prepared by Plamen Plamen Patchev Patchev
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Table of contents
THE ECONOMIC AND SOCIAL COUNCIL .............................................................................. 3
TOPIC A: LOW OIL PRICES AND THEIR IMPACT ON THE GLOBAL ECONOMY ......................... ...................................... .......................... ........................... ........................... ........................... ........................... .......................... ........................... ................... ..... 4 INTRODUCTIO INTRODUCTION N ............................................. .................................................................... ............................................. ............................................. .............................. ....... 4 RECENT HISTORY AND IMPLICATIONS ON THE OIL PRICE ........................................................... 7 2003-20 2003-2014 14 .......................................... ................................................................. ............................................. ............................................ ......................................... ................... 8 2014-toda 2014-today y............................................. ................................................................... ............................................ ............................................ ...................................... ................ 9 OUTLOOK DEMAND AND SUPPLY............................................................................................ 11
SITUATION AND OUTLOOK FOR MAJOR OIL PRODUCERS ................................................. 12 THE OPEC...................................................... ............................................................................. ............................................. ............................................ ............................ ...... 12 DESCRIPTION OF THE OPEC .......................................................................................................... .......................................................................................................... 12 OUTLOOK SUPPLY .............................................................................................................. ......................................................................................................................... ........... 13 13 ECONOMIC ECONOMIC SITUATIO SITUATION N .......................................... ................................................................ ............................................ ........................................... ..................... 13 NON-OPEC NON-OPEC PRODUCERS PRODUCERS.................................................... .......................................................................... ............................................. ................................ ......... 17 NORTH AMERICA (US, CANADA, MEXICO) ................................................................................... 17 OUTLOOK SUPPLY .............................................................................................................. ......................................................................................................................... ........... 17 17 RUSSIA RUSSIA ............................................ .................................................................. ............................................ ............................................ ........................................... ..................... 17 OUTLOOK SUPPLY .............................................................................................................. ......................................................................................................................... ........... 17 17 ECONOMIC SITUATION ................................................................................................................. ................................................................................................................. 18 OTHER IMPORTAN IMPORTANT T ACTO ACTORS RS......................................... ............................................................... ............................................ .................................... .............. 19 THE IEA.................................................................... .......................................................................................................................................... ...................................................................... 19 THE IEF: A PLATFORM FOR DIALOGUE ......................................................................................... 20
IMPACT ON THE GLOBAL ECONOMY ............................................................................... 21 FOOD PRICES PRICES..................................................... ........................................................................... ............................................ ............................................ ......................... ... 21 OIL DEMAND AND DEVELOPMENT .......................................................................................... 21
QUESTIONS A RESOLUTION RESOLUTION SHOULD ANSWER..................... .......... ...................... ...................... ...................... ...................... ........... 24 BIBLIOGRAPHY AND RECOMMENDED READING .............................................................. 25 Dictionary Dictionary .......................................... ................................................................. ............................................. ............................................ ....................................... ................. 26
TOPIC B: IMPLICATIONS OF SLOWING GLOBAL GROWTH FOR THE GLOBAL ECONOMY ......................... ....................................... ........................... .......................... .......................... ........................... ........................... ....................... .......... 27 INTRODUCTION .............................................................................................................. 27 NATIONAL NATIONAL ACCO ACCOUNT UNTING ING .......................................... ................................................................. ............................................. ....................................... ................. 27
IMPORTANCE OF THE GROSS DOMESTIC PRODUCT ......................................................... 31 STATUS QUO- SLOWING GROWTH AND ITS IMPLICATIONS ...................................................... 31
POSSIBLE APPROACHES TO THE PROBLEM ...................................................................... 38 IS GROWTH GROWTH FAIR? FAIR? ................................... ......................................................... ............................................ ............................................. .................................... ............. 42 IS GROWTH GROWTH GREEN? GREEN? .......................................... ................................................................ ............................................ ............................................. ......................... .. 43 IS GROWTH IMPROVING OUR LIVES? ...................................................................................... 43
QUESTIONS A RESOLUTION SHOULD ADDRESS ................................................................ 44 BIBLIOGRAPHY AND RECOMMENDED READINGS ............................................................ 45 TOPIC B: ANNEX ON HISTORY OF GLOBAL ECONOMIC GROWTH ...................................... 47 2
THE ECONOMIC AND SOCIAL COUNCIL
“Making ECOSOC a truly meaningful organ that has the capacity to make a difference calls
for new approach. This is so especially now, during times of hardened economic uncertainty that ECOSOC`s role and relevance is ever- incre asing”
H.E. Mr. Miloš Koterec President, ECOSOC 2012
The Economic and Social Council (ECOSOC) was established under the United Nations Charter as the principal organ to coordinate economic, social, and related work of the 14 UN specialized agencies, functional commissions and five regional commissions. The Council also receives reports from 11 UN funds and programs. ECOSOC serves as the central forum for discussing
international
economic
and
social
issues,
and
for
formulating
policy
recommendations addressed to Member States and the United Nations system. It is responsible for:
promoting higher standards of living, full employment, and economic and social progress;
identifying solutions to international economic, social and health problems;
facilitating international cultural and educational cooperation; and
encouraging universal respect for human rights and fundamental freedoms.
It has the power to make or initiate studies and reports on these issues. It also has the power to assist the preparations and organization of major international conferences in the economic and social and related fields and to facilitate a coordinated follow-up to these conferences. With its broad mandate, mand ate, the Council's purview extends to over o ver 70 per cent c ent of the human h uman and financial resources of the entire UN system. The Council meets in alternating years at UN Headquarters or at the UN Office in Geneva. The ECOSOC serves as the central forum for discussing international economic and social issues, and for formulating policy recommendations 3
addressed to member states and the United Nations system. A number of non-governmental organizations have been granted consultative status to the Council to participate in the work of the United Nations. The Council has 65 member states out of the 193 UN member states, which are elected by the United Nations General Assembly for overlapping three-year terms. Seats on the Council are based on geographical representation with 18 allocated to African states, 13 to Asian states, 8 to East European states, 13 to Latin American and Caribbean states and 13 to West European and other states.1 For more information visit: http://www.un.org/en/ecosoc/about/
TOPIC A: LOW OIL PRICES AND THEIR IMPACT ON THE GLOBAL ECONOMY INTRODUCTION
Many of us may still be able to imagine a time without the internet or cellphones, but most of us will not be able to imagine a world without oil. Child ren’s ren’s toys, pharmaceuticals, agricultural products and almost every good you can buy have one thing in common: their transport and the packaging, if not the product itself, need materials produced from petrochemicals. So even though we have so many touchpoints, touchpoints, we hardly ever think about the world’s most important commodity, except for when refueling ours cars maybe. Mankind has been using oil for over 2000 years. The first reports about oil use date back to Babylon and ancient Persia, where it was used in medicine and lighting. li ghting. The latter use case was also the reason for the first boom and the creation of the modern oil industry. In the mid-19th century the discovery of various distillation products and mainly kerosene from crude oil changed the industrial landscape. Kerosene was used as lamp oil back in the day while today you may know it as jet fuel.
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http://www.unep.org/newyork/IntergovernmentalPolicyCoordination/EconomicandSocialCouncil/tabid/52272/ Default.aspx 4
Figure 1: World primary energy usage (Mtoe) http://www.tsp-data-portal.org/ With With new use cases and exploration of oil wells worldwide, oil soon became the world’s most traded commodity and replaced coal as most important source of primary energy. Almost 2/3 of all produced oil products go into transportation, relating the increase in consumption to the increase in demand for transportation. Other important consumers are the chemical industry
Global cured oil consumption by sector 2012 Transport 12%
Industry 16%
use)
power
generation
and
(industry).
Figure 2: Oil Production and energy consumption by
Non-energy-use 8%
(non-energy
region
source
yearbook.enerdata.net yearbook.enerdata.net
64%
Other (agriculture, buildings, etc.)
Consequently the regions consuming most crude oil are developed and developing nations. Therefore the demand is highly dependent on their economic success. The demand for oil in most of the developed and developing countries exceeds their local supply. Therefore they are depending dependin g on imports from oil-rich regions in the
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Middle East, Russia, Africa or Latin America. (see fig. 3). This discrepancy between local supply and demand is the origin of the global hydrocarbon market.
OIL PRODUCTION BY REGION 2008-2104
14 ] T M 0 0 1 [ N O I T C U D O R P L I O
12 10 8 6 4 2 0 2008
North America
2009
Russia
2010
Asia
2011
Europe
2012
Latin America
2013
2014
Middle-East
Africa
TOTAL ENERGY CONSUMPTION BY REGION
60 50 ] T M 0 0 1 [ N O I T P M U S N O S L I O
40 30 20 10 0 2008
North America
2009
Russia
2010
Asia
2011
Europe
2012
Latin America
2013
Middle-East
2014
Africa
Figure 3: Oil Production and Energy consumption consumption by Region source yearbook.enerd yearbook.enerdata.net ata.net
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RECENT HISTORY AND IMPLICATIONS ON THE OIL PRICE
In addition to the geographical factors there is a lot more to consider when it comes to the question of determining the price. Since modern economies are highly dependend on the availibility of oil, the market has also a political dimension, making it even more complex. The figure 4 below shows the most important importan t events with an influence on the oil price between the years 1841-2014. 1841- 2014. Events and developments devel opments influencing the th e oil price have become more frequent and drastic with the process of globalization. However, for the purpose of the Sofia-Serdika Rotaract Global MUN 2016, the ECOSOC is recommended to address only the developments from the year 2003 onwards. Nevertheless, it should sh ould be borne in mind mi nd that the event preceding the year 2003 can be seen s een as origins of many current developments.
