Risks

1
Risks Opportunities in the Global Economy
MScIF 01/2008

• Michel Henry Bouchet
• Glob_at_l Finance Center

2

• Today, more than ever before, the global economy
  is an echo chamber that amplifies and spreads
  national and regional economic, financial and
  even political imbalances

3
What is Globalization all about?

• Stage of capitalist development where
  market-based and profit-oriented forces prevail
  in almost every production and exchange of goods
  and services worldwide

4
Who coined the term Globalization?

• Theodore Levitt (1925-2006) former profesor at
  Harvard Business School (1983)
•  Globalization involves the change in technology
  and social behavior that allows MNCs to sell the
  same products worldwide under global brands 

5
Marxist approach to economic development

• 1848 The capitalist economic system is
  doomed to become worldwide in its never-ending
  struggle to increase the rate of profit under the
  pressure of competition

6
Globalization is an endeavor that can spread
worldwide the values of freedom and civil contact
the antithesis of terrorism!.
Alan
GreenspanGlobalization, like the telephone, is
both a blessing and a curseGlobalization is like
a giant wave that can either capsize nations or
carry them forward on its crest J. Stiglitz
7
Transforming the poor into global stakeholders?

•  Globalization reveals the liberating potential
  of the market for generating unlimited wealth,
  and its blindness as a mechanism for
  distributing the consequences of wealth 
• Ashraf Ghani, Washington Quarterly, Autumn 2006

8
The  flat world  by Thomas Friedman (2006)

• As the world goes flat, and the dynamics of
  collaboration and exchanges gets stronger and
  stronger, the gap between cultures that have the
  will, the way and the focus to adopt and adapt
  this dynamics and those that do not, will get
  larger and larger.
• How outward is a countrys culture, i.e. open to
  foreign influence and ideas? How well does it
   glocalize ?
• How inward is the culture, i.e., is there a sense
  of national solidarity and identity, and to what
  extent the elites focus on long-term sustainable
  development?

9
General Colin Powell on Globalization (2000)

• There is no point in being  for  or  against 
  globalization. Like the weather, it is just
  there!
• One should concentrate on how to live with it,
  maximize its benefits, and minimize its cost! 

10
 Globalization Dynamics 
11
The 4 prerequisites of Globalization

• Sharp increase in productivity (1850 industrial
  revolution)
• Economic and trade liberalization (1960 trade
  openness)
• Technological progress in NTIC (1980-90)
  reduction in transaction costs
• Keen competition for market shares and profits
  shareholder pressure for wealth maximization
• responsiveness revolution
• Premium on competitiveness and flexibility

12
Marked acceleration of productivity economic
take-off
1850 Industrial revolution
Source R. Lucas
13
The Prerequisites to Globalization Population,
Productivity and Income annual growth rates
Year 1-1000 1000-1500 1500-1850 1850-2008
GDP per capita 0 0,05 0,2 1,25
Population 0,09 0,1 0,3 1
Productivity STAGNATION STAGNATION 0,5 1,5
STAGNATION STAGNATION Pre-Conditions ACCELERATION
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Population growth and GDP per capita
Year 1-1000 1000 - 2008
Overall population growth 12 x 22
Overall GDP growth 8 x 320
Overall GDP per capita growth 1 x 14
Average population density/Km2 2 43
15
Emerging Globalization
YEAR 1750 1850 1900 1960 1980 85-90 95-98 1999 2002 2005 2007 2015
Population 760 1100 1600 3021 4435 5220 5900 6000 6200 6500 6650 7000
? 0,3 0,5 0,6 2,2 1,7 1,6 1,3 1,3 1,2 1,15 1,15 1
GDP 500 825 1800 6500 10900 20000 29000 30000 32810 44700 51500 60000
? 0,4 2,5 3,5 2,4 2,5 3,3 2,8 3,7 3,1 4,9 4,7 3
GDP per capita 650 750 1100 2150 2610 3800 4900 5000 5225 6990 7750 8500
? 0,2 0,5 1,5 0,03 1,5 1,5 1,2 1,5 1,5 1,5 1,6 2,1
Wealth Gap 1 4 10 33 45 50 60 70 100 100 100 90
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Technological Innovation Cycles
Genetics ?
Internet
Computers
Aeronautics Transportation
Chemistry Automobile
Electricity Telephone Radio
Steam Engine
1870
1950
1980
1990
2020
1800
1900
17
Cost of a 3-Minute Telephone Call NY-
London (Constant 1990, U.S. )
0.30
18
Number of years for mass-access (gt50 million
people market)
19
Measuring Globalization?

