GLOBAL

ECONOMY
LECTURE ONE
AUGUST 2011
INTERDEPENDENCE
Globalisation means inter-linked, inter-
related, inter-dependent
For this reason, it is difficult if not
impossible to discuss topics
individually
Growth, trade, currencies, deficits,
interest rates, investment strategies all
spill over into one another.
TOPICS
The handout lists a large number of
topics, some of which can be
analysed in isolation
Most cannot, which makes
presentation and structure untidy
FOCUS
How global economic and financial
developments influence finance,
banking, investment, industrial
strategies
Current not historical issues
Policies, options, consequences
Industry and enterprise level analysis
where possible
 RELEVANCE
Arguably, this MBA programme is weak
in four respects:
1. It is too theoretical the real world of
management and business is remote
from much of the discussion.
2. It is too parochial participants are too
pre-occupied with events in Zimbabwe
or neighbouring countries to see or
understand the wider picture.
3. It is too quantitative we make a fetish
of accounts, stats, mathematical
models for investment and portfolio
management, etc
We spend too much time teaching
techniques and not enough teaching
understanding and analysis.
4. It is not sufficiently integrative too
many modules stand alone they are
not cross-cutting, they do not relate to
one another.
RELEVANCE
This module seeks to tackle these 4
criticisms head-on
(A)It is about practical, real-world business
economics, and
(B)The module focuses on global
economic developments and how they
impact on business decisions, not just
in finance, as well as on their relevance
for business in Africa and Zimbabwe.
(C) It is integrative finance, economics,
business strategy, geopolitics, and
(D) It is non-quantitative in fact it
discusses how quantitative models are
partly to blame for the global recession.
FINANCE
Because the current global crisis has its
roots in banking and finance,
international financial issues will be
given special attention.
But, as already argued, it is simply
impossible to separate financial issues
like exchange and interest rates
from trade, growth and indeed
geopolitical, issues.
INTEGRATION
Accordingly, the approach has to be
integrative.
As the outline shows, one example of
this integration is the relationship
between real and financial globalisation.
The two go together they cannot be
analyzed in isolation from each other.
COMBINATION
There are complex linkages between,
for instance, an FDI decision and its
financing.
Financial and real globalisation impact
on one another.
PROBLEM/ISSUE-BASED
The approach used is problem-based
and issue-based.
It is impossible to start at the beginning
and move logically from topic to topic
Instead we have to ask what are the
issues that dominate the global
economy in mid-2011 and analyze
them.
DYNAMIC
One consequence is that the syllabus
changes from semester to semester.
An issue, highly topical a year ago, may
have faded from public view.
The approach has therefore to be
dynamic to discuss issues that matter
now.
POLICY-BASED
As well as being problem- or issue-
based, the module has to be policy
based - at two levels:
Government policy, including
international policy, and
Corporate level policy
WHAT ARE THE
ISSUES?
POLICYMAKERS SEEK:
Faster economic growth in output and
employment
Greater price and currency stability
Reduced economic volatility, and
Rapid poverty reduction and increased
income and wealth equality.
CORPORATIONS SEEK:
Increased market share and,
as a spinoff, increased earnings.
More efficient production, distribution
and sales networks.
Fewer surprises in terms of exchange
rate, economic or price volatility.
Reduced state control and intervention.
Greater decision-making certainty.
COMMONALITY
There is therefore considerable common
interest between policymakers
(governments) and corporations
But because increasingly corporations
are multinational, not national, there is
scope for conflict of interest between
governments and multinationals.
CONFLICT
Indeed, we often get conflict between a
home government and its own
multinationals.
Classic examples are the Obama
Administrations criticism of US
multinationals for exporting jobs or
Zimbabwes indigenization policy.
NEW PHENOMENON
Also there is an important new cross-
over point in international political
economy.
This is the rapid expansion of the so-
called Sovereign Wealth Fund industry.
(SWFs) and of State Capitalism.
SWFs
SWFs are state-owned investment
companies.
Mostly they have been set up in oil rich
