PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | SPEECHES & EDITORIALS | 1999 | THE GLOBAL ECONOMIC SITUATION

The Global Economic Situation: Where Are We Heading? Helmut Sohmen PBEC Chairman Thursday, March 4, 1999 Presented at a luncheon sponsored by the Chamber of Commerce of Hawaii and the Pacific Basin Economic Council. It is good of you to sacrifice your lunchtime to come and hear me speak. I hope you will not feel like the customers of the restaurant which had a sign outside its door that said "Come on in and get fed up." I am also very appreciative of your support of PBEC and its efforts. I am particularly grateful for the interest both the State and City Governments and the local business community have shown in assisting with the plans for PBEC's International General Meeting in 2000 here in Honolulu. The title of my remarks is "The Global Economic Situation: Where Are We Heading?" This is a wide subject and I may not be able to cover it in 25 minutes except by being a bit superficial and taking some shortcuts. To put it bluntly, the global economic situation is confused. On the one hand we have the United States powering along at incredible speed and with great robustness. On the other hand we have Russia looking like a basket case. In between, we have the countries of East Asia which are still in the midst of the crisis that started in Thailand in July 1997. Since I live in that part of the world, let me begin by a brief description of the situation in East Asia, one of the present crisis spots. Japan is by no means out of the woods, although the first active steps have now been taken to solve the banking crisis, at some considerable expense to taxpayers. But the mood in the country is still far from buoyant, and as long as consumers are not sufficiently inspired to spend their money (and in Japan it is not a question of not having enough money, it is a question of being willing to use it), Japan's short-term growth prospects will remain cloudy, with forecasts predicting another 1.5% contraction in GDP this year. Japan cannot rely on exports alone to help it recover; it needs a resurgence in domestic demand that so far has failed to materialize. Fiscal measures announced in November last year (tax breaks and greater public spending in fiscal 1999), together with the stimulus package of April, if implemented quickly, might help to provide the necessary boost in this respect. As the world's second-largest economy, Japan clearly continues to play a significant role in the region and the world. South Korea was one of the economies worst affected by the crisis. Huge external borrowings, the large but insufficiently recognized corporate debt, a general lack of corporate and financial transparency, and an ultimate reliance on explicit or implicit government support have been the principal causes for the country's difficulties which climaxed in December 1997. But Korea is making efforts to get his house in order, as complicated as the process is, especially given the militancy of the labor unions. The decline in economic activity has now moderated. Corporate restructuring is underway, particularly with regard to the big conglomerates. interest rates have fallen. Korea has opened up to foreign investments in previously closed sectors, as the recent takeovers of Korean banks by U.S. interests and by the Hong Kong and Shanghai Bank group have demonstrated. In Thailand, the other seriously affected economy, important financial indicators point to progress: the decline in manufacturing output has slowed. Interest rates have come down, equity prices have picked up, inflation has stayed low, and the currency has appreciated. The government is pursuing an expansionary fiscal policy to promote recovery, and a modest growth rate of about 1% for 1999 is predicted. However, the pace of recovery will remain slow, as long as there is continuing uncertainty about reforms in the corporate and financial sectors. Even in Indonesia, much in the news of late because of political turbulence and the secessionist tendencies of some of its provinces, the economic picture is perhaps no longer quite as bleak as it might appear from the headlines. The country of course has a long way to go in terms of restoring social and political stability, and it is not clear whether the forthcoming elections will create a clearer picture of the way ahead. Bank recapitalization, and improved supervision and regulation of the financial industry continue to be essential. Workouts of the problems in the corporate sector are equally important but they will take time, given the rudimentary legal framework that exists. However, interest rates have also been falling in Indonesia, and the currency has recovered from the sharp drops it saw in 1997 and 1998. The government accepts that a sizeable fiscal deficit (some 6% of GOP) is needed to stimulate economic recovery. Forecasts about a return to growth are not easy to make but would appear to be a couple of years away. For last year, GDP growth is anticipated to have been negative at some minus 15%. For this year, the forecast is minus 3%. To the surprise of many observers, the Philippines, and to some extent Taiwan, were less affected by the crisis than many of their neighbors. In the Philippines, prospects for growth for 1999 at 2 - 3 % remain valid. It is expected that policies to support domestic demand, i.e. easier monetary policy and an expansionary fiscal policy, will continue this year and next. Structural reform programs in both the private and public sectors under the previous administration, and trade liberalization measures, have borne fruit in the country In Taiwan, while there has recently been a noticeable slowdown in exports, the economy remains reasonably strong and GDP growth is expected remain positive. a tribute to the adaptability and flexibility of Taiwanese enterprises, a majority of which are in the small and medium size category. Nevertheless, 1998 fourth quarter GOP growth in Taiwan was only 4.8%, the lowest in 16 years. By contrast, the economic outlook for Malaysia