Transcript of a Conference Call on the Analytic Chapters of the
Spring 2006 World Economic Outlook
with Raghuram Rajan, Economic Counselor and Director of Research
David J. Robinson, Deputy Director, Research
Timothy Callen, Chief, World Economic Studies Division
International Monetary Fund
Washington, D.C.
Thursday, April 13, 2006
The world economy has done very well over the past few years. An important reason
for this good performance has been the greater flows of goods, services, and capital
across the world, a phenomenon known locally as globalization.
"How has Globalization Affected Inflation?" finds that globalization has held down
inflation in the past decade in a number of ways. Most people think of globalization
reducing inflation by reducing the price of imported goods. This has been important
at times. For instance, after the 1997-1998 crisis in emerging markets, lower import
prices probably shaved more than 1 percentage point of actual inflation in some
advanced economies over a 1- to 2-year period. But in normal times, it is not as
important as most people think. In fact, at this point, because of higher oil and
commodities prices, imports are adding to headline inflation in most industrial
countries.
First, globalization may lower the inflationary response to domestic capacity
constraints. Put another way, a sudden expansion in demand for goods now
translates into higher imports rather than into higher prices, since in an integrated
world, domestic supply constraints do not matter as much. This is partly why the
U.S. can consume 7 percent more of its GDP than it produces without serious
inflation.
Second, foreign competition has constrained wage increases in industries most open
to global competition, and even lowered the sensitivity of wages to productivity
increases. Of course, this does not mean globalization necessarily lowers wages,
because it also spurs productivity growth itself. Nevertheless, the effect of
globalization on wages will become an increasingly debated issue, especially as the
share of labor income in total output of developed countries continues to fall.
despite being helpful in the past, globalization may not continue to be a crutch for
central bankers to lean on. Spare capacity is decreasing worldwide, and tight
domestic labor markets can also attenuate the effects of global competition on
wages. Central bankers must, therefore, be prepared for their jobs to become more
difficult in the period ahead.
Another aspect of globalization is an integrated market for world savings and
borrowing. Interestingly, the identity of the savers and borrowers have shifted in the
last few years. Corporations are usually net borrowers. In 2003 and 2004, though,
total corporate excess savings which is their undistributed profit less any capital
expenditure they might make, this number in the G7 countries amounted to US$1.3
trillion which is more than twice the combined current account surpluses of
emerging markets in developing countries over the same period. The latter, of
course, is something which has gained a lot of attention in the last few years.
This increase in corporate savings can be decomposed into two main components.
First, there has been a substantial increase in corporate profits in the G7 since about
2000. In general, this has not been because of better operating profits, but because
taxes and interest rates have come down so that profits after interest and taxes
have gone up. In other words, profitability is more due to accommodative monetary
and fiscal policy than perhaps greater efficiency.
The second and arguably more important component for excess corporate savings is
falling capital spending. It accounted for as much as three-quarters of the total
increase in corporate excess savings since 2000. One reason for lower capital
spending is that the price of capital goods has declined sharply, so less has to be
invested to increase the real capital stock by a given amount. Another reason is the
drop in real capital spending. The United States and Germany are responsible for
much of this decline.
Going forward, we expect one-off tax measures to lapse and interest rates to move
higher as monetary policy tightens and the global liquidity cycle turns. Furthermore,
given low investment in the past few years, corporate investment is likely to pick up
somewhat as investment opportunities and pricing power improve. So it is unlikely
that corporate savings will continue at their current pace, which will be yet another
factor of pushing real interest rates higher.
Finally, Chapter II looks at the effects of higher oil prices on global current account
imbalances. In some ways, this is the third act in the saga of imbalances. In the first
act in the late 1990s, foreign capital was attracted to the United States causing a
counterpart current account deficit. In the second act, expansionary policies in the
U.S. caused the deficit to widen. And in the third act, which is what we are seeing
now, higher oil prices will widen existing global current imbalances and prolong them.
Because the inflationary consequences of oil prices have been limited partly as the
result of globalization which we have talked about, and because financing conditions
have been benign, oil consumers have not had to adjust as much as they did in the
past.
The bottom line is that a number of factors like global restraints on inflation and
corporate savings have contributed to a benign environment which has supported
global growth over the last few years. But internal and external imbalances are
growing, and the environment could become less hospitable.