Figure 4: History of Crude Oil Prices 1861-2014 Source: Goldman Sachs Global Investment Research
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2003-2014
From the mid-1980s to September 2003 the inflation adjusted adjus ted price for a barrel of crude oil was under 25$. In the early 2000s the Chinese demand for oil increased due to an acceleration in economic growth, leading to a higher industry demand and a wealthier population with more vehicles on the road. At the same time, aging oil fields and a lack of investment in the U.S. decreased the production. Similar developments can be observed in the United Kingdom, Mexico and Indonesia, leading to an increase to almost 30$/bbl in 2003. In 2003 the invasion of Iraq marked a significant event for the oil markets. The war shortened the supply for oil even further and slowed down global glob al oil production in the region. The markets reacted to this scarcity and uncertainty with a dramatic increase in the oil price over the following years. Until June 2005 the price broke the psychological barrier of 60$/bbl, reaching 79$/bbl in mid 2006. 2005 marked a tipping point in price development. Before 2005 the suppl y matched the demand of crude oil, leading to elastic prices. However, oil thirst in the BRIC countries continued to increase dramatically, leading to an excess demand for oil. Drastic price swings and therefore inelastic prices are the consequent effect. The price volatility in the following years is largely explained by shifts in demand for crude oil. This market situation is also an ideal breeding ground for financial speculation. In the short term, financial speculations in the future markets may lead to price increases. Some sources argued, the increase prior to the 2007/2008 financial crisis was also due to speculations in the future markets:
Interesting fact: During 2004-2007 the t he profit of all 6 supermajor companies (Exxon, Total, Shepp, BP, Chevron, ConocoPhilipps) totaled 498,8 billion $ and now over 250,000 oil workers have lost their jobs. Meanwhile, conflicts in the Middle East continued. The situation in Iraq has still not settle d and Israel and Lebanon went to war. Additionally, North Korea started its missile launches and nuclear tests and tensions in eastern Turkey arose, followed by tensions in Nigeria. On 2nd January 2008 the crude oil price cracked the 100$ mark. The climb continued to 145.85$ on 3rd July 2008 due to fired shots at an Iranian boat and speculations about an Israeli attack on Iran. 8
Until the financial crisis took hold in July 2008, prices for oil plummeted to as low as 32$ in December that year. The crisis left its marks mainly on European countries. The European economy contracted and so did the demand for oil, impacting also the American economy, which reduced the demand even further. A strong dollar also contributed to the development. But the global excess supply was a short phenomenon. As a reaction to the development of the global economy, the OPEC decreased its production, which lead to an oil price of 100$ in December 2010. In 2011 the Arab Spring with political turmoil in Egypt, Libya, Yemen, and Bahrain broke out. Together with a weak dollar, this drove the prices back to 114$/bbl in May 2011. Especially supply problems in Europe held the European oil price high. Libya was a major source for European oil imports, but production was halted after the civil war. On the other side the pessimistic outlook on the European economy and concerns about another global recessions lowered the price to below 100$. With the European debt crisis still stunning the global economy and rising tensions with Iran, after sanctions due to their nuclear program, the price of oil stayed near 100$. The European debt crisis was the main influence factor for price swings during 2012 between 85 and 107$. The impact of the Libyan conflict still caused European oil prices to be higher than the U.S. counterparts. In 2013 good economic data from the U.S., China and Europe drove prices. Furthermore, trouble in Egypt and the Syrian conflict made investors uncertain, resulting in a high of 100$/bbl. Global conflicts continued in 2014. The dispute over Crimea, the rise of IS in Iraq, Libya and Syria caused prices to stay high.
2014-today
In 2014 a turning point was reached and the prices plummeted from over 106$ in June to as low as 26$ in February 2016. But why did this price drop occur?
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This complicated question may be reduced to the main economic principle: Supply and demand. Since 2014 the production of oil has been significantly larger than consumption, ergo the markets react to this significant excess oil with a fall in prices.
Figure 2 Oil Production and Consumption Balance, source: Short-term energy outlook May 2016 eia The explanation for the excess demand on the other hand, is not so easy. But, as always in recent history, one could start with looking at the United States. With new platforms in the Gulf of Mexico connected to the grid and the exploration of shale gas and oil, the domestic production of oil in the US has nearly doubled over the last couple of years. The Arabian, African and Southern American oil that once was sold in the United States is now competing for Asian markets, and the producers are forced to drop prices. Canadian and Iraqi oil production and exports exp orts are rising year after year. Even the Russians, who are heavily stricken by economic problems, manage to keep pumping at record levels and Iran, in need for foreign currency, increased production after the agreement on easing sanctions in 2014.
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Top 5 crude oil producing countries
600 t M n i n 400 o i t c u d o r P l i O200 e d r u C
Saudi Arabia
0 2008
2009
Russia
United States
2010
2011
Canada
2012
2013
Iran 2014
Figure 3: Top 5 oil producing countries source yearbook.enerdata.ne yearbook.enerdata.nett
OUTLOOK DEMAND AND SUPPLY
Analysts expect that oil consumption in the OECD to stagnate this year and to resume its structural decline from 2017, driven by demographic and income trends, as well as by efforts to improve energy efficiency. Meanwhile, demand growth in emerging markets will stand at 2.2%, its lowest rate since 1998. This predominantly reflects moderating economic expansion and declining energy intensity in China. Furthermore, the boost to apparent production provided in 2015 by purchases for China's strategic petroleum reserves is likely to ebb. Troubles in other major emerging economies — — including Brazil and Russia, which are both forecast to face a second consecutive year of contraction in 2016 — will will further constrain demand growth outside the OECD. This will be only partly offset by buoyant demand deman d in fast-growing India. In 2017 global globa l demand growth will pick up slightly, to 1.4%, in line lin e with a stronger world economy. econom y. US oil consumption is expected to rise by 0,3% in 2016, supported by steady economic growth and low fuel prices. On the Supply side 2016 and 2017 will be particularly challenging for oil producers globally as a deepening plunge in prices hurts profitability and forces firms to slash costs, including on investment. Reflecting these challenges, the world oil production is expected to slip marginally 11
in 2016, marking the first decline in seven years. The fall will be entirely driven by non-OPEC producers, predominantly predominantl y in the US. Many non-OPEC producers managed to sustain — or or even increase — output output in 2015, despite depressed prices. In part, this reflects an unwitting consequence of OPEC's strategy. By focusing on maintaining its own market share over the global price, OPEC has encouraged its competitors to do the same. The US output in particular is expected to fall sharply in 2016 as shale firms face growing pressures from falling revenue and tightening financing conditions.
SITUATION AND OUTLOOK FOR MAJOR OIL PRODUCERS
In the panorama of international institutions, the absence of a universal institution dealing with energy is quite remarkable. Historically, the OPEC was established as first institution dealing with oil and its membership restricted to oil exporting countries.
THE OPEC
DESCRIPTION OF THE OPEC
The Organization of the Petroleum Exporting Countries (OPEC) is an intergovernmental organization of 13 nations, founded in 1960 in Baghdad by the first five members, and headquartered since 1965 in Vienna. The 13 countries account for 40 percent of global oil production and 73 percent of the world's oil reserves, giving OPEC OPEC a major influence on global oil prices. OPEC's stated mission is "to coordinate and unify the petroleum policies of its member countries and ensure the stabilization of oil markets, in order to secure an efficient, economical and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry." As of June 2016, OPEC's members are Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia (the de facto leader), United Arab Emirates, and Venezuela. Two-thirds of OPEC's oil production and reserves are in its six Middle Eastern countries that surround the oil-rich Persian Gulf. 12
OUTLOOK SUPPLY
OPEC supply will continue to increase this year. The much-anticipated meetings between OPEC countries (excluding Iran and Libya) and Russia (until (unt il 5th June) were flops. Saudi Arabia insisted that any deal to freeze output should include Iran, which refuses to accept any such curbs as it attempts to rebuild its production following the removal of sanctions. Nothing was agreed and consequently leading producers such as Saudi Arabia and Iraq keep pumping at record levels, while Iran will gradually raise output and exports back crude oil to pre-sanctions levels. The Saudis have all but said outright that their national natio nal priorities in energy would always trump OPEC priorities. So the strategy can be summed up as “pump as much as you can, don’t let the shale boomers get a breather” have not led to a clear victory. They have not led to a sharp sharp rise in prices, which was expected to take place after the shale producers threw in the towel. But U.S. shale companies have lasted much longer than expected. The International Monetary Fund estimates that the revenues of Saudi Arabia and its Persian Gulf allies will slip by $300 billion this year. Technical issues and small production producti on declines in Nigeria, Iraq and the UAE in February-March 2016 and a strike in Kuwait in April have highlighted how output in most OPEC members is close to sustainable capacity and thus vulnerable to disruptions.