remains uncertain. Estimates of a GDP decline (of some -8% in 1998, and -2% this year) remain realistic. Capital and exchange controls introduced in September last year have frightened some investors and have counteracted the steps that have been taken in the country to strengthen the financial and corporate sectors. But more needs to be done, as evidence of sponsored lending and insufficient supervision of the financial sector seem to persist. The publicity surrounding the trial of Former Deputy Prime Minister Anwar Ibrahim also continues to keep Malaysia negatively in the news. Hong Kong and Singapore face unexpected difficulties as well. They should not really come as a surprise, given the environment the two communities find themselves in. Hong Kong's economy has declined by some 5% in 1998. Singapore apparently still had positive growth last year. The forecasts for this year are however not too sanguine in both cases. Unemployment figures are still rising, government revenues are declining, and the fiscal deficit is increasing. Consumers are extremely cautious. In Hong Kong in particular the property market has experienced a sharp fall, causing problems for many investors and borrowers. Observers predict a string of further corporate failures and credit defaults this year. While the attacks on the Hong Kong dollar peg were successfully defeated last year, albeit at some cost to Hong Kong's credibility as a laissez-faire financial center. The Special Administrative Region does not have the benefit of Singapore in gaining a competitive advantage through a lower foreign exchange rate. Naturally, lower rents and labor costs will help both economies to become more attractive again by comparison to other locations in the Far East, and this may turn out to be a blessing in disguise over the longer term. China has been successful so far in maintaining the value of its currency, and by so doing has lent a degree of stability to the region's financial markets. I continue to believe that the statements by the Chinese leadership about the lack of a necessity to devalue the Renminbi should be taken at face value. Unless the Japanese Yen were to depreciate significantly again, and/or there are other major external shocks, I think China faces no immediate pressure to act. The country's export performance has been quite strong, as witnessed particularly in the US/China trade figures showing a -surplus (when trade via Hong Kong is included) of some US$60 billion for last year, while imports are more tightly controlled. Foreign exchange reserves remain respectable, and the Chinese currency is of course not convertible. The real problems in China continue to be the loss-making state sector, the fragility of the financial system, and the rapid decline in domestic consumer demand. The recent news concerning the discovery of large liabilities of various of the International Trust and Investment Companies (owned by provincial and municipal governments), as well as concerns about a number of illiquid Hong Kong "window companies" of Chinese state-owned entities, has created worries in the minds of foreign investors and led to significant provisioning among lenders to Chinese enterprises. Developments are in flux and it is difficult to say to what extent overall credit to China may tighten if at the end of the day foreign lenders have to take large haircuts. It is equally difficult to predict with any degree of certainty today what China's chances are to be admitted to the World Trade Organization (WTO). it appears that there is now less insistence on the Chinese side for membership than there was in previous years. The whole issue may in any event become submerged in the planned new millennium round of renewed multilateral negotiations While GDP growth in China last year was officially reported to be a respectable 7.2%, expectations for this year are not much more than 6%, despite significant public spending on infrastructure projects. Unemployment is clearly on the rise in China, and consumer spending is way down. The reform policies continue but the pace has been slowing. It will be interesting to hear what Premier Zhu Rongji has to say when he makes his report on the state of the economy to the National People's Congress this week. When there is concern about social unrest as a result of economic hardship, the Chinese leadership tends to toughen up on internal dissent to avoid problems in steering the reforms further. It is unfortunate that this negatively impacts on relationships between China and other countries, and in particular works to retard progress on the way to stronger bilateral ties between the United States and the European Union, respectively, and China. While not part of East Asia, and not Included in PBEC, it is worth to briefly mention the Indian sub-continent, often prominent by the benign neglect accorded to it by commentators on Asia. The recent nuclear tests in both India and Pakistan have managed to heighten awareness again that these countries exist, that they have military capability of some significance, and that they house a major part of the world's population. With India's high birthrate the country is forecast to overtake China as the most populous on earth within the first half of the next century. Unfortunately, the economic picture in all three big countries (India, Pakistan, and Bangladesh: not including Sri Lanka or Nepal) does not look particularly bright. India is the country that probably suffered most from the collapse of the old Soviet Union with which it had strong foreign trade and investment relationships. India does not seem have recovered from the loss of that captive market, although there were strong hopes of a better economic performance in the early part of the 1 990s. Frequent changes in government policies, rapid monetary growth, budget deficits, inflation, and currency depreciation have all contributed to a weak performance. Structural reforms and the elimination of bureaucratic obstacles on all fronts continue to be difficult to put in place. Bangladesh is one of the poorer