Role of globalization after the crisis

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Era of Financial Crisis

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The world economy has just after the financial turmoil has become a very large-scale destruction of wealth, and declines in industrial production and global trade. According to the International Labor Organization, continued labor-market deterioration in 2009 may lead to an estimated increase in global unemployment of 39-61 million workers relative to 2007. By the end of this year, the worldwide ranks of the unemployed were range from 219-241 million - the highest number on record. Global growth in real wages, which slowed dramatically in 2008, is expected to have dropped even further in 2009, despite signs of a possible economic recovery. In a sample of 53 countries for which data are available, median growth in real average wages had declined from 4.3 percent in 2007 to 1.4 percent in 2008.

The World Bank warns that 89 million more people may be trapped in poverty in the wake of the crisis, adding to the 1.4 billion people estimated in 2005 to be living below the international poverty line of 1.25 U.S. dollars a day.

To ensure a durable exit from the crisis, and to build foundations for sustained and broad-based growth in a globalized world, developing countries in 2010 and beyond must draw the right lessons from history.  In the current crisis, China, India, and certain other emerging-market countries are coping fairly well. These countries all had strong external balance sheets and ample room for fiscal maneuver before the crisis, which allowed them to apply countercyclical policies to combat external shocks. They have also nurtured industries in line with their comparative advantage, which has helped them weather through the storm. Indeed, comparative advantage - determined by the relative abundance of labor, natural resources, and capital endowments - is the foundation for competitiveness, which in turn underpins dynamic growth and strong fiscal and external positions.

To pursue its comparative advantage and prosper in a globalized world, a country needs a price system that reflects the relative abundance of its factor endowments. Firms in such a context will have incentives to enter industries that can use their relatively abundant labor to replace relatively scarce capital, or vice versa, thereby reducing costs and enhancing competitiveness. Examples include the development of garments in Bangladesh, software outsourcing in India, and light manufacturing in China. But such a relative price system is feasible only in a market economy.

In today's competitive global marketplace, countries need to upgrade and diversify their industries continuously according to their changing endowments. A pioneering firm's success or failure in upgrading and/or diversifying will influence whether other firms follow or not. Government compensation for such pioneering firms can speed the process. Industrial progress also requires coordination of related investments among firms. In Ecuador, a country that is now a successful exporter of cut flowers, farmers would not grow flowers decades ago because there was no modern cooling facility near the airport, and private firms would not invest in such facilities without a supply of flowers for export.

The world is now so far down the path of integration that turning back is no longer a viable option. We must internalize lessons from the past and focus on establishing well-functioning markets that enable developing countries fully to tap their economies' comparative advantage. As part of this process, a facilitating role for the state is desirable in developing and developed economies alike, although the appropriate role may be different depending on a country's stage of development.

What are the perceptions and realities of power after this crisis?

The current assumption is that the post-crisis political economy will reflect the rising influence of China, probably of India, and of other large emerging economies. Supposedly, the United States, the epicenter of the financial crisis, will see its economic power and influence diminish.

There are good reasons for this perception. China has responded strongly to the crisis, both in terms of stimulus and monetary policies, and it seems to have a deep treasure chest to back up its first moves. China has enjoyed a rapid recovery, which has assisted others, underscoring China’s growing influence.

Indeed, today, China acts as a stabilizing force in the global economy. Together, China and India account for 8.5 percent of world output. They and other developing countries are growing substantially more rapidly than developed countries.

And yet … China’s future is not yet determined. Its rapid recovery in 2009 was fueled by an expansion of credit of 26 percent of GDP in the first eight months of this year. This flood is now easing, and authorities are likely to limit it further for fear of effects on asset prices, asset quality, and eventually general inflation. China still faces big uncertainties in 2010.

China’s leaders recognize these risks, including the continued dependence of China and other emerging economies on export-led growth. It will not be easy for China to shift to increasing reliance on domestic demand, especially to greater consumption that could help balance world growth while contributing to China’s goal of a more “ harmonious society.” China’s protected service sector, including financial services, limits opportunities for entrepreneurs and increases in productivity.

The United States, in turn, has been hit hard by the crisis. But America has a culture of resilience to set-backs, adapting to new circumstances and remaking itself.

The future for the United States will depend on whether and how it will address large deficits, recover without inflation that could undermine its credit and currency, and overhaul its financial system to preserve innovation while adding to safety and soundness. The United States also needs to help people adjust to change, so that it can maintain its greatest trump card: openness to trade, investment, people, and ideas. The geopoliticians will be on the watch for signs that America’s economic troubles are leading to a weakening of U.S. confidence, energy and resources to project its interests globally in cooperation with others.

Japan is the first leading industrial power to experience a political upheaval in the wake of the crisis. The election of the Democratic Party of Japan could create a sustainable two-party democracy for the first time in the country’s history.

Japan rose from the ashes of World War II as a “trading state,” the model for export-led growth. It is not clear that the old export model of growth will be sustainable in a more “balanced” global economy that does not rely so heavily on the U.S. consumer. An aging Japan will have new consumption needs. A global economy with more poles of growth could offer Japan new markets, especially for its impressive capabilities to use energy efficiently.

