Transcript

Washington, D.C.
Wednesday, April 14, 2010

P R O C E E D I N G S

MS. LOTZE: Good day and welcome to this press briefing on the Analytical Chapters of the World Economic Outlook, Chapters 3 and 4. As you know, the Chapters 1 and 2 of the WEO will be released next Wednesday, April 21st, ahead of the Spring Meetings on April 24th and 25th.

You had an opportunity to look at the chapters and the press points under embargo.

Let me introduce our speakers today who will make short introductory remarks. To my right is Jörg Decressin, Assistant Director in the Research Department, and to his right is Ravi Balakrishnan, Senior Economist in the Research Department and one of the authors of Chapter 3 on unemployment dynamics, and at the end is Marco Terrones, Deputy Chief of the World Economic Studies Division and one of the authors of Chapter 4 on transitioning out of current account surpluses.

Let’s begin with the introductory remarks, Jörg, please.

MR. DECRESSIN: Thank you. Thank you all for your interest in today’s press conference on the Analytical Chapters for the 2010 Spring World Economic Outlook. These are Chapters 3 and 4 of the full report. The growth projections, the conjunctional analysis and the policy challenges will be presented in Chapters 1 and 2 next Wednesday.

Now Chapter 3 focuses on the major policy challenge facing advanced economies, which is high unemployment. The title of the Chapter is “Unemployment Dynamics During Recessions and Recoveries: Okun’s Law and Beyond.” The main authors are Ravi Balakrishnan, to my right, Mitali Das, and Prakash Kannan.

Chapter 4 focuses on another challenge facing the global economy today, which is global demand rebalancing to sustain a high growth trajectory. Specifically, it reviews the historic experience of countries that reduced large current account surpluses. The title of the chapter is “Getting the Balance Right: Transitioning Out of Sustained Current Account Surpluses.” The main authors of this chapter are Abdul Abiad, Daniel Leigh, and Marco Terrones who is sitting to my right.

Without further ado, let me pass over to Ravi who will talk about Chapter 3 before Marco presents Chapter 4. We will then open the floor for questions. Thank you.

MR. BALAKRISHNAN: Thank you, Jörg and Conny.

So Chapter 3 really takes a close look at the drivers of unemployment fluctuations across advanced economies during the Great Recession. As you can see from the figure here, there’s been a variety of responses of output and unemployment during the Great Recession.

For example, Ireland and Spain suffered the biggest increases in unemployment of around 7.5 percentage points, but the declines in output were very different. In Ireland, the peak-to-trough decline was around 8 percent, whereas in Spain it was around 4. At the same time, Germany’s performance has been striking. It suffered a major output decline of around 7 percent, but its unemployment rate during its recession actually decreased.

In light of this and to have something to say about near-term prospects for the recovery, the chapter provides a systematic analysis of unemployment developments across advanced economies over the last 30 years.

Now, because unemployment is largely driven by output fluctuations, the chapter uses Okun’s Law, which is the relationship between changes in unemployment and output growth as the organizing framework. Having said that, as you can see from this figure, there have been a whole variety of responses. So it suggests that there’s something else going on apart from simply output driving unemployment—for example, the impacts of policies, of shocks, and also the institutional framework—and this is what the chapter analyzes in depth.

So what do we find? Well, this figure really is a summary of the results for the Great Recession. As you can see, in some countries like Spain and the United States the output declines combined with financial stress and house price busts can explain largely the increases in the unemployment rate. In some other countries which have implemented large short-term work schemes—for example, Germany, the Netherlands, Japan and Italy—you can see that these factors tend to over-predict the rise in unemployment. Other countries like Canada and the U.K. also have some unexplained component; in particular, our models tend to over-predict their increase in unemployment, and they remain somewhat of a puzzle.

Now what about prospects for the recovery? Well, I think this chart summarizes, in a sense, what we’re in for. Usually, it takes around three quarters for employment to turn after the start of a recovery. Unemployment usually takes another two quarters before it starts to decline. Now the pickup in employment and the decline in the unemployment rate usually are delayed after a financial crisis or a house price bust. So, essentially, our prognosis is not particularly great for the advanced economies. In particular, our forecasts, at least from this chapter, are that employment growth will turn in 2010, but the unemployment rate will remain high through 2011.