nations of the world, plagued additionally by frequent natural disasters. Pakistan is supposed to be more cohesive, but has in recent years suffered from internal political strife that has overshadowed all attempts to produce sustained economic growth. All in all, the sub-continent continues to be an area which must carry some promise for the longer term, but where expectations for business in the short term should be tempered by a large dose of caution. All in all I am optimistic about the ability of the East Asian countries to return to high growth rates in due course. The only real question is when. The crisis is also a learning process. Especially so when the concerned economies and their governments are willing to try and identify the reasons for the market failures and make dedicated efforts to remedy their weaknesses. Open Societies, the rule of law, freedom of expression, sound financial systems, a competitive and independent private sector, good education, high standards of public sector governance, and full transparency and accountability are obviously some of the goals that these countries should endeavor to reach. Then we have the nations of Latin America, again suffering from very traditional ills. You are closer to the scene than I am living in Hong Kong, so you will know more in detail about the situation. I happen to believe that these countries will get help when needed, as Mexico has in the past. Not least because of the geopolitical importance they hold for the United States. but also because they have been modernizing over the years and the politicians in these nations are less proud today in accepting good advice and financial assistance, many of them having been educated in the United States. The Middle East remains unstable, given ethnic conflicts, religious fanaticism, dictatorial grandeur, traditional ways of using power, and the world's largest oil and gas reserves. It will remain a trouble spot for a tong time to come, unless the world creates a new religion that appeals to all believers in the area. Or unless we discover new, and hopefully endlessly renewable and ubiquitous sources of energy to feed the increasing global demand and could then end our global dependence on reserves in the Middle East. With very low oil prices, many of the producing countries (including those in other parts of the world) are now facing budget problems; this is usually not a good omen for political stability and social peace. Africa continues to look like a black hole, with only a few bright spots. Even South Africa has not delivered on the promise it seemed to show at the end of apartheid, and most of the rest of the continent keeps degenerating into tribal conflict and endless bloodshed. It Is difficult to see how Africa can emerge from political and economic doldrums, without a massive and concerted international effort to help it. Even then, the widespread lack of education and considerable apathy among a majority of the peoples of Africa will mean that such an effort will likely take generations to show better results. That leaves Europe. Europe presents a bit of an ambiguity. Success stories like the transition of many of the old Eastern Bloc countries to capitalism, the enlargement of the European Union to 15 nations, the recent introduction of the "Euro," the imminent admission of Hungary, Poland, and the Czech Republic to NATO (and their possible accession to the EU in a few years' time, together with a few other Eastern countries) are positive news and creditable achievements. Once they are all united and count some 480 million inhabitants, Europe will be a formidable economic force in the world. But there are failures as well: disarray over budgetary reform in the EU (especially as regards the Common Agricultural Policy, the inability to develop a common foreign policy, frequent jurisdictional disputes, or lack of consensus on tax harmonization and fiscal policies. There is a need for more flexibility in European labor markets to combat what has become chronic high unemployment. There is an urgent need to deal with mounting deficits in the extensive social welfare programs. But with the shift to the left in governments in many of the major European economies, there is a natural reluctance to disturb social security nets, or to tackle minimum wages and the practice of collective bargaining. By and large Western European nations are still doing reasonably well in economic terms and showing positive growth rates. The shock of the Russian defaults seems to have been weathered, and so far the impact of the Asian crisis has not apparently been too severe, although it clearly could not be avoided. But many European companies are not investing presently in Europe, but prefer to put their funds into North America or Asia. They are happier with the access they now find in Asia to sectors that were previously closed to foreign interests. Europe generally is also showing more interest in fostering political, social and commercial links with Asia, to try and catch up with the closer ties that exist between North American and the Western Pacific. On the global horizon there remain only Australia and New Zealand. Australia has done surprisingly well during the last year, considering its dependence on trade with East Asia (Japan in particular) and on the sale of raw materials whose prices have dropped in line with the general decline in commodities globally. New Zealand has also fared reasonably well. The country continues to act as an example of a highly regulated economy that liberalized by its own volition. New Zealand is working proof that privatization, deregulation, and the removal of subsidies, of import controls, and of other administrative barriers, as well as the treatment of citizens as customers rather than as taxpayers leads to stronger entrepreneurship, less dependence on the state, positive motivation, higher productivity, and renewed growth. This brings me to the United States. An almost incredible achievement of impressive annual growth with low inflation and a strong dollar over a good number