EC120 Spring 2016: Week 24, Topic 19, Slide 0 EC120: The World Economy in Historical Perspective Topics Week 24: The Great Moderation and (for some, some times) the NICE (Non-Inflationary Constant Expansion) years, 1981 2007, before the Fall 1. The fundamental background: technological progress after The macroeconomic experience : broad global growth, punctuated by crises. 3. Japans extraordinary post-war experience: growth, capital flows, and financial crises. 4. Asia in the Japanese Mirror: growth, capital flows, and financial crises. 5. Contagion: the Asian crisis ( ) goes global: Brazil, Russia, Argentina. 6. Illusions of stability at the beginning of the 21 st century. EC120 Spring 2016: Week 24, Topic 19, Slide 1 EC120: The World Economy in Historical Perspective 1a. Productivity growth after 1980: The Background Once again: the over-riding importance of productivity growth for welfare. Was the disappointing economic performance of the 1970s transitory, a product of a momentary spike in oil prices combined with a lull in the pace of technological development, or is it to become the new norm? The future of work? Inside the Googleplex (or some such) or not? EC120 Spring 2016: Week 24, Topic 19, Slide 2 EC120: The World Economy in Historical Perspective 1b. Technological Progress after 1980: The Optimistic Case While productivity has historically advanced in many directions simultaneously, the promise of Information and Communications Technologies (ICT) appears to many particularly great because: the cost of computing power has fallen exponentially since the 1950s and is likely to continue doing so for the foreseeable future; ICT appears to be a general purpose technology (like steam power and electricity) with applications throughout the economy. Hence, while the exact timing and nature of the impact of future developments in ICT may not be clear, the outlook is promising. 2-1C Medical Android Genome Analyzing Machine EC120 Spring 2016: Week 24, Topic 19, Slide 3 EC120: The World Economy in Historical Perspective 1c. Technological Progress after 1980: The Pessimistic Case Diminishing returns to ICT quickly set in. Much ICT expenditure has resulted in much low-productivity duplication. ICT has had a bigger impact on consumption than on production. To be used effectively, ICT requires high levels of human capital, which much of the labour force does not possess, resulting in low productivity (and low incomes) for many. Sensory Overload Computer Games (Toshibas Bubble Helmet) EC120 Spring 2016: Week 24, Topic 19, Slide 4 EC120: The World Economy in Historical Perspective 1d. Technological Progress after 1980: The Current Balance (Spring, 2016) The burst of productivity experienced in the later 1990s has not been sustained, as pessimists had forecast. The cost of computing power has continued to fall and new uses for it some anticipated, some not - have arisen, such as automating certain healthcare functions and the internet of things, as optimists anticipated. Has the promise of ICT thus simply been postponed, only requiring more invention, more learning-by-doing, and more computing power to be realized, or will it always be a mirage, forever receding just out of reach? Or will productivity gains be realized selectively, only to leave large numbers of workers either unemployed or seriously under-employed. EC120 Spring 2016: Week 24, Topic 19, Slide 5 EC120: The World Economy in Historical Perspective 2. The Macroeconomic Experience : Broad Global Growth Punctuated by Crises Background The end of Bretton Woods, in a context of still-rapid economic growth ( ) and accompanied by rapidly increasing international liquidity (and, not coincidentally, rising inflation) encouraged international bank lending (re-cycling petro-dollars after 1973). In these circumstances, awash with cheap deposits, Western banks lent freely (but often not wisely). As interest rates (both nominal and real) rose in the early 1980s, many of these borrowers, facing repayment in foreign currencies of short- term loans, defaulted, threatening the solvency of their lenders banking systems while compromising borrowers continued access to foreign credit markets. In the following decades, inflation gradually fell and growth became more stable, but still vulnerable to largely unpredicted crises, often linked to international capital flows. The sovereign debt of advanced economies (as a percentage of GDP), which had been falling since the end of the Second World War, began to rise in the 1970s (and is still rising) as countries have struggled to cope with less favourable circumstances. See Jord et. al. (2013), Fig. 1. EC120 Spring 2016: Week 24, Topic 19, Slide 6 EC120: The World Economy in Historical Perspective 3a. Japans Post-War Miracle: Growth, Capital Flows, Financial Crises Background: the legacy of Japanese exceptionalism - the only non-Western country to begin industrialization before Although defeated in 1945 and shorn of its Empire, Japan, like Germany, still possessed significant economic capability. The Korean War ( ) provided considerable macroeconomic stimulus to Japan and greatly increased its foreign exchange reserves. With still-limited foreign exchange reserves and no foreign assets, Japans growth in the 1950s relied heavily on exports to obtain raw materials and capital goods, as it had before Sony transistor radio c (left) Toyota Toyopet Corona, 1960 (right) EC120 Spring 2016: Week 24, Topic 19, Slide 7 EC120: The World Economy in Historical Perspective 3b. Japans Post-War Miracle: Growth, Capital Flows, Financial Crises [cont.] Japan benefited from the great upsurge in international trade that began in the 1950s, pegging its exchange rate at 360 yen to the US dollar in April 1949 and