The world will be deeply interested in the shape of a Japanese foreign policy that can be sustained across parties and that might assume new responsibilities. Such a foreign policy could build on Japan’s experiences in development. Japan could deepen cooperation with other Asia-Pacific actors in ASEAN, Australia, China, and Korea, while maintaining its global role, especially through relations with the United States. Development opportunities in Africa, Latin America, Central Asia, and the Middle East would also enable Japan to “do well while doing good.”

The European Union may have been slow to recognize that this economic crisis was the first big test of the New Europe made possible by the revolutions of 1989. But it adapted relatively quickly, and European institutions may come out stronger for it.

Central and Eastern European economies were hit especially hard by the crisis. And their problems are far from over. At least for European Union members, however, the support offered by the European Commission, the European Bank for Reconstruction and Development, and the European Investment Bank – with assistance from the World Bank Group -- has been critical. It appears that the European banks that invested in their Central and Eastern European neighbors are staying with them. The good strategic news is that the European states, for all their internal debates and negotiations, have recognized their interdependence. Under stress, this time, Europe did not splinter.

The European Central Bank played a decisive role under the able leadership of its president, Jean-Claude Trichet. The ECB walked a fine line in supporting the European financial system and even helping Europeans outside the Eurozone, while assuring the Euro’s credibility. As a result, newer EU members outside the Eurozone may well strive to gain its security.

Yet, amidst tighter economic times, the European Union must still face insecurities. Its energy vulnerability feeds worries, aggravating difficult relations with its neighbors to the east, especially Ukraine and Russia. The Balkans still smolder, and inattention to Bosnia could revive apprehensions about the EU’s ability to offer security, even on its own continent. The EU and Turkey have yet to cultivate a common view of their shared future. As its demographics age, Europe will also struggle with the integration of immigrants.

South East Asia may also have been given a boost by the crisis – depending on how opportunities are seized. The region lies at a geographic crossroads between India and China, two rising powers. ASEAN seems to have recognized the moment, and has taken actions to deepen its integration even while reaching out to others.

Given the sizeable weight of Indonesia and the rising influence of Vietnam, their sound performance amidst economic turmoil has stood in sharp contrast to a decade ago. But there remain questions of adjustments and political transitions in countries such as Thailand and Malaysia. There is also a question of whether others will recognize the emerging ASEAN. China and India seem to be doing so – but will North America and the European Union?

For others, the long-term impact of the crisis may depend upon commodities, especially oil prices, which, in recent years, gave high returns. When the oil price is at $100, these countries are strong. When it is at $30, most are in serious trouble. This reliance on oil and commodities is a precarious basis upon which to build an economy in a world that is struggling to reduce its reliance on fossil fuels, and in which commodity prices gyrate as investors move in and out of an “asset class.” Will countries use these returns wisely – to diversify and build broader-based economic development? These are the questions for Russia, countries in the Gulf, and some countries in Latin America and Africa.

Understanding shifting power relations is fundamental for shaping the future -- as the Bretton Woods’ delegates appreciated. The political basis for that system was forged through a shared experience in failed responsibility after World War I and a clear assessment of power after World War II. Change those power relations -- and the nature of the markets that connect them -- and the system looks out of touch. Let’s examine a few examples.

Role of developing countries after the crisis?

The crisis has underscored the growing importance of the large emerging economies, especially China and India, but others as well. In effect, the world economy is being “rebalanced” toward the relative shares of some two hundred years ago, before the industrial revolution, plus a new North America.

The rising developing economies should play a key role in the recovery. Most forecasters expect demand to be tepid, with a pullback by the U.S. consumer. Many developing countries could expand demand if they can get access to financing. They have fiscal space to borrow, but cannot get the volumes they need at reasonable prices without crowding out their private sectors. Moreover, the middle income countries are home to 70 percent of the world’s extreme poor. The World Bank Group and the regional development banks can assist.

Looking beyond, a more balanced and inclusive growth model for the world would benefit from multiple poles of growth. With investments in infrastructure, people, and private businesses, countries in Latin America, Asia, and the broader Middle East could contribute to a “New Normal” for the world economy.

Over time, Africa can also become a pole of growth. The messages I hear in most African countries are the same: Africans want energy, infrastructure, more productive agriculture, a dynamic private sector, and regionally integrated markets linked to open trade. It is a message one might have heard in a devastated Europe 60 years ago.

Prior to the crisis, the growth rates of a number of African countries were achieving impressive levels with consistency. Coming out of the crisis, there could be a new opportunity. Some Chinese manufacturing firms, with government support, are considering shifting their basic production to Africa. The World Bank Group is working with China to explore the development of new industrial zones that match infrastructure, energy, and training with these ventures.

China’s African prospects -- which include resource development and infrastructure -- are likely to be complemented by others. Brazil is interested in sharing its agricultural development experience. India is building railways. These are the early days of a trend that will build.

The World Bank Group can offer a counterweight to financial and trade protectionism by supporting this development globally: We have launched a new Asset Management Corporation, through IFC, our private sector arm, to invest in banks, equity, infrastructure, and debt restructuring. We have a parallel effort to support and invest in the development of local currency bond markets. Longer term investors –such as sovereign and pension funds—now recognize that developed markets pose risks, too, and developing markets can offer good growth prospects.