of years, with no sign of abating. The U.S. equity markets, often seen as heading for disaster at current high levels, astound observers with their resilience and their ability to climb even higher. Clearly the United States acts not only as the only superpower and policeman in the world, but as the only real global economic locomotive. in keeping its markets open to imports from East Asia and from other parts of the world (i.e. from Europe, Canada and Mexico), while at the same time accepting a reduction in its own exports, the United States is helping countries to pull out of recession. There must however come a limit to this generosity at one stage, and with a US$300 billion trade deficit looming, that point may arrive soon. Indeed, U.S. trade negotiators are making threatening noises already. It is hoped that they are not an overture to protectionist instincts rearing their ugly head that could of course be quickly followed in other places. The current "banana war" between the United States and the European Union, and the US sanctions recently imposed on European exports, do not make happy reading. The United States is not of course a complete loser. Slowing demand for a range of goods in Asia has helped to push global prices lower. Lower energy costs have certainly helped the USA to keep inflation in check, keeping in mind the reduction of 29% in the total oil bill in 1998 over 1997. Semiconductors, an essential ingredient for America's hi-tech industries, have become much cheaper as well. Barring any sudden collapses on Wall Street, or a massive default in Latin America, the United States might see a flattening of the growth curve in the next couple of years but not necessarily a real decline in its economic advance, even if interest rates were to move up somewhat. Against this quick and broad-brush backdrop of where we find ourselves today, let me come to the question in the title of my speech. Where are we heading? This is by far the more difficult part of my task this afternoon- I will obviously not go through the list of regions again to try and give you a case-by-case answer. This would be time-consuming apart from being silly, especially since I am not a trained economist. Economists of course always know what will happen, at least when they can stick to the assumptions in their models. Alas, the real world is not so predictable and the world in considerable flux in which we live today is even less so. Nobody really knows what will happen in the next three or five years. We can only guess and draw conclusions from observable trends. One major conclusion from judging current developments is obvious: the globalization process will continue. There is no way back, and there is no way of avoiding it or stopping it. There is only the question of how soon everybody will accept it as given, and will adjust to the demands it makes on all our lives, on our institutions, and on our political organizations. I keep being radical in suggesting that while we are slowly coming around to acknowledging and coping with the economic consequences of globalization (such as instantaneous capital transfers, economic concentration of business sectors through an accelerating process of mergers and acquisitions, the multinational ownership of assets, easier access to markets, truly global marketing and distribution networks, the spread of the service sector, the advance of electronic commerce, etc.). we are well behind in accepting the political reality of globalization. That reality consists of a progressive inability of national governments to deal with or control many manifestations of globalization within the confines of their jurisdictions. A good example was the obvious lack of effective supervision of hedge funds, a failure that remains despite various attempts at subsequent rectification. There is plenty of talk about a reform of the international financial architecture, and there has been agreement just recently in the G-7 to establish a financial stability forum. Little of -substantive change will come out of these efforts, other than a closer liaison among the concerned parties and a better information exchange. Because as long as different national interests co-exist, and any policing of the behavior of market participants has to be done through local authorities applying national rules, implementation of any agreements on a cohesive basis will be difficult and results remain elusive. Another example is the argument about nationality, recently much debated in Germany. There is an ever larger expatriate workforce living in different countries every year. Providers of services are now often totally free in their choice of residence or base from which to conduct their business. go why should countries not allow more than one citizenship, if for no other reason but to tie highly-skilled manpower to their shores? Corporations already need to comply with rules in different jurisdiction that in many cases make little difference in practice as to whether the legal entity Is locally incorporated or not. Why should the same not be possible for individuals? Take another example. Given the existence of global enterprises doing business around the world, by definition the larger companies, should there not be agreement on a global competition policy to ensure that market power does not impact on a competitive framework? Restrictions on trade abuses are also built into the WTO rules. But which organization would be able to devise such a competition framework and, more importantly, would be able to guarantee enforcement on a uniform and consistent basis? There is limited progress so far with efforts to establish an international criminal court, since government jealously guard the right to prosecute within their jurisdictions. Yet the fact is that more crime is committed that transcends national boundaries or is organized on a global basis, allowing loopholes in both the search for culprits, and in their detention and prosecution, is not readily accepted or effectively dealt with. Similar problems exist in education and