maintaining that rate until August 1971; capital flows were stringently controlled while rapid productivity growth caused the yen to be progressively undervalued; trade surpluses became very large. In the 1980s, to avoid further appreciation of the yen as currencies floated, Japan agreed to a programme of macroeconomic stimulation and to liberalization of its capital markets, leading to a huge, largely bank-led credit surge that ended in disaster in the early 1990s. Nevertheless, Japans success set an extremely powerful example of the effectiveness of technology-driven export-led growth (crucially aided by a highly competitive exchange rate). EC120 Spring 2016: Week 24, Topic 19, Slide 8 EC120: The World Economy in Historical Perspective 4a. Asia in the Japanese Mirror: Growth, Capital Flows, Financial Crises The success of Japans export-led economic model was first copied in East Asia (South Korea, Taiwan), beginning in the 1960s. Familiar elements of the model: exchange rate targets were set at low levels, enabling internationally competitive firms to earn high profits, which were expected to be used to enhance technological capability, enabling these firms to expand further; the banking system was used to support favoured industries; exchange controls were used to keep the exchange rate low (hence advantageous for exporters and industries that faced import competition); government policies were generally supportive (infrastructure, education, research subsidies) and have achieved notable success, notably in the high-tech industries of South Korea and Taiwan. EC120 Spring 2016: Week 24, Topic 19, Slide 9 EC120: The World Economy in Historical Perspective 4b. Asia in the Japanese Mirror: Growth, Capital Flows, Financial Crises [cont.] Crisis first struck non-Japan Asia (but not China) in 1997, following a long period of rapid growth. The crisis began in Thailand in July 1997, when the long-stable Thai baht was abruptly and sharply devalued, causing great distress in the banking system, which carried large amounts of short-term debt denominated in foreign currencies. The crisis then spread within weeks to Indonesia, Malaysia, and the Philippines, neighbouring countries that had also been growing rapidly (albeit from a lower base) but which shared many of Thailands problems (large current account deficits, high inflation, large amounts of foreign-currency debt relative to reserves, property booms, and over- stretched banks) but few direct trade or financial links. The crisis entered a new phase in October 1997, when it spread to Taiwan and closely linked Hong Kong, and then, with particular virulence, to South Korea. EC120 Spring 2016: Week 24, Topic 19, Slide 10 EC120: The World Economy in Historical Perspective 6. Contagion: the Asian Crisis Goes Global - Russia, Brazil, and Argentina Russia, familiar problems and more: a flawed transition from a centrally- planned economy to a market-based one; chronic government budget deficits; a pegged exchange rate; falling oil prices. The result: devaluation and debt default, followed by financial panic. Collateral damage: hedge funds. Brazil: the risks of exchange-rate-based stabilization of inflation when budget control is weak. Argentina: another episode in a country sporting a famous history of serial defaults (Reinhart & Rogoff, p.53). The IMF was criticized by many for responding to these crises by imposing harsh measures while extending only limited support. EC120 Spring 2016: Week 24, Topic 19, Slide 11 EC120: The World Economy in Historical Perspective 7. Illusions of Stability at the Beginning of the 21st Century The US: until 2008, growth performance had been supported to an important extent by a sequence of easy-money bubbles, first general stock market expansion (burst 1987), then technology (burst 2001), then housing and finance (burst 2008), the latter ushering in an unusually severe slump, followed by an unusually weak recovery. The UK: an experience similar to the US, but with a more muted technology bubble and a more virulent housing and finance bubble. The Eurozone: incomplete adaptation to a single currency accompanied by large pre-crisis cross-border financial flows, similar to those in Asia in the 1990s, left the borrowing regions of the zone with few means of recovery other than internal devaluation when the cross-border flows abruptly ended in the crisis of 2008. EC120 Spring 2016: Week 24, Topic 19, Slide 12 EC120: The World Economy in Historical Perspective 7b. Illusions of Stability at the Beginning of the 21st Century [cont] Japan: a delayed and incomplete recovery from a credit bubble that burst in 1990, resulting in an extraordinarily protracted gradual deflation accompanied by a vast accumulation of debt and leading to unprecedented attempts to stimulate the economy. Unresolved issues: will emerging markets, above all China and India, be able to sustain their remarkable development when advanced countries, traditionally the drivers of the global economy, are so fragile and growing so slowly? Modern Shanghai Modern Mumbai EC120 Spring 2016: Week 24, Topic 19, Slide 13 EC120: The World Economy in Historical Perspective Summing Up: Interpretation and Assessment In the absence of historical perspective, more questions than answers: Is the technological basis for economic growth weakening? Did the move to floating exchange rates after the collapse of Bretton Woods gravely weaken the monetary discipline that had underpinned fixed exchange rates? Export-led grow has been the primary path to development in the post-1945 ear, but does it tend to result in an under-developed domestic economies that produce savings gluts, systematically generating export surpluses that leave the global economy unbalanced?