World Bank Chief Economists Roundtable Transcript
September 21, 2011
MODERATOR: Good afternoon, everybody. Welcome to this two-hour discussion. You're thinking is probably the same as my thinking, and that is that this can be a very fascinating discussion. We are living in perilous times. There has been a lot of debate about Western Europe, about the United States. There will be a lot more talk during the Annual Meetings about the high-income countries. There has not been a lot of talk about what this means for the developing world and what the role of the developing world is, and this is an opportunity to fill that gap, and we have in the panel the best that the Bank can offer.
We have the Chief Economist of the World Bank, Justin Lin, in the middle.
And then, on top of that, we have all the six regional Chief Economists. So, let me start there at the end.
That is Indermit Gill, responsible for emerging Europe and Central Asia.
And then, Kalpana Kochhar for South Asia.
Shanta Devarajan for Sub-Saharan Africa.
Caroline Freund for the Middle East and North Africa.
And then, Bert Hofman for East Asia.
And Augusto de la Torre for Latin America and the Caribbean. They are all here, present.
My name is Hans Timmer. I was asked to moderate this and I'm inclined not to do that. Instead of moderating the discussion, I would like to stimulate the discussion.
So, the way we are thinking of organizing this is that we start with some observations by Justin Lin who will set the stage. And then, we will have, for the remainder of the first hour a kind of a debate between the Regional Chief Economists, first, on what the impact is on the Regions and the countries in the Regions and where the vulnerabilities are.
And then, the second part of that hour, we shift the discussion to the possible policy responses. After that hour, we still have another hour, and then we open it up for the audience and we can have an even broader debate.
So, let me start with Justin Lin, and I want to ask him how he sees the possible scenarios going forward for the world economy.
MR. LIN: [Off microphone.] Well, Hans, thank you very much, and welcome to the Chief Economists Roundtable, and I'd like to say this is the first time we've organized all the Chief Economists together to present our thinking, our view, about the global economy and the regional economies. And I think there is good reason for us to do that.
When we met in Washington, D.C., six months ago during the Spring Meetings, although at the time, there was some concern about the tsunami, the earthquake in Japan and its impact on the global economy. But at that time, you know, most people still comforted the global recovery will continue.
But now, things start to change because we see quite a number of uncertainties that may cause the global economy to turn into a new period, potentially, and "uncertainty" appears in the financial markets because we once again see the financial markets in the world in turmoil.
And also, the creditworthiness of high-income countries like the U.S. and so on, which had never been in question but now on both sides of Atlantic, quite a number of countries--some have already been downgraded; some may be on the watch list.
And we also see another concern about the ability of global banking sectors to sustain one or two major shocks, their "abilities" are in doubt.
And I think that these kinds of uncertainties and so on in effect are alarming to the developing countries, especially we see the evolution since August. Before that, yes, those kind of concerns has been there about the sovereign debt, about the banking, you know, capitalization and so on, but developing countries seem to be able to insulate themselves and continue, you know, their economic growth and recovery. But since August, things started to change, because we see further effects on emerging markets, with their spreads increasing about 70 basis points compared to the beginning of August.
We are also for the first time seeing equity markets, stock markets, in developing countries decline in parallel with the decline of the equity market in high-income countries, and globally we know that, you know, about 7 trillion value of wealth has "evaporated" [ph].
And so, this kind of situation certainly may affect the market sentiments in the developing countries and may cause investors to pull back their investment. It may also cause consumers to be cautious in their spending, and the decline, or the likely decline, of the investment for the consumption, its impact on growth may be at least equal to the impact of the decline in export market in the import to high-income country or can--[ends abruptly.]
MR. LIN: [continued]--even larger, and especially in the situation in high-income countries, you know, deteriorated further, such kind of impact we need to pay attention to.
And [unclear] scenario that we have in spring or two months ago to assume that the best scenario is that the developing countries is likely to continue the growth of 6 percent--this year--6 percent in 2012 may not be realized. We need to pay more attention to the downside risks, that's one thing.
And most certainly, we read the newspapers every day, the most attention, certainly, is still on the high-income countries in the Eurozone and so forth, but I think that the vulnerability of the developing countries also requires action, because we know that in the past three years the developing countries certainly fared quite well, and they have countercyclical interventions and so on and then maintain the high growth and became a driver of global recovery, but there are some costs, too.
We saw--because some countries, their current account deficit increased, and also their household indebtedness also increased. At the same time, quite a number of countries, their fiscal position deteriorated in 50 percent of the developing countries, their fiscal position deteriorated about 2 percentage point of their GDP and 40 percent of that--now, they have government public debt, 4 percent of their GDP.
So, therefore, we should pay attention to--and especially, if the growth in the developing countries, they slow down substantially, and there also a large downturn in the equity market, we need to pay attention to their banking sectors, because [unclear] in the emerging market and especially for those countries that have seen rapid capital inflows during the past two years, they have a lot of expansion of their credit as the source of their growth and so on, and they may be caught with a situation that leads to vulnerability in the banking sectors.
And also, I think that it is very important for us to draw attention to developing countries, certainly developing countries there are so many, and yet with different situations, and the way of the, you know, contagions or the "impact channel" mechanisms, and their ability [unclear] policy space will also be different.
So, I'm very delighted we have six Regional Chief Economists, and each specialize on a group of countries in their Region. So, I'm sure they will be in a very good position to tell you how to interpret their current position.
MODERATOR: Thank you so much. Thank you so much, Justin.
That indeed sets the stage. So, the world has changed since August. The probability of downside risks in developing countries has increased so that, indeed, see now how that works out in the individual Regions.
I said we will have a free-floating discussion, despite the fact that this basically is a media event, everything is on record, there will be a transcript, but let's not be deterred by that, and have a discussion.
First, I would like to go to Bert Hofman to talk about East Asia, partly because of practical reasons, because Bert has to leave very soon because he has to meet President Aquino of the Philippines, but also it's logical to start in East Asia because East Asia was in its center--China has been the driver of the global recovery, but now recently you see also there that growth is slowing and stock markets are coming down. So, my question is, do you see the impact that Justin described also in your Region and how do you see the role of the Region going forward?
MR. HOFMAN: Well, thanks, Hans.
Well, clearly, the Region is affected by this, and we're currently looking at our forecast, and basically we come out half a percent lower than we were in March in terms of growth for the Region.
China, we've already--so, we're dipping below the 8 percent, so 7.8 percent for this year. Our forecast in the next year will also be affected.
For China, we had already 9 percent on record last March and so, we need to look at that again and [unclear] 9 percent which is quite slow for China.
The situation, though, in--we're still quite comfortable, actually, here. That is quite a high--still a high growth rate, excluding some more severe events in Europe or elsewhere.
And to some extent, there is an upside to the turmoil for East Asia because just a few months ago, East Asia was battling against large liquidity inflows and currencies had to be appreciated with some risk for competitiveness for all kinds of measures to stimulate outflows of capital. So, this recent slowdown of capital flows gives some room for monetary policy to, if you want, normalize.
Normalization of monetary policy was on hold already over the last six months, and so this gives a bit more control of East Asian countries over their own monetary policy.
In case really bad weather hits, the Region still looks pretty good in terms of fiscal space, but one of the observations that I would have is, unlike 2008, if there is a major slowdown on the external front, probably that fiscal space can be used differently than before, namely to target much more domestic growth and to target much more stimulation of services, growth, stimulation of consumption, particularly for China but also in some of the other parts of the Region. So, there is room for, if you want, the stimulus if necessary, but that can also be done differently.
Looking forward in the medium-term, we also believe there's going to be relatively low growth in Europe and in the U.S. and therefore the structural agenda, the trade integration agenda, and the domestic demand agenda is going to remain very important for East Asia.
MODERATOR: Still a strong picture.
Let's go from East Asia to Latin America. It's a logical transition if only because Augusto yesterday published a report, "Long-term Growth in Latin America: Made in China."
Latin America has been remarkably resilient. Do you see changes now, since August?
MR. DE LA TORRE: I think--I think it's fair to say that there's a global recognition that August marked a change in the degree of global uncertainty and raised the tension to a level that was unprecedented.
The sense that most Latin America countries have now is, of course, they are hoping for the best and preparing for the rest, and of course the ability to forecast has been severely handicapped by this great deal of uncertainty.
I think in most of Latin America, we are generally and cautiously optimistic because we have had a fairly strong decade of progress in economic and social development. It not only has been a good decade for growth but also a good decade for equity and for strengthening of the--let's call it macro and financial immune system, and this is one reason why Latin America did fairly well in the previous crisis.
But what's in front of is I think is something extremely serious. The unresolved problems in Europe threaten a possible unraveling of market sentiment if it's not resolved appropriately, and it can lead to a fairly bad scenario for the world.
I think Latin Americans are envisioning two possible scenarios, and the sad thing is that the two scenarios are very, very different. One possible scenario is what in our report we call a great recoupling, meaning a scenario where financial channels get activated because tail risks materialize, financial markets spiral away, and as a result of that, global economic activity enters into a downward cycle, and in that situation, we are hoping that China has the fiscal muscle to upset but under that type of scenario, I would think that not even China's capacity to offset will do the trick and we may see our world entering into a global recession. In that case, the question is, how much shock absorbing capacity Latin American countries have.
There is another scenario which I think is more benign, and I hope [ends abruptly.]