ECONOMIC SITUATION
Oil receipts typically account for more than 80% of GCC government revenues, rising to over 90% of Saudi Arabia’s budget before befo re the crisis. Dubai, one of the emirates emir ates making up the UAE, is an exception, with oil accounting for only 5% of revenues. That is because it has successfull y diversified: tourism and services account for most of its government revenues. Governments are reacting to the squeeze on their incomes with a mixture of strategies, drawing down reserves and taking on debt on the one hand, and imposing spending cuts on the other. Last year they made tweaks, such as curbing benefits for public servants. This year will be 13
tougher. Oman has told all state-owned enterprises to remove perks such as cars. Qatari companies including Al Jazeera and the Qatar Foundation, a cultural organi zation, have laid off employees. With such tweaks Kuwait, the UAE and Qatar, which have small populations and high foreign-exchange reserves, can get by for a decade. But the other three states are in a trickier position. Oman and Bahrain have relatively low reserves. Oman posted a larger than expected budget deficit in 2015, at almost 16% of GDP. By the end of 2017 Bahrain’s debt is expected to reach 65% of GDP. GDP. It needs an oil price of $120 to balance its books. The two have other concerns, too. Bahrain’s Shia-majority Shia-majority population bristles brist les at being ruled by b y a Sunni monarchy. There is a lack of leadership in Oman; Sultan Qaboos is, again, in Germany being treated for suspected cancer. Though, predictions that the oil price will not rise quickly are focusing minds on all sorts of structural reforms. “This is good for the Gulf; it will be a rich period for policypolicy-making,” says Nasser Saidi, an economist in Dubai. The UAE cut fuel subsidies last year, and other states are following suit. Bahrain removed subsidies on some food items. Saudi Arabia raised the cost of electricity and water. Oman is printing the cost of the fuel subsidy on househo ld electricity bills to prepare the population for paying the whole lot. But with real prices now near the subsidized prices, there is less room for savings from cuts than there was a few years ago. And outgoings outgoin gs remain high. It is not just that th at the Gulf states are committed to large infrastructure projects — — metros, metros, financial centers, ports and railways. They spend billions of dollars on wages and handouts to their rapidly growing populations. The relatively young states need to spend cash on education. And they are embroiled in costly wars in the region. Making matters worse, cuts in spending affect the nascent private sectors where, apart from the UAE and Bahrain, most activity is linked to oil, such as services to the industry; and to public spending, such as construction. Economic Economic growth is slowing. “The lack of countercyclical measures is amplifying the pain,” says Mr. Nasser. Banks are getting tougher on loan s just when the state wants to encourage more small businesses. By some reckonings, the private sector in the Gulf contributes less to GDP now than in earlier decades. The GCC countries need to do much more if the books are to balance in the future. Diversification, long talked talke d about, has to happen now, although althou gh it is harder to do it in bad times. 14
Plans look good on paper — encouraging encouraging tourism and logistics, for example — but more uncertain in real life. Saudi Arabia is not keen on Westerners trampling around the kingdom. A modest value-added tax, long discussed, of up to 5%, will be introduced across the region by 2018. Oman has raised corporate tax from 12% to 15%. Other states are considering taxing expatriates’ incomes. But above all, the public sector has to stop acting as the main employer. That would be a big shift. Gulf citizens have got used to earning without doing much. Private firms are not creating enough jobs to keep up with the number of young people graduating from university, and large expatriate workforces provide tough competition. Gulf rulers fear that cutting spending would alter the social contract in which largesse largesse buys their people’s quiescence. But they have no choice. A new generation of younger leaders, such as Saudi Arabia’s Muhammad bin Salman and Muhammad bin Zayed in the UAE, are more willing to make tough changes. The GCC states have had amazing few years in which they built up infrastructure and savings. But they did too little to prepare for a post-oil future. Now they must catch up. Other OPEC countries are confronted with even more severe challenges. The hardest-hit large producers in Latin America, Ecuador and Venezuela, are facing dram atic economic, social and even political consequences following the recent drop of oil prices. The Ecuadorean economy, which still has to deal with the consequences of a heavy earthquake in April, is suffering from persistent fiscal weakness weaknes s in the wake of low oil prices. Venezuela, where electricity is being rationed, the work week has been shortened and the government even changed the time zone to reduce evening electricity usage, remains rooted in a profound political and economic crisis which is following years of econo mic mismanagement. While oil prices have been slowly recovering for the past months and hit their highest level since October in May, oil prices remain too low to shore up public finances or mend the economy. While the International Monetary Monetar y Fund (IMF) is convinced that lower oil prices should translate into higher spending and therefore support global economic growth, oil drilling countries keep a wary eye on the current developments. The role of energy, especially oil, in the states’ economy, the available mechanisms to hedge against the decline in oil prices and the impact of
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low oil prices on private and state oil companies are three significant factors shaping the future of highly oil dependent states. Venezuela and Ecuador, both dependent on the oil price as major exporters, are highly exposed to the effects of low prices as their GDP depends significantly on oil rents (23,8% Venezuela, 17,5% Ecuador). The comparison with other major oil producers illustrates that the percentage of oil rents adds significantly to the effects of policy mismanagement of a country's resources. Oil rents in the United States (0,9%) and Brazil (2,5%) and even in Mexico (6,8%) make up only a small percentage of their GDP which gives clear evidence to the importance of a diversified economy. Major oil producing countries also have to rethink their strategies how to brace themselves for long-lasting low points of the oil price. Sovereign wealth funds and long-term contracts could not proof to have an efficient buffering effect. Venezuela implemented a macroeconomic stabilization fund in late 1990’s which mostly failed to help the state being largely spent on domestic consumption and increased government spending. Others such as Mexico sought for help on the international financial market to insure against low oil prices. These states need to find a future fu ture strategy which will be partly part ly made up by a mix of budget cuts and borrowing of international capital. Unfortunately, Unfortunately, this won’t be possible for those countries which have already drifted too deep into an economic depression as their status is mostly evaluated as risky investments. The advantage a country could gain from a low oil price is difficult to establish, as low prices hurt domestic oil producers while it benefits major domestic energy consumers. This will be problematic for heavily indebted state oil companies for example in Venezuela. In September 2015, the Venezuelan president Maduro demanded a minimum oil price of $70 and sought a fair price that would support economic growth and energy demand. 95% of Venezuela’s export earnings dependent on crude oil which exposes them most brutally to any fall in the oil price. Therefore, Venezuela called for an emergency meeting which was refused by Saudi Arabia and other states as they were not ready to agree to a production limit, necessary to achieve such rise of prices. Analysts presume that the point where Venezuela could balance its country’s budget lies at $89 per bar rel. rel.
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Qatari energy minister Mohammed bin Salet al-Sad follows his example in May 2016 demanding a “minimum price of $65 a barrel for oil”. Such increase of the oil price would be “badly needed at the moment” according to the head of OPEC. He suggests that member countries halt production to force the price of oil up. The last meeting of the OPEC failed to result in a production freeze after Saudi Arabia backed off. This is another proof of how the cartel has stopped existing as a united organization since major producers see themselves confronted to strong rivals like Russia and especially the USA. If the distribution of power remains as it is, an agreement on a price and thus on a production limit seems very improbable.
NON-OPEC PRODUCERS
NORTH AMERICA (US, CANADA, MEXICO) OUTLOOK SUPPLY
The low oil price is preventing oil companies in Northern America from making the necessary investments to sustain output. Many shale players are highly leveraged and may struggle to maintain their credit limits. By some estimates, close to 60 oil and gas producers have gone bankrupt in the US since 2015, and the rate has recently r ecently picked pic ked up. In line with this, thi s, analysts anal ysts expect US oil output to contract for a second consecutive year in 2017, by 1.5% (previously 0.5%). Nevertheless, the US shale sector will remain a dominant player in global markets, with production in 2016-17 2016-1 7 still close to record highs. Considering the fact that OPEC countries as well as Russia intensified their production significantly with the dawn of US oil drilling, one can assume that US production will continue to put pressure on main OPEC states and Russia.
RUSSIA
OUTLOOK SUPPLY
Russian producers will make every effort to sustain output in 2016-17, for two reasons at least. First, both state-owned firms such as Rosneft and private companies face political pressure to continue contributing contributin g to the federal budget. Second, many of Russia's most politically powerful 17
oligarchs are involved in the oil services and pipeline industries. Their contracts depend on investment spending, which means that they vigorously oppose any decline in oil output. But EU and US sanctions, raise the cost of financing and prevent the export of high-end technology needed to maintain the current output. ECONOMIC SITUATION
Russia’s economy, which depends heavily on oil revenues with oil and gas accounting for 70 % of export incomes, is in recession. The Kremlin’s desperation for higher prices is palpable; the country is committed to two wars, in Ukraine and Syria. Heavy military spending has added a further strain on the economy. At home, wages are being cut, bringing signs of social unrest ahead of a parliamentary election in September. With its GDP contracting by 3.7 percent and the value of the ruble falling about 127 percent in 2015, Russia is now in the midst of a severe economic crunch. Various factors like falling oil prices, economic sanctions, and a weak domestic market have contributed to the ongoing downturn. The country’s status as an oil and gas producer, which previously which previously helped its economic growth, has now emerged as its major challenge. Russia’s energy minister, Alexander Novak, who attended the Doha meeting, has been a crucial supporter of a freeze. A role assigned to Mr. Novak was to bring in Iran, but he has failed so far. The country’s isolation from international markets and financial sanctions have only worsened the impact of falling oil prices. However, it is the policy uncertainty within Russia that raises the largest questions over its short-term growth. growth. Russia’s 2016 budget was made in October last year on the assumption of $50 a barrel prices for oil. The current prices stand at less than $30 per barrel, which means that the t he government has no other othe r alternative but to make cuts. The Transatlantic Trade and Investment Partnership (TTIP) is also a matter of concern for Russia. The TTIP is bound to impact the energy market, which works against Russia. European stakeholders have long been interested in accessing the U.S. crude oil and natural gas. If the United States is able to supply these resources, it would reduce Europe’s depen dence on energy imports from Russia. According to World Bank forecasts, the Russian economy is expected to continue to contract in 2016, albeit a little less than last year. Slow yet positive growth is expected from 2017 onward. 18
OTHER IMPORTANT ACTORS THE IEA
The International Energy Agency was created in contraposition to OPEC in 1974 as a response to the 1973 oil crisis. Its mandate is much broader as it deals with all forms of energy while comprising 29 member countries of the OECD. The period of its birth was marked by deep conflicts between the US and some European countries. Until then, mostly national policy measures were available to react to fluctuations on the oil market. Although the original motivation as a bastion against OPEC is nowadays less important, IEA plays an important role primarily in the organization and management of the Emergency Response System and as a “soft power” in the context of the global energy debate. debate. Ensuring security of supply and solidarity among the major industrial countries is a core objective of the IEA, which makes its Emergency Response System a central feature of the organization. Emergency oil reserves, programs of demand-restraint measures and oil allocation among IEA countries are part of the key strategy which was crucial during shortfalls in Libyan production in 2011 for instance. The IEA established itself as a competent source of shared knowledge with respect to various technologies and the publication of scenarios about global energy futures. Such scenarios are regularly elaborated by oil companies by OPEC and he US EIA, but access to them is only limited. Therefore, the IEA scenarios published in the World Energy Outlook (WEO) are the most widely quoted and thus allows the IEA to shape the global energy debate. Its involvement in the G-7 meetings and contribution to the climate change agenda, energy poverty and other international policy debates are equally based on these scenarios. While oil is still the most important component of the global energ y supply, its role is shrinking and thus the dialectic IEA-OPEC is no longer representative for fo r conflict or cooperation between energy supply and demand. Furthermore, the OECD is no longer the most important component of demand. Thus the IEA at times acts as if it were the universal energy agency, but due to its limited membership, it will never fully establish its position as universal organization. The IEA will rely on its soft power which it could proof many times with its collaboration with IMF and World Bank. 19
THE IEF: A PLATFORM FOR DIALOGUE
The International Energy Forum, also known as IEF, is the world's largest recurring gathering of energy ministers. The 88 Member Countries of the Forum are signatories to the IEF Charter, which outlines the framework of the global energy dialogue through this inter-governmental arrangement. Covering all six continents and accounting for around 90% of global supply and demand for oil and gas, the IEF is unique in that it comprises c omprises not only consuming consumin g and producing countries of the IEA and OPEC, but also Transit States and major players outside of their memberships, including Argentina, Brazil, China, India, Mexico, Oman, Russia and South Africa. Originally a sequence of conferences, the IEF now is promoted by a permanent Secretariat based in the Diplomatic Quarter of Riyadh, Saudi Arabia. The first years of the producer-consumer dialogue were mainly spent on slow confidence building after years of tense confrontation on the oil market. Having built up their secretary, investment in oil and gas became important topics in IEF’s second decade. With demand growing, concerns about supply being able to meet growing demand were mounting. Prices were never discussed, because in the decade of liberalization it was believed that these were best left to the market and an d some countries did not n ot wish to discuss them th em in such a forum. While security of demand is a big issue for producing countries, consuming countries mostly sought to intensify discussions when confronted with higher prices and the fear for secured supply. Since the Amsterdam meeting in 2004, each IEF meeting has been accompanied by a business meeting. The Charter, signed in February 2011 has elevated the status of the IEF further securing the engagement among the signatories. The third decade of dialogue is challenging the dialogue as newcomers of producer and consumer countries bring new dimensions to the dialogue. The establishment of the Joint Oil Data Initiative (JODI) is another visible example of success of IEF addressing the issue of market data transparency. Data collection methods in different countries must be improved with the assistance of the Secretariat. Twenty years after the first meeting took place in Paris in July 1991, the IEF has evolved into one of the most inclusive platforms for dialogue bringing closer together the two main consumer and producer organizations and ensuring their cooperation with the Charter: OPEC and IEA. Although the IEF has achieved a certain degree of institutionalization structuring the dialogue without affecting the informality of the dialogue. 20
IMPACT ON THE GLOBAL ECONOMY
FOOD PRICES
On average, oil prices roughly quadrupled during 2002 and 2008, triggering widespread protest activities. A similar price surge for petroleum-based fertilizers contributed to the 2007 – 08 08 world food price crisis and further unrest. The connection between food and oil is systemic, and the prices of both food and fuel have risen and fallen more or less in tandem in recent years. Modern agriculture uses oil products
Figure 5: Correlation of the food price index and the oil price index, source: FAO
to fuel farm machinery, to transport other inputs to the farm, and to transport farm output to the ultimate consumer. Oil is often also used as input in agricultural agricu ltural chemicals. Therefore, Oil price increases put pressure on all these aspects of commercial food systems.