Now this, in some ways, somber forecast really begs the question as to what policies can really help. In our view, the standard macroeconomic policy levers of monetary and fiscal policy remain the primary tools via their impacts on economic activity. In many countries, there’s been a financial crisis, and so financial sector repair will also be very important, in particular because a lot of labor-intensive sectors rely heavily on bank credit.

Above and beyond this, and generally encouraging wage flexibility and improving labor market institutions, we can also think of a couple of key specific labor market policies. In countries which have lingering macroeconomic uncertainty and where labor productivity is strong, there may be a role for targeted and temporary job subsidies. But an important caveat is that the international evidence suggests that the key to having a successful subsidy is really how it’s targeted, how it’s designed and how it’s implemented, and the record is pretty mixed on that.

Secondly, in countries which have implemented large short-term work programs, the key will be how to exit from these during the recovery and to encourage the reallocation which will likely be needed during the recovery. In this regard, some wage loss insurance schemes may aid this process.

Finally, in countries which have two-tiered labor markets, where there’s a strong element of dualism between permanent and temporary contracts, this recession has shown, has highlighted some structural issues which have been there for many years. In our view, one way of addressing this problem and reducing the duality would be to encourage a transition to open-ended employment contracts under which employment security gradually increases with tenure.

Thank you. I’ll pass on to Marco now.

MR. TERRONES: Thank you, Ravi.

The fourth chapter studies the experience of economies that transitioned out of large and sustained current account surpluses through policy actions, mainly exchange rate appreciation or macroeconomic stimulus.

As shown in the first slide, global imbalances narrowed sharply in the year 2009, but a strong and sustained global recovery requires that this narrowing be made more durable. As private demand in countries with large external deficits before the crisis is likely to be weak in the coming years, a key challenge facing large surplus economies is to rebalance growth from external to domestic sources and to run smaller surpluses. But what are the implications of these transitions out of large current account surpluses for output growth and employment? What policies work best?

To address these questions, we have examined the experience of countries that made the policy-induced transition away from large and sustained surpluses. In particular, we have studied 28 surplus reversal episodes in advanced and emerging market economies over the past 50 years.

So what did we find? As shown in Slide 2, despite a sharp narrowing of the current account, surplus reversals were not associated with lower growth in output or employment. Output growth in the three years following the start of a reversal was, on average, higher than in the preceding three years, although the change was not statistically different from zero.

Perhaps more importantly, the quality of growth in these economies improved. That’s shown in Slide 3. Demand shifted from external to domestic sources with rising consumption and investment, offsetting a fall in net exports. Moreover, total employment rose slightly as the gains in nontradable employment more than offset employment losses in the tradable sector.

What factors are behind these findings? Although real exchange rate appreciation itself seems to have a slow growth, other factors tended to offset this adverse effect. In many cases, macroeconomic policy stimulus boosted demand. In other cases, exporters gained competitiveness by improving the quality of their exports. Lastly, improvements in global demand helped in a number of cases.

Importantly, the best results were achieved when real exchange rate appreciation was accompanied by macroeconomic stimulus and structural reforms that addressed underlying distortions on savings and investment. In some cases, however, macroeconomic stimulus was kept too long, leading to overheating of the economy and asset price booms.

Now looking ahead, what are the lessons for economies waiting to transition out of large surpluses? There are three main lessons. First, a surplus reversal does not need to undermine growth. The average effect on output growth and employment is small, but the quality of growth improves. There is a better balance between external and domestic demand, and between growth in the tradables and nontradeables sectors.

Second, although exchange rate appreciation plays a key role in many surplus reversals, the best results were achieved when appreciation was accompanied with macroeconomic stimulus and structural reforms that address distortions that gave rise to the large current account surpluses.

Finally, macroeconomic stimulus should be gradually withdrawn to avoid overheating the economy and creating asset price booms. Thank you.

QUESTIONER: A question I’m sure you weren’t expecting: What are the implications of what you say in Chapter 4 for China and what China should be doing to get rid of its current account surplus?

MR. TERRONES: Well, the chapter, as I mentioned, provides several important lessons. First, countries that have large and sustained surpluses should not fear to exit from these surpluses as growth is not affected significantly, and moreover in some cases employment rises.

Second, in order to achieve the best results from a transition from these large surpluses, you need a well-designed program that includes exchange rate appreciation, but also macroeconomic stimulus and structural reforms.