MR. DE LA TORRE: [continued]--materializes, which is one scenario where, on total, growth continues to be low in the United States and in Europe, commodity prices remain high and China does not decelerate too much. That scenario, as Bert was saying, we'll actually get some relief, because capital inflow pressures and currency pressures may diminish, and growth may be still be possible. And that scenario is one that we call the continued real decoupling, meaning that you have stagnation in the center, in the rich countries, and continue positive growth in the emerging economies, including in much of Latin America.
So, that--I think that's our thinking. I mean, you see the behavior of central banks: They are preparing for a possible bad scenario, hoping for the better scenario but preparing for the bad scenario.
And how does this--it has translated into a general stalling of interest rates [coughing] in Latin America, interest rates by central banks have been raised very aggressively in the past 18 or 15 months. So, I think a big cushion in the Region, compared to other middle-income countries, is that there is, I think, greater ability to do countercyclical monetary policy.
MODERATOR: Yeah. We will have the opportunity to go into the policies later on, but hoping for the best and preparing for the worst, the best and the worst are these--are these two scenarios, you are saying?
MR. DE LA TORRE: Yeah, I think the great recoupling downwards of the globe, that's the bad scenario, and continued decoupling and real activity between emerging and rich countries would be the other, more benign scenario.
Let's go to a very different Region but also with a remarkable strong performance, Sub-Saharan Africa.
MR. DEVARAJAN: Thank you.
Africa also is expecting relatively robust growth this year. Our median forecast is about an average of 4.8 percent growth for the year, and that's just down from about 5.1 percent in the spring, and if you look at the--among the 15 fastest growing economies in the world, about 10 or 11 are from Sub-Saharan Africa, including Ghana, which is projected to grow about 13 percent this year, and several others.
But I would say that that's exactly why we are concerned. What Justin just pointed to, the looming threats in the global economy--the looming threats in the global economy, including a crisis in Europe and the United States and possibly a slowdown in China could have a profound effect on growth in Africa.
Just Europe alone--you know, 37 percent of our non-oil exports go to the European Union, and we calculate that about a 1 percent decline in European growth rates will reduce African growth rates by about .8 percent. So, it's roughly a one-to-one translation. The--and of course there are other ties, as well.
Now, it's easy to say, well, you know, Africa did quite well in weathering the last global recession. Growth fell but it didn't go into the negative zone. It came down to about 1.7 percent in 2009 and rebounded quite rapidly by 2010, but again, I think this time it's different, to borrow a phrase from Reinhart and Rogoff.
And it's different for two reasons: One is, African countries--the last recession actually used the fiscal space that they had built up in the previous five to six years to cushion themselves from an even worse recession, and that was quite appropriate. But then, again, as Justin alluded to, that means that they have much less fiscal space with which to respond, and let me give you one example, which is Kenya.
I mean, Kenya is one of the few low-income countries that didn't even have debt relief. They didn't need debt relief in the HIPC Initiative, but they've running now fiscal deficits of about 5 or 6 percent a year, and the debt-to-GDP ratio is over 50 percent. So, that leaves much less room to maneuver.
But the second is that the other reason why African countries rebounded after the last recession was that the policy framework continued to follow prudent macroeconomic policies. They were much more cautious during the global recession, and indeed you saw countries like Ghana and Ethiopia during a global recession in 2008 and 2009 actually contracting their economy because they had had a large fiscal deficit to start with. So, they were having to contract, and this was politically very difficult.
Now, having done that and having begun to show signs of rebound, if you're now faced with another global shock, just think about the political pressure that politicians are going to face if they say, well, we have to tighten our belts even more.
And so, I'm worried on both the political front as well as the economic front if there's another global recession.
Let me just add, though, that the other risks we're facing are not just a global recession. Africa is subject to a whole series of other shocks that could be just as damaging: Food and fuel prices, natural disasters, as the one we're seeing in the Horn of Africa, and possibly political turmoil with the events of the Arab Spring moving southwards.
MODERATOR: Thanks a lot.
Let's move north a little bit to the Middle East and North Africa and there are lots of political developments within the countries that might put even this global crisis into a shadow, but focusing on the global crisis, do you see already an impact from Western Europe into your Region, Caroline?
MS. FREUND: Just to go back for one minute, the world changed for the global economy in August, but it changed for the Middle East and North Africa back in January and in the spring, and that's still by far the main--having the largest effects on the economy of the Region.
That said, of course, global conditions also matter. So, this would be a shock on top of an already large shock.
So, back in the spring, we downgraded our forecast by about 1.5 percentage points because of business disruptions, drop in tourism, and a decline in investment, and now we see global conditions worsening and that has lowered our forecast for 2012 by about a half a percentage point, and now we see growth both this year and next around 4 percent.
In this Region, there is a lot of very different economies. So, on the one hand we have the oil exporters, and where we see, again, one of the fastest growing countries in the world, Qatar, with 20 percent growth, and then we also have the oil importing countries which are much more dependent on trade and on--and in North Africa on trade with Europe.
So, for example, Morocco sends about two-thirds of its exports to Europe while Tunisia sends over 80 percent; so, clearly there are effects.
That said, Tunisia's exports have actually increased early this year in part because of good agriculture conditions. So, there are some little bright spots that do tend to appear.
We've also seen larger than expected rebound in industrial production and rapid rebound in recent months in both Tunisia and Egypt.
In terms of being prepared for another crisis, one thing is, in 2008, surpluses in the Region, because of, in part, of the high oil prices at that time were around 12 percent of GDP. Now, they are much lower, around 1 percent.
So, there is less readiness, but again, there's a lot of variation in the Region where, in the GCC countries, there's been a lot of fiscal stimulus, they have room for more, and in some sense they're already prepared for a global downturn because the policy lag and implementation lag that can take a year to be felt, the fiscal stimulus could be coming on right at the right time were conditions to worsen.
So, I think in the oil importing developing countries, the risk is really from trade with Europe, and also remittances which are important for several countries, while, in the oil-exporting countries, a decline in oil prices will reduce somewhat their ability to respond and also their expected growth.
But again, the risks here are such that resolving the political and economic uncertainty within the Region at this point is much more pressing than global conditions--[ends abruptly.]
MODERATOR: Thanks a lot.
Let's move to South Asia, traditionally a Region less affected by the global economy because less integrated, but recently we see growth in India declining, growth in Pakistan sharply declining, stock markets coming down.
What is driving them? Kalpana.
MS. KOCHHAR: Thank you, Hans.
So, let me first say something that should be obvious to everybody: South Asia is, as a Region--is actually very difficult to talk about in a one-sentence kind of way, because you have India on the one hand and you have a whole bunch of other countries with very different circumstances, not just in the way that Hans described in terms of integration into global markets.
But let me--and also, let me just rewind a little bit to what happened after the Lehman shock. There was--an immediate impact was felt in India. You had stock markets declining, you had even money markets sort of declining, almost in panic, but it was very short-lived. So, overall, it was kind of a glancing blow to the Region and the recovery was quick.
They did manage to lower interest rates and put in some fiscal stimulus. Some luck was involved: India was going into an election period and had done expansionary fiscal policies just ahead of the collapse of Lehman Brothers and so that--the timing of that was good, and they were able to sort of come out of it.
This time around, I think the--you're already seeing, as Justin said earlier, Indian stock markets have--India is actually the only country in the Region that's globally integrated both on trade and on finance--Sri Lanka to a lesser extent.
You've seen the main stock market index fall, actually, as much or more than in advanced countries, certainly more than the emerging markets composite indices and so on.
So, what we've had is you had a big rebound, you had a pickup in inflation because these are chronically supply constrained economies, and now you are facing--and of course, the RBI, as some of you might know, went on an aggressive policy of tightening monetary policy and raised interest rates, I think, 12 times, for a total of 500 basis points, 5 percentage points.
And so, naturally, growth is slowing. There's also, unfortunately, some homegrown problems with regulatory uncertainty and some policy paralysis in India, but also in many of the other countries. I mean, Pakistan is one of them, Bangladesh another. So, as a result, the prospects are--in spite of the fact that they're insulated from the global economy on the financial side, the prospects are grim for many of those countries.
On the trade side, Bangladesh, Sri Lanka, Pakistan, they are still--their largest trading partners are the U.S. and Europe, and so they will feel the impact of a prolonged slowdown in both of those Regions. And there, again, those countries are less equipped as they were--than they were before to deal with that. We'll discuss that when we come to the policy issues and the risks going forward.
I just wanted to say, as well, that this is a Region that has amongst the lowest revenue mobilization, it has amongst the highest fiscal deficits and debt, and that's something to keep in mind when we discuss what their policy options are going forward.
MODERATOR: Thanks a lot.
In the meantime, Bert Hofman has announced--has left us and Ivalo Esvorsky [ph] is replacing him, so he will answer also the questions on East Asia and will participate in the debate.
There is a reason why I left emerging Europe and Central Asia for the last Region to be discussed, because first of all it was the Region hit hardest in 2008 with large macroeconomic vulnerabilities. And now, on top of that, you have the strong integration with the Western European banking system. So, you would assume there are a lot of vulnerabilities.
So, Indermit, how nervous should we be?
MR. GILL: Well, I think we should be nervous; I am very nervous. But you know, I think it's not easy to talk about Europe and Central Asia, because we actually cover 32 countries, Hans. 12 are members of the European Union, 8 are candidates for joining the Union, and this includes the former Yugoslavia, Albania, and Turkey, 6 are Eastern Partnership countries like Ukraine and Georgia that used to be in the Soviet Union, and then you have 6 more which--6 more that include Russia and the 5 countries in Central Asia.
