Emerging regional economies have proved resilient to the slowdown in both economic growth and international trade seen in recent years. For Central America in particular, the challenge involved sustaining the impact of reduced demand for its products from key partners like the United States and the European Union – in 2015 extra regional trade decreased by 11.2%. Despite this, a growth of 1.5% in intraregional trade in the same period has helped the region maintain healthier levels of growth. In line with UNCTAD’s argument that regional trade is an essential part of developing countries’ inclusive development and poverty reduction, Central America has indeed made strides in developing its industries through increased value-added trade within its members. Taking advantage of specialization and complementarities between the different economies in the isthmus, the region has boosted regional production networks to enhance productivity.
After the United States, Central America is the second market for its own products – 32.7% of its exports remain within the region. And while main export products reaching external markets are commodity-intensive (with top products including coffee, sugar, bananas and plantains, and fruits) agroindustry and industrial products make up 90% of trade within the economies in the region. Industrial products alone make up 65.9% of the total, pointing to the increased value-added of intraregional trade in sectors like medicines; plastic packaging items; food preparations; bakery and pastry products; water, mineral and carbonated; paper containers; insecticides, rat poison and anti-rodents.
As trade within the region is more sophisticated and diverse than trade with external partners, economies in the region could leverage intraregional trade to move away from commodity-based economies. Market forces have indeed supported the development of regional value chains in the Central American market. Examples include Unipharm Group, a pharmaceutical company with presence in all countries in the region and in six other markets in Latin America and the Caribbean. With operations based in Guatemala and Mexico, Unipharm develops, produces and trades over 1,200 pharmaceutical products throughout the region.
Because the development of these chains has been spontaneous, however, most of the opportunities the private sector has focused on remain biased to trade between neighbouring countries. The textile production chain, for instance, developed full-package production capacity in Central America’s northern triangle (Guatemala, Honduras, and El Salvador). And most intraregional trade is carried out between neighboring countries – besides the above, for example, Costa Rica and Panama have more intensive commercial links than do more distant peers (see table).
Central America: Intraregional Exports per Country (2015) Participation rates (%)
|Exporting Country||Destination of exports|
|Costa Rica||El Salvador||Guatemala||Honduras||Nicaragua||Panama||Total|
|Total intraregional trade|
Source: Secretariat for Central American Economic Integration (SIECA)
Taking advantage of cross-border coordination and exploiting the benefits of economies of scale is crucial to advance in this line. Policymakers addressing this issue have focused on initiatives to reduce the time and cost of international freight, strengthen cross-border coordination, and implementing trade facilitation measures. This points in the right direction. As shown by the experience of the Association of Southeast Asian Nations (ASEAN), the consolidation of the intraregional market – which makes up 24% of total trade – has been a vital factor for it to become the world’s fastest-developing economic region.
A combination of tariff reform, a strong emphasis on the facilitation of trade flows, and a focus on services have strengthened ASEAN’s participation in global trade. But it has also supported the development of more sophisticated value chains. Singaporean instant food and beverage firm Super Group has expanded its production to over 300 different items for consumption throughout the region in 3 decades. This example also shows how the diversification and specialization through regional production networks increases and shapes the regional trade. Super developed joint-ventures in the Philippines in 2004, built a production base in Malaysia in 2005-2006 and in China in 2010-2011.
Services, too, have become more relevant in intraregional trade. Indonesian company WIKA expanded its operations and diversified its core business, from electrical supplies and pipe fitting to construction, engineering procurement and investments more broadly.
In fact, we often overlook the opportunities available in the region, and some key industries have the potential to help insert Central America in global trade more actively. But as we move forward, policymakers need to focus on raising productivity and nurturing the development of higher value-added production networks. To do this, Ministers of Trade and Economic Integration are already working on a region-wide agenda to facilitate trade, boost infrastructure investment, and foster the development of regional value chains. And they’re also working in tandem with the private sector to explore hitherto unforeseen opportunities. Adapting policies to accommodate these efforts will prove crucial in years to come, and allow the region to harness a larger market size and boost productive capacity.