countries, but also in a number of Asian
countries, with the aim of investing
excess government money abroad.
CROSSOVER POINT
They are a crossover point because
they mean that a foreign state say the
Norwegian (state) Pension Fund
Global (as it is called) invests in private
equities, bonds, etc, or in government
paper in another country.
POLITICAL INFLUENCE
In other words, it is not a straightforward
financial investment as with a
privately-owned pension fund or hedge
fund
But it is a government-owned investor
and as such it may well be motivated by
considerations other than the financial
rate of return on the investment.
INTERNATIONALISM
Supranational bodies IMF, World
Bank, WTO, EU, UN agencies, etc are
umpires or arbitrators
They seek to achieve the best possible
outcome for the global economy
This often conflicts with the goals of
national governments or firms, and
regional bodies like the EU or SADC.
DYNAMICS
The situation is dynamic, fast changing
Seldom is a problem really solved
permanently
Invariably solutions are fragile
compromises that do not last long
Attention spans are short a crucial
issue today is solved by fragile
compromise, only to re-emerge years,
or even months, later.
ANALYSIS
All of this highlights the dangers of
taking a superficial, descriptive
approach
Accordingly, this module sets out to be
analytical
The approach will be to discuss the key
issues facing the global economy today,
identified in the handout
A MANAGERIAL VIEWPOINT
Where at all possible, the issues will be
viewed from a business management
and a policymakers viewpoint
Not from an economists viewpoint.
The challenge is to examine what global
economic events mean for managers in
business and in government.
RING-FENCE
However, as noted already, it is simply
impossible to ring-fence financial issues
and analyse them in isolation from trade
or geo-politics.
By this stage of the MBA, you are well
aware that strategic decisions cannot be
compartmentalised into finance,
marketing, production, HR, etc.
MAJOR TOPICS
1. The global economy in 2011 the
recession, why, how long and what
next? Will there be a double-dip?
2. The New Normal global economy
what has changed in recent years, why
and how
3. What are the implications for trade,
investment and currencies.
TOPICS
4. Capital flows: portfolio and direct
5. Global industrial economics in the 21st
century
6. Corporate Strategies in a globalized
economy
7. The Sovereign Debt crisis what is it
and how did it arise? What does it mean
for the global economy?
8. Implications for business :Is capitalism
dead and is private sector capitalism
being replaced by state capitalism?
Are we on the road back to 1960s and
1970s-style socialism?
What are the implications for?
1. Policy
2. Corporate strategies and decision-
making
3. Investment decisions
4. Financing decisions
5. Location decisions
6. Value-chain decisions
IMPLICATIONS
For country/regional performance
For currencies
For companies
For competitiveness and productivity
For growth and development
WHAT MIGHT COULD
HAPPEN?
Module looks forward
Analyses current problems and
challenges, and
How they might evolve
How they might be solved, and
What the likely implications are
THE WORLD
ECONOMY IN
AUGUST 2011
Positive Outlook
Up until 4 years ago (late 2007) the
world economic outlook was very
positive.
Government leaders and the Bretton
Woods Institutions (BWI) were worried
about global economic overheating and
potential inflation.
 That changed dramatically in mid-
2008 when the world plunged into a
severe recession.
Indeed it took 2 years - until the final
quarter of 2010 for the US economy
to get back to where it had been in mid-
2008.
GLOBAL GDP GROWTH
(% p.a.)
Series 1
6
5
4
3
2
1
0
-1 2000-07 2008 2009 2010 2011f 2012f
 At the same time, the policy focus
swung dramatically from concern about
escalating inflation in the first half of
2008 to fears of a deep recession.
Deflation rather than inflation was
then seen as the main danger.
DEFLATION
Deflation is a danger because falling
prices are associated with:
Rising unemployment
Falling output and investment
Trade protectionism
Consumer reluctance to spend
LATEST FORECASTS
The latest IMF estimate (June 2011) is
that following a fall of 0.5% in global GDP
in 2009, there will be a strong rebound in
2011/2012 when growth will average 4.4%
a year.
This is what is described as a V-shaped
recovery a strong rebound after a less
severe decline in 2009 previously forecast
at over 1%.
INDUSTRIAL VERSUS
EMERGING GROWTH RATES
8