And as you might expect, it's not easy to tell one single story about them, but to make things simply, you have an east side story of about 4--about 12 countries, and then you have a west side story for the others; all right?
Now, there is one thing common about them: When things are really bad in Western Europe, things get bad everywhere in the Region, the west side as well as the east side. So, essentially, when, in 2009, not 2008, when there was a big hit in Western Europe, our countries took the biggest hit among emerging economies, and what you actually found was that the Region shrank by 5 percent with the western part shrinking by a little less, actually, at 4 percent, and the eastern part shrinking by 6 percent; right?
Now, when things get a little better in Europe, the fortunes of the east and west actually diverge then.
And what we see is that the 12 countries in the east which really depend on oil and gas markets one way or the other, they do well if the price of oil goes up, and they are, I guess, a little like Latin America, only they are more integrated with each other because of a common past in the Soviet Union.
Now, the 20 countries in the west you find actually depend a lot more on what is happening in Western Europe, and this is the big export market and the source of finance. So, they are actually a bit more like East Asia because they depend on exporting to these advanced countries, but they are different from East Asia because they are integrated mostly with just one part of the word--with one part of the developed world--and because of a common future as part of the European Union.
Now, what we found is that their growth rates, since the crisis, have not been very high, essentially because Western Europe went straight from one global crisis to a regional one.
So, while the 12 countries in the east grew at around 4 percent--4.5 percent in 2010--the 20 countries to the west, closer to Europe, grew at 2 percent, and Turkey was the only exception which actually surprised everybody and it grew at 9 percent; right?
Now, this year, what we find is that, with oil prices above $100 a barrel, we expect the eastern 12 to grow at 4 percent--4.5 percent--again, the same as last year, and the western 20, we are finding are growing at around 3 percent. Now, Turkey is again surprising us. It is growing at around 6 percent.
But what we find--just like some of the other countries, we find that most countries have paid a price for this growth. What we find is that their public debt levels have gone up a lot so now have treasuries that are much weaker than they were in 2007, and this is especially true of the treasuries on the western side.
On the eastern side, they have much lower debt levels, and that has to do with public finance. What we find for private finance, we actually think that things are a lot better in the west.
Essentially, what we found were that private capital flows in the eastern 12 have behaved a lot like they did in East Asia after the 1997 crisis, in that they went down a lot.
But if you're closer to the European Union, what we find is that private capital flows were not reversed. So, essentially, these countries, the ones that are close to the European Union--and these are both the new member states of the European Union, as well as those that are going to join the Union, they are quite unique among emerging economies, in that they don't actually see these big declines in capital flows during bad times.
Now, essentially, what we find is that, as countries integrate more and more into the European Union, either by becoming members or signaling that they will become members, they become what we say is uniquely European; right?
And when I get the chance to talk again, I'll tell you why that's a very good thing.
MODERATOR: Thank you so much. We will have another 20 minutes to summarize the policy options that are available, and let's try to summarize that in some sound bites.
Let me start with Justin. You said in your introduction that the probability of downside risks has increased. You even said that it might be alarming for developing countries. There are a lot of policymakers gathered here now--the coming weekend. What is key for a global solution to avoid these downside risks?
MR. LIN: Well, as said, we should hope for the best. That means that those kind of downside risks, those kind of warnings I said will not happen; however, for the developing countries, it is very important for them to prepare in case the downside risk turns into reality.
And for that, certainly, countries in different category, their policy option might be different. Well--[ends abruptly.]
MR. LIN: [continued]--overall, I'd like to offer four directions.
The first one I think is very important to identify new drivers of growth for the economy. In the past, some countries rely on exports. Some countries rely on investment-led growth, and those kinds of drivers, you know, in consideration of the current short-term volatilities and also the likelihood of a protracted slowdown slow growth in high-income countries. There, I think it's very important for developing countries to identify new drivers of their growth.
And secondly, certainly, it's very important, as I mentioned, you know, in the past two years, some countries expend their credit very rapidly, and if there is some slowdown in the equity markets and so on may put a pressure on their banking sectors, and certainly we don't want to see some kind of homegrown banking crisis.
And now, there is some time, [unclear] time the country may have to find a way either to increase their capital or their banking sectors or find a way to have some kind of prudential regulations; that's my second, you know, policy recommendation.
And the third one is that we noticed, you know, the fiscal position in many countries in a way have less room now but if there is some downturn from outside and also because of the consumer and investors' sentiment, slowdown--their investment, their consumption, and their export and to avoid the increase in unemployment or the pressure on the banking sectors, some kind of government countercyclical measure will be important, but how to do that? I think they need to prepare.
And I think very important--maybe we need to consider temporarily increase the debt ceiling, but the [unclear] to be used in a way that can be ensure one creates demand, creates job, but in the long run support productivity growth, and they need to start to prepare those kind of projects on the shelf in case the government need to engage in the fiscal stimulus, they can use the money for the short-term purpose and the long-term purpose, and those kind of projects may be able to "self-replicate", so, temporary increase in the debt ceiling, the debt level, will be acceptable, and they can also turn the opportunity into promoting long-term growth; that's the third policy option, from what I can see.
And then, the last one, certainly, the need to rebalance the external exposure.
We see that in our capital flow in in the previous period, in the past two months, we see capital outflow again, but in the high-income countries, the need to rely on a continuation of very loose, very expansionary monetary policy.
When this kind of market sentiment and so on settle down a little bit, there may be another inflow of capital, and how to cope with that, and especially how to channel the capital into some kind of long-term direct investment to support long-term growth and create short-term demand and to avoid short-term volatilities. I think that, you know, the [unclear] thinking needs to start to prepare for that.
So, those are the overall four policy directions I would like to offer to my colleagues here, and certainly, you know, how to pursue that and which policies should be, you know, emphasized, I would say it depends on the country, and I think my colleagues will know better than I do.
MODERATOR: Okay. Thank you so much. So, based on that, I would have a couple of questions for Augusto.
So, Justin emphasized the structural policies to improve productivity. How important is that for Latin America?
Justin said, try to avoid a domestic banking crisis. How important is that for Latin America and how do you do that?
Justin talked about the capital flows and change the character of the capital flows; is that important?
And more in generally, I would ask--you said that the policymakers in Latin America are preparing for the worst, and they seem to be very successful there, and can other countries learn from that?
So, a lot of questions.
MR. DE LA TORRE: Okay. So, let me quickly go over two dimensions of what Justin has put on the table, and you, too.
I think there is one--one consideration is the nature of the transmission of the problems from Europe to--or the United States to our countries in the shock-absorbing capacity that we have, and the second is a consideration about how do we still protect your growth fundamentals.
So, let's talk about shock absorption first.
I think there are four lines of defense. All of them are very important and not every country has that similar capacity to deploy them. I think, by and large, the first line of defense, which is the monetary policy, Latin America has gained quite a bit there. Many countries in Latin America have regained monetary policy independence.
Latin America is a Region that is very integrated into world financial markets. So, having independent monetary policy is a great thing to have: You have flexibility in your exchange rate, countries have built quite a bit of international reserves, and they can move the interest rates independently as the economy needs.
A lot of room has been built to undertake countercyclical monetary policy if it is needed. For 15 or 18 months, central banks have been raising interest rates, so there is quite a bit to bring them down. Brazil has interest rates that are more than 1,000 basis points above those of the U.S. On average, Latin America has interest rates that are about 400 to 500 basis points above the U.S. So, there's room to bring it down. Let the exchange rate move to absorb the shock and use the international reserves as needed.
So, on the monetary front, first line of defense, many Latin countries are in good condition.
Central American and the Caribbean is a different story, but the large countries--then, you have the fiscal cushions. I think the general perception we have with my colleagues here is that the fiscal cushions are not as strong any place in the world as they were in 2008. They are not bad, however, in Latin America. I think there is a consciousness that, over the next months, it would be important to continue to build fiscal buffers, to make room for a more countercyclical monetary policy and also to prepare for the possibility of having a countercyclical fiscal policy.
The more comforting part in Latin America is that the local currency debt markets for governments have developed, and as we saw in 2009, Latin Americans did not leave the countries when the shock hit, and they may stay, which means that there may be available local funding for governments to finance themselves in local currency that's needed.
Then, the third line of defense is the financial sector shock absorbers, and I think the general perception we have is that some risks may have been built during the very strong credit expansion of the past years, but they are not systemic and by and large most Latin American systems have high indices of liquidity, capital, and provisions.
And finally, you have the social safety net shock absorbers, and there, I think the Region has led the emerging markets in creating the so-called conditional cash transfer systems, which means that, in many Latin American countries, we have a very good mapping of where the poor are and we have systems to transfer money to the poor families on short notice, and I think there was some experimentation in 2009 creating an ability to scale up those transfer programs.
So, by and large, I think the cushions are in better shape, most of the risks are coming from outside, but in a very bad scenario, even those cushions may not be enough. The bigger question for Latin America is precisely what Justin has mentioned, is that, so far, we have been growing--pushed by strong tail winds from commodity prices and capital inflows. Going forward, the challenge will be bigger because we will need to grow on the basis of productivity growth and more capital accumulation on the human and physical side, and that's a pending agenda for the Region, but shock absorption capacity I think is much improved.