OIL DEMAND AND DEVELOPMENT 21
The global food price is a concrete
example
to
demonstrate the impact of oil in sectors that affect everyday life. Mostly, the oil price has a remarkable influence on transportation costs in general, as well as on the industry sector, the commercial/agricultural/ residential sector and the electricity sector.
Figure 6: Oil demand by sector in the OECD, source: OPEC While the demand for oil is foreseen to decrease in the OECD countries until 2040, the outlook for developing countries differs significantly.
Figure 7: Oil demand in Developing countries countries by sector, source: OPEC High oil prices typically affect less-affluent countries first, particularly the developing world with less discretionary income. There are fewer vehicles per capita, and oil is often used for electricity generation as well as private transport. The World Bank has looked more deeply at 22
the effect of oil prices in the developing countries. One analysis found that in South Africa a 125% increase in the price of crude oil and refined petroleum reduces employment and GDP by approximately 2%, and reduces household consumption by approximately 7%, affecting mainly the poor. Looking at the table above, one can recognize that the future of developing countries highly depends on oil and thus, a stable oil price. Many developing countries require large amounts of oil to promote their own progress. Depending on the degree of development a country can achieve in the next years, oil demand for road transportation will grow as more and more people get access to the middle class and wish to benefit from newly gained mobility. Adding to this, population growth will intensify i ntensify these trends. Furthermore, the need for food production and transportation in areas with weak infrastructure will increase. It is also this primary infrastructure for which construction will rely on oil generators as electricity supply is still not guaranteed in many regions of the world. The lack of electricity affects over one billion people in the world, while three billion people rely on wood, coal, char coal or animal waste for cooking and heating. Oil and other liquid fuels are often considered energy carriers of choice when it comes to establishing reliable back-up or peak demand power generation support systems. This is not only true for developing countries but especially for states that are currently expanding into alternative power generation e.g. solar and wind. As long as fluctuations in power supply and demand are not fully balanced, there might be the need for fossil fuels and a reliable and fast back-up system. To achieve Sustainable Development Goals, it is crucial to ensure access to affordable, reliable, sustainable and modern energy for all and promote innovation and green technologies especially in the transportation sector. Nevertheless, oil won’t be easily replaceable in a few years – years – if if it will ever be- , but it must be included includ ed into a sustainable process pro cess that does not endanger energy supply or economic systems.
23
QUESTIONS A RESOLUTION SHOULD ANSWER
The dependency on a stable supply from the Middle East is evident. This region holds half of the global oil reserves and is responsible for 1/3 of the current production. There are ever new conflicts arising in the former colonial region and a new rivalry due to strong US oil drilling. Could the future of the oil market lie within the hands of an international organization to find agreements on oil drilling regulations or will the oil market function as a free market? Which role could OPEC, IEA and IEF play in the future? The Latin American states illustrate the complex situation in which highly oil dependent countries are stuck and the possible and necessary strategies such as diversification and borrowing that tha t have to be b e considered to avoid an economic econ omic collapse collaps e in the following followin g years of uncertainty on the oil market. More efficient tools need to be developed by delegates of highly oil dependent countries. How can these economies be stabilized? Which countries or institutions might have a great interest and the necessary measures to secure the position of such countries and which role could bilateral, regional or multilateral agreements play? Since the price drop of 2014, the debate about new regulatory actions, especially an agreement on a minimum oil price, was revived. Nevertheless, Saudi Arabia, Iran and Non-OPEC countries continue their drilling activity without any sign of hesitation. For many oil dependent economies within the OPEC this might soon endanger their economic and political stability. How could an agreement be reached? Which price limit is desirable or necessary for the different states? Negotiation partners should elaborate on their own interest to find binding measures to limit future oil price fluctuations. And last but not least thinking one step ahead: To reach the 2°C climate goal, renewable energy technologies, green technology solutions for transport and many more innovations are needed. Meanwhile, to achieve the basic Sustainable Development Goals, human development must be promoted quickly and efficiently. How can oil resources help to realize the energy transition
24
many highly developed countries pursuit in the next decades? How can oil contribute to the construction of key infrastructure and electricity supply to promote basic human development?
BIBLIOGRAPHY AND RECOMMENDED READING J. Murray, D. King, Oil’s tipping point has passed , Comment, 26 January 2012: http://www.washington.edu/research/.SITEPARTS/.documents/.or/Nature_Comment_01_26_ 2012.pdf C. Krauss, Oil Prices Explained: Signs of a Modest Revival , New York Times, 02 June 2016 http://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html?_r=0 S. Reed, A. E. Kramer, In Doha, Major Oil Exporters Fail to Agree on Production Freeze , 17 April 2016 http://www.nytimes.com/2016/04/18/business/energy-environment/major-oil-exporters-failto-agree-on-production-freeze.html Ed Wallace, Oil Prices Are All Speculation , Bloomberg, 28 http://www.bloomberg.com/news/articles/2008-06-27/oil-prices-are-allspeculationbusinessweek-business-news-stock-market-and-financial-advice Irina Slav, 11 OPEC Is Dead, What’s Next? , http://oilprice.com/Energy/Crude-Oil/OPEC-Is-Dead-Whats-Next.html
June
May
2008:
2016:
H. Trinkunas, Three things to know about the impact of low oil prices on Latin America , 17 February 2016: http://www.brookings.edu/blogs/order-from-chaos/posts/2016/02/17-lowoil-prices-latin-america-trinkunas Organization of the Petroleum Exporting Countries, World Oil Outlook 2015 : http://www.opec.org/opec_web/static_files_project/media/downloads/publications/WOO%20 2015.pdf H. Pant, Russia's Economy Economy in 2016 , 11 May 2016: http://thediplomat.com/2016/05/russias-economy-in-2016/ The Economist, The low oil price is manageable in the short term; but the Gulf states must make big changes to face the future , 26 March 2016 http://www.economist.com/news/middle-east-and-africa/21695539-low-oil-pricemanageable-short-term-gulf-states-must-make
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The European Commission, Energy Security https://ec.europa.eu/energy/en/topics/energy-strategy/energy-security-strategy
Strategy :
The United Nations, Goal 7: Ensure access to affordable, reliable, sustainable and modern energy for all: http://www.un.org/sustainabledevelopment/energy/ Van der Linde, Coby & Luciani, Giacomo (2012): The International Energy Agency (IEA), the t he Organization of Oil Exporting Countries (OPEC) and the International Energy Forul (IEF): The elusive quest for institutional cooperation in oil and gas international trade , POLINARES working paper n° 60.
Dictionary Oil Price
Spot price of a barrel of benchmark crude oil such as West Texas Intermediate, Brent ICE, Dubai Crude, etc.
Barrel
Volumen Measurement Unit Oil, corresponding to 150 litres.
26
TOPIC B: IMPLICATIONS OF SLOWING GLOBAL GROWTH FOR THE GLOBAL ECONOMY
INTRODUCTION When speaking about growth or economic growth, a Gross Domestic Product-growth is meant. The GDP, an abbreviation for gross domestic product product , is the value of all final goods and services produced in a period (year or quarter of a year) within the territory of a country. Normally, it is said, that if, for example exampl e in year 2016, the value of all final goods good s and services ser vices produced inside a particular particu lar country, coun try, exceeds exce eds with 2% the value from f rom year 2015, then t hen we are observing a 2% growth. The term growth refers to the real GDP growth, that is, the value of economic output adjusted for price changes (inflation or deflation). This distinction is important in order to remove the possible biasing of the result through inflation. Presence of inflation would bias the result as inflation differs throughout the world, and the produced output of a particular country is measured in the national currency of the counry. Thus, if inflation is present, the value of the output, measured in the national currency would get bigger, but a fraction of this number would be accounted to inflation and not to economic performance. An estimation of the economic growth is performed through the so called national accounts. This is in fact an accounting process done at aggregate level, that is, for the whole state as an entity. As this process can get complex in its nature, the delegates should bear in mind only the most crucial issues will be outlined in the th e Study Guide. “International Economics” by b y Krugman, Obstfield, and Melitz for example, provides intuitive examples based on international trade.
NATIONAL ACCOUNTING National accounting may vary from country to country, however, every country has these main national accounts:2
1) Current accounts
-
Production account: records the value of domestic output and the goods and services
used up in producing that output. The balancing item of the accounts is value added,
2
https://en.wikipedia.org/wiki/National_accounts https://en.wikipedia.org/wiki/Nation al_accounts
27
which is equal to GDP when expressed for the whole economy at market prices and in gross terms.
-
Income account: shows primary and secondary income flows - both the income
generated in production (e.g. wages and salaries) and distributive income flows (predominantly the redistributive effects of government taxes and social benefit payments). The balancing item of the accounts is disposable income ("National Income" when measured for the whole economy).
-
Expenditure account: Shows how disposable income is either consumed or saved.
The balancing item of these accounts is saving. 2) Capital accounts : record the net accumulation, as the result of transactions, of nonfinancial assets and the financing, by way of saving and capital transfers, of the accumulation. Net lending/borrowing is the balancing item for these accounts.
3) Financial accounts : show the net acquisition of financial assets and the net incurrence of liabilities. The balance on these accounts is the net change in financial position.
4) Balance accounts: record the stock of assets, both financial and non-financial, and liabilities at a particular point in time. Net worth is the balance from the balance sheets.
All these accounts may be measured as gross or net of consumption of fixed capital. It is easy to estimate the output produced by a single firm. But just estimating the output from every single economic player and summing it, is not a reliable measure. Example: a pasta producing company is facing 2 production scenarios in 2 years in a given region. In the th e first year, there is one Firm A which produces 100 tons of Pasta, each ton is valued at 1000 dollars. That is, total output equals 100*1000= 100 000 dollars. Now let it be supposed that in year 2, Firm A reorganizes itself and splits in 2 firms- A1, specialized in making the flour, worth 30 000 dollars, and selling it to Firm A2 which carries the final production of pasta. Both A1 and A2 are belonging to the same manager as in the first year. However, now, Firm A2 will be producing again 100 tons of pasta, for 1000 dollars per ton. But the national accounting will record firm A1 as well and would add to the total output of the region where the firms are operating, 30 000 dollars. dollars . So, in the second year we will have 130 000 00 0 output, or 30% of growth. Well, it is evident that this is absurd as the firm that is generating the output the same is. The 28
difference is only that in year 2, a restructuring is done. This fact exemplifies the difficulty in “just” adding the total output produced by all economic actors. Thus, another methods are needed.3 From the paradox as outlined above, the concept of calculating the “value
added” emerged.
