Transcript of a Press Briefing on the Analytic Chapters of the World Economic Outlook with Raghuram Rajan, Economic Counselor and Director of Research, Charles Collyns, Deputy Director of Research, and Timothy Callen, Chief of the World Economic Studies Division, IMF

September 6, 2006

with Raghuram Rajan, Economic Counselor and Director of Research
Charles Collyns, Deputy Director of Research
Timothy Callen, Chief of the World Economic Studies Division
International Monetary Fund
Washington, DC
Wednesday, September 6, 2006

View a Webcast of the press briefing

MR. MURRAY: Hello, I am William Murray, Acting Chief of Media Relations at the IMF.

This is our latest semi-annual briefing on the World Economic Outlook. Today's briefing is focused exclusively on Chapters 3, 4, and 5 of the World Economic Outlook. The press briefing on Chapters 1 and 2, which are the global forecasts that are issued on a semi-annual basis under the WEO, will take place on September 14th in Singapore, 10:00 a.m. Singapore time.

Today's briefing is live on the IMF's Media Briefing Center, but the contents of the report and the contents of this briefing are under embargo until 11:00 a.m. Washington time or 1500 GMT. I will repeat the embargo at the conclusion of this briefing. Before I have some brief introductions here, and we turn the table over to the briefers, let me reiterate to those watching via the Media Briefing Center that I would encourage you to start asking questions, sending in your questions via text message, and we will try to get to as many of them as possible in the time we have available.

Now, let me turn to the introductions. Of course, in the center of the table is Raghuram Rajan, our Economic Counselor and Director of Research; to my immediate right is Charles Collyns, the Deputy Director of Research; and to my far right, is Timothy Callen, who is the Chief of the World Economic Studies Division.

Now, let me turn the table over to Raghu for some brief opening remarks. Thank you.

MR. RAJAN: Thank you.

We are trying a new format this year for this kind of press conference, so we will decide at the end of it how successful we have been.

We are now in the fourth year of very strong world growth, growth that has been maintained in the face of impediments such as higher commodities prices, oil prices, and so on. The question is: What accounts for this tremendous performance? The essays in this WEO touch upon different aspects of this issue.

I will start first with the tremendous and continuing growth of emerging Asia. Asia's growth has been driven by fast accumulation of physical and human capital but also by rapid increases in total factor productivity, that is, growth that typically comes from producing in a clever and more efficient way. Indeed, in both China and India, TFP growth exceeds the contribution of physical or human capital accumulation. This extraordinary change has been made possible through an enabling environment that has fostered the development of efficient manufacturing, certainly in China, and in the case of India, services, even while encouraging some movement out of low productivity agriculture. Now, in this regard, I should note that a lot of attention has been paid to the extraordinary surge in U.S. productivity since 1995, but productivity growth in emerging markets, which is equally extraordinary, has been little commented upon. Taken together though, U.S. productivity growth and productivity growth outside the U.S., could explain why the demand for commodities is so strong, how emerging markets have weathered commodity price increases without a serious slowdown in investment, why inflation is largely contained despite the large increases in raw material costs, and why household incomes and corporate profits are both buoyant at the same time.

Now, for the good times to continue, it is very important that productivity growth in the rest of the world continues to be strong even while the U.S. slows down. One big question is: What can Asia suggest on this? Chapter 3 in the Outlook offers some answers.

For China and India, where the typical citizen is still a farmer and not an assembly line worker or a call center employee, continued productivity growth will come from the shift out of agriculture, but because a substantial portion of the population will still be employed in agriculture in these poor Asian economies for some time, an important objective of policy should be to improve agricultural productivity. For the richer Asian countries, the typical worker will increasingly be a stockbroker or a shop assistant, not a manufacturing worker. The focus there should be on improving service sector productivity. The problem here is service sector productivity has been trending downwards. Again, while governments should create an enabling environment for productivity growth by providing citizens broad-based access to education and finance as well as securing private property, they should also open to agriculture and services, especially open these to foreign competition as well as to domestic competition, so that these sectors have the same chance to generate the strong productivity growth that manufacturing has done in much of Asia.