MODERATOR: Thanks a lot.
Ivailo, Augusto just said that the general perception is that almost all countries have much less fiscal space. Bert Hofman seemed to suggest in his intervention that there might be some exceptions in East Asia.
Do you see a role for East Asia in a downside scenario for fiscal stimulus?
MR. IZVORSKY: Well—
MR. IZVORSKY: [continued]--I mean, clearly, East Asia has ample fiscal space. Certainly it's a bit less than it was before the crisis. Fiscal deficits now still are twice the level they were before--sorry--so, we have fiscal deficits on average that are 3.5 percent compared to less than 2 percent before the crisis. But there is ample fiscal space, with the exception of some countries that are apparently overheating--probably Vietnam, certainly probably Mongolia. I mean, there is room for governments to introduce fiscal stimulus packages.
Now, the question becomes, it is wise; to what extent; in what areas? And I think this is where the question now becomes much more relevant.
In China, for example, there is a very active debate whether the lessons from the first fiscal stimulus package which was both monetary, all right, quasi-fiscal, and fiscal-focused almost exclusively on infrastructure. Whether there are valuable lessons to be learned now so that the fiscal stimulus package that is more directed towards trying to rebalance the economy, improve conditions for low-income housing, introduce or strengthen the role of pensions, that could be a more useful fiscal stimulus package.
And from there, one probably could wonder whether China could have the same positive impact on the regional economy and on the global economy as it did during the previous crisis, when many observers noted that China saved the world. This rapid draw of imports from the Region and from the world actually contributed very substantially to global growth.
So, we're going to wait--watch that space and see what happens over the next several months.
MODERATOR: Thanks so much. That's a very important observation: For governments, it's not only the question of how much to spend but how to spend it in a situation like that, often forgotten.
Let me turn Sub-Saharan Africa and the MENA Region, North Africa and the Middle East, because both have similarities: Both very much dependent on Europe, Western Europe, we heard, and both very much dependent on commodity prices.
So, in that situation, what are the policy options?
MR. DEVARAJAN: Well, I think the policy option that we start with is the one that Augusto ended with, which is safety nets.
In low-income Africa in particular, that's pretty much the preferred instrument for cushioning poor people in particular against an adverse shock, be it a global recession or a spike in food prices or fuel prices, and there are actually quite a few safety nets now that can be scaled up.
Ethiopia has a program called Productive Safety Nets where people build small infrastructure in return for a daily wage, and at the last--during the last crisis, they just doubled the wage, with the same program and everything else. You were able to get some cash in people's hands right away.
And also, I want to add that the safety net prevents or helps us to avoid the temptation to slap on price controls or other types of policies that could be quite unproductive. So, it gives government also some room, political space, to respond to the crisis, but by no means is that enough, because as I said earlier in my remarks, I think the big fear is the policy framework and whether that's going to be damaged as a result of this crisis.
And so, I think one of the other things that we should be doing is preparing with a dialogue--with civil society, with the private sector, with academics in these countries about the appropriate policy framework today, before the crisis hits, so that there will be some political support when there's a temptation by some governments, at least to panic and do counterproductive things.
Now, in particular, and coming back again to Justin's point, I think one of the areas where we need to work on in Africa is improving the effectiveness of our public expenditures, because one of the reasons that we can't run even bigger stimuli is because the public investment system and the public expenditure system is so clogged that even if you pour more money into it, you're not going to get more jobs. You're not going to get more growth.
And so, if we can, again, in preparation try to improve on the public investment management, then you can flow more money into the system.
And similarly, I think we could be also thinking about using the crisis as an opportunity for some of the harder policy reforms that have been eluding us up to now.
One thing I see, and I've been seeing it at these meetings already, is the pervasiveness of petroleum subsidies in our countries. These are hugely costly. There is one country where it's 5 percent of GDP just for that one subsidy, and we know that they are not pro-poor. They are actually enjoyed by the non-poor. But politically, they are very difficult to remove. But if you can put it in terms of, this is what's going--the opportunity cost of the subsidy is the safety net, then you might be able to garner some political support.
And then, finally, I want to second what Justin said, that the big challenge for us how to diversify our economies. That growth that I was presenting in a positive light about 5 percent growth this year and some of the fastest-growing economies are all due to primary economies. They're really--you know, the reason Ghana is growing at 13 percent is oil. They've just discovered oil and they have oil coming on-stream. Now, that's good to have growth, but it's not a sustainable growth path, and until Africa is able to diversify its economy, diversify its exports, and create more labor-intensive employment, labor-intensive production, it will be very difficult for us to sustain that growth.
MODERATOR: So, going to the north of Africa, you see very many similarities, the same kind of external shocks, pervasiveness of oil subsidies, lack of diversification. Does that mean that also the policy options are also the same?
MS. FREUND: Well, I think there's a lot of similarity except that, in some sense, the Middle East and North Africa is at a different point on this timeline.
So, what Shanta mentioned is that the potential decline would increase the political support for food and energy subsidies. We've already seen that actually played out in the Middle East and North Africa. So, in fact, after the Arab Spring, this was a response across the Region to actually expand already high food and fuel subsidies and other policies that are difficult to sustain, such as increasing the civil service and raising civil service wages.
And just to mention--to add onto what Shanta has said--that in the Region, it's very common--Egypt has energy subsidies about 6 percent of GDP and since the onset of the Arab Spring, I think they've gone up to about 8.5 percent of GDP.
Yemen has energy subsidies, 10 percent of GDP. So, this is a real problem already in the Region and it's already been exacerbated by the events that have taken place.
A problem with this is that energy subsidies direct resources precisely to the energy-intensive industries which tend not to be the labor-intensive industries, so you end up in a situation where resources aren't aligned properly because of these subsidies in addition to how costly they are to the budget.
So, I think that reorganizing the way government spending is used to protect the poor is vital at this time, and it can both be used to stimulate the economy more and also, at the same time, to protect the poor better without costing anymore, simply by redesigning it.
This, however, is politically very difficult, because having subsidies in place is much harder to remove. So, I would really just like to emphasize what Shanta has said that, during this time, we have to be very aware of the type of policy and how to redesign it or, in the case of Africa, not to have it in the first place happen during this time, and I think that global weakness could provide an impetus to do this, because if fuel prices are lower, it might be easier to slowly remove those subsidies.
Iran has actually begun the process and used cash transfers in the place of the fuel subsidies, and this has been quite successful.
Just to add something different to the policy responses, there's also a lot of sovereign wealth, both in the Middle East and North Africa, East Asia, and other places, so I think there is some potential to use this wealth for development funds for the Region, and it's already been done on a smaller scale within the Region, but I think there's potential for expanding this during a downturn.
MODERATOR: Iran eliminated the subsidies overnight, completely, and then substituted it with lump-sum transfers. That kind of a shock therapy, is that an example for other countries?
MS. FREUND: You know, we're actually looking into that right now, whether it is.
Actually, one thing in our--I'm sorry--[ends abruptly.]
MODERATOR: I'll come back to you.
MODERATOR: South Asia, many countries in your Region, Kalpana, they really have no space anymore for cyclical response.
What do you do in a situation like that?
MS. KOCHHAR: So, Hans, you're right.
Let me just go back to--they don't have room for shock absorption, you're right, partly because they used the space in the previous crisis, and partly because, chronically, they are weak on policy space. But fortunately, the shock isn't that great because, you know, that isn't, say, as impactful as some of the other Regions.
So, I would actually say these countries, in some ways, are sort of unburdened by the firefighting needs or the immediate worries. So, therefore, in a word, I think there's one word that characterizes it--I said there was a different Region, but there is actually many similarities. These countries need investment. They have 1 to 1.2 million people entering the labor force each month for the next 20 to 30 years--1 to 1.2 million people each month.
They need to create jobs. Growth in South Asia has been rapid in many countries over the last decade or so, but it's been mainly on the back of productivity growth. This may sound counterintuitive, but that's basically what's driving it.
Now, they need to focus on capital accumulation in order to continue the growth and to continue to generate jobs for this large number of entrants into the labor market, and the range, 1 to 1.2, by the way is--depends on female labor force participation rates.
So, the point is, I think--and the other thing that they are unburdened by, unlike East Asia, is they don't have large external surpluses. They don't really need to look at rebalancing growth between domestic and external sources. So, in our view, South Asian countries need to look both inward and outward for growth drivers, as Justin was saying. External sources of growth are particularly important for the smaller countries, Pakistan, Sri Lanka, Bangladesh, but--and actually, there's--the salutary lesson, even from India--India is open to trade but over the last decade has aggressively diversified its markets. It now--China is the single biggest trading partner, which took over that position from the U.S. only a couple of years--a year or so ago, and India also has the peculiar nature of exports which tend to be a bit countercyclical when advanced countries slow, service exports from India tend to increase because they're associated with cost-cutting.
Anyway, the point is I think these countries do need to look at different growth so they need to focus on structural reforms to raise investment. as I said, 1 to 1.2 million people entering the labor force, and still the largest number of poor in the world, so, altogether, I think staying focused on structural policies, in particular on investment, I think is the lesson--is the policy advice I would give.
MODERATOR: Okay. Thanks a lot.
So, Indermit, you said that, in the case of a bad scenario in Western Europe, there's no difference between the western and eastern part of your Region; it's bad in both cases. So, let's assume that we are in a world like that. What is the priority, then, for the policymakers? What is the bottom line?
