How CountriesCompete: How Countries Compete Professor Richard Vietor Harvard Business School United States Studies Centre National Summit 2007 The University of Sydney December 2007


Slide2: Markets have become global Globalization, underway for more than half a century, is a process of economic integration and cultural homogenization across national borders. Fostered by advances in transportation and communication technologies after World War II and a eight rounds of trade negotiations under GATT, trade has grown at twice the rate of world GDP. Floating exchange rates, sovereign lending and the liberalization of capital accounts have accelerated this process. Today, nearly 73,000 multinational corporations manage more than 880,000 multinational subsidiaries. © Richard Vietor


Slide4: Share of the World GDP 2005 Source: World Bank, World Development Indicators 2007.. $45 trillion


Slide5: Share of the World GDP 2005 Purchasing power parity adjusted Source: World Bank, World Development Indicators 2007. $61 trillion


Countries compete: Countries compete Within this global market place, countries compete for exports, for foreign direct investment and other capital resources, for technology and managerial know-how and for access to natural resources. The purpose of this competition is growth and development – to reduce poverty, accommodate urbanization, create jobs and increase living standards.


Slide7: “Preparing our nation to compete is a goal that all of us can share… In a dynamic world economy, we are seeing new competitors, like China and India, and this creates uncertainty.” President George W. Bush State of the Union Message, 2006


National Development Strategy : National Development Strategy Countries have development strategies: - either explicit (carefully formulated and discussed by senior government officials); - or implicit (a loose collection of goals and policies that merely net to strategy, after the fact).


Organizational structure: Organizational structure Countries – like companies – need an organizational structure suited to implementing the strategy; That structure must fit the domestic context – the skills, assets, polity and culture of its people – and the international context – its geography and political relationships abroad.


The Role of Government is Crucial: The Role of Government is Crucial Mediates the strategy Determines the organizational structure Shapes the context by building and regulating the institutions that shape the market


Essential role of state: : Essential role of state: Provide security – domestic and international; Enforce contracts, property rights and laws; Back risk – incorporation, bankruptcy, unemployment insurance, pensions, nuclear facilities; Provide money; Manage macro-economy; Implement industrial policy (explicit or implicit).


Developmental Strategy of Government: Developmental Strategy of Government Fiscal policy Revenue sources Expenditure choices Monetary policy Control money/inflation Regulate banking Control exchange rates Incomes policy Wages, prices, work rules, distribution of income Trade policy Tariffs, taxes, non-tariff barriers Foreign direct investment controls Nationalization/privatization Economic regulation Externalities (environment) and market failures (telecom, banking, infrastructure and competition) Provision of subsidies


Government management of institutions: Government management of institutions Corporations, partnerships, proprietorships Infrastructural resources (water, power, roads, rails, air traffic, telecom) Human resources (schools, colleges/universities, healthcare) Technological resources (patents, defense and public-science research) Capital resources (banking, securities, insurance)


Trajectories of Development: Trajectories of Development Asian high growth Post Soviet restructuring of Russia and East Europe Latin American recovery from debt crises Islamic resurgence African renaissance European integration Deficits and debt in Japan and the USA


Singapore – Desperation Strategy:: Singapore – Desperation Strategy: Build on the entrepot advantage; Free trade and foreign direct investment Tight monetary policy Market exchange rates Forced savings Invest in public housing and infrastructure State sector –> 25% GDP Balanced budget (by late 80s)


Singapore’s institutional web: Singapore’s institutional web Ministry of Trade and Industry Economic Development Board (EDB) Housing Development Board Jurong Town Corporation Temasek Holdings Singapore Airlines, Singapore Technologies Monetary Authority of Singapore (MAS) Central Provident Fund SPRING (productivity board) ASTAR (science and biotechnology) National Trade Union Congress Corrupt Practices Investigation Board