Third, there are risks with these transitions. Particularly, if you keep stimulative policies for too long, you can overheat the economy, and you can create asset prices booms.

These lessons can be applied not only to China, but also to many other countries that currently have sustained and large surpluses. Indeed, in the chapter we list 17 countries that qualify as such cases.

QUESTIONER: Hi. For Mr. Balakrishnan, I was wondering if you could be a little more precise. When you say unemployment is expected to remain high, what are we talking about? I mean over the next two years how much of progress in lowering the employment rate could be expected in the U.S., say?

MR. BALAKRISHNAN: I think Jörg will speak a little bit more precisely about some of the forecasts in the Chapter 1 press conference next week. But what I can say is that in this chapter our forecast is, as I was saying, that employment growth will become positive in 2010, but the unemployment rate will remain more or less, in the OECD as a group, around 9 percent in 2011.

QUESTIONER: So, across the OECD?

MR. BALAKRISHNAN: That’s across the OECD.

Pretty much, I think the forecast coming, emanating from our chapter for the U.S. is that unemployment will largely flatline in 2011.

QUESTIONER: From where it is now?

MR. BALAKRISHNAN: Right. But employment growth will definitely be positive in 2010, as it has been so far I think since November last year.

QUESTIONER: And if I could just follow up, I’m interested in, similar to what was just asked about China, what the policy prescriptions would be for U.S. labor markets if the government wanted to attack this.

MR. DECRESSIN: Just a point on the specific recommendations for U.S. policies at the current conjuncture, we’ll be speaking to those in the context of Chapters 1 and 2. So what we can draw on here is general lessons that we’ve identified in the paper.

MR. BALAKRISHNAN: I think the lessons for the U.S. are still pretty much what I mentioned before. The first line of defense is standard macro policy, monetary and fiscal policy through their impact on economic activity. Output has a pretty significant impact on unemployment dynamics in the U.S., as our paper shows. Financial sector repair will be very important again, given that the U.S. has suffered a financial crisis. Jörg will talk more about specific policies.

The policy which I guess could be applicable to the U.S. in this scenario—above and beyond monetary and fiscal policy, and financial sector repair—is, potentially, a job subsidy. There’s been a large debate about that. As I mentioned, the evidence is pretty mixed. The important thing is how it’s targeted and designed.

The U.S. is implementing a scheme. From what we understand, it’s targeted. We have to see. The devil is in the detail in terms of the implementation. But the key driver we believe for unemployment dynamics in the U.S. will be output growth. So the primary tools remain monetary and fiscal policy.

QUESTIONER: A question on both chapters, I’ll start with the rebalancing chapter. Could you comment on the current conditions? You talked about, I think in your first slide, how the current account balances, or the gaps, have narrowed. Is that sustainable, or do countries need to draw on the conclusions of your report to ensure that this phenomenon continues?

MR. TERRONES: Yes, we mention in the chapter that this narrowing is not going to be sustainable if deficit and surplus countries don’t rebalance their demands, and that’s the main motivation of the chapter. In this chapter, we have focused on the surplus countries. This doesn’t mean that the deficit countries don’t need to rebalance their demand, away from domestic demand towards net exports.

In summary, we argue that in order to have a strong recovery, you need to work on rebalancing demand on both the surplus countries and the deficit countries.

QUESTIONER: And my question on the labor chapter, would it be correct to assume based on your conclusions that interest rates generally have to remain lower than they may have in the past, and deficits might have to run longer than they have in the past, in order to offset your prediction of a sustained high unemployment rate?

MR. DECRESSIN: I think that’s right now. How long they should remain low—the interest rates—and how long fiscal support should be provided—we’ll discuss in detail again next week in Chapters 1 and 2, but the general gist of it, of the answer is yes, we need to have accommodative policy still.

QUESTIONER: I have a question about the unemployment level chapter since Italy, the analysis about Italy and Germany, like if I understand correctly, countries with these duality programs you were mentioning, Mr. Balakrishnan. So I would like to ask you first of all, if I understand correctly, that unemployment in Italy was less than predicted, and how much less than what you had predicted, and how the exit strategy for Italy to exit from this duality of short-term programs and to increase employment. Thanks.