MR. GILL: I thought that you might ask me this question. I was also thinking about what Justin was saying about what are the four things needed.
Just two or three days ago I saw Robert Mandel being interviewed by The Economist, and those of you who don't know who Professor Mandel is, he won the Nobel Prize for economics in 1999 for his work on international monetary systems and optimum currency areas. So, he's obviously a good person to speak with at this time; right?
And he was asked, what needs to be done to increase the resiliency of the global monetary system, and his answer surprised me. He said, there are three things that the U.S. and Europe need, and they are growth, growth, and growth; all right? It is the only thing that can bring about--it is the only thing that can bring about a resolution of the European problem and the American problem.
So, basically, my first answer to your question, Hans, is, it's growth; right?
And the second one--
MODERATOR: So, how do you achieve that?
MR. GILL: You are absolutely right.
Actually, in a rare instance of good judgment, about a year ago we brought together a team to work on a report on European growth. So, I'm going to tell you a few things about that, too; all right?
But I mean, the first is economic growth, the second we think is more structural flexibility, which will help, and I think it is also what Kaufman [ph] has spoke about, and then the third one is actually more Europe--at least, in the case of Europe; right?
So, I'm going to tell you two or three things about each one of these.
The first one is, I would have shown you some charts, but Hans won't let me. I mean, we have a chart that shows the productivity level of workers in different countries in the European Union in 2002, and what you see is what you expect. You see that it is high in the north and it is middle in the south and it is low in the east.
Now, what should happen is that productivity growth should actually be low in the north, it should be--and it should be middle in the south, and it should be high in the east, and you see two of these things.
You actually do see high productivity growth in the east, which is [unclear] countries. You also see low productivity growth in the north, but what you see is that it is actually the lowest in the south; okay?
So, basically, what is happening is that the east is catching up and the north and the center have some productivity growth, but the south had negative growth; right? And we call this section of the report a three-speed union. The problem is that one part of the Union is stuck in reverse; right?
So, one of the things is that you actually can't--you actually can't have a Union with one part of the Union going in a completely opposite direction; right?
Okay. Now, so, I'll say a few things about the report. Now, when we actually started to work on the report last year, we went to Warsaw to talk with Governor Marek Belka [ph] of the National Bank of Poland, and I asked him what questions he would like the report to answer. I thought he would be the right guy to ask. He said he just had one question: He said, "We pretty much know what are the monetary and fiscal prerequisites for qualifying for the euro, but what are the structural and social prerequisites for a successful euro adoption?"
So, we thought it was a very difficult question to answer, but we thought it was the right question to ask; right? So, you know, essentially, if a country is giving up monetary flexibility and if it's reducing fiscal flexibility, it better have structural flexibility to withstand big shocks, because these big shocks are going to come.
So, essentially, what we did was, to answer the question, and this was--we actually looked at six parts of the structure of an economy, right, we looked at trade, finance, enterprise, innovation, labor, and government, and we tried to answer--in each of these questions, we tried to answer--in each of these areas, we tried to answer the question, what does Europe need to do? What does Europe need to do? And in two weeks we will actually release the report and you can see it.
But basically, what you find is that, if you want to be a productive part of the European Union, you have to be structurally flexible.
Now, I just want to end with one quick thing, which is that there are lots of people asking outside of the European--who are asking, if it takes so much to be part of the European Union, is it even worth it to actually belong there. And if you read our report, you will actually find that you would be convinced that it is actually a wonderful place to be in, especially if you are a poor country or a poor person. Essentially, what you see is that Europe--just as the U.S. takes in people one by one and makes them into high-income families, we find that the European Union takes in countries one by one and makes them into high-income economies; right?
Now, what--I wanted to show you another chart from the report--which Hans won't let me--
MR. GILL: --but basically, what it shows is that, if you look at a country's income level in 1970 across the world, and if you look at how it did over the next 30 years, right, you actually seen no relationship between its growth and its income level.
If you look at just the European 27 countries, you see a perfect correlation. The rich countries grew, but around 2 percent per year over these 30 years. The poorer countries grew at 4 percent a year; right? Essentially, what we wanted to sort of see was, you needed to--if you were close to Europe, you did not need to be very fortunate, like finding oil, and you did not need to be very ferocious, like the East Asian Tigers. You just had to be very disciplined, and I think part of the problem is the--[ends abruptly.]
[continuing]--these countries have to become much more disciplined, and we talk about that in the report as well.
MODERATOR: Thanks so much.
Discipline, structural, flexibility, and more Europe. That is very useful, and I am impressed that you can show charts without having them on the screen.
We have 50 minutes left--5-0--for an interaction with the audience and the media. If you are from the media, please state your name and your affiliation.
So let's start with the media--and we need a microphone over there, then, I assume.
QUESTION: Thank you.
My name is Danny Xufeng, with China Xinhua News Agency.
Now, the current crisis is kind of different from the one of several years ago. Several years ago, the banks in the euro area and the States lacked liquidity; but now, the world doesn't lack liquidity but growth. So, how can the world work out of the current negative feedback loop of the debt crisis, providing liquidity, uncertainty, and slow growth, and how?
Secondly, for the emerging economies and the developing countries, how can they prepare to draw the lessons from this crisis in advanced economies? Should they, including China, speed up the economic mode restructuring to get prepared for a worse economic scenario and less external demand? Should they avoid a high debt-driven economic and social welfare system?
MODERATOR: Whom would you like to answer that question?
QUESTION: Any chief economist.
MODERATOR: We are not going to get seven answers to every question, so let me start with Justin.
MR. LIN: Well, let me respond to the first question, that you see abundant liquidity, you see the uncertainty, and at the same time the slow growth may come, and how to cope with these kinds of challenges.
I would like to respond in two ways. One is to link liquidity to growth, because as you say, liquidity is not a constraint, but how do you put that liquidity into use that can promote growth and create demand--demand and growth now--and also, pave a foundation for high growth in the future so the project can pay back itself. And in effect, the World Bank has been advocating that--like infrastructure projects both in high-income countries and also in developing countries. And especially in developing countries, you see the bottlenecks of infrastructure everywhere. We know that in India, they have a plan to invest $1 trillion to $1.2 trillion in the coming five years, but they have a shortage of liquidity. Those projects, as long as you design well and implement with good governance, will create job growth now, not only in India but also the export market for the high-income countries and help solve the unemployment in high-income countries as well as pave higher growth in the future in India and then also create demand.
So we can turn this crisis into an opportunity by linking the liquidity to the [unclear] of growth to promote growth, and the World Bank is prepared to help do that kind of work, and the World Bank and the Singaporean Government have set up a center for excellence on infrastructure finance, and also the IFC, the International Finance Corporation, has issued some infrastructure bonds, hopefully to channel the excess liquidity and the liquidity available now into those kinds of long-term investment.
Secondly, about uncertainty, certainly we need to prepare if it hits, and as some of my colleagues mentioned, we need to prepare for the social safety nets now so we can help lots of poor people and lots of vulnerable people to weather the possible hit and so on. And the Bank can also prepare for that. We have some funds available from IDA, from the Global Food Response Facility, and so on, in case uncertainty turns into a downside scenario, we can prepare for that.
So that is my response to your first question.
MODERATOR: Thanks a lot.
Let me give Kalpana the opportunity to follow up on that and what are the challenges if you try to mobilize the existing liquidity to fund infrastructure projects.
MS. KOCHHAR: Yes.
Actually, as Justin mentioned, India is a very good example, but many countries in the Region face that same infrastructure deficit, if you wish.
But let's just stick with India for the time being. So, $1 to $1.2 trillion is what they are aiming for, and the question is how is that going to be financed. There are issues about governance, there are issues about choice of project, and there are issues about who does it, the public sector or the private sector. But let's just stick with the question of financing.
India is going to need capital from abroad. It is a high saving country, but that is not enough. The question is how do you manage this. You have waves of capital coming in, they cause macroeconomic management problems, but at the same time, you need this for development, and it is a real challenge. You have to make sure that they are modulated; you don't want them to come in in surges so that it complicates management. And I think the way to do it is to be really vigilant on your banking sector, make sure that whatever is going through your banking sector is done prudently, make sure that you have a broad range of financial instruments that can be used, bonds, including through the development of a domestic bond market, because these in fact are the best instruments for long-term investments like infrastructure.
And I think there is liquidity in the world. Now, how do you get that? There will be all kinds of countries, emerging markets and developing countries, competing for this liquidity, and I think every country is going to have to really work hard to set itself apart and to try to break away from the rest, which of course is difficult to do collectively.
MODERATOR: You will get three answers to that question, because Augusto volunteered, or even more, but let's stick to three, and then we'll go to the next question.
MR. DE LA TORRE: I just want to make two points on this issue of liquidity.
Your question is a very important question, but it is a question that should invite the world to really focus on what is blocking that. The reason why there is a lot of liquidity parked there is because there is high risk aversion. People perceive that there is a potential impairment of assets, of risky assets, so they have left all risky assets, and they are parked in U.S. Treasury bills and U.S. dollars and under the mattress--wherever people can, because of the high uncertainty and the risk aversion.
The only way you can escape that trip is through very decisive and clear policies. So the first premium is on the quality of policies in the U.S. and in Europe. Those are the countries that are creating the high level of risk aversion, and until the policy framework in those countries gets clarified, the world will have all of these resources without using them. In fact, what happens in the U.S. and Europe is precisely not a shortage of resources. You have workers, you have capital. It is just that the economies are not using those resources to generate growth.