One source of productivity growth is the financial sector. In Chapter 4, we use a newly created index to distinguish between countries that have a more arms-length financial system where the parties in a transaction typically only have knowledge or information about each other that is publicly available versus countries that have a relationship-based system where parties typically have transacted together for a long time. The study in Chapter 4 finds that relationship-based systems are less effective than arms-length systems at responding to new growth opportunities opened up by technological innovation and globalization. The relatively slow growth of productivity in much of the Euro Zone could in part be attributed to the nature of the financial system prevalent there. Well-developed arms-length financial systems, like those in the United Kingdom and in the United States, also enable households to borrow against the rising level of their incomes and their homes, thereby boosting consumption and supporting strong economic growth. This, however, results in households having higher debt, an average of 160 percent of disposable income in 2005 in arms-length systems compared to less than 100 percent in more relationship-based systems. Households in arms-length systems are therefore more vulnerable to rising interest rates and a downturn in asset prices. This is one more reason why housing in the United States bears careful watching in the months to come.

Indeed, countries with arms-length systems may have responded to the productivity surge stemming from this communications/information technology revolution as well as the rationalization of production for the creation of global supply chains by investing more and consuming more, thus running large current account deficits. Given the sophistication of a financial system like that of the United States and given that the arms-length system affords investors a level playing field, foreigners also have been very willing and eager to buy claims on such systems, especially on the United States. Of course, neither household nor national indebtedness can expand indefinitely. Eventually, foreigners accumulate enough claims on others, and their own financial systems become more sophisticated. Domestic demand in arms-length systems like the United States will then have to slow. It is therefore reassuring that demand is picking up in a number of previously relationship-based countries around the world. These countries are expanding private consumption in part as their financial systems become more arms-length.

It is, however, important that they support of greater arms-length systems to reallocate resources by doing the other policy changes that are very important, for example, making it easier to hire and fire workers or to start and close companies. At the same time, though, this will create uncertainty for workers which means that they should also create a strong portable safety net to protect their workers against adversity.

Finally, the tremendous growth in world demand has led to unprecedented growth in commodities prices. As Chapter 5 documents, metals prices have risen by 180 percent in real terms since 2002, outstripping even the increase in oil prices. Typically, the rise in input prices should either result in higher output price inflation, lower profit margins, lower wages, or less activity. That none of this has happened must owe in significant degree to strong productivity growth in a large part of the world. Indeed, Chinese manufacturers contributed about 50 percent to the increase in net world demand for the main metals, that is, aluminum, copper, and steel, over the past four years. As you know, Chinese manufacturing has been subject to large productivity gains.

Contrary to the popular wisdom, however, financial investors don't seem to be playing a big role in driving non-fuel commodities prices. There is little statistical evidence that purchases by these investors leads prices upwards. As the chapter suggests, however, non-oil commodities are different from oil and, in this case, I should especially note metals. They are different in the sense that there is likely to be a robust supply response. Production is likely to increase over time as investment increases to meet the unexpectedly high demand. Our model as well as futures prices suggest that metals prices are likely to decline in the future. Non-oil commodity-dependent economies should anticipate this risk by being more cautious on expenditures that are hard to reverse, such as public sector salaries, and instead focus on expenditures that help build diversified productive capacity for the future.

With that, let me turn to questions.

MR. MURRAY: Great; thanks, Raghu.

We are going to have a copy of Raghu's opening remarks posted on the Media Briefing Center immediately at the end, and we will give you copies before you leave here today.

Let us turn to the floor. Lesley?

QUESTIONER: Mr. Rajan, I want to ask you more about the metals issue. Do you think the prices are fairly valued at the current rates, or do you think they are in the other direction?

The other question is: As China moves from investment to consumption, can you see a lot of non-China Asia picking up a lot of the slack in demand for metals?