 ASEAN, 2015. A blue print for growth ASEAN Economic Community 2015: Progress and Key Achievements. Jakarta: ASEAN.
Decán, M. V. P., 2015. Costa Rica, suelo fértil para los startups. Estrategia y Negocios, 7 Septiembre.
ITC, 2012. International Trade Center. Available at: http://www.intracen.org/news/Interregional-and-intraregional-trade-in-emerging-markets-identified-as-key-to-addressing-global-economic-crisis/
Lincoln, E. J., 2004. East Asian Economic Regionalism. New York: Brookings Institution Press.
Matthews, A., 2003. Regional integration and food security in developing countries. Rome: FAO .
Towards Human Resilience: Sustaining MDG Progress in an Age of Economic Uncertainty , New York: UNDP,2011
UNCTAD, 2015. Policy brief: Strengthening the private sector to boost continental trade and integration in Africa, Geneva: United Nations Publication .
Catherine L. Mann, OECD Chief Economist and Head of the Economics Department, and Andrew W. Wyckoff, Director, OECD Directorate for Science, Technology and Innovation.
Today’s post is also being published on the OECD Ecoscope blog
The nexus of slowing productivity growth and rising inequality is capturing the attention of policymakers and researchers. The productivity slowdown, its causes, and the link with inclusiveness will be discussed on 7-8 July in Lisbon at the first Annual Conference of the new Global Forum on Productivity, which was created by the OECD in collaboration with a number of Member and non-Member countries.
The fact that productivity growth is slowing in most countries is a puzzle, often referred to as the “productivity paradox”, because you would expect the opposite to happen during a period like the current one where many new technologies are being introduced, more firms and countries are integrated into global value chains, and workers are more highly educated. The crisis may be part of the explanation, but OECD data show that productivity growth has been slowing since the early 2000s in Canada, the United Kingdom and the United States, and even longer, since the 1970s, in France, Germany, Italy and Japan.
A recent OECD study on The Future of Productivity argues that the economic forces shaping productivity developments can be better understood by focusing on three types of firms: the globally most productive (“global frontier” firms); the most advanced firms nationally; and those lagging behind. This suggests a more nuanced picture than simply looking at the overall figures. Labour productivity in global frontier firms increased at an average annual rate of 3.5 per cent in the manufacturing sector over the 2000s, compared to 0.5% for non-frontier firms.
This gap in productivity growth between the global frontier and other firms raises questions about the ability of the most advanced firms nationally to adopt new technologies and knowledge developed by the global leaders, and for the firms trailing them at national level to catch up. Speaking at the China Development Forum in March 2016, the OECD Secretary-General put it like this: “It’s clear that the knowledge and technology diffusion “machine” is broken”, and called on governments to implement structural reforms to promote trade, encourage innovation, and boost competition to fix the machine. At the same time, a new OECD report, The Productivity-Inclusiveness Nexus, looked into the linkage between these productivity patterns and rising inequality identifying a number of factors that underpin both and thus deserve additional research .
Governments are already thinking about these issues. In the US for instance, the February 2015 Economic Report of the President stated that “The ultimate test of an economy’s performance is the well-being of its middle class. This in turn has been shaped by three factors: how productivity has grown, how income is distributed, and how many people are participating in the labour force”. Other OECD governments have productivity high on their agendas, too. These include Mexico’s seeking to “democratise productivity” through its new National Productivity Council. Mexico is not alone: Chile’s president Michelle Bachelet has established a “Productivity, growth and innovation agenda.” Improving productivity is seen as the key to future well-being outside the OECD, too, for instance by the Chinese Academy of Sciences: “the real potential for sustaining Chinese growth is in improving productivity.” And the European Commission has advised countries to establish Competitiveness Councils to deal, among other things, with productivity-enhancing policies.
The OECD proposes a three-pronged approach to boosting productivity: help the firms that are the most innovative at a global level and facilitate the diffusion of new technologies and innovations from the global frontier firms to firms at the national frontier; create a market environment where the most productive firms are allowed to thrive, thereby facilitating the more widespread penetration of available technologies and innovations; and improve the matching of skills to jobs to better use the pool of available talent in the economy.