So the first order of business is to remove global risk aversion through good policies so that you can use the available savings for investment. If you don't do that, the money will be parked away.
Second, for our countries, the next big challenge is not so much going to be on the side of saving constraints. What we are seeing in emerging markets is that emerging markets, compared to the emerging markets of the fifties, are no longer constrained by savings. So the issues have moved to two different dimensions. One dimension is exactly what Kalpana was saying. Do we have the right structure in financial systems that can mobilize and channel those savings appropriately to the best uses?
Now, that's a big challenge. Remember that in the U.S., we thought they had the best financial system in the planet, and they mobilized savings and channeled in a very wrong way and created the sub-prime crisis.
So, working on the quality of financial systems to read the appropriate signals, to move resources to the right places, to go long-term, to finance growth, is a tricky one.
And then, of course, the other side of the question is to have good projects. You may have all the money you want, but if you don't have good projects, you won't have anything to finance, and people won't finance it. So the ability of countries to generate good projects is crucial.
MODERATOR: Thanks a lot.
We'll go to the next question here--and please choose one of the panelists whom you would like to answer the question.
QUESTION: My name is Pascal Fletcher, and I work for Reuters.
You have made clear that the global situation presents great policy challenges for the developing countries, and quite apart from whatever the BRIC aid initiative might do or bring to the euro zone, do you think that this current situation opens an opportunity for developing countries to ask the leaders of the developed world and the advanced economies to perhaps redress or address some of the perceived imbalances in trade, the way trade and finance is organized in the world--I am thinking of farm subsidies and other long-term complaints from the developing countries. Is this an opportunity, or would that be not a useful and helpful exercise at the moment?
SPEAKER: And "you" is Justin Lin?
MODERATOR: Yes--or anybody else who wants to address that.
MR. DE LA TORRE: No, no, no. Please think of somebody.
MR. LIN: I'll be very happy to respond, and I'm sure that my colleagues will also have some ideas about this.
This question has been asked not only for three years, but I think maybe for seven or eight years. And I think that the trade imbalance from all kinds of analysis we know is basically a structural issue. And the structural issue is very important, and we need to address that, but that takes time.
But for the current situation, I think the most important thing is growth. If we can generate growth, we can restore the market confidence. But certainly, the best way to generate growth is at the same time as part of the solution for improving the structural balance. Certainly that requires some kind of policy thinking and policy design, and we have started to see things moving in that direction.
But in terms of the structural issue, I think we need to be a little bit patient, and currently, most important again is how we generate growth.
MODERATOR: You will get two answers, and the second one was Shanta, I wanted to say--but go ahead. You will get three very quick answers.
MS. FREUND: Mine is very short, so I think there will be time.
I just wanted to add to that something that came up during the financial crisis, which was a fear of protectionism, which actually never happened to the extent people feared, fortunately, so in that sense, the WTO really did work and the conditions it requires. But I think it is something to fear again in this round, especially if the European Union moves away from integration.
So just to say that I think a move to support free trade and also if the Doha Round could come to some kind of conclusion, that could be a very good indication of countries working together.
MODERATOR: Thanks, Caroline.
We go to Shanta and then to the next question.
MR. DEVARAJAN: Yes, but I think your question was really about things like agricultural subsidies and some of the longstanding issues, and there, I would take a slightly different tack, although I agree with what Justin and Caroline said, which is that it is a matter of domestic politics in the European countries and in the United States. It is not a question of the developing countries not asking for redressing these imbalances. They have been doing so for years. But we haven't seen much progress because the domestic politics has not changed in Europe and the United States. And today, with a crisis, I'm not sure that domestic politics--well, the domestic politics might change, but it might change in the wrong direction, so the chances of getting much traction there might be even less.
MODERATOR: Thanks so much.
QUESTION: Mr. Lin, Greg Brosnan [ph.] from Emerging Markets.
Under your worst case scenario for Europe over the next few months or the next year, what kind of an impact could we be looking at in terms of jobs and in terms of impacts on poverty?
MR. LIN: Well, okay. Actually, my colleagues in ECA Region or in MENA Region will be in a better position to answer, but I'd like to kick off.
In the first one, certainly we see the worst case scenario happened in separate channels. One, certainly the export market may be reduced. And we see Africa, North Africa, and the Eastern European countries and so on rely very much on the export markets to European countries. So that will be one channel.
A second channel certainly is likely to be remittances, because that is also a very important source of capital to those Regions I just mentioned.
And a third channel is certainly the financial flow. It may be causing some kind of outflow of the financial resources back, and it will reduce their ability to continue some kinds of financing for investment or consumption.
So those are three likely channels of effects from what I can see, but I'm sure my colleagues can--
MODERATOR: Okay. Following Justin's suggestion, Indermit, how bad can it get in terms of growth and jobs?
MR. GILL: Let me try to answer that.
Well, I think you had two parts to your question. One was poverty, and one was jobs. At least--
QUESTION: Growth and poverty.
MR. GILL: Growth and poverty. Well, at least in terms of poverty rates, as we looked to the last crisis, we saw how much poverty rates increased as a result of the last crisis and so on. At least in Europe and Central Asia, we have good social safety nets that actually help people keep out of poverty. That is not the problem. The problem is jobs. What we see is that already you have, I think, about one out of eight people unemployed in the Region. We expect this rate to now go down very quickly even if there is recovery. So, if in fact we have another setback, this will go down even more, and aid will get worse.
Now, the special part of this that we found especially worrying is jobs for young people. Essentially, what we find is that about three out of ten young workers are actually out of jobs already now. So you will start to see that stress a lot. And there are lots of things that one can do about it, but it is jobs that would be the problem, not poverty, at least in Europe and Central Asia.
Let's go to the next question.
QUESTION: Thanks. Adam Green from the Financial Times Africa Magazine.
I had a question for Mr. Devarajan. You spoke about using the crisis as an opportunity to take on some of the economically unproductive but perhaps politically expedient structures that exist in some countries, and you touched upon an issue, and I wondered if you could talk a little more about it.
With a number of countries in Sub-Saharan Africa confronting growing political unrest, how worried are you by the lack of, if you like, political space--we have talked a lot about fiscal space, but also political space--to galvanize the enthusiasm to actually take on some of these structures which all have a certain political logic to them.
Do you have any comment about how worrying that is for reforms and for making the most of the current problems?
MR. DEVARAJAN: Well, I think we can draw some lessons from what happened during the last crisis, where several policymakers actually used it as an opportunity to make some pretty fundamental reforms, including in the last crisis, oil prices came tumbling down at the peak of the crisis, at which point, the size of the subsidy was so small that some of them actually chose to eliminate it, so that when t he prices went back up, though, there was no subsidy, but it was a less painful way of doing it when prices were down.
There were also opportunities for banking sector reforms in countries like Tanzania and so on, which actually were somewhat longstanding, and they were able to put them in place.
But I think the lesson from the Arab Spring is almost going in the other direction, because many of our leaders are beginning to realize that, as Caroline was saying earlier, there were these subsidies and other distortions in the economy that were eating into the social fabric to the point where then they exploded. And we have some of those subsidies and some of those distortions in Africa, and in discussions with some of the leadership, they are saying, well, let's try to do something about them now. I mean, it is galvanizing support for trying to do something, because now they are seeing what the downside risk is.
I have been asked to write notes on youth unemployment in dozens of countries because this is a worry suddenly coming into sharp relief.
MODERATOR: Thanks so much for that.
Let's go to the next question.
QUESTION: Hi. My name is Kanya DiAlmeda [ph.] from the Inter Press Service.
I'm sorry, but my question was equally for Ms. Kochhar, Mr. Devarajan, and Mr. de la Torre. You can decide between the three of you who will answer.
I want to press you a little bit on the question of alternative economies, specifically in Asia.
[continuing]--Africa and Latin America, the growing movement of, for example, credit unions, worker coops, peasant collectives. And I would like to know if you think that there is space for these alternative economies and alternative currencies within the dominant sort of new liberal framework in which development is taking place, especially since there has been a lot of concern that multinationals and to some extent also the state itself has acted to prevent the blossoming of these alternative economies.
So, do you see a future for these economies in these Regions, and if so, what does that look like?
MODERATOR: Let's ask Kalpana and Augusto to answer that question.
MS. KOCHHAR: Let me take a shot at it. I'm not sure I will be addressing your question, because I'm not sure that I fully understand it, but anyhow, look, one of the things--and I am going to take it in a slightly different direction maybe--let me talk again about India, but this applies to other countries in South Asia as well.
Financial inclusion is a big theme, right? In a country like India, for example, you have a very large banking system if you measure by the number of banks, but you have a very limited banking system if you measure by the assets, 35, 40 percent of banking system assets, to GDP.
So, yes, there has been a movement to try alternative forms of getting people into the financial--more formal financial system--and they have not been without flaws, but I don't think it is right to say that multinationals have not supported it. In fact, I think, for example, the Bank has been very active in supporting, say, microfinance institutions, the Bank and the IFC, in India.
The problem there, I think, is that so far--and this is a problem that is not just unique to South Asia; it has actually happened in Latin America and also in some parts of Europe--the focus has been on credit, pushing credit out. In fact, the lesson we are learning is that in order to make that a viable model, you really need to have risk management, savings mobilization, and credit, so the whole range of services, available to these people. And I think we are learning those lessons and trying to incorporate those also in our operations in those areas.