Singapore – Results!: Singapore – Results! Real GDP growth – 7.5% for 37 years; Savings 51% GDP; Investment 38% X&M = 3xGDP Inflation –> 2.1% Balanced budget Current account 23% GDP GDP/capita - $27,580 ($29,780 ppp)


Slide18: Keep economy growing? Cut taxes and balance budget? Move to higher value-added exports? Attract intellectual talent? Refocus on biomedicine? Deal with Chinese (and Indian) competition? But in 2007, Can Singapore:


China – a Greater Challenge: China – a Greater Challenge $200 per capita Closed, Communist economy Inefficient collective agriculture State-owned enterprise 987 million people “Cultural Revolution”


Slide20: Deng’s Pragmatic Liberalization One-child policy Agriculture – household responsibility system TVEs – Township & village enterprises SEZs – Special economic zones SOEs – management responsibility system; then privatization Gradual price decontrol Tax reform (1994) Currency reform (1994) WTO - 2001


China - Results: China - Results 9.4% real GDP growth Investment 42%; Savings 52% Consumption down to 38% Exports 3% -> 37% Imports 3% -> 31% Inflation 1.5% Unemployment – 7% Balance of trade $218 bil; current account $250 bil. Cumulative FDI - $645 bil


Slide22: Structure of China’s Industrial Output percent of total value


Slide23: U.S. Goods Trade Balance with China: Tariff Cuts, Agreements, 20 years of MFN, WTO and Accelerating Collapse ($ Billions per Year: US Merchandise Net Exports)


China’s steadfast exchange rate: China’s steadfast exchange rate


Slide25: Tightly managed economic liberalization; Institutional reform still lagging (e.g., SOEs, banks, federalist relations); Externalities mounting (e.g., environment, under-employment, corruption, food and energy dependence); Income distribution, rural population chafing… WTO – partial implementation; Trade surplus with US ($233 bn)– sustainable? Next round – economic/political balance? China – Great Performance, but...


India – Failed Import Substitution: India – Failed Import Substitution Hindu rate of growth – 3.5% per year (with population growing 2.5% per year) 50% of output owned by public sector; 100% of banks and insurance firms; Highest tariffs, capacity licensing, imports allocated and price controls; “Sick units” protected; Widespread corruption.


India after 1991 Washington Consensus…gradually: India after 1991 Washington Consensus…gradually Fiscal policy – deficit reduction; Monetary policy – tightened; Exchange rates – floated; Capacity licensing – removed; Price controls – removed; Tariffs lowered; Privatization begun; Foreign direct investment allowed; Spending on infrastructure and education increased.


Slide28: GDP Growth Current Account Deficit Government Deficit Source: Compiled from Center for Monitoring the Indian Economy; HSBC securities; Jardine Flaming India Broking Ltd. Note: Fiscal deficit is the difference between revenues and spending; current account balance is the broadest measure of goods, service and money that crosses a country’s border, with a deficit indicating more imports than exports. % % % © Richard Vietor India’s Results: Year-to-year percentage growth in gross domestic product, and government deficit and current account deficit as percent of GDP; all figures for year ending March 31


Slide29: Foreign Investment in India Since 1991


Slide30: (0 = most corrupt 10 = least corrupt) Source: Compiled from Transparency International, 2006 Corruption Index Ratings © Richard Vietor Corruption 2006 Rank 5 17 20 45 51 60 66 66 66 66 121


Slide31: The Government Takes Shape: India’s Lower House of Parliament


Mexico and Latin America (debt, structural adjustment, and micro-reform): Mexico and Latin America (debt, structural adjustment, and micro-reform) Old Strategy Import substitution strategies with resource-led growth High tariffs, limited FDI, large public sectors, fiscal deficits, monetization, fixed exchange rates Revised Strategy Debt leveraged growth, 1974-1982; Debt crises & IMF bailouts


Economic Liberalization Strategy – 1982-1996: Economic Liberalization Strategy – 1982-1996 Devaluations Fiscal and monetary control Tariffs down -> NAFTA Privatizations – domestic & foreign FDI – maquiladoras Wage controls Brady plan debt reductions But, overvaluation, current account deficits and foreign debt up – second “tequila” crisis.