MR. RAJAN: Both good questions; first, the markets, unless there are serious distortions, are fairly valued at the current time, fairly valued, given supply constraints. There is limited supply of a number of metals and a lot of demand. The point we are making is more about the medium-term prospects for these metals, where we believe that a lot of supply is in the works through higher investment, and therefore we expect the supply-demand balance to be of a nature which will lower prices. So that is on metals.

As far as China increasing domestic demand goes, I suspect that that is not necessarily going to reduce demand for metals. In some sense, for an economy at China's level of income, the kinds of things that the Chinese will consume or use will be very material-intensive; more housing, for example, more cars, more hard goods. In that sense, if domestic demand in China picks up, I would think that, in fact, we would have more demand for these metals. Right now, a lot of Chinese demand is being re-exported outside to feed the rest of the world as China becomes more of a manufacturing hub, but I don't see that falling off if Chinese domestic demand picks up.

MR. MURRAY: We have a related question to this chapter on the Media Briefing Center from Brazil. Let me just repeat the question.

How can biofuels change the agricultural commodities scenario for the next few years? The U.S. alone is going to consume 50 million tons of corn next year to produce ethanol which is equivalent of 100 percent of what is traded globally every year.

So the question is: How can biofuels change the agricultural commodities scenario for the next few years?

MR. COLLYNS: Clearly increasing demand for agricultural products from any source, including new demands from the energy sector, will tend to provide an upward boost to agricultural prices, which would be very welcome. What I think is important is that there should be more international trade in these products. Brazil has been very successful in developing its biofuels industry domestically. I think it would be tremendous, both for Brazil and for other countries with opportunities in the agricultural area, if there were more free trade in biofuels. That would help both the exporting countries, who would clearly benefit from the new export opportunities, and also the importing, energy-dependent countries, by diversifying their sources of energy.

MR. MURRAY: Thank you, Charles.

QUESTIONER: On Asia, can you talk a little bit about which countries are successfully moving away from an over-reliance on agriculture and which still have some work to do?

MR. RAJAN: Well, a number of countries have moved away successfully in the past, and currently we have India, China, Vietnam and also other Asian countries, which still have a substantial fraction of the workforce in agriculture, all following that process. For the large countries, like China, it is a somewhat slower process. To some extent, what you see happening in these countries is rising inequality levels as the coastal urban areas benefit more from the tremendous growth in services and manufacturing, while the agricultural areas have benefited less. Clearly, what needs to be done over time is you have to, to some extent, move the jobs, industry, services to the agricultural areas, but also you have to open up agriculture to more value-added uses, that is, link the agricultural areas to the cities, ports, airports, and so on, so that you can add value. This means not just infrastructure as in the case of India, but it also means things like securing property rights in the case of China.

So there is a lot that these countries can do in order to improve the lot of agriculture. I think they ought to do it because for some time yet, they will be predominantly agricultural economies even though our image of them is of manufacturing hubs or service economies. The average citizen is still or the median citizen is still an agricultural worker.

QUESTIONER: If I understood your opening remarks correctly, Mr. Rajan, you are saying that countries with arms-length financial systems attract more capital inflows[off mike]

I was wondering if you could elaborate on that and perhaps comment on the sustainability of the U.S. current account deficit as more other countries move to arms-length.

MR. RAJAN: I think the motivating force is less that other countries would move towards arms-length but that over time, countries that are currently arms-length and have already issued a lot of claims outside would find that they have increasing deficits, their households are increasingly stretched on their own household debt. So, over time, sensible finance would suggest that they would have to fit their coats to the cloth, in a sense. I think there is a process by which they themselves would slow independent of the others, but what I was saying there is that process could accelerate further as people in other countries find more attractive investment opportunities domestically, and so there would be more competition for the savings that those countries generate.

But I think the primary force will still be internal. Within arms-length systems like the United States, a current account deficit of 6.5 percent cannot continue indefinitely, and therefore there will be change over time and it will be more market-driven within the United States.

MR. MURRAY: Back to you, Lesley.

QUESTIONER: As these countries move more from dependence on agriculture to services and so on, what have you seen in other countries that have been successful in this, and then how long has this taken, and are there any shocks on the way as the economy adjusts to that?