MODERATOR: Augusto, do you want to add on the role of the informal sector in Latin American countries?
MR. DE LA TORRE: Yes and no, because I was going to talk about alternative economies, believe it or not.
There are several organizations and organizational arrangements in Latin American countries, particularly in the Andes, where the peasants and the indigenous people have made communal arrangements to organize production and distribution, and there are actually some very good success stories of these types of arrangements. They have been arrangements that have facilitated a number of good things. They have facilitated the maintenance of indigenous identifies. They have facilitated the flourishing of some artisan re-work which these communities are very good at. They have allowed them to pool resources and to therefore have a better entry into the market system, one that is possibly fair. And they have also allowed them to share technologies and improvements. Some of this has been facilitated by microfinance experiments, which in the Region have been very prosperous.
So I think there are some good stories about this. What we have to be cognizant of is that there is a limit as to how much they can do for overall growth. These are arrangements that facilitate the sustenance of living standards for some communities, protection of values and identities, some pooling of costs and some pooling of risks. But in terms of getting growth potential out of that, really, that will depend on a broader integration with a bigger economy.
When these alternative economies go too much in the direction of isolating themselves from the market, the success has been much lower, and many bad experiences have happened.
So, without exaggerating the benefits, there have been some good experiments, but there are also some risks if you create little islands within a country of these types of alternative economies.
MODERATOR: Thanks a lot.
The next question comes here from the table.
QUESTION: Chris Wright [ph.] from Emerging Markets newspaper.
My question is around South Asia, if I may--two, if I can.
On Pakistan, I wondered if you could speak a little on the outlook that you see for that country, particularly in light of the IMF programs coming to an end with apparently so much still to be done and achieved.
And secondly, on India, clearly, a great challenge for the central bank at the moment with high inflation at exactly the same time as threats to growth through the integration with the global economy that you outlined. How do you think the Reserve Bank is doing and what ought its priorities to be?
MS. KOCHHAR: Yes. Let me start with the second question first on India.
Yes, high inflation, and it has actually been high inflation for a couple of years, driven initially by food prices and then, very quickly, it went into core non-food and non-energy prices.
The RBI, I think, has done a good job with trying to put a lid on demand pressures. A lot of these demand pressures, by the way, you also have to be cognizant of, are coming from a big increase in rural demand which is a result of the push for inclusive growth, the number of major projects, the National Rural Employment Guarantee scheme, all kinds of infrastructure projects in rural areas, and so on.
So, on the one hand, it is a good story--you have more money in the hands of the poor and so on and so forth--but it is straining the resources of the economy, and that is causing inflation.
Just one final word on that. I think you asked--the momentum of inflation is actually coming down. One of the problems that you find when you look at year-on-year changes in inflation--so, annual changes in inflation, which is the way the RBI likes to look at it--is that you miss turning points. And actually, if you look at something that is more sequential, say, monthly inflation rates, it is actually starting to come down.
So I think if I were to say how they have done, I think quite successfully, they have brought inflation down, and with it, of course, you are going to see a slowing in activity, but that comes with the territory.
Pakistan is complicated and not very positive. Growth is slowing. It is actually the slowest growing, I think, in the Region. Inflation is very high. Tax revenues-to-GDP are on a secular decline. They have now fallen to something like 9.5 percent of GDP. And they have massive problems in the power sector arising from governance, arising from financial problems, arising from the fact that they haven't adjusted rates, and so on.
And then, yes, the ending of the IMF program is another blow, is another set of risks.
Look, so far, on the external front, there is a positive story--they have remittances that have done well; exports have also done well--but clearly, that is risky in this environment--we have just finished talking about how the global economy is looking weaker. So I must say the prospects for Pakistan are certainly uncertain and not very positive.
MODERATOR: Thanks, Kalpana.
The next two questions will come here, from the front row.
QUESTION: Thank you.
My questions go to Shanta. I am Kolbena [ph.] from the East African Newspaper.
My first question is what is the outlook for the East African Region.
You also mentioned in your opening remarks about the possible effects of a euro zone crisis. I am wondering to what extent you see the euro zone crisis affecting the East African Region.
And third, how should countries respond to such shocks, and going forward, what do you think countries should be looking at in terms of enhancing their growth prospects?
MR. DEVARAJAN: I'll try to be brief; there were lots of questions there. And maybe we can speak bilaterally afterward.
The outlook for the East African countries is slightly below the African average for two reasons--and the African average was 4.8 percent, which is what I said earlier--for two reasons. One is that the crisis in the Horn of Africa has brought down the growth rate in the big countries like Kenya, Ethiopia, and so on--not by much; it is about 0.5 percent of GDP, but that still can be sufficient to bring you below the average. The other is that these countries, with one exception, are not as mineral-intensive as some of the West and Central African ones. So, for instance, Ethiopia and Kenya don't depend that much on minerals. The exception is South Sudan, which is an oil-producing country, and also the newest country in East Africa.
[continued]--On the euro zone, again, the links are actually tighter with West Africa, particularly the Francophone West African countries, but there are some exceptions. Kenya, for instance, exports cut flowers and other types of horticulture to the European Union, and in fact, we have already seen a slowing of the growth in horticultural exports. The idea is that when times are bad, you don't buy as many flowers and other luxury goods, or something like that.
And the second big source is tourism, which again, it is European tourism that affects East Africa.
And how to respond is basically what we were talking about earlier--the safety nets--and I mentioned Ethiopia as an example of that--and preparing the policy framework so that if a crisis hits, you will be able to adjust without having to delay or reverse reforms that might be counterproductive.
MODERATOR: Thank you.
The next question, here.
QUESTION: My name is Matelova Cache [ph.] from De La Monde [ph.] in Uganda.
The first question goes to Justin. You did mention that in the first crisis, African countries managed so well. Now, the second looming crisis, there seem to be worries that they may not manage so well, because they are left with very little fiscal space. What is your advice? Should they go on borrowing from the multilaterals? What should they do in case it becomes a reality?
Now to Shanta. You did mention something about diversification of African exports. The question is what strategies should they use to diversify their economies, stock, exports?
MODERATOR: Let me start with Justin Lin.
MR. LIN: Well, I think that maybe if we reverse the questions--the first question to Shanta, the second question to me--we will be in a better position to respond.
MR. LIN: I think that African countries overall are resource-rich countries, and that is their comparative advantage. And they need to continue to benefit from the resources. But resources alone will not be enough for them to achieve sustainable and inclusive growth, because we know that resource exploitation is very capital-intensive; it generates high revenue but not many jobs.
However, you have a huge youth employment issue. So it is very important for resource-rich African countries to use their revenue from resources. On one hand, certainly, you need to save some to prepare for the volatility in the global market, and secondly, you should use those resource revenues to facilitate structural transformation by improving infrastructure, by improving education, and by making investments in labor-intensive manufacturing sectors or service sectors to be competitive, just like in this country and in every country. They are doing quite well, so they can move from resource-rich countries to other sectors and continue their dynamic growth in a very inclusive way. I think the African countries have a lot of potential for that.
Certainly, African countries have some that are not resource-rich, like Ethiopia and others. But I think the most important resource for any economy is the human capital, the labor force. So they also have opportunities to diversify, to be labor-intensive, starting from low-skill, labor-intensive sectors and gradually accumulating human capital, physical capital, and climbing up the ladder.
And I think it is a good opportunity for African countries now. I delivered a UN-WIDER lecture in Mozambique, talking about in a multi-polar world in which emerging markets like China, like India and others are growing very dynamically, wages are increasing very rapidly. That means that their labor-intensive manufacturing sectors will gradually need to relocate to other countries with low wage rates. And I think that low-income countries, certainly in South Asia and other parts, but also African countries, can benefit a lot from that. And especially labor-abundant countries should grasp that opportunity to diversify their economies. If they can do that, I think there are opportunities for African countries to grow as dynamically as the East Asian countries, not only for a short period of time--it can be 10 years, 20 years, or 30 years.
MR. DEVARAJAN: Okay, thanks.
I'll answer the question that you asked Justin, since he did a great job with my question.
On fiscal space, you are right that countries, if there is a crisis, have to start looking for sources of finance. But I'm afraid the international financial institutions, including the World Bank--these are low-income countries, so our resources are limited. There is an IDA allocation for a three-year period, and that is fixed. So there are no additional resources to be had from the IFIs. At best, you can front-load it, so if there is a crisis today, and IDA is on a three-year basis, you can borrow off of IDA from Years 2 and 3 because you need the money now. So that is limited.
The other thing that is limited is, quite likely, foreign aid, the other official development bilateral donors, because--keep in mind where the crisis is starting--it's in the high-income countries, which are the main donors. And as we were talking about earlier, the politics in these developed countries today is one that seems to be rather, shall we say, unfriendly to foreign aid, and this includes some of the traditional aid donors.
So I think the two big sources that African countries can tap into for finance--one is the private sector, and in particular for these infrastructure projects that Justin was talking about--but to do that, the policy framework has to improve. That is why I was going back to the petroleum subsidies and some of the other distortions if they can remove that.
And finally but very importantly is domestic finance, domestic borrowing. It is an interesting statistic that of the African countries that ran fiscal deficits during the last crisis, 80 percent of that deficit was financed from domestic sources. So already, they realized that there wasn't any additional money coming from the developed world, so they have got to finance it themselves, and as the banking systems and the financial sectors develop, they are able to rely more on domestic sources.