Mexico Recovery(real GDP): Mexico Recovery (real GDP)


Inflation under control: Inflation under control


Political Liberalization StrategyVincente Fox and Felipe Calderon: Political Liberalization Strategy Vincente Fox and Felipe Calderon Macro-economy stable – now microeconomic and institutional reform; Fix pensions; Poverty, education, income distribution, labor law, oil and gas sector, environment; Control crime and drugs But PAN a minority party; And China competition threatening maquilas!


Slide41: Mexico – democratizing and economic reform – privatized, well-managed fiscal and monetary stability, and NAFTA dependent; now, microeconomics; Argentina – is stable government restored? Will Argentina inflate? Will either make it competitive? Will default have lasting ill-effects? Brazil – fragile condition of Real – Can institutional reform continue, with effective debt management, tension reform and income redistribution- will Lula alleviate corruption and manage responsibly? Latin American Recovery? Growth of GDP % Inflation Cur acct (%/GDP


Slide42: 1995 GDP(bil$) GDP Growth 90-95 GDP Growth 2006 Kenya 9.1 1.4 6.0 Tanzania 3.6 3.2 5.9 Congo 14.4 1.8 5.1 Zambia 4.0 -0.2 6.0 Zimbabwe 6.5 1.0 -5.1 Malawi 1.5 0.7 8.4 Uganda 5.6 6.6 5.4 Angola 0.5 -4.5 15.3 Botswana 0.2 4.2 4.2 Mozambique 0.4 7.1 7.9 Namibia 0.4 3.8 4.5 South Africa 136.0 0.6 5.0 Lesotho 1.0 7.5 1.6 Africa Recovery Map source: http://www.politicalresources.net/africa-map.htm


GEAR – Growth, Equality and Redistribution: GEAR – Growth, Equality and Redistribution Fiscal policy (deficit reduction) Monetary policy (constant real exchange rate) Privatization – now stopped Two-pronged industrial policy Lower tariffs - WTO Two-tier wage policy - failed Now Black Empowerment


Slide44: South Africa’s Recovery from Apartheid Rand billions © Richard Vietor Real Rand


Slide45: South Africa’s Trade and Current Account Balances Billions $$ * estimated Source: Economist Intelligence Unit, South Africa, February 2007.. © Richard Vietor


Slide46: South African Social Issues: Unemployment: 30.2% Infrastructure: electricity, plumbing, telephone, housing; Education: 32% illiterate Crime: 26,000 homicides;1 felony/21 people AIDS: 19% - 24% of adult population - 2005 © Richard Vietor


Black Economic Empowerment Act 2003: Black Economic Empowerment Act 2003 Address slow pace of change in economic equity (gap in income inequality among blacks growing (GINI up from .59 to .63) BEE: hiring, training, promotion, ownership & control; Charters – voluntary commitments – in mining, finance, information technology so far; FINANCIAL CHARTER 25% senior mgt, 50% middle mgt. by 2008 50% black-owned procurement; Financial services for 80% of population; 25% black ownership by 2010; 33% of the board should be black


Slide48: Brazil, Argentina, Chile, Mexico, South Africa, Malaysia and Turkey- if not -> low cost -> differentiation -> focus “Stuck in the Middle”?


Slide49: Japan – Deficits, Debt and Deflation © Richard Vietor


Slide50: Japan: Major Bank Profits, FY 90-99 (in trillions of yen) Source: Fitch IBCA


Japan’s inflation rate: Japan’s inflation rate


Slide52: Discount Rate


Japan’s market interest rates: Japan’s market interest rates


Slide54: Japan’s Fiscal Deficits


Public Debt of Japan (as percent of GDP): Public Debt of Japan (as percent of GDP)


Japan Unable to Change Strategies: Japan Unable to Change Strategies Monetary policy won’t work – liquidity trap Fiscal policy won’t work – deficits & debt Institutions need modernization Political gridlock Totally dependent on exports Debt/GDP 178% and rising? Collapse pending? Or Restructuring? Yen?