professional qualifications. Education is an essential prerequisite for the use and the dissemination of information, the latest and now probably the most powerful of the factors of production. How many countries automatically accept the certificates issued by universities or professional bodies in another state without further examination? How many countries still demand local approvals for the exercise of a commercial activity even when evidence of past experience is ample? The same applies to technical standards for certain goods and services which national jurisdictions like to impose, and frequently not just for quality, safety, or environmental reasons. Serious global issues are often debated in fora in which each nation-state has a vote, whether it is Fiji or the United States. Economic relevance might ultimately carry the day, but does not always. Economic relevance certainly means that the richer countries carry more of a cost burden for the defense of the global order that is to the benefit of all. What I am getting at with all these references is the need for the world to look at how the nation state, which as a concept is after only about 120 years old, could be reformed to stop it being a constraint on a globalizing world where commercial activity and social intercourse more and more frequently go beyond or ignore national borders. Abolishing the nation state may sound like a wild idea at this point, and I admit is probably something ahead of its time. But I believe an investigation of the disadvantages of carrying on with the current political order, and some analysis to determine how to achieve improvements, is well worth spending some time on. To progress on this line of thought will probably require as a first step the examination as to how many state functions can be reduced to the absolute minimum that may be required to maintain and protect the social order. Privatizing present government activity at national level by transfers to the private sector (not just selling off state-owned enterprises) should be the objective. Once achieved, this would in the following more easily allow either a cession of remaining state authority to supranational institutions, or alternatively their delegation to smaller administrative districts. To quote Professor Milton Friedman (AWSJ editorial, December 1998): "We do not need more powerful government agencies spending still more of the taxpayers! money, with limited or non-existent accountability. That would simply be throwing good money after bad. We need government, both within the nations and internationally, to get out of the way and let the market work. The more that people spend or lend their own money, and the less they spend or lend taxpayer money, the better." Globalization produces other important effects. One is the inevitable arrival of a stricter requirement for "benchmarking," in other words, the need to follow best practice in all aspects of social and commercial behavior. That "best practice" is now more and more often determined on a global basis and has therefore become much more demanding. It extends from issues such as the treatment of human rights to the ready acceptance of internationally recognized accounting standards, from prudential supervision to the fight against corruption, and from environmental protection to bankruptcy laws. Globalization here acts as a great leveler, but at the same time creates strains because of the existing differences in national norms, cultural traits, and communal attitudes. Globalization is a reason behind what is denounced as the more frequent "interference in domestic affairs," when outsiders (be they governments or special interest groups) take it on themselves to criticize what are seen as less than adequate forms of behavior or activities when judged against what is regarded as better or best practice globally. Such criticism naturally puts pressure on the working environments within national jurisdictions, and this spotlighting is therefore very often seen as most unwelcome and is then actively resisted. Globalization means the gradual elimination of more and more traditional "niches": areas of economic activity that are, for whatever reason, shielded from the mainstream and either enjoy cost advantages or reduced competition, and/or permit-protected positions or allow monopolistic practices allowing higher returns. Here again some market participants, and protective governments, do not always appreciate the winds of change early enough, and prepare themselves for the adjustments that become necessary for the survival of the activity. Globalization acts to continually shorten the time span between the development of new technologies, and their implementation. Globalization has so far shown the most dramatic effects in the financial sector and in other service industries, but effectively all commercial endeavors are touched by the process, alone by the advances in communications technology and cheaper global transport costs. In light of these changes on a global scene, it is becoming more and more important for market participants. in whatever field or profession they are engaged in, to keep abreast of developments. Even more important, they must try to help educate their national bureaucrats to be equally aware of the need for openness, and to be ready for the adaptation of existing structures and norms, in order to be better able to face the challenges that globalization brings with ft. This is where an organization like PBEC can have a significant role: as a communicator and data and of ideas between the business world and governments. PBEC's broad base and independence makes it an ideal organization for this task, and for acting as an echo chamber. This is where we see PBEC's principal role today, apart from making friends across the vast distances of the Pacific, and having an educational time at our gatherings. Let me encourage those of you not yet members of PBEC to come on board, and in particular let me encourage all of you to come to Hong Kong in May for our next International General Meeting.