QUESTION: I was wondering, in Chapter II, do you have an estimate on what kind
of range we should expect in oil prices in the coming year or two?
MR. ROBINSON: This is David Robinson speaking. Let me take a stab at that
question.
Of course, projecting the oil price is something that is fraught with uncertainty. One
thing I can say to you is that when we look at the futures markets which include the
expectations of what markets think are going to happen to prices, basically they see
prices remaining at around the current level over the medium-term, a little bit of a
rise in the short-term, a little bit of a decline in the longer-run, but around the same
level overall. And I think that reflects the very tight fundamentals in the oil market,
the low level of excess capacity that we have, and the fact that investment is not
taking place in the oil sector as fast as we would like to see, given that demand in
the world continues to increase. So I think we are looking at a period of continued
sustained high oil prices, but there is a lot of uncertainty.
QUESTION: Yes. What I would like to do is this cash that the companies have now, if
we can expect that this money could come to countries like Brazil in foreign direct
investments.
MR. RAJAN: Some of the excess-savings is already in the form of foreign direct
investment. Part of the savings build-up is not just cash, but it is also financial
assets which reflects ownership claims on companies in other countries. So certainly
some of it is going away. For example, when we look at equity holdings of G7
companies which potentially could be in other countries, and add that back to
investment in the United States, we find that U.S. investment is about where it
should be, suggesting that part of what is going on is we are getting investment
taking place in other countries.
However, we have commented earlier, in the last WEO, on the somewhat muted
investment all over the world, especially in emerging markets. So part of what we
are saying is the responsibility for increasing investment lies also with emerging
markets in terms of improving the business environment and the climate so that
some of these savings which are generated in developed countries can flow more
readily into these emerging markets.
MR. RAJAN: I guess what I am saying is, globalization has been very beneficial in
the past and is partly responsible for these good years we are having. The chapters
point to at least a couple of channels. One is the fact that with the global market for
goods, we have managed to keep inflation down because spare capacity in some
parts of the world, certainly in Asia, for example, has been utilized by countries that
have not had as much spare capacity. As a result, we have tapped into global
capacity. That has been a good thing.
Similarly, we have tapped into global savings, the low interest rates the world over
in part are because of the excess savings that are being generated by corporations,
and also excess savings generated by emerging markets. So we have, in a sense,
the global market holding down interest rates.
However, one of the things that I would like to caution about is that these things are
not infinite. At some point they come to an end for a variety of reasons. For the
corporate savings, part of what is going on is investment opportunities look far
better now than they looked a few years ago. They are picking up, not just in
industrial countries, but also in emerging markets, and as the Brazilian reporter
asked, there will be also investment by industrial country corporations in emerging
markets.
So by and large we expect investment to start picking up which means greater
demand in the market for global savings which would suggest interest rates will
push up, and then naturally affect some of the other things that depend on savings.
So that is potentially one cause for concern.
The other is, global capacity is also limited. We see that in oil, and what we see is
high oil prices because we have hit global capacity without too much investment
taking place in oil in the last few years. That, again, is probably something which we
are going to see more of in other markets going forward which would suggest the
effects of globalization on inflation will not be as helpful as in the past, and
inflationary pressures have to be watched out for because they will be there.
Of course, what has happened over the last 10 years is that central banks have
gained a lot of credibility for managing inflation, and if you look at inflation
expectations, they are pretty well anchored. But what this means is they may have
to work harder in order to keep them anchored going forward than they had to in
the past.
QUESTION: What should they be doing with these reserves now? They should invest
in their own economies?
MR. RAJAN: I think over time they have to make sensible investments in their own
economies because some fraction of the petrodollars they are earning now are
permanent. To the extent that they do not use them, that is a subtraction from
world demand. If they are using them only in building up financial assets, that is in
a sense a subtraction from world demand. So what they would need to do over time
is think about useful ways of using them.
However, they have to be very conscious of the fact that the last time they earned
these petrodollars, some of the uses weren't the wisest, and so what we have been
suggesting to these countries is a careful ramp-up of spending, and, in fact, that is
what they are doing. There are a number of things that they have to do, including
diversifying away from oil, but also investing in their own people through more
education and so on.