MR. BALAKRISHNAN: Ok, Nicoletta, there are two issues here. One is short-term work programs where both Italy and Germany were analyzed in detail in Box 3.2. Duality, at least as we talk about it in the chapters, is a slightly separate issue. That’s when you have a two-tiered labor market, i.e., you have systems which are very strict, employment protection legislation on permanent contracts, but they also have a sizable sector—they have a sizable share of temporary contracts or workers who are on temporary contracts.

So this is a little bit of a problem in Italy, but we’re thinking more about countries like Spain, for example, in terms of duality.

Now Italy certainly has a large short-term work program, and in actual fact our analysis shows it is, in many ways, slightly bigger than the one in Germany in terms of the actual enrollment. I think the peak enrollment was around about 4 percent of the labor force, but you can check the details in Box 3.2

Now I think something we do analyze in the chapter is how the design features of the programs make a big difference in terms of the results. So exit is a key issue. In Germany, for example, it seems that workers are already exiting from these schemes. The actual enrollment levels have fallen significantly.

In the case of Italy, we do point to certain features which could suggest that the program may have some elements which are structural, like the fact that certain sectors have been receiving short-term work subsidies for a long period of time, even before the recession. So there are some design features in Italy which certainly, probably, need to be looked at or examined carefully. But certainly exit will be very important for reallocation. We believe that wage insurance policies could help that process.

And if you have any other questions, I’m happy to answer if that was too vague.

QUESTIONER: Just a little follow-up, if you could say how less than predicted was the unemployment in Italy, and compared to the general suggested recipe of monetary and fiscal policy, what policy you would suggest for Italy.

MR. BALAKRISHNAN: Well, I think the best way is if you look at Figure 3.9 in the chapter, which is on Page 20 if you have a copy. You’ll see there that there is a comparison of the countries.

So, in Figure 3.8 actually, if you look at the top panel of Figure 3.8, you can see the comparison for countries if we use the Okun’s Law relationship which is the relationship between output and unemployment. You can see what our predicted increase in unemployment would be and what the actual change was.

Now Italy is the fourth country from the left. You can see that there’s a slightly higher prediction than the actual change. It’s not hugely different. But when you take into account the size of the short-term work scheme, which is in Figure 3.9—we make a correction for Italy and Germany for their short-term work schemes because we have detailed data—you can see that actually the unemployment increase was, if you take into account the short-term work scheme, was a little bit larger than what we would have predicted. So the short-term work scheme in Italy has made a big difference to unemployment dynamics.

MS. LOTZE: I have a question—this goes in a similar vein here—from the Online Media Briefing Center, which I want to take:

You mentioned that Spain had the largest increase in unemployment. Is it one of the countries with a two-tier labor market where you would recommend open-ended contracts? That would require to weaken job protection laws for the current workers in the permanent job tier, correct?

MR. BALAKRISHNAN: Spain is certainly one of the countries we were thinking of in terms of having a two-tiered labor market. In many ways, it’s probably the biggest example of a two-tiered labor market.

Certainly, what we’re proposing would require two facets. One is to, in a way, weaken job protection laws on permanent contracts, but also tighten them, if anything, on temporary contracts. What we want to do is essentially reduce the duality between the two regimes of contracts. So, yes, that is correct.

QUESTIONER: I wanted to save my parochial question for the end. You talked about the unexplained factors in your predictions, or your attempts to try to analyze what’s going on in Canada and the U.K. Could you elaborate on that?

You can elaborate on the U.K. for my friend from the U.K. here, but of course I’m more interested in what is going on Canada.

MR. BALAKRISHNAN: Absolutely. There are various factors which we couldn’t take into account in the chapter. I think probably the key one is wage flexibility and wage moderation. I think a Bank of England report has actually suggested that may be an important factor for the U.K. this time around. The problem is that to really analyze wage flexibility in detail you need to have sector level data and micro data, which we didn’t really have to use in the chapter on a cross-country basis.

Another factor which may be important probably for both countries, and which I think requires a little bit more examination, is the hypothesis that a lot of the output declines have been in high productivity sectors, like manufacturing for example, and that may have mitigated the employment losses, as opposed to say if they’re in the construction sector, like in Spain.

MS. LOTZE: No more questions in the room, and I have no more questions online. So we’ll conclude the press briefing here. Thank you very much for attending and thank you to our speakers.