The simplest definition of this is the value that each firm adds to that of the firms that supply its inputs. Let the above example be considered again now. Compared with the situation in the first year where there was only Firm A, the added value by Firm A2 is not 100 000 doll ars. This is because Firm A2 buys flour for 30 000 dollars from Firm A1. In the first year, firm A made the flour by himself and thus, the produced flour was not recorded from the national accounting as an output. Therefore, in year 2, the national accounting suggests to calculate the value added from firm A2 as 100 000 – 000 – 30 30 000 dollars. In other words, the value of the firm’s output minus the value of the products used to carry out its production during this period. The products consumed in the production process during the period are known as intermediate consumption. By subtracting this value from the output of the currently currentl y observed entity, one eliminates the double counting that appeared in the beginning of our example. In the second year, the output of flour was in fact counted twice- once as output of Firm A1 and then as part par t of the final output of Firm A2, although output of Firm A2 pasta and not flour flour is.4 If this reasoning is applied to all firms, then double counting is eliminated and value added can be estimated, independently independentl y how firms are organized. In order to illustrate it more comprehensively, let a third entity be included, a farmer, who is supplying the flour. Let it be assumed for simplicity no intermediate consumption by the farmer, that is, flour is produced solely by machinery and labor.5
3
Lequiller 2014 Lequiller 2014 5 Lequiller 2014 4
29
If we perform this operation for the whole country, we will arrive at the fact that = ∑ (1)
As you have seen from the table right side of (1) can be decomposed in ∑ = ∑ − ∑ (2)
Adding (2) into (1) yields: = ∑ − ∑ (3) This is, by far, not the whole procedure of the GDP-calculation. An essential part of the GDP calculation is constituted by the so-called so-called “three fundamental equations”. Check the “Recommended Readings” part for a com prehensive explanation exp lanation of them.
30
IMPORTANCE OF THE GROSS DOMESTIC PRODUCT 6
Let us now come to the importance of GDP. It is the most frequently used indicator in the national accounts. It lies at the heart of the entire system of national accounts,and its definition is internationally agreed upon. GDP combines in a single figure all the output carried out by all the firms, non-profit institutions, government bodies, and households in a given country during a given period, regardless of the type of goods and services produced, provided, of course, that the production takes place inside the country’s territory. The indicator is important because it measures in fact the performance of the national economy as a whole. One can imagine that in case cas e GDP is high, that means that overall production pro duction levels are also high, from this follows that employment is high, thus, welfare in total would be also high as if more people are employed, then consumption is fostered, tax incomes are also provided for the state, and through not consumed money amounts, savings are generated, which helps the financial sector. By following this line of thought, it is pretty straightforward that the growth of this indicator is desired, in order to ensure the people’s overall well-being. well-being.
STATUS QUO- SLOWING GROWTH AND ITS IMPLICATIONS 7
With the outbreak of the Global Financial Crisis in 2008, the growth decreased worldwide. Beginning from Europe and North America, few years later, China and the other part of Asia followed. This is, however, not the full pictures. Some countries, like Russia, are experiencing slowing growth due to political reasons, that is, sanctions, imposed by EU due to the events in Crimea. It is also important to be noted that a single reason for slowing growth is not presented, rather a trigger, which, combined with other factors, is increasing the impact. The world economies are nowadays more interconnected than ever and thus, every business shock is making an
6
Jones 2015 This chapter is, in its whole, based on the report by the World Bank Group „ Global Economic Prospects- a flagship report“ report“ as well as on DESA- World Economic Prospects. Update as of mid-2016 31 7
impact on multiple locations, depending on where the shock occurred and what kind of trade relationships does the country of shock origin have. In the year 2015, the global growth, on average, amounted to 2,4% , and for 2016, no different picture is expected. While Europe’s growth is barely managing to surpass the 1% threshold, emerging markets are also slowing in their economic development. Africa as well. From this issue, the actual question emerges- what kind of implications does the slowing global growth pose to the world’s economic econ omic performance? Indeed, from a level of 2,6% in 2014, 20 14, global growth seems to be b e on the downturn. A big number of developing economies are struggling to sustain the high levels of growth that were provided at the beginning of the 21st century. Economic activities there declined, prices of commodities (raw materials or primary agricultural products that can be bought and sold) weakened, and global trade and capital flows decreased. While the housing bubbles in the emerging economies pose only a local risk, the recession in Europe has a direct dir ect effect on the trade volumes volu mes with the emerging markets and thus, leading to a decrease in them. A housing bubble is a process where the prices of houses are getting too high, due to unrealistic expectations of the market players. Still, the downturm both in developed and emerging economies fell sharper than expected. A particular concern should be placed on the developing countries as since the beginning of the new millennium, their growth was the highest one and thus, contributed to the world trade tremendously. In the last few years, however, their growth was slowing. On average, in 2015, the growth in this part of the world was 4,3% while in 2014, the level was 4,9%. For three consecutive years, the average growth level is slowing. This is unprecedented since 1980s. In China, the economic rebalancing is continuing and thus growth is slowed. With economic rebalancing, it is meant that China, being the world’s largest producer of labor -intense goods, is reducing its exports of these goods and concentrating on the internal consumption and production for fo r the internal demand (inside China). This is needed as the biggest customers cus tomers for Chinese exports are Europe and the th e USA. Both regions are experiencing lower growth and from this, demand for consumption is also decreasing. Thus, it is not profitable for China anymore to export that much goods to these regions. Instead, the country is trying to foster the domestic demand by appropriate means in order to compensate the breakdown of orders from Europe and USA. So, balance is shifted- from exports to domestic production. Brazil and Russia were additionally hit by some external policy pol icy factors. Declining demand for goods also imply decline 32
in commodity prices which is hitting countries, specialized in exports of particular commodities. So the contributions to the global growth by these countries got lower. However, there are some exceptions, mainly in South Asia. Countries like India managed to reduce the macroeconomic vulnerabilities and to implement successfully domestic policy reforms. Growth in low-income countries generally remained robust in 2015, despite the decrease from 6,1% in 2014 to 5,1% in 2015. African countries like Ethiopia, Rwanda and Tansania invested heavily in infrastructure, developed mining further, and fostered consumer spending. However, fiscal risks continued to pose danger to many African countries because of sharp increase in public debt and contingent liabilities. Apart from the decreased exports to Europe and USA, the slowing growth in emerging markets has also a direct implication on the poverty reduction. More than 40% of the world’s poor live exactly in the developing countries where growth growth slowed in 2015. Slowing GDP growth growth for them means less produced goods and services so people are going to work less and thus get lower wage or lose their jobs as there is not much to produce. Thus, a return to poverty can be expected. This slowdown of the global trade coincided with financial market volatility and a decrease in capital inflows. In expectation of tighter US monetary policy, currency pressures have intensified and borrowing costs increased, in particular for a number of commodity exporters. Significant nominal currency depreciation against the US dollar (that is, more currency units will be needed in order to exchange it for 1 dollar) are extending the size of liabilities, denominated in US dollars in the country’s balance sheets, thus, making it more expensive to service debts, denominated in US dollars. In contrast to developing countries, the recovery in developed economies was partly driven by increased domestic demand as labor markets recovered a bit and credit conditions improved. However, this recovery was rather more present in the US instead of Europe. With the exception of Germany and some Central and Eastern European states, the overall economic situation remains grey. The appreciation of the US dollar confirms this trend. As a major risk to the global growth, a faster-than-expected slowdown in China combined with a downturn of other large emerging markets is to be observed. Empirical estimates suggest that 1 percentage point growth decline in BRICS states, would reduce growth in other developing 33
economies by 0,8% and thus reduce global growth by 0,4 percentage point. This suggests a substantial risk of transmission through other emerging markets with potential negative effects for some advanced economies as well. In addition, baseline forecasts of a monetary policy tightening cycle in the US are subjects of uncertainty. A sudden readjustment of expectations about the future trajectory of US interest rates could cause some domestic fragilities and policy uncertainties in developing countries and so financial stess could emerge. Given the weak outlook and increasing vulnerabilities in many developing countries, these risks have the potential to be a source sourc e of damaging sudden stops stop s in capital flows for the th e fragile economies. Policies can play an important role in mitigating risks and supporting growth. A combination of structural and cyclical policies could prove mutually reinforcing. From this situation, the following implications emerge:
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Increasing financial market volatility. It rose noticeably in 2015 against the backdrop
of slowing activity in large emerging economies, diverging monetary policies of major central banks, continued declines in commodity prices, and fragile liquidity conditions. In this context, market adjustments to unexpected news have remained sudden. Following a correction from overvalued equity prices in China and an unforeseen change in its exchange rate regime during the summer of 2015, the VIX index of stockmarket volatility, often considered as a benchmark of global risk aversion, bursted to levels last seen during the Euro crisis 2011-2012. While there was no unusual stress in short-term funding markets or a credit crunch cru nch in any large emerging market, the summer market turmoil led to a sharp sell-off in developing country assets and a drop in capital inflows to those economies. Half of the 20 largest developing country stock markets saw declines in their indexes by 20% or more, compared with 2015 peaks. Currencies of key commodity exporters and developing countries exposed to political risk fell to multi year lows against the US-dollar.