Some will argue that we don’t know how to ensure that all the factors that contribute to productivity growth will work together, Robert Samuelson for example: “There are always rhetorical solutions: more infrastructure spending; better schools; simpler taxes; more research. Though some policies may be desirable, there’s no guarantee they will improve productivity. Influencing productivity is hard because it depends on so much (management and workers, technology, market behaviour, government policies and more).”
Given the complexity of the issues and their interactions, the Global Forum on Productivity will share analysis, data, experience, and ideas among OECD and non-member countries. The Forum is a practical, interactive tool that will be useful for those inside or outside governments seeking answers to three questions:
- What factors can explain the productivity slowdown?
- What can countries do to improve future prospects for productivity growth and innovation?
- What can countries do to improve the design of institutions seeking to promote higher productivity and inclusiveness
At the 2016 meeting of the Global Forum on Productivity around 200 participants from 43 OECD and non-Member countries will look at the role of public policy in stimulating productivity growth; productivity spillovers, diffusion, and public policies; divergence in productivity and implications for inclusion; the link between trade, global value chains and productivity; getting institutions right for productivity-enhancing policies; public sector productivity; and agglomeration economies and productivity (the benefits for firms of being located near each other).
OECD Economic Outlook 2016 sees global economy stuck in low-growth trap unless policymakers act now to keep promises
Continuing the cycle of forecast optimism followed by disappointment, global growth has been marked down, by some 0.3 per cent, for 2016 and 2017 in the 2016 OECD Economic Outlook since the November 2015 OECD Interim Economic Outlook and the global economy is set to grow by only 3.3 per cent in 2017. This reflects a combination of subdued aggregate demand, poor underlying supply-side developments, with weak investment, trade and productivity growth, and diminished reform momentum.
OECD GDP growth is projected to be just under 2% on average over 2016-17, broadly in line with outcomes in the previous two years. Supportive macroeconomic policies and low commodity prices should continue to underpin a modest recovery in the advanced economies, assuming that wage increases and business investment growth both start to pick up and tensions in financial markets do not reoccur. However, weakness in external demand stemming from the emerging economies remains a drag on the advanced economies.
The potential exit of the United Kingdom from the European Union (Brexit) is a major downside risk. Brexit would have much stronger spillovers if it were to undermine confidence in the future of the European Union. In such a scenario, equity prices would drop further and risk premia for euro area sovereign and corporate bonds would increase by more, slowing GDP growth more substantially. Together with a fall in the euro, this would add to pressures on private and public finances, especially in countries where debt remains high. This risk would compound the existing political tensions in the European Union related to high refugee inflows and ongoing financial efforts to stabilise Greece. Other downside risks to global activity relate to a possible escalation of conflicts, including in Ukraine and the Middle East.
The prolonged period of low growth has precipitated a self-fulfilling low-growth trap. Business has little incentive to invest given insufficient demand at home and in the global economy, continued uncertainties, and a slowed pace of structural reform. In addition, although the unemployment rate in the OECD is projected to fall to 6.2 per cent by 2017, 39 million people will still be out of work, almost 6.5 million more than before the crisis. Muted wage gains and rising inequality depress consumption growth.
In per capita terms, the potential of the OECD economies to grow has halved from just below 2 per cent 20 years ago to less than one per cent per year, and the drop across emerging markets is similarly dramatic. It will take 70 years, instead of 35, to double living standards.
Global trade growth, at less than 3 per cent on average over the projection period, is well below historical rates, as value-chain intensive and commodity-based trade are being held back by factors ranging from spreading protectionism to China rebalancing toward consumption-oriented growth.
In trying to revive economic growth with monetary policy alone, with little help from fiscal or structural policies, the balance of benefits-to-risks is tipping. Financial markets have been signalling that monetary policy is overburdened. Pricing of risks to maturity, credit, and liquidity are so sensitised that small changes in investor attitude have generated volatility spikes, such as in late 2015 and again in early 2016.
Fiscal policy must be deployed more