4
Industrial
2
Emerging
0
2000-07 2008 2009 2010 2011f 2012f
-2

-4
 Emerging Markets (EMs) have been
growing far faster than rich countries
(OECD) for more than a decade now.
Asia excluding Japan has been
growing at over 8% annually well
above the EM average as a whole of
6.6%.
EMERGING MARKETS
Going forward, the fastest growth will be
in Asia (8.4%) in 2011/12 spearheaded
by China (9.5%) and India (8.2%) while
the US will be the fastest growing
industrialized country (2.8%).
The EU will grow at 1.6% and the UK at
2.1%.
RUSSIA
Japan will grow 1.8% a year and Russia
about 4.4% annually in 2011/12.
Sub-Saharan Africa will grow at about
5.6% a year and Latin America 4.2% a
year.
DISCREPANCIES
IMF forecasts are more optimistic than
those of the World Bank and many
other private forecasters who take a
more sober many would say more
balanced - approach.
GROWTH COMPARISONS
% p.a. 2009 2010 2011 2012
World IMF - 0.6 5.0 4.4 4.5
World WB - 0.8 4.8 4.1 4.4
OECD IMF - 3.4 3.0 2.5 2.5
OECD- WB - 3.4 2.8 2.4 2.7
EMs IMF 2.5 7.1 6.5 6.5
EMs WB 2.0 7.0 6.0 6.1
FIRST FOR 60 YEARS
The fall in global GDP in 2009 year was
not only be the first such decline since
World War 2 (1945)
But it was also the first time since the
1950s that all major regions went into
recession simultaneously.
LINKAGES
It was highly synchronized but has
become less so as Ems have recovered
much faster than the industrial
countries.
The global economic situation today
illustrates vividly the linkages between
different issues.
LINKAGES IN ACTION
Global imbalances in trade are mirrored
not just by exchange rate movements,
but also GDP growth rates in different
countries and regions.
As well as by trends in interest rates
and budget deficits.
 TWO ECONOMIES DOMINATE
Prior to the 2008 slowdown, 46% of global
growth came from two regions emerging
Asia (mostly China) and the US (Table)
Chinas growth was driven by a massive
investment boom
In the US, it was loose monetary policy,
low interest rates and high levels of
consumer and government spending,
including a substantial real estate boom.
GROWTH CONTRIBUTION
Region % p.a. Region % p.a.

US 1.06 Other 0.74

LDCs
China 0.85 Other 0.61
industrial
Euro 0.81 East 0.39
Europe
Asia 0.64 Japan 0.36
US HOUSING

Growth began to slow in 2005 as the

US raised interest rates in response to
fears of rising inflation.
In 2006 the slowdown intensified fuelled
increasingly by a shake-out in the
property market falling house prices
and declines in new home construction.
GLOBAL GROWTH ADVANCED
ECONOMIES
6

2
World
0 US
EU

f
00

01

02

03

04

05

06

07

08

09

10
11

12
-2
20

20

20

20

20

20

20

20

20

20

20
20

20
Japan
-4

-6

-8
 0
2
4
6
8
10
12
14
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20 f
10
20 f
11
20 f
EMERGING MARKETS