Following this volatility, global investors withdrew withdr ew about 52 billion $ in terms of equity and bond funds in the third quarter of 2015. This was mostly driven by institutional investors reducing their exposure as a response to deteriorating confidence about longterm prospects. Bank outflows from China, combined with downsizing of economic performance in Russia in 2015, accounted for the bulk of the outflow from emerging 34
markets but portfolio and short-term capital inflows also dried up. Meanwhile, FDI inflows remained generally stable. International bond issuance by emerging markets corporates slowed significantly, particularly in the oil and gas sector. A bond is an instrument of indebtedness of the bond issuer to the holders. hold ers. Since 2010, bonds have ha ve been issued more often of ten to refinance debt than for investment purposes. As a concequence, some commodity firms have become highly highl y leveraged, that is, is , owning too much foreign financing sources s ources and thus issuing the majority of their stocks to the foreign investers which leads to losing control over the company in favor of those who gave the money. So are these commodity firms vulnerable to a combination of increasing borrowing costs (caused by currency depreciation against the US dollar) and declining commodity prices. Lets now have a brief look on the monetary policy of two world key players- United States and European Union. Following a first hike in December 2015, the pace of interest rate increase is expected to be gradual and notably slower than in previous tightening tighte ning cycles, reflecting in fact the low inflation expectations and US dollar appreciation. Legacies from the crisis such as elevated household debt and weak productivity growth, also because of the period of protracted interest rates. Since the tightening cycle has been widely anticipated, baseline projections assume a positive impact on capital inflows to emerging and developed economies. However, as financial market expectations are vulnerable to scares, risks of volatility during the fed tightening cycle remain significant. Continued quantitative easing by the ECB should keep in order the global liquidity. Negative interest rates in Europe could contribute to a further appreciation of the US dollar and have mixed effects for developing countries. On the one hand, the increase in cross-border lending from European banks and Eurobond issuance during 2015 is likely lik ely to continue as the Euro zone recovery becomes more firmly entrenched and as bank balance sheets improve. On the other hand, continued strengthening of the dollar could contribute to refinancing pressures in countries with significant dollar-denominated liabilities. Capital inflows to developing countries plunged to a post-crisis low relative to GDP in 2015. They are expected to recover slowly in 2016-17 as developing-country growth stabilizes. 35
A gradual shift from portfolio to cross-border bank lending flows is likely to continue, supported in particular by a healing European banking sector and ongoing policy accommodation by the European Central Bank. A gradual rise in global interest rates and continued weakness in commodity prices could affect Foreign Direct Investment decision, particularly in mining minin g and exploration, while the th e cost of infrastructure infrastructu re financing is expected exp ected to rise. Renewed eruptions volatility or increased concerns about developing country growth prospects represent some so me risks to this scenario. scenario .
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Renewed decline in commodity prices. Commodity prices fell further in the second
half of 2015. By November, the three industrial commodity price indexes- energy, metals, and agricultural raw materials went down on average 45% compared with the peaks in 2011. Abundant supplies, due in part to investment during the decade-long decade-lon g price boom, and softening demand are the main factors behind the continued weakness. The appreciation of US dollar, the currency in which most commodities are traded, has also contributed to the price weaknesses. Consider Consi der now the most important commodities separately. Oil: The price of oil (average of Brent, Dubai, and West Texas Intermediate) dropped below 40$ per barrel towards the end of 2015. Some analysts are forecasting a historic drop under the 20$-threshold. However, this is rather not probable. Low oil prices have been driven low by high stocks in OECD economies and expectations of slowing global demand (particularly from large emerging markets). US crude oil production declined due to intensive intensi ve investments and concentration of shale gas production. OPEC production increased further, reaching a threeyear high, with much of the increase coming from Saudi Arabia and Iraq. A removal of sanctions following the implementation of the Iran nuclear programme is also seen as a potential production increase source. The government of Iran confirmed several times that the “comeback of Iran on the world markets would become visible”. PrePre-sanctions level of Iran’s oil production amounted about 4% of the global oil consumption. As oil prices are directly or indirectly linked to other energy prices like natural gas, a lowering of prices of these energy products is also expected. exp ected. Metals: The slump in metal prices, which reached their lowest levels in more than 6 years in November 2015, reflects well-supplied markets as well as weaker growth in major emerging markets. New mining capacity came into operation in several countries, especially Australia, adding new volumes to the already abundant ones. 36
Agricultural commodities: Grain and oilseed prices dipped in 2015, mostly in response to wellsupplied markets, with the agricultural price index standing 33% below its early-2011 high as of November. The stocks-to-use ratio, that is, a measure of how well supplied markets are for key grains remains well above 5 and 10 year average levels. Supply fluctuations due to El Nino weather pattern seems to be unlikely to raise global food commodity commod ity prices in a significant way. Conditions remain in place for protracted period of low commodity prices in coming years. Oil prices are projected to average 49$ per barrel in 2016 and rise is only in a gradual manner projected. However, the forecasts didn’t really hold as in the beginning of 2016, in February and March, the crude oil price dropped at 31$ per pe r barrel. Metal and agricultural prices are likely to edge up in the range of 1-2%. This forecast is more likely to hold as till now, no drastic fluctuations are observed. While geopolitical risks and not advantageous weather conditions could lead to a more rapid recovery in prices, risks are rather on the downside.
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Global trade weakness: Global merchandise trade decreased in its size in the first half
of 2015, for the first time since 2009. As already explained, this was largely driven by a drop in import demands from emerging and developing countries. Growing import demand from the United States and the Euro Area did not offset the drop in developing countries import demand, which now accounts for a half of global trade. From this contraction of global trade, 4 trends are implying.
Lowering of GDP in Brazil and Russia: Recessions in these countries reduced import demand. Sacntions against Russia further reduced trade. More generally, sharp declines in commodity prices reduced export revenues and demand across commodity exporters, leading to a significant slowdown in imports from these countries. Rebalancing in China: As a result of an increasingly pronounced shift in sources of growth from trade-intensive investment and exports toward less trade-intensive consumption and services, import growth has slowed. Currency depreciations: Real effective exchange rate depreciations have been accompanied by a decline in imports in several countries but have thus far shown limited benefits for exports. This may partly reflect changes in global value chains that may be reducing the elasticity of exports to real effective appreciation. However, conventional trade which still represents 37
roughly half of the global trade flows, shows greater responsiveness to exchange rate developments. Stabilization of value chains: During 1990-2008, countries that were integrating faster into global value chains also saw more rapid export growth than others. Since then, value chains appear to have stabilized such that manufacturing sub-sectors with a higher degree of vertical specialization witnessed the largest deceleration in trade growth. Estimates for trade flows in 2015 and forecasts for 2016-17 have been revised down, in line with the weakened post-crisis relationship between trade and activity. Persistent weakness in global trade diminishes export opportunities but also the scope for productivity gains through increasing specialization and diffusion of technologies. This could continue to put a cap on growth prospects, particularly on more open and smaller developing economies.
POSSIBLE APPROACHES TO THE PROBLEM
Before we turn to the approaches, let us discuss the theoretical reasons for the slowing global growth. As these reasons are very big in its number, I will outline only the crucial ones. The mainstream economic theory, that is, the neoclassical one, defines growth as the rise of the aggregate production function of the economy as a whole. In the most cases, a simple example with a Cobb-Douglas production function is given. The function looks as follows:
Yt denotes the whole economic performance or the economy at time point t, A denotes the technological level of the economy, Lt denotes the quantity of labor employed at time point t, and Kt denotes the capital employed in the production process at time t. The parameter α denotes the amount each factor needs to be employed emplo yed in the production process, in percentages. percen tages. The sum of the exponents must equal 1. One need to pay p ay attention that in this case, under und er capital, we are considering only mechanical production factors like machines, NOT stocks, treasury bonds, etc. Of course this function is very abstract and neglects many real issues, but let us concentrate on the abstract level as the implications from this analysis would prove crucial for 38
the understanding of growth later. Just imagine that the economic output of the country we are observing is generated only through production of tangible goods. Growth for year t is measured just by relating the production level of the country for year t, to the production level for year t-1, that is, Yt/Yt-1. Now, by employing elementary mathematical reasoning, one may claim that growth can be generated just by increasing the parameters- A, K, or L. In practical terms, that would mean that technological progress, mechanization of production, and creating creatin g new working places should shoul d foster growth. Well, this is partially partia lly true. The keyword in this case is “marginal product”. Marginal product shows the change of the production function fu nction when one on e of the factors, by keeping keepin g all other factors constant, constan t, is changed. As the factors labor and capital are under exponents, exp onents, the derivative should be taken. The graphs of these derivatives are shown below.
39
The interpretations of the graphs are as follows: if the economy has a small initial amount of capital (machines), then adding a small amount extra capital would boost the productivity enormously. For labor, the reasoning goes in the other direction: a small initial amount of labor is very productive, however, adding more labor decreases the productivity as for example more people would service one machine and thus, the productivity prod uctivity could suffer. The increase of the factor A, that is, technolog y level, would be a different story. As A does not have exponents, the increase of A would not need taking the derivatives. That means if, for example, the number of new technologies in the production process doubles, then the whole output, generated by the production function will just double. This is not the case for K and L. Increasing them would lead to a bigger and bigger output lowering. At some point of time, the output wouldn’t increase anymore. These theoretical implications have found a broad practical confirmation. They hold mainly for the production process, but the phenomena can also be observed in other industries. Thus, one of the reasons for slowing global growth could definitely be the fact that the world production has reached its limits, according to the aforementioned production function. This is already the case for Europe and North America where, since decades, production is not emphasized that much as it was after the WWII. Instead of this, countries in Asia have developed themselves as the “world’s production factories”. However, the weight of these countries in the world’s 40
economic performance is still much smaller than the weight of Europe and USA. Thus, the production boom there cannot compensate compen sate for the t he slowing of the global growth. Additionally, the recession in Europe is causing the leading European companies to reduce their manufacturing orders in Asia as well as to import less from there. As Europe is one of the main customers of the production industry in Asia, the decrease of orders from Europe is causing an immediate impact on the production volumes in Asia. It seems that technology improvements also don’t bring the desired growth perspectives. A possible explanation for this is the fact that many technological improvements in fact reduce the humans employed in the production process. With these improvements, a company can produce more output, output , at a cheaper price, however, howev er, the absence of human hu man employees is causing causin g something that I will call it “withering of the economic chain”. This process is described as follows: a human employee gets a wage, pays taxes to the state, and I using part of his/her wage for consumption. With the payed taxes, the state could invest in public services which are crucial for economic activity (for example, roads, street lights, water and electricity infrastructure etc). The fraction of the employee’s wage which is spent for consumption, fosters the demand for the good and services demanded and an d thus, their production. With the production producti on of goods and services, the companies are operating and employees in these companies are getting their wages etc. This is a kind of cycle which every human employee is contributing to. On the contrary, when machines are taking over human employees, paying taxes by them and spending part of their wage for consumption is not provided. When the company that is employing the machine, buys the machine, then only onl y a single payment for the machine is made. In the case of having human employees, payments are made every month (wage). This activity withers the economic chain and hampers growth. In the past, technological improvements weren’t connected so much to direct replacement of employees through machines. Instead, the new technologies were employed by the existing human employees. So indeed, we are now in the middle of o f a process, so called “degrowth”. There is no single recipe how this question can be addressed. Some experts are suggesting to create more jobs through public investments, some are relying on the potential of “Industry 4.0” which is uncertain, and some are raising a voice that GDP growth is not an adequate measure for welfare anymore. In the last lines, I will discuss the last issue.