MR. RAJAN: Let me turn to one of the authors and see if they have something to say. Then I will add to that on the shift out of agriculture in some of the other countries.

MR. SPATAFORA: Nikola Spatafora from the Research Department.

As far as the timeline goes, we have seen that the agricultural share of total employment in many of these economies has declined from 50 percent or more to less than a third of its initial value over periods of two to three decades. One can have quite substantial movements over relatively short timeframes. If conditions are suitable, change can occur rapidly.

MR. RAJAN: You have had movements, pretty rapid movements, in some of the smaller economies. The difference with India and China is they are much larger economies, and having a similar movement would imply a huge increase in the manufacturing and service workforce. Also, India and China, to some extent, start out at somewhat lower income levels than some of these other countries started out. So I would say that the process may be a little slower, but it is progressing.

What could interrupt the process? Well, anything that would seriously interrupt growth. I think there is a process movement which accompanies growth, the creation of jobs in the cities and outside the rural areas; so anything which seriously interrupts growth. One factor that could be worrisome going forward is barriers to trade because I think these countries have created a lot of jobs based on the increasing openness of the world economy. In fact, also barriers to trade in agriculture could have uncertain effects. On the one hand, for these countries, it makes agriculture less remunerative in some sense, but to the extent that these countries are also able to keep up barriers to their own agriculture, in a sense, facing competition from outside, it could retain too many people in agriculture for too long. So there are both sides to that issue.

QUESTIONER: This has to do with metals. How much do you think the slowdown of the U.S. is going to affect anything to do with the demand for metals?

MR. SOMMER: Good morning. Martin Sommer, I am the main author of the chapter on non-fuel commodities.

What we have observed over the past four years is that in most metal sectors, the vast majority of demand additions for metals has come from China. So given that fact and given the model of the metals market that we have built, we would expect that any slowdown in metal demand as a result of this slowdown in the U.S. would probably come indirectly from metal demand in emerging markets. In the short term, the actual price response is very hard to forecast because, at the moment, metal inventories are at very low levels and metal prices can respond sharply to relatively minor changes in demand and supply conditions.

MR. MURRAY: That is great. Thank you.

I would like to remind everybody that is online right now. The 47-odd journalists that are watching. I would suggest you start submitting your questions because we do have a limited amount of time in which we can handle them.

Let me turn to a question that has been submitted. It is really reflective of a paper that Raghu produced and presented for the Jackson Hole conference a few weeks ago. So it is not exactly germane to the WEO chapters, but I will read it out for the sake of transparency. This is from a Turkish journalist.

You have argued in your research that there is no strict relationship between foreign investment and growth. How would you comment on Turkey's experience with this perspective? What are your specific suggestions to countries such as Turkey which have achieved growth through foreign investment?

MR. RAJAN: Well, quickly because this is not central to this conference; this is based on a paper we presented at Jackson Hole, and the paper was long-term averages across a number of countries and was basically suggesting that it is very hard to find strong positive relationship between a country's reliance on foreign capital and growth, not necessarily because foreign capital is bad for growth but because, in a sense, countries that are successful in growing often generate their own private savings, their domestic savings to fund the investment opportunities they have. And so, in that sense, they don't need the foreign capital. You find less of a correlation.

That said, I think what we did find in that paper was foreign direct investments seemed to have different characteristics from foreign capital in general. And so, certain kinds of foreign direct investment can accompany the growth process, even on average.

Finally, the fact that we find, over long periods of time, the result is that there is very little correlation doesn't necessary mean that you can't have periods of growth spurts where growth is being fueled by foreign direct investment or by foreign capital in general, something which certainly seems to be true at present in Eastern Europe and Turkey. So this is not denying the possibility that we could have growth spurts, but it was just talking more generally about a long-term relationship.

MR. MURRAY: Thanks, Raghu.

Any further questions? The gentleman on the left?