12
f
Asia
Africa

China
Emg MKts
OIL
Most importantly oil prices surged to
new highs, peaking in July 2008 at $147
a barrel.
This had serious adverse implications
for global inflation and growth.
The World Bank estimates that a $10 a
barrel increase in the oil price reduces
GDP growth by 0.5% a year.
WHAT WENT
WRONG?
TWO FEATURES
Two striking features characterize the
recent recession:
(1) What began as a financial crisis in on
sector the mortgage market in one
country (US), was quickly transmitted
around the world by financial
globalization, and
From Wall Street to Main Street
(2) What started out as a crisis in the
financial economy quickly turned into a
real economic crisis.
The global credit crunch became a
global recession.
 ORIGINS
How and why did the global economic
situation deteriorate so rapidly?
The simplistic answer is to blame financial
globalisation.
What began as a strictly domestic problem
the housing boom partly financed by
sub-prime loans in the US became a
global problem through international
financial intermediation.
TOO SIMPLISTIC
But this is too simplistic an answer
because it glosses over the more
substantive issue.
Namely that globally, policymakers
believed their own propaganda.
They convinced themselves that boom
would not translate into bust and that
the world economy would slow
gradually.
DENIALISM
They were guilty of denialism, based on
their supreme, if ill-conceived,
confidence that the Trade Cycle Boom
and Bust had been abolished.
Governments, central banks and
bankers were convinced that they had
cracked the problem of economic
fluctuations.
SOFT LANDING

It became for them, an article of faith

that economic management was so
sophisticated that there was bound to
be a Soft Landing as and when the
global economy slowed.
MISJUDGMENT
This gave rise to overconfidence and a
reluctance to take the necessary steps
to curb what Alan Greenspan himself
called irrational exuberance.
The result was that housing and credit
booms were allowed to become bubbles
by which is meant that asset prices
rose excessively.
BUBBLE OPTIMISM

At the same time, the glut of finance

sloshing around the global financial
system, largely resulting from the
commodity boom surpluses of emerging
economies, especially oil and mineral
exporters, drove asset prices up and
yields down.
SEARCH FOR YIELD

Investors were hungry for yields and as

a result there was a repricing of risk.
By this is meant that investors became
too optimistic about risk and became
increasingly LESS risk averse.
HEDGE FUNDS
As a result they were willing to borrow
more and lend more.
Hedge funds blossomed.
They take investments from super-rich
individuals and from institutions and
follow extremely aggressive investment
strategies.
OVERGEARING

They put their money into higher-risk

assets, including subprime loans from
the US, commodities and hedge funds.
Banks and businesses followed this
trend and became increasingly highly
geared (overborrowed).
 The collapse of Lehman Brothers on
Sept 15 2008, the bail-outs of Fannie
Mae and Freddie Mac (US govt-owned
mortgage lenders), and the rescue of
insurance group AIG, followed by
rescues of 2 of the Big Three Detroit
auto-manufacturers and major banks
signalled the onset of recession.
SOFT LANDING
Almost overnight so-called soft landing
scenario a gentle, gradual slowdown
degenerated into a global economic
rout.
It seems that there were errors on all
sides.
It was not just sub-prime mortgage
lending that was to blame.
GLOBAL REAL ESTATE BOOM
The housing boom was never a purely
US phenomenon (table).
Many other countries including the
UK, SA, Australia, etc had the same
experience.
None of their governments took
remedial action believing that the
markets would ensure a soft landing.
HOUSING PRICES (1997-2008)
Country % change Country % change
US + 86 Italy + 107
Australia + 175 Japan -32