41
Put it more straightforward- imagine that you are driving a car. When the car drives more and more faster, this is nice, however, it could be the case that the engine will overheat soon. By observing the car from outside, you couldn’t really see whether the car’s engine is overheating. This simple example shows greatly the problem of using GDP growth as the sole economic performance indicator. Yes, the th e fast car is showing good performance, pe rformance, but for how long?8 In the economic field, this question is gaining importance. At the last annual meeting of the World Economic Forum, the Nobel Prize laureate, Joseph E. Stiglitz addressed the issue that GDP growth is not a good measure for well-being. The chief-economist of the Forum, Jennifer Blanke also addressed it by stating that in the current world of rapid technological change and demographic shifts, GDP falls short of measuring welfare.9 After all, GDP measures just the final goods and services produced in an economy over a given period, without any attention to what is produced, how it’s produced or who is producing it. Simon Kuznets, who defined the modern version of GDP in the 1930s, specifically warned against using it as a measure of welfare. Of course, GDP is highly correlated with a lot of the things that we prize in a society: good education, quality infrastructure, functioning markets. And yet, as has been long recognized, as a concept it is missing critical parts of the puzzle.10 Such parts can be as follows:11
IS GROWTH FAIR? Recent years have seen a significant rise in inequality across most OECD economies and it remains high in many developing countries. What are needed are good jobs, education and opportunities for improved living standards more generally. Researchers at the IMF and the OECD have started to measure the extent to which inequality slows growth through channels such as lower consumption. At an extreme, economies that are not inclusive risk societal unrest and breakdown, as we saw during the Arab Spring and elsewhere. It is not about how much is produced, but how the gains are distributed and the extent to which growth translates into broad based improvements in living livin g standards, touching all citizens citiz ens rather than the lucky few. This is
8
World Economic Forum 2016 World Economic Forum 2016 10 World Economic Forum 2016 11 World Economic Forum 2016 9
42
true at a particular point in time but also with regard to future generations. For example, are we building up debts that we will simply simpl y leave to future generations? Are we living at the expense ex pense of tomorrow? With public pension systems around the world, heavingly overwhelmed by the increasing number of pensioneers and at the same time, decreasing number of contributors, the question whether retirement schemes could provide adequate funds for the life after work should also be put on the agenda.
IS GROWTH GREEN? Another way to ensure that we don’t live at the expense of tomorrow is through responsible environmental behavior and ensuring that growth is as “green” as possible. It is not not just about how much we produce and grow but how we do it and how much pressure this puts on our natural environment. This is important in areas ranging from energy to agriculture to manufacturing of consumer goods and requires a focus on the how of production and also the life cycle of what we produce. Efforts towards developing a more “circular economy” where manufacturing pays attention to how inputs will be reused in future production (in a sense “recycling “rec ycling 2.0”) are an important part of this story. Environmental accounting accountin g can play a critical role, making sure that companies pay attention to and are held accountable for their environmental as well as financial impacts. The fundamental question here is - in what state will we leave the planet for ourselves and for futur e generations? Constructing a well-functioning market for CO-2 emission quotas should also be placed on the agenda. agend a. The reason r eason why wh y it failed fai led till now is to be found mainly main ly in the t he uncertain uncert ain willingness-to-pay of the actors involved in it.
IS GROWTH IMPROVING OUR LIVES? New business models that are both adding more value as well as holding the promise of a greener future should be investigated. Consumers around the world increasingly derive great value from new “sharing economy” business models models such as Airbnb and Uber, where we make more use of what already exists rather than simply producing more “stuff”. It is a question of adding economic and consumer value rather than quantity. And yet the shortcomings of GDP are also clear here since much of this value derived from new technologies is not picked up in GDP and productivity numbers. 43
Many developing countries have learned from the experience of advanced economies that simply focusing on GDP growth is not the way forward. Indeed, the considerations outlined above are in some ways even more acute for those countries that are still in the process of raising living standards, and it very much matters how they go about the “catch“catch-up” process. For example, the African Development Bank, and many of its regional member countries, emphasizes the importance of fostering growth that is both inclusive and green, not merely high. There is also an understanding in developing economies that it is important to focus on particular sectors in the development process - for example improving productivity in agriculture is widely seen to be of particular importance. Thus, some life quality indicators could be taken into account.
QUESTIONS A RESOLUTION SHOULD ADDRESS
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How should we measure welfare? Using GDP growth as the sole measure or also including other measures?
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Should we target our efforts on tackling the global financial crisis first and then concentrate on measures for fostering global growth?
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Which measures from the economic and fiscal policy set could prove effective in tackling the global financial crisis and/or fostering economic growth?
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How should we approach the problem of high youth unemployment- a ticking bomb with regards to future growth perspectives?
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Should we promote public investments in the economies or just rely on the concept of supply and demand?
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Industry 4.0- who are the winners and who the losers?
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Will the automatization of the working process enhance growth?
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Should a wealth redistribution (for example, exampl e, in form of various taxes) take place in order to diminish the wealth inequality?
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Should we further push on fostering globalization?
44
BIBLIOGRAPHY AND RECOMMENDED READINGS
Lequiller, F. and D. Blades (2014)- Understanding National Accounts , second edition. OECD publishing Jones, C.I (2015)- The facts of Economic Growth. Stanford GSB and NBER Crafts, N (2003)- Fifty years of economic Growth in Western Europe: No Longer catching up
but falling behind? Discussion paper, issued by the Stanford Institute for Economic Policy Research Broadberry, S. and L. Gardner (2013)- Africa’s Growth Prospects in a European Mirror: Mirr or: A
historical perspective perspective . The GAGE Chatham House Series, No. 5 Bunker, N. (2014)- A Post-War History of US Economic Growth. An examination of the
contributions to Growth of the components of Gross Domestic Product . Washington Center for Equitable Growth Radelet, S., J. Sachs, and J-W- Lee (1997)- Economic Growth in Asia. Background Background paper for the Asian Development Bank’s study st udy “Emerging Asia: changes and challenges”
Lee, J-W. and K.Hong (2010)- Economic Growth Growth in Asia: Determinants and Prospects Prospects . Asian Development Bank Economics Working Paper Series No. 220 World Bank Group (2016)- Global Economic Prospects , a flagship report Department of Economic and Sofial Affairs at the United Nations (DESA) (2016)- World
Economic Situation and Prospects Prospects . Update as of mid- 2016. Regling, K. (2016)- The European Economy after the Crisis . Presentation slides, shown in Singapore on the 18.02.2016 World Economic Forum (2016)- Agenda in focus: focus: Beyond GDP World
Economics:
Global
Growth
Monitor ,
available
http://www.worldeconomics.com/papers/Global%20Growth%20Monitor_7c66ffca-ff864e4c-979d-7c5d7a22ef21.paper
45
at:
Krugman, P., M.J. Melitz, M.Obstfield (2014)- International Economics, theory and policy. Pearson Series in Economics Acemoglu, D., J. Robinson (2012)- Why nations fail: The origins of Power, Prosperity, and Poverty. Crown Publishing Group World Economic Forum (2016)- Agenda in focus: Beyond GDP Regling, K. (2016)- The European Economy after the Crisis. Presentation slides, shown in Singapore on the 18.02.2016 AT Kearney, Global Business Policy Council (2014)- Beyond the Crisis: Sustained Global Economic Growth? The
Impact
of
the
financial
crisis
on
the
real
economy.
Available
at:
archive.intereconomics.eu/do archive.intereconomics.eu/downloads/getfile.php? wnloads/getfile.php?id=719 id=719 IMF
World
Economic
Outlook
Update,
January
2016.
Available
at:
http://www.imf.org/external/pubs/ft/weo/2016/update/01/info.htm De Grauwe, P. (2010)- The Financial Crisis and the Future of the Eurozone. Bruges Economic Policy Briefings
46
TOPIC B: ANNEX ON HISTORY OF GLOBAL ECONOMIC GROWTH
It may come as a surprise for some, but growth as a concept has been present only in the last 2 centuries. Let the following table be consulted:
For other world regions, cross-century cross-centur y data is barely available, however, the picture for the pre1830s is more or less the same throughout the world. The pattern after 1830s is also similar for other world regions, however, the timing is different as the main reason for the increase of growth (Industrial Revolution) did not occur all over the world simultaneously. After 1830, the growth levels jumped from 0.2 to more than 1 per cent. The main reason for that was the Industrial Revolution in Great Britain which lasted approximately from the 1760s to the 1830s. The change that occurred in the manufacturing processes, improved the productivity enormously. Before the Revolution, a big deal of the output was produced by employing only labor. The introduction of steam engines and the succeeding mechanized cotton spinning for example, greatly increased the output per worker in the textile industry. Other industries also benefited from this so in general, the added value improved greatly. From this, the increase of growth followed. 1930s and 1940s were time of international armed conflicts, thus growth was hampered as the majority of the means of production was employed in creating war machines and weapons. Additionally, many countries experienced severe collateral damages which did not miss production facilities. After the end of the World War II, growth in Western Europe marked the highest levels in history. The period from the 1950s till middle 1970s is known as the Golden Age of European Economic Growth. In that period, the Western European countries transformed in fact to welfare states. The rapid growth came mainly from the shift of the workforce from agriculture 47
to industry. In the postwar era, production was deteriorated and therefore, a need for catch-up emerged. Also the favorable macroeconomic conditions in these decades caused an increase in investments.12 In the middle of the 1970s, a phenomenon called “productivity slowdown” caused a slowdown to the growth in Western Europe. There were many reasons for this. Positive transitory factors were weakened, the returns to investments diminished as the postwar boom went on and a significant reduction in the scope of catch-up growth as the productivity gap with the United States narrowed. In fact, for many countries, this last factor may have been the most important. As growth slowed down, the postwar settlements came under severe pressure and became less capable of delivering wage modernization moderniz ation while capital found new options in a more globalized world. Till the 1970s there was also an increase in public publi c spending and taxation relative relativ e to GDP. Regulation of labor markets was also present. According to some experts, this was also among the reasons of the slowdown.13 In the 80s, 90s, and beginning of the new century, growth levels were fluctuating around 2%. USA may be considered as an interesting case. The country also experienced the Industrial Revolution as in the 18th and 19th century, the ties with Great Britain were good. However, the USA started with a certain lag. The main reason is to be found in the fact that the abundance of land and scarcity of labor in the ‘New World’ made it less attractive to conduct expensive investments in machine production. Nevertheless, the shift occurred, and the United States also enjoyed the benefits like in Great Britain. The growth pattern in the USA in the early 20th century was similar to those of Western Europe, and was accounted mainly to some breakthroughs like electrification, steam turbines, internal combustion engine. Some managerial concepts that originated in the United States in the early 20th century like the production line, employed emplo yed by Henry Ford, were broadly adopted, also in Europe. Eur ope. At the end of the 1920s, the United States became the largest economy in the world. While in Europe the First World War broke out, the USA economy flourished.14 However, in the 1929 the Great Depression occurred, and almost the whole world was hit. Global economic growth decreased on average with 15% p.a, and unemployment hit
12
Crafts 2003 Crafts 2003 14 Bunker 2014 13
48