• How much  global  is the global economy?
• How  globalized  is a country?
• Globalization should not be taken for granted
• Trend, threshold or ideology?

20
Globalization stages financial relations were
truly globalized in the XIX and early XX
century under the gold standard and the British
world leadership.
21
Share of Exports/GDP in
22
Global trade indexXGS/GDP
16140/51500
31
26
20
12
5
IMF/WEO 2007
23
Trade openness ratio (XM/GDP)
Brazil 24 India 20
24
Globalization Index The Top 20 /62

• 1. Singapore
• 2. Ireland
• 3. Switzerland
• 4. US
• 5. Netherlands
• 6. Canada
• 7. Denmark
• 8. Sweden
• 9. Austria
• 10. Finland
• 11. New Zealand
• 12. UK

• 13. Australia
• 14. Norway
• 15. Czech Rep.
• 16. Croatia
• 17. Israel
• 18. France
• 19. Malaysia
• 20. Slovenia
• 52. Russia
• 54. China
• 62. Iran

ATKearney
25
The 7 major risks of Globalization?

• 1. Triumph of Flows vs Stocks
• 2. Volatility Spill-over effect
• 3. Digital divide
• 4. Wealth gap
• 5. Capital concentration
• 6. Markets versus nation-states
• 7. The challenge of global regulation

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1. The triumph of Flows vs Stocks

• The overwhelming supremacy of cross-border
  transactions
• what gets value is what is traded

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Country risk challenge n1!

• Analyzing volatility risk for those countries
  that fully depend on import and export trade
  flows!
• Comparative advantage for those countries that
  have an open, flexible, well diversified economy
  Chile, Mexico, Poland, Thailand, Korea
• Risks for those countries that depend on a few
  commodities to export, in volatile markets
  Africa

28
Old world/New world Overwhelming importance of
trans-national flows
STOCKS
FLOWS

• Trade of Goods Services
• Capital flows and FDI
• Culture Knowledge
• Information

• Territory
• Population
• Tanks and jet fighters
• Raw materials
• Official reserve assets
• Gold stock

29
? GDP and Global Trade

(p) IMF
IMF/WEO 07
30
Discrepancy between growing financial flows vs
real output

• Total daily FX transactions US3200 billion gt20
  times worth the daily underlying production of
  goods and services.
• Total world official reserves lt US6500 billion
• Destabilizing speculation ex. oil trading (one
  physical barrel gives rise to 5 to 7 financial
  barrel transactions)
• Private capital puts profits before people
• Capital is both smart and coward risk-aversion!

31
Hedge Funds

• 6000 hedge funds
• US1300 billion of assets (twice Belgiums GNP)
• 25 anual growth rate over the last ten years
• LTCM lost gt1.8 billion in 1998 after borrowing gt
  50 times its equity capital!
• Calperss investment fund 135 billion (it
  decided to pull out of 12 EMCs in 2003)

32
Hedge Funds Assets
US billion
Around 10,000 hedge funds manage close to US2000
billion
33
The USA currently attract 60 of global capital
flows
Source IMF/2007
34
The overwhelming supremacy of Finance over the
 real  economy
In US billion
400 of GDP
Source IMF/2007
35
2. Volatility Spill-over effect

Trade and financial liberalization (current
capital accounts) increases vulnerability to
exogenous shocks and crisis contamination

36
Country risk challenge n2!

• Analyzing volatility risk for those countries
  that fully depend on external capital flows!
• FDI, portfolio and external credit
• Risk of abrupt credit crunch, higher spread, and
  shorter maturities

37
Globalization Rising volatility?

• Why has volatility risen so much since the
  1970s-80s?
• sharp increase in worldwide inflation that
  followed the oil shocks
• poor monetary and fiscal policy responses,
  following the end of the Bretton Woods agreements
• global deregulation and liberalization of
  financial markets and capital flows
• rapid spread of NTIC

38
Long-term trend in bond and stock return
volatilities
Source BIS 2006
39
Exchange rate volatility 1972-2006 (daily data in
)
Source BIS 08/2006
40
Globalization Rising volatility?