SA + 389 Ireland + 210

Spain + 195 Denmark + 123
UK + 179 NZ + 117
France + 149 Belgium + 147
 No-one wanted to cast the first stone
to spoil the boom.
So Central Banks turned a blind eye to
the asset price bubble in the stock
markets, the housing market and bank
lending, especially the resulting build-up
of household debt.
 For their part, Western governments, in
particular, loosened fiscal policy and
agreed with central banks that there
was no justification for raising interest
rates and curbing spending.
 The problem was most severe in those
countries running a current account
balance-of-payments deficit and
needing to borrow money from abroad
to finance it US, UK, Australia, Spain
and South Africa.
COMPLACENT
All of this suggests that it was not
financial globalisation that is to blame,
but poor economic and political
management.
That said, it is certainly true that
financial globalisation allowed even
encouraged governments and central
banks to become smug and
complacent.
 But it does not make sense to blame
the system financial globalisation for
the poor judgment of bankers,
governments and central bankers.
CAUSE AND EFFECT
Indeed, what is particularly worrying
about the current situation is the
manner in which until a few months
ago - all sides now seem to agree that
the way out of crisis is to lend, borrow
and spend.
NO FREE LUNCH

But surely that is what caused the crisis

in the first place?
Some cynics pessimists like myself
ask who is picking up the tab for all this.
There is no such thing as a free lunch.
 Meaning that as governments lower
interest rates, cut taxes and spend more,
they have created money that will be
inflationary.
At the same time they are building up
larger debt burdens in both the private
and public sectors, that will come back to
haunt them at some later stage.
SHORT-TERMISM

But governments and politicians are

notoriously short-termist.
They fixate on opinion polls and winning
the next election, hopeful (praying?)
that the future will look after itself.
SIX CULPRITS
1. Governments and central
banks
Governments and their central banks
failed to burst the credit bubbles in the
equity, housing and bank lending
markets
As noted earlier, they were in denial
boom and bust had been abolished and
a soft landing was inevitable.
 Interest rates were kept low for too long
Some countries US and UK allowed
their fiscal positions to deteriorate, for
different reasons.
The UK for electoral reasons, the Bush
Administration to finance two wars.
2. Fiscal balance
In the US/UK the fiscal position was
allowed to deteriorate, so that when the
slump came, it was harder to stimulate
the economy by spending more and
cutting taxes.
Both governments are doing it but in the
process making the long-term debt
situation much worse.
EUROZONE DEBT CRISIS
By 2010/11 this had become a serious
debt crisis.
In the Eurozone Greece, Ireland and
Portugual defaulted on their debt and
had to be rescued by a combination of
the EU and the IMF
WHOS NEXT?
In the last few days concerns about two
other much bigger economies,
Spain and Italy have begun to grow.
The key indicator is the cost of
borrowing what interest rate the govts
of these 2 countries have to pay on their
bond issues.
ACROSS THE POND
On the other side of the ocean, the US
debt crisis exploded recently as
Congress was reluctant to increase the
US debt ceiling.
A compromise was reached last
weekend but it has widely criticized as a
political stitch-up that fails to tackle the
key issue.
BUDGET DEFICIT
The US problem is a huge budget deficit
of 10% of GDP
This means that the debt is growing by
$1.4 trillion a year and will exceed 100%
of GDP by 2015, if not sooner.
3. BANKS AND BANKERS
By re-pricing risk assuming that risk
could be managed easily using their
own complicated, mathematical models,
banks borrowed and lent too much.
They took risks with other peoples
money which they should never have
taken.
MISMANAGING RISK
Instead of diversifying risk, which is
what they claimed they were doing, -
perhaps more fairly - what they thought
they were doing.
They were contaminating the entire
system, not just at home, but globally.
4. INVESTORS
Investors many of them banks, or
acting on the advice of bankers made
serious misjudgments too.
They too swallowed the soft landing
dogma convincing themelves and
their clients that the markets would
continue to go up.
5. REGULATORS

Regulators failed to detect the

seriousness of the risk being taken on
by banks, partly because this risk was
in theory, not in practice being passed
along to others in the form of
securitization.
 In the UK too, because regulation is
separated from the central bank, no one
was really responsible.
Above all there was no global regulator
so that global banks were not regulated
properly by anyone.
6.RATING AGENCIES
These were guilty of failure to assess
risk properly.
They too created a sense of false
security, false and misleading optimism.
Partly they did this because their clients
- the banks and companies paid them
to do so.