unprecedented heights. What was the cause of the Depression, is still being debated. It is, however, widely accepted that the beginning oft he Great Depression was marked by the Stock Market Crash of 1929, called the ‘Black Tuesday'. The main events that triggered this crash were on the one hand, the overurbanization of the American cities as many people moved from small to large cities, in order to find more prosperous jobs. On the other hand, the overproduction of agricultural products, products , caused by the mechanization of agriculture contributed to the crash as well as the overoptimism of the investors who believed that markets will rise forever. When we add some speculations with financial instruments or raw materials into the equation, then it is clear that stock markets cannot sustain it. The graph below depicts the dimension of the Dow Jones Industrial Average Index. This index shows how the 30 largest publicly owned companies based in the United States have traded during a standard trading session in the stock market. Thus, we can say that this index is one of the major indicators of the performance of the US economy.15
Source: Wikipedia
15
https://en.wikipedia.org/wiki/Great_Depression ; ushistory.org 49
As said previously, the “Black Tuesday” as an isolated event cannot event cannot be accounted for the only reason for worldwide financial crisis. As can be seen from the graph, the recovery of the Dow Jones Industrial Average started few days after the crash. “The roaring twenties”, as historians say, were a time of booming business business activity. American firms earned huge profits at that time and invested a lot into expanding. By 1929 companies expanded to a bubble point. Workers were not able to fuel further expansion anymore, so a slowdown was unavoidable. On the other side, while corporate profits skyrocketed, wages increased only marginally. This sharpened the distribution of wealth. So the richest 1 % of the americans owned over a third of all American assets. Such distribution is limiting growth because of the fact that, in this setting, the wealthy wealth y people tended to save the money that might have been put back into the economy econom y if it were distributed among the middle and lower classes. Middle class Americans already stretched their debt capacities by purchasing automobiles and household appliances on installment plans. Thus, they didn’t have additional liquid assets, that is, for example cash. cash.16 There were also some structural problems in the American economy that led to the outbreak of the Great Depression. It should be notices that in those days banks operated without guarantees to their customers, were very light regulated, and they lent money to people that speculated in stocks very intensively. Prices of the agricultural production were low during the 1920s, leaving farmers with tied hands. Their situation worsened worsen ed as well as the impact of the Great Depression spread in Europe, forcing European customers to limit their consumption and thus, making them less keen on American (agricultural) products.17 The dimensions of the economic damage can be observed in the following graphs.18
16
ushistory.org ushistory.org 18 Source: Wikipedia 17
50
Change in the economic indicators for the time period 1929-1932
Source: Global Growth Monitor
Some European countries did not manage to recover until the very beginning of the Second World War. Germany was also one of those countries. Some historians clai m that the economic
51
damage from the Great Depression was the main reason for the rise of the national socialistic government led by Adolf Hitler. On the contrary, USA managed to recover smoothly, mainly through intensified interventions of the government into the economy. Banks were also stricter regulated. In this context, a special attention should be paid to the Glass-Steagall Act. This act is in fact an amendment to the Banking Act of 1933 and contains four provisions that forbid a bank to operate as a commercial and investment one at the same time. The act was abolished in 1999 and some economists argue that in this way, the trigger for the global financial crisis of 2008 was set. In the aftermath of the Second World War, the growth rates were the highest. Average annual growth was about 2,5%. The largest driver of it was personal consumption expenditures. Next were government expenditures, private investments, and net exports. This high level of growth sustained till 1973. The period from 1973 to 1981 is known as the “transition era”. The oil embargo of 1973, the second oil shock in 1978, and the abolishment of the Bretton Woods system triggered a period of slower growth and high inflation. inflati on. The US Federal Reserve brought the inflation partly under control by raising interest rates. However, a new recession was not able to be avoided.
In this period, annual growth was 1,4% on average, with personal
consumption being again the largest driver with 0,9%.19 The time period between 1981-2007 1981-2007 is labelled by the economists as “The great moderation”. This period of economic growth coincided with a period of low inflation. Income inequality also has risen. In this period, average growth levels were about 2,1% on an annual basis. Personal consumption was again the main contributor to it. Private investments, net exports, and government expenditures were the other posts that contributed.20 The growth development in Asia was very different from Europe and the Americas. Long time ago, the economies on the continent were rather closed and the countries of the region did not trade that much, internationally, compared with Europe. The Great Depression also barely affected Asia. Maybe the most remarkable implication from the Great Depression on Asia was the fact that China decreased its trade volumes with the USA tremendously. However, after the 1960s, the growth of the Asian countries was unprecedented in the human history amounting to an average of 5,5% annually. Especially East Asian countries grew tremendously for four 19
Bunker 2014 Bunker 2014
20
52
key reasons: they had a substantial potential for catching up, since they entered the 1960s with really low incomes. Their economies, structural and demographic characteristics were favorable due to the unaffectedness by Second World War. Additionally, the economic policies and strategies enforced worked in favor of a sustained growth. Due to the fact that East Asian countries have had on average very low wages, they decided to use this advantage in order to produce products that are labor intensive, but not very technologically technologicall y advanced. These products were exported to almost every part of the world. Politics managed to negotiate intensified free trade with the rest of the world, the currencies were made convertible, that is, able to be traded on the global currency markets, macroeconomic stabili ty was provided, mainly in the sense that inflation were kept under control, and some innovative institutions like export processing zones, duty exemption schemes, incentive packages for foreign direct investment were established. Rapid growth was also promoted by some demographic factors- literacy and education level increased, improved public health policies were implemented, and they contributed to the rise of life expectancy, to the agricultural sector was paid special attention by the government, thus, subsidies (financial aid from the state) for farmers were provided, and at the end, agricultural products were made affordable for the population, thus, increasing their disposable income, that is, the income that is left out o ut of the total income for spending or saving. savin g. Natural conditions cond itions such s uch as proximity to sea and natural harbours played also al so a role, however, howeve r, the main role was due to well organized economic and political institutions.21 Nevertheless, the continent contine nt was shaken by an economic econo mic crisis, “the Asian crisis of 1997”. 1 997”. Currently, some leading Asian countries, are showing slowing economic growth which is proving problematic for the rest of the world. This would be elaborated in the second chapter. The growth story of the African continent was quite different. Until the beginning of the 20th century, the continent, in its biggest part, was colonized. The main reasons for this colonization are to be found in the need for resources that various European Empires needed in order to sustain the welfare of their citizens. Most of the colonized countries served as exporters of raw materials to the empire that colonized them. This activity gained importance especially after the outbreak of the Industrial Revolution where the need for resources for processing by the new machines increased tremendously. The liberation of the African countries from their colonizers started roughly with the end of the first world war and was completed by the 1960s. 21
Radelet, Sachs, Lee 1997 ; Lee and Hong 2010
53
During the colonial time, information on GDP-growth is barely available, partly because of the fact that statistics were not run and partly because of the fact that, in case of empire had colonized certain African countries, these counties belonged administratively to the empire and thus, only aggregated statistics for the whole region were performed. However, as already said, the economic pattern of the most African countries until 1950s was exporting mainly raw materials which were abundant.22 It is important to note that after the African countries liberated themselves from colonists, their historical development was very heterogeneous. This have had important implications on their economic indicators. Thus, when it comes to aggregate conclusions about ab out the African continent, rather single countries or regions should be compared. For example, considering the chart below, yielding the level lev el of GDP per capita in South Africa, Afric a, Kenya, Nigeria, and Sierra Leone from 1950 to 2008. The GDP per capita in South Africa was throughout the whole period substantially larger than this of Kenya, Nigeria, or Sierra Leone. The GDP per capita of Nigeria was in year 1968 the lowest inside the compared group, while from 1972 to 1980 surpassed Kenya and Sierra Leone. The GDP per capita of Sierra Leone, in the 1990s, started to decline systematically, mainly due to the several civil wars that exploded in this period.
Source: Broadberry and Gardner 2013
22
Broadberry and Gardner 2013
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Indeed, the different resource endowments and unique political histories in the African countries implied so different growth paths. Sustained growth was not achieved. However, one is clear- the wealthiest African country is South Africa and this country is considered to be the economic leader of the continent. In the 19th century, the begin of the mineral discoveries was set. It became clear that the supplies of gold and diamonds are very substantial. This enabled some foreign direct investments and following, public revenue for the state treasury. This enabled the government to push state-led industrialization and so the country became the most industrialized one at the continent. Manufacturing outpaced mining and agriculture as South Africa’s leading industry by the 1970s. During the 1980s, however, increased political instability resulting from protests against the repressive apartheid regime, combined with a falling gold price, led to a period of economic slowdown, which lasted until 1994.23 Nigeria was a different story. Some tribal conflicts hampered their growth prospects in the 1950s. Due to its favorable geographic position, abundance of many important natural resources- petrol, gas, tin, iron, plumbum, zinc, as well as a lot of land, suitable for agricultural purposes, Nigeria established establ ished a clear example of a country countr y where incapability of political poli tical and economic institutions was a hindering factor for sustainable economic growth. Moreover, the fluctuations of oil prices as well as some civil armed conflicts in the 1960s made the economic situation unsecure.24 Kenya’s economic performance since 1950 has been less volatile, but is shares many of the countries, pictured in the Figure above. Its economic success in the 1950s and 196 0s was largely due to agricultural exports, but Kenya benefited also from its dominant position in East Africa. However, mismanagement of public revenues earned through the coffee boom in the 1970s along with the increasing of public funds for political patronage during the 1980s led to a poor economic performance. A short recovery came to an end after the outbreak of ethnic violence in the aftermath of highly doubtful national elections in 1992 and 1997. Droughts and high oil prices as a result from the Gulf war worsened worsen ed the situation further. furth er.25
23
Broadberry and Gardner 2013 Broadberry and Gardner 2013 25 Broadberry and Gardner 2013 24
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Sierra Leone enjoyed favorable growth conditions in the 1950s due to its abundance of natural resources as well. Until the early 1970s, the growth pattern was similar to Kenya and South Africa. However, a gradual transition to a one-party state and following a more and more repressive regime which culminated into a brutal civil war in the 1991 which declined the GDP per capita substantiall y. Recovery remained difficult difficul t task even until today. toda y.26 These 4 countries can serve as a representation of the different growth and economic patterns of the continent. As a summary, we can identify four patterns:
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Countries that, due to their natural resource abundance, managed to pursue an industrialization of their national economies.
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Countries where utilization of natural resouces was hampered by tribal conflicts.
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Countries where poor performance of political and economic institutions led to stagnation of the welfare.
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Countries that have established dictator regimes and thus, hampered their natural resource utilization.
Of course, we cannot always subordinate a particular African country to exactly one of these patterns, thus, mixing would woul d seem sometimes inevitable.
26
Broadberry and Gardner 2013
56