Slide57: Japanese Yen/U.S. Dollar (inverted scale)


USA 1980 – Inefficient Markets: USA 1980 – Inefficient Markets GDP growth –0.3% Unemployment 7.5% and rising Inflation 10% (cpi 12.6%) Trade deficit $28 billion and rising Productivity –0.6% Unit labor costs up 10.3% Regulated sectors inefficient Interest rates 19% Fiscal deficit 2.4% GDP $$ depreciating (against Y and DM)


Decontrol: Decontrol Tighten monetary policy Cut taxes (25% marginal income tax plus accelerated depreciation and itc) Deregulate transportation, energy telecommunications and banking Let dollar rise 63%


Phase One: Phase One Deep recession (1982-83) Dollar appreciates Massive trade and current account deficits Huge defense expenditures Oil prices weaken US economy grows 3.4% annually Inflation drops to 2.3% Real interest rates eventually fall Massive fiscal deficits (1989-92) Gulf war


Phase Two: Phase Two Deficit Reduction Act (1993) Maximum marginal tax rates hiked (41.5%) Expenditures cut ($112 bil./yr) Free trade (Uruguay Round & NAFTA) Investment boom Productivity grows 2.1%/year – mfg 4.1% GDP growth 4.1% per year Budget balanced Unit labor costs negative Dollar strengthens (’95-01) Savings falls to 1%, current account to -$410 bn


Phase Three – Deficits & Terrorism: Phase Three – Deficits & Terrorism September 11th Afghanistan Homeland Security Iraq Four tax cuts - $1.3 tril,$100 bil,$360 bil, $156 bil. Fiscal surplus ($236 bn) to deficit ($413 bn), now $163 bil. Debt from $5.6 to $9.0 trillion (back to 63%/GDP) Current account deficit to $811 billion Net foreign debt to $2.1 trillion $$ depreciating…


Slide63: Bad News – Budget Deficits Nixon Ford Carter Reagan Bush Clinton Bush $$ bil. Source: Compiled from Economic Report of the President 2007. © Richard Vietor


Slide65: Good News - US Productivity: 1981-2007 Source: Department of Labor Statistics. © Richard Vietor Percent


Slide66: Bad News - Personal Savings Has Collapsed as a Percent of Disposable Income in the United States


Slide67: Worse News - US Balance of Trade and Current Account, 1960-2006 Billions $$


Overall Global Current Account Imbalances in 2006: Overall Global Current Account Imbalances in 2006 Source: IMF World Economic Outlook, April 2007


Slide70: Good news – US Dollar has weakened, some * Includes Euro Area, Canada, Japan, Mexico, United Kingdom, Switzerland, Australia and Sweden. Euro Area includes Germany, France, Italy, Netherlands, Belgium/Luxembourg, Ireland, Spain, Austria, Finland, Portugal and Greece.


Sad News for the next generation: Sad News for the next generation © Richard Vietor


How Countries Compete: How Countries Compete Governments must guarantee basic property rights; Governments must maintain sound macroeconomic policies: Fiscal deficits cannot continue indefinitely, Entitlements should be limited and securely funded; Taxes should be somewhat redistributive and discourage excessive consumption; Governments must stimulate savings and investment; Strong (not necessarily independent) central banks are necessary for non-inflationary growth; Microeconomic liberalization (trade, foreign investment and privatization) by government is eventually necessary in a competitive global economy; Governments must maintain labor market flexibility to enhance productivity and facilitate competitiveness; Government must manage resource endowments carefully; Governments must control corruption; Governments are responsible for insuring equitable income distribution; Governments can not allow unsustainable current account asymmetries.