• Measures of volatility based on monthly stock and
  bond prices, available since the second half of
  the 19th century, reveal that since the 1970s
  volatility in the major industrialized countries
  has been on average higher than in the previous
  100 years
• However, in the recent period volatility has
  been low simultaneously across different assets
  and markets, in industrial countries and EMEs
  alike, including short-term and long-term
  interest rates, stocks, exchange rates and
  corporate spreads
• higher market liquidity, lower inflation,
  sustained GDP expansion, gradualism in central
  banks monetary policy

41
Recent trend in Global volatility indices
Annualized daily volatility of an international
portfolio BIS Working paper, n29, 2006
42
Evolution of Euro- LIBOR
43
Evolution in Gold Price
Afghan crisis
Iraq crisis
Koweit crisis
Kippour crisis
Asian crisis
44
Brent Oil Price
45
Short-term capital flow volatility
46
3. The Knowledge Societyand the digital divide
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Country risk challenge n3!

• Identifying the countrys integration in the
   Knowledge Economy  and its access to NTIC!

48
How many people are online throughout the world?
Source Nua Internet
49
The two-tier global economy

• Those who are kicking into e-gear and those who
  are still struggling with getting hard-wired
  phones into houses!
• lt than 20 of the world population (610 million)
  uses the Internet, and 88 of them live in
  industrialized countries! Tokyo and NYs
  Manhattan district alone have more telephone
  lines than the whole of Africa.

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The Knowledge Society
51
Digital divide RD Distribution
85
52
4. Wealth Gap
53
Country risk challenge n4!

• Identifying the wealth gap and its impact on
  market scope as well as on socio-political risk!
• Identifying tomorrows key markets?

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Bridging the divide?

• Link between globalization, inequality and
  poverty. Modern technology and economic
  liberalization have not made the poor poorer. But
  globalization has helped make the rich countries
  richer.
• Result growing global inequality and a
  concentration of extreme poverty in the countries
  that have not jumped on to the growth ladder and
  stay on it.
• Rich countries have failed to give the poor the
  technical, financial and institutional assistance
  as well as market access they need.

55
Global economic divide GDP
150 countries 48
30 countries 52
Source FMI 2007
56
How rich is China?

• Until recently, China had never participated in
  the careful price surveys needed to convert
  accurately its gross domestic product into PPP
  dollars. China has repeatedly raised the prices
  of food, housing, healthcare and a range of other
  non-traded goods and services. These reforms
  should have lowered the PPP adjustment.
• 2007 new, more accurate ADB statistics
  describing a smaller, poorer China and India. PPP
  adjustments affect poverty measures because the
  World Bank's dollar-a-day poverty line is a PPP
  dollar poverty line.
• Reducing PPP consumption estimates drops large
  numbers of additional households below the
  poverty line. For China, the number is likely
  more than 500m.
• China's economy is smaller and poorer than
  established estimates say. China's economy turns
  out to be 40 per cent smaller than previously
  stated. This more accurate picture of China
  clarifies why Beijing concentrates so heavily on
  domestic priorities such as growth, public
  investment, pollution control and poverty
  reduction.
• GDP share of global output 10,9

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Regional shares of global GDP in ppp
160 countries
Source FMI/2007
58
GLOBAL GDP DISTRIBUTION
52 of global GDP
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Share in GDP, trade and population
Source IMF/WEO
60
Higher productivity cost competitiveness
faster growth rate catch up process
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Source R. Lucas
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Globalisation Income Divergence(ppp-based GDP
per capita in 000s)
A. Maddison and IMF
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Taking off? (US-PIB per capita on ppp basis)
OCDE-2007
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The BRICs catch up process
Goldman Sachs 2007
65
30 OECD
160 EMCs
66
Source IMF
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Unequal rise in life expectancy
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The poorest countries 5 of world population

