The World Economy at the Start of the 21st Century, Remarks by Anne O. Krueger, First Deputy Managing Director, IMF

IMF News, April 6, 2006

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The World Economy at the Start of the 21st Century, Remarks by Anne O. Krueger, First Deputy Managing Director, IMF

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• Published: April 6, 2006

Historical evolution of globalization (19th century to World Wars)

• Technical change and falling transport costs in the 19th century drove rapid expansion of global trade and rising living standards between 1870 and 1914.
• Key figures and dynamics:
  • World trade grew at an annual rate of 3.4 percent between 1870 and 1914.
  • Ocean shipping costs by around 1850 were about a third of what they had been thirty years earlier (Douglas North).
  • Data implying a drop in transport costs between the U.S. and Europe from about 80 percent of the price of the commodity to less than 20 percent during the late 19th century (O'Rourke and Williamson).
  • At its peak, foreign-owned assets were about equal to about 20 percent of world GDP by the early 20th century.
  • The United Kingdom owned 80 percent of foreign assets globally at its peak; capital outflows averaged 4.5 percent of GDP per year between 1870 and 1914, and reached as much as 10 percent of GDP in some years.
• Reversals and disruptions:
  • First World War disrupted trade and financial ties; Great Depression and 1930s protectionism (including Hawley-Smoot tariff yielding an average tariff level of 59 percent in 1932 in the United States) further fragmented the global economy.
  • Competitive devaluations and "beggar-thy-neighbor" policies intensified the downturn.
  • By 1950–1960 the degree of integration of the world economy was considerably less than fifty years earlier.

Postwar institutional framework and its effects (1945–1973)

• Postwar premises and institutions:
  • Premises: U.S. economic preeminence; devastated Europe and Japan; avoid the 1930s mistakes through multilateral cooperation; limited long-term private capital.
  • Institutions established: International Monetary Fund (Articles of Agreement ratified by 38 countries by March 1946), International Bank for Reconstruction and Development (World Bank), General Agreement on Tariffs and Trade (GATT) in 1947.
  • Article VIII commitments on convertibility for current account transactions were expected from signatories.
• Outcomes through the "golden quarter century":
  • Rapid reconstruction and sustained growth in Europe and Japan; prewar output levels generally attained by the early 1950s.
  • World trade grew at an average rate of almost 8 percent per year from 1950 to 1973.
  • By 1950 the United States produced 27 percent of global real output and accounted for over 14 percent of global exports; the U.S. held 54 percent of international reserves.
  • In 1950, 79 percent of foreign exchange reserves of industrial countries were held in gold; by 1973 more than 90 percent of reported foreign exchange reserves holdings of those industrial countries were held in U.S. dollars.
  • The IMF played an important role in providing financial assistance to countries in balance of payments crises; Britain was the last major industrial country to borrow on a large scale from the Fund in 1977.

Structural shifts and trends through the 1970s–1990s

• Major shocks and transitions:
  • 1971 U.S. suspension of gold convertibility; by 1973 floating exchange rates became prevalent among major currencies.
  • 1973–74 oil price shock quadrupled nominal oil prices in a short period.
  • Early 1980s U.S. monetary tightening produced high nominal and real interest rates, contributing to developing country debt crises and the "lost decade" of the 1980s for many heavily indebted developing countries.
  • Financial crisis examples: Mexico 1994 (current account deficit of 7.6 percent of GDP in 1994; effective nominal devaluation of 65 percent within three months), East Asian crises in the late 1990s, and South Korea's recovery (l997 level of real per capita income re-attained within 6 quarters; by 2004 real GDP almost 40 percent above its l997 pre-crisis level).
• Changing geography of growth:
  • The "Asian tigers" and broader East Asian outward-oriented strategies yielded exceptional export and income growth (example: South Korea increased exports at over 40 percent a year in the 1960s; real per capita income growth of 7-9 percent a year in that period).
  • By 2000, developing countries as a group accounted for about 47 per cent of world GDP and a third of world trade.
  • European Union had 38 percent of world trade and 26 percent of world GDP as of 2000.
  • The United States per capita income estimates (in 2005 dollars): $13,000 in 1950; $22,200 in 1975; $41,900 in 2005.