QUESTIONER: My question is about hedge funds. Under certain market systems and financial systems, hedge funds achieve very high growth. They are buoyed by investments, but some European countries and also Japan are afraid that hedge funds growth is also risky for world financial systems. So can I ask you about some people criticize that hedge funds should open their performance and their investment information to the world but they don't do that? What do you think about this?

MR. RAJAN: The question is: Why are hedge funds risky, and should they offer more disclosure? Again, in different contexts, we have certainly commented on these issues. My sense is that disclosure is never a bad thing unless people rely too much on it. My worry is that for many hedge funds which shift their positions very fast, dramatically in many cases -- they can move their positions overnight -- disclosure gives a false sense of comfort that you know what they are doing and you know that the risks are contained. My sense is that, given the current state of disclosure, given the current state of the ability to act upon that disclosure, it is not going to be enough comfort to outsiders. So while I think disclosure could help and be a step in the right direction, I am not sure that it will do what the proponents are suggesting, that is, give people a sense of comfort about hedge funds themselves.

My sense is that, not just hedge funds but all forms of private equity, if you really think you want comfort, the only way you can really achieve comfort is being fairly comfortable about the kinds of incentives they have because it is very hard to track their actual activities.

MR. MURRAY: Very good. Okay, we have a few more questions coming in online. Again, basically a five-minute warning, if you want to get questions in via the Media Briefing Center, please start submitting them right now. This is from Mexico, and the question is as follows:

How is the expected evolution of commodities markets? How will they affect or contribute to Latin American economies, especially Mexico?

MR. COLLYNS: Certainly, the boom in commodities prices has been very favorable for emerging markets and many emerging markets in Latin America. Mexico and other oil producers have benefited from high oil prices, but you also have metals producers like Chile and Peru. If you calculate the terms of trade gains from high commodity prices, these countries have gained as much if not more as Mexico and other oil producers. Agricultural producers such as Argentina, Uruguay, and Brazil have also benefited.

Looking ahead, our analysis does suggest that the non-fuel commodities prices may well weaken in the future as new sources of supply come online. I think it is important that countries in Latin America and elsewhere be aware of this possibility as they plan how best to use the strong revenues that they are now getting from high commodity prices. In this respect, I think Chile is really following a very strong model by being very transparent in saving a substantial proportion of the high revenues from their copper industry by setting up copper stabilization funds and adjusting their fiscal targets to aim at a larger fiscal surplus in the context of copper prices that are clearly above the long-term trends. I think it would be appropriate for other countries also to consider following such an approach as Chile.

MR. MURRAY: Thanks, Charles.

If there are any questions in the room, I will turn there. If not, let me to turn to the Media Briefing Center. We have a question from Chile.

You are forecasting a copper price around $1.50 in 2010. That is a 57 percent increase from today's market price which is quite high compared to the long-term price that experts are forecasting in Chile of $1.21. In your view, have costs risen more structurally rather than cyclically?

MR. SOMMER: Again, this is Martin Sommer, the author of the chapter on non-fuel commodities.

The estimates presented in the chapter are obviously subject to considerable uncertainties. The baseline forecast for the copper price in the year 2010 is indeed about $3,000 per metric ton, where if you have a look at the uncertainties that we note in the chapter, you can see that the price range or the confidence band for the price in 2010 for copper is somewhere between $2,000 and $5,000 per metric ton. From that example, you can see that forecasting the accurate copper price is rather difficult. Having said that, it is clear that copper prices will come down in the future, though not necessarily to the 2002 levels to the extent that energy costs are likely to remain high and they make up a significant part of the cost of making copper.

MR. MURRAY: Thank you, Martin.

Any other questions? Great.

Let me just repeat the ground rules again. This briefing and the contents of the Chapters 3, 4, and 5 are under embargo until 11:00 a.m. Washington time or 1500 GMT.

I thank the journalists that joined us via the Media Briefing Center. If you have any follow-up questions, drop me an email at, and I will follow up with the members of our panel here along with the authors of the WEO chapters.

Again, thank you very much. Thank you, Raghu, for joining us, Charles and Tim as well. Thanks.

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