• 1980
• ETHIOPIA
• TANZANIA
• BHUTAN
• BANGLADESH
• YEMEN
• MOZAMBIQUE
• CHAD
• MALAWI
• LAOS
• VIETNAM

• 2005 GDP lt1000
• SIERRA LEONE
• MADAGASCAR
• ETHIOPIA
• TANZANIA
• Guinea-Bissau
• CONGO (DEM. REP.)
• BURUNDI
• YEMEN
• MALAWI
• MALI
• RWANDA
• NIGER
• NIGERIA
• ZAMBIA

Residents of poorest countries experienced almost
no real income growth during 1980-2000! 80 years
of income growth needed for 10 increase.
Meanwhile, the rich are getting richer!
69
Stubborn world poverty
of population
2,71 billion
2,74 billion
1,22 billion
1,1 billion
70
5. Bigger Better? Capital concentration and
eroding competition...

• What constrains companies in their endless quest
  for profits is not governments but market
  competition

71
Country risk challenge n5!

• Identifying the countrys market economy features
  and its openness to FDI flows and global
  companies competition, corruption, access to
  information, transparency, monopolies, regulatory
  framework, governance

72
Global MAs 1990-2007 (in US billion)
73
The most Global Companies
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Worldwide corporate Giants

• General Electric
• Microsoft
• Exxon/Mobil
• Pfizer
• Citigroup
• Wal-Mart
• Intel
• BP
• HSBC
• IBM
• Toyota
• Coca Cola
• Bank of America
• Royal/Dutch Shell
• General Motors
• Ford Motors
• Total/Fina

• The 100 largest international companies comprise
  gt 6 million employees outside their country of
  origin and generate 2100 billion of turnover!

75
Global Company

• Largest private corporation on the planet (after
  Exxon)
• 2007 sales 351 billion
• Objective to double sales within five years!

• 33 of Canadas GDP
• 100 x Argentinas GDP
• 130 x Polands GDP
• 2 x Thailands GDP
• 7 x Moroccos GDP
• 26 x Tanzanias GDP

76
Nationality Breakdown of 500 Largest MNCs
worldwide
Fortune/07-2000
77
6. Government groveling to Big Business the
dictatorship of ratings

• Globalization rates and ranks nations like any
  private business according to market-based
  principles of openness and efficiency
• The nation-state is no longer the deciding
  economic agent!

78
Country risk challenge n6!

• Identifying the countrys business conditions
  such as labor costs, legal and regulatory
  framework, institutions

79
World Bank Doing business in 2007

• 7 criteria
• 145 countries
• New company creation employment procedure
  company registration financing mobilization
  investment protection contract enforcement
  liquidation.
• 3 days to set up a company in Canada vs 12 days
  in New Zealand and 52 in Slovakia and 153 in
  Mozambique

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World Bank Doing Business in 2007

• Singapore
• New Zealand
• USA
• Canada
• HK
• UK
• Denmark
• Australa
• Norway
• 11. Japan
• 21. Germany
• 35. France (44 en 2006)
• 39. Spain
• 93. China
• 96. Russia
• 121. Brazil
• 134. India
• 171. RDC

The ranking does not take into consideration the
macroeconomic framework nor organized crime
81
Economic Freedom Rating/Fraser Institute 2007

1. Hongkong
2. Singapore
3. New Zealand
4. Switzerland
5. US
6. Ireland
7. UK
8. Canada
9. Iceland
10. Luxembourg
11. Australia
12. Austria
13. Estonia
14. Finland
15. Netherland

• 20. Chile
• 24. France
• 30. Spain
• 35. Korea
• 45. Italy
• 60. Mexico
• 60. Thailand
• 83. Indonesia
• 88. Brazil
• 95. China
• 102. Russia
• 124. Algeria
• 126. Venezuela
• 130. Zimbabwe

82
World Economic Forum competitiveness ranking

• The Global Competitiveness Report, which examines
  the growth prospects of 80 countries, remains the
  most up-to-date and comprehensive data source
  available on the comparative strengths and
  weaknesses of leading economies of the world.
• Countries in The Global Competitiveness Report
  are ranked by the Growth Competitiveness Index
  (GCI) (GCI Rankings) and the Microeconomic
  Competitiveness Index (MICI) (MICI Rankings),
  which combined encapsulate the relative strengths
  and weaknesses of growth within each economy.