The global economy at the turn of the 21st century — key changes and statistics

• Openness and technology:
  • Trade's share of the world economy rose from 5.5 percent in 1950 to 17.2 percent in 2000 (Maddison).
  • Composition of trade shifts (selected years):
  • 1950: 45 percent of merchandise exports were agricultural and 37 percent were manufactures.
  • 1980: services constituted 15 percent of all goods and services trade; agriculture 12 percent; manufactures 45 percent.
  • 2004: agriculture 7 percent; services almost 20 percent; manufactures 59 percent.
  • Communications cost example: cost of a three minute phone call from New York to London in constant 1998 prices was $293 in 1931 and around $1 by 2001; in 2006 the same call costs just a few cents.
• Health and living standards:
  • China infant mortality rate fell from 150 deaths per 1000 births in 1960 to 30 in 2003.
  • Since 1960 life expectancy in developing countries has risen at roughly double the rate in the richest; the life expectancy gap between industrial and developing countries narrowed from around 30 years in 1950 to around 10 years today.
  • Stark divergences: Ghana per capita income estimated at US$ 1,874 (in 2000 prices PPP) in 1956 and $2,114 in 2003 (13 percent above 1956 level); Korea's per capita GDP was $1,347 in 1956 and $16,977 in 2003 (nearly 13 times 1956 level).
• Financial integration:
  • In 1952 only seven countries had free exchange rate regimes for current account transactions under Article VIII; by the early 21st century 164 countries have accepted Article VIII obligations and capital account transactions are much freer.

Lessons learned (policy-relevant findings)

• Importance of economic policies and institutions:
  • Appropriate market-friendly policies, institutions, infrastructure and legal frameworks are central to faster relative and absolute economic performance.
  • Open markets promote competition, technical change, higher productivity and higher rates of growth.
• Macroeconomic stability and inflation control:
  • Reducing and controlling inflation has been associated with more rapid and sustained growth.
  • Overly expansionary policies can produce illusory short-term growth followed by severe contraction (case example: Peru under Alain Garcia, 1985–1990: foreign debt as a percentage of GDP rose from 73 in 1985 to 165 three years later; current account deficit reached 5 percent of GDP in 1990; subsequent real GDP fell by 9 and 13 percent in the next two years).
• Exchange rate flexibility, FDI, and financial sector strength:
  • Flexible exchange rate regimes enable smoother adjustment; foreign direct investment and stronger financial sectors reduce vulnerabilities associated with private capital flows.
• Necessity of adapting international institutions:
  • Relative economic importance of countries changes; international institutions need to be more flexible and to reflect the increased roles of rapidly growing economies—especially in Asia.

Challenges going forward (policy recommendations and priorities)

• Trade liberalization and the Doha Round:
  • A successful Doha Round is needed to underpin continued expansion of trade and future global growth; failure risks strengthening protectionist pressures and undermining past progress.
  • The Doha Round is more complex due to membership (WTO now has 149 members) and inclusion of agriculture and services; developing countries stand to gain the most because their remaining trade barriers are highest.
  • Preferential trading arrangements and bilateral FTAs can boost trade but are not substitutes for multilateral liberalization and may hinder multilateral progress if treated as an alternative.
• International financial system and global imbalances:
  • Give Asia appropriate weight in the international financial system, including in the IMF; Asia has a legitimate claim to greater weight than current rules allow.
  • Strengthen mechanisms for resolving global imbalances through action on multiple fronts and enhanced multilateral surveillance by the IMF.
• Domestic policies to broaden gains and manage demographics:
  • Improve access to high quality education to enable long-term inclusion in growth benefits.
  • Implement well-targeted and affordable social safety nets; avoid subsidies that mainly help the middle classes or distort incentives excessively.
  • Address demographic change and public pension sustainability; industrial countries should act sooner rather than later to avoid fiscal crunches; emerging markets may have more time but face potentially greater challenges.
• Assistance for countries left behind:
  • Domestic policy reform (improved governance, end to corruption, macroeconomic stability) remains central to enabling poor countries to integrate and reduce poverty.
  • International community support via aid transfers, capacity-building, policy advice and technical assistance remains vital; IMF work includes aiding public expenditure management and tax administration to help absorption of aid without undermining progress.

Conclusion — risks and the path forward

• The postwar multilateral economic framework has been durable and has delivered substantial global gains; globalization and technological change have brought enormous benefits.
• However, the 19th century precedent shows that reversal is possible; current risks include:
  • Failure of the Doha Round and rising protectionism.
  • Disorderly unwinding of global imbalances.
  • Neglect of countries that have not shared meaningfully in globalization.
• Addressing these challenges through strengthened multilateralism, appropriate domestic reforms, and targeted international support will consolidate and increase gains; ignoring them risks undoing much progress.

Remarks by Anne O. Krueger, First Deputy Managing Director, IMF, April 6, 2006.

References

• People's Republic of China and the IMF
• India and the IMF
• Japan and the IMF
• Republic of Korea and the IMF
• Mexico and the IMF
• Peru and the IMF
• United States and the IMF
• Gold in the IMF -- A Factsheet
• IMF Policy Advice -- A Factsheet
• The IMF and the World Trade Organization -- A Factsheet
• Speeches
• Anne O. Krueger
• PRESS CENTER
• https://www.imf.org/en/home