MODERATOR: The next question comes from Carlos Braga.
MR. BRAGA: Thanks.
I take my cue from Indermit Gill, who said it is good to be in Europe. So I am the Director of External Affairs, and I sit in Paris for the World Bank. But my question is to Augusto, because if I understood correctly the two scenarios, in either one of them, you see low growth for Europe. The benign scenario is that although we have low growth in Europe, China and emerging economies will continue to be locomotives of growth.
The more negative one is that we have some kind of contagion, be it through financial channels, be it through trade, that will further damage the situation of emerging economies.
Now, just thinking through these two scenarios and the situation of European countries, Western European countries, right now, we all know that in terms of levels of debt, they have gone well beyond levels that we could characterize as reasonable. Our estimates that exist in the literature suggest that when you go beyond 80 percent of GDP, you are in the danger zone. Of course, each country is a case, but if we look at corporate level, household level, and public sector level in Europe, most countries are above 300 percent if we add everything. So, inevitably, you don't need to do any additional econometric study; but just go back to Shakespeare and look at Hamlet. We know that "excessive debt dulls the edge of husbandry." For those who are not on very good terms with Elizabethan English, this means that too much debt is bad for you.
So, how do you get--the question is the following, Augusto--how do you get out of debt? Typically, through growth, but you already took growth out of the equation.
[continued]--Through inflation? Through fiscal austerity or through adjustment or through financial repression, basically, allocating resources through negative interest rates.
So my question to you is do you see a dramatic increase in financial repression in European countries in the coming years, because growth is out of the equation; inflation doesn't seem a major issue; and fiscal austerity, probably we are reaching the limits in terms of the political situation.
MODERATOR: Thanks a lot. Lessons from Latin American for Europe, and you have some experience there.
MR. DE LA TORRE: Yes. You know, there is a very interesting stylized fact in Carmen Reinhart's and Rogoff's book, which is that when you look at long history, the pattern has been that the big financial crisis tends to be followed by a big debt crisis, and that is what prolongs the recovery of the economy, because you have a balance sheet problem first in financial, and then you have a balance sheet problem in the households and in the government. And some of that pattern is unfortunately before us, where much of the debt increase was related to the rescue efforts of the financial crisis that we had.
What we have learned in Latin America--and this is not something that we are proud of, but we have learned through the hard way--is that it is very, very hard to get growth rekindled without major relative price adjustments. And at some stage, the relative price adjustments become inevitable.
In Europe, what that means is that the euro would have to move, or something would have to happen with the currencies, and that is what people are fearing. So what people have in mind is can we get out of this trap of low competitiveness, high debt and low growth without abandoning the European project. And I think it is not impossible. It is still possible to do so, but it requires a very clear path of policy going forward for the leaders. We need to know how that project will be maintained while--what you need to do in this type of situation where you have these debt problems is you need to engineer in an orderly way a number of very important transfers within society, transfer from the rich to the less rich, from the more productive to the less productive, from savers to debtors. And those kinds of transfers require heavy-duty policy--heavy-duty policy--which is politically very difficult to implement. When the policies cannot do that to rearrange the distribution of transfers in a very orderly way, the need for relative price changes will become bigger, and I think that is the big conundrum for Europe.
When you look at the history of Argentina, Argentina for two years tried to get growth going again, but it couldn't get the politics and the institutions to create the types of internal transfers that were needed for the economy to snap out of that. In the end, it couldn't resist, and the convertibility had to be abandoned.
Now, that was Argentina, and it was extremely costly. I would suspect that something of that nature for Europe would be of a massive greater cost. So, relative to those costs, I think what is upon the European leaders is can they figure out a system to keep the European project moving forward while at the same time organizing the types of transfers that will be needed for balances to get restored so that growth can be rekindled.
MODERATOR: Thank you so much.
This has been a very broad-ranging discussion, and I would like to give each of the panelists 30 seconds for a final observation that you want to leave us with.
Let's start with Indermit--and no more than 30 seconds.
MR. GILL: I was going to take 15 seconds to answer this question about how to lower debt.
We looked at two countries that have actually successfully lowered public debt over the last decade or so. One was Turkey, which actually came down from about 80 percent to about 40 percent--and it wasn't just growth; it was also fiscal adjustment, and it was the appreciation of the lira.
The other one was New Zealand, but I am out of time, so I don't want to--basically, what I just want to say is that I have actually focused on the European part of the countries, because those are the ones mostly in focus right now. But I think I would actually say that most countries in the Europe and Central Asia Region are very fortunate countries. The group to the East actually has access to huge amounts of wealth in the form of oil and gas, or they have access to countries that have oil and gas. And the group to the West has access to huge amounts of accumulated wealth in the form of Western Europe. And what is great about Western Europe, actually, is that the people there are willing to share this wealth with the poorer countries.
But to make good use of either type of wealth, I think governments just have to be disciplined. They have to be much more disciplined. One of the nice things that we see in our Region is that you do see examples of countries, from Kazakhstan to Georgia to Turkey to Poland, that are actually showing how this can be done.
MODERATOR: Thanks a lot.
Kalpana, a final observation.
MS. KOCHHAR: Thank you, Hans.
I am going to make broad statements, because there are actually lots and lots of caveats, and as economists, we like to make them, but I'll restrain myself.
I will pick up on something that Justin said earlier. I think that in South Asia, this is really a chance to turn this crisis into an opportunity. As I said, they don't have to worry so much about fire-fighting. Some countries might be affected and so on. And they have not only a chance to turn this crisis into an opportunity, I think they have an obligation to turn this crisis into an opportunity given the number of jobs that need to be created and the number of people that need to be lifted out of poverty.
MODERATOR: Thanks a lot.
Shanta, what is your bottom line?
MR. DEVARAJAN: My bottom line is that from what I have heard in this very interesting--and I am very grateful for this discussion--the situation, the global economy, is actually even more precarious than when we started out.
I think Augusto's two scenarios--the recoupling or the decoupling--both of those actually pose serious risks for African countries. So I am on that side more worried.
On the other side, though, I think the discussions here and some of the questions demonstrate that there are things we can do. There are actions that we can do in preparation as well as in the event of a crisis, and that gives me some confidence that we can actually weather this the way we have done it before.
MODERATOR: Thanks a lot.
I'm going to skip Justin, because I want to give him the final word. So, Caroline, 30 seconds.
MS. FREUND: I'll use my 30 seconds to promote a report that is coming out right now, there on the table outside, and I think it fits with the session. It has our forecast for the Region, and it is called "Investing for Growth and Jobs." The main punch line of the report is really about governance, that if you don't have governance right, public investment doesn't promote growth, you get less private investment, and because of the distortions in the economy and rent-seeking behavior, the right industries that are driving growth and driving jobs are not moving forward.
So I hope you'll pick one up.
MR. DE LA TORRE: Two thoughts.
One, I think it is increasingly impossible not to think globally and act locally. What this conversation has shown is that it is impossible to think about emerging markets in isolation. There are a lot of things that we can do locally, but we have to think globally, and that is increasingly going to be the case.
The second point I want to make is that I think we are in the midst of a tectonic shift in the rotation of economic activity in the world. Emerging markets will continue to be more important, they will occupy a bigger role in the overall economic activity, but for a while, the rich countries will continue to be the center of finance. So we are going to have to live within a symmetry which will have huge implications for development, which will be that we will have real economic activity rotating to emerging markets, Africa, Latin America, an d so forth, but finance still concentrated in New York, London, and Tokyo.
MODERATOR: Thanks a lot.
SPEAKER: Very similar thoughts.
We actually from the East Asian perspective are in the midst of a 50-year transfer of the economic weight of the world to East Asia. East Asia now counts for more than one-fifth of global outputs, and it is going to be increasingly important in the future. This crisis is not likely to derail East Asia's progress as long as countries, led by China, are able to refocus their attention on what matters--urbanization, which has been driving tremendously growth in outputs; on providing conditions for energy security in a Region that consumes a lot of global energy and is accountable for a large share of global emissions; for ensuring that an innovative work force, an innovative--
[continued]--companies can flourish together with these well-connected cities. And we think that in the midst of this profound structural transformation, the authorities need to consider whether fiscal stimulus packages, monetary stimulus packages, are actually a distraction from addressing the structural challenges more than a way to cope with these temporary hardships.
MODERATOR: Thanks a lot.
Before I give Justin the final word, let me thank everybody for participating in this fascinating and very important discussion. Let me thank especially the panelists for sharing their thoughts.
But the final word, Justin.
MR. LIN: Well, thank you.
The purpose of this Roundtable is to hope for the best, prepare for the worst. And by preparing for the worst, we hope to turn the crisis into an opportunity for promoting sustainable inclusive growth. And I think we achieved both goals.
Through this discussion, we have a better understanding of the possible challenges that we may face and also, as the Chief Economist of the World Bank, as head of the Coleagues of Chief Economists, I am also very delighted to see that our friends, our colleagues, are prepared to help our client countries to take the opportunity to engage in the necessary improvements in governance reform in some of their programs and prepare some necessary projects with changes and to grasp this opportunity to promote poverty reduction and sustainable inclusive growth in our client countries.
I would like to thank you for your participation and also your very challenging but very informative and insightful questions.
Thank you very much.