83
Davos-WEF 2007 Competitiveness Index
Switzerland 1 Canada 16
Finland 2 Austria 17
Sweden 3 France 18
Denmark 4 Australia 19
Singapore 5 Belgium 20
United States 6 Ireland 21
Japan 7 Luxembourg 22
Germany 8 New Zealand 23
Netherlands 9 Korea, Rep. 24
United Kingdom 10 Estonia 25
Hong Kong SAR 11 Malaysia 26
Norway 12 Chile 27
Taiwan, China 13 Spain 28
Iceland 14 Czech Republic 29
Israel 15 Tunisia 30
84
Davos-WEF 2007 Competitiveness Index

• Thailand 38
• China 57
• Mexico 58
• Russia 62
• Brazil 66
• Vietnam 77
• Venezuela 88
• Pakistan 91

• Bolivia 97
• Nigeria 101
• Cambodia 103
• Paraguay 106
• Cameroon 108
• Zimbabwe 119
• Ethiopia 120
• Angola 125

85
IMD Criteria

• Over 300 competitiveness criteria are selected.

Economic Performance (74 criteria) Macro-economic evaluation of the domestic economy.
Government Efficiency (84 criteria) Extent to which government policies are conducive to competitiveness.
Business Efficiency (66 criteria) Extent to which enterprises are performing in an innovative, profitable and responsible manner.
Infrastructure (90 criteria) Extent to which basic, technological, scientific and human resources meet the needs of business.
86
IMD 2007 Competitiveness Index

• 1. USA
• 2. Singapore
• 3. HK
• 3. Luxembourg
• 4. Denmark
• 5. Switzerland
• 15. China
• 16. Germany
• 20. UK
• 24. Japan
• 26. Chile

• 27. India
• 28. France
• 29. Korea
• 30. Spain
• 33. Thailand
• 35. Hungary
• 38. Colombia
• 43. Russia
• 44. Romania
• 47. Mexico
• 55. Venezuela

BEST
87
7. Market forces crowding out the state

• Is the State doomed to death given the challenge
  of free-market forces and transnational flows?

88
Country risk challenge n7!

• Risk of systemic transition from closed and
  centralized growth model towards market-driven
  development model
• Risk of institutional deficiencies during the
  soico-economic development take-off

89
Shrinking role from key actor to facilitator

• End of the monopoly position of the State, as
• guardian of national security end of
  bipolarity and cold war
• provider of information Internet
• main economic driving force in growth and
  development economic liberalization
• main employer provider of public services
  privatization
• deciding agent in economic policy issues
  caught between market forces and the IFIs
  guidance

90
Worldwide privatisation operations
91
 Washington Neoliberal Consensus  One size
fits all!

• Trade Financial liberalization Floating
  exchange rates Macroeconomic stabilization
  Minimum government intervention
• Governments are bypassed by market forces and
  under the control of regional and international
  organizations

92
Washington Consensus Ten rule of sustainable
market-economic developmentJohn Williamson (IIE
1990)

1. Fiscal discipline
2. A redirection of public expenditure priorities
   toward fields offering both high economic returns
   and the potential to improve income distribution,
   such as primary health care, primary education,
   and infrastructure
3. Tax reform (to lower marginal rates and broaden
   the tax base)
4. Interest rate liberalization
5. A competitive exchange rate
6. Trade liberalization
7. Liberalization of inflows of foreign direct
   investment
8. Privatization
9. Deregulation (to abolish barriers to entry and
   exit)
10. Secure property rights

93
International financial regulation

• BIS (1933) Cooke Committee for international
  regulation
• Bretton Woods Institutions (1944) IMF and World
  Bank
• OECD (1961)
• IIF (1983)
• G7 G10 G24
• IOSCO (International organization for securities)
• IAS (International accounting standards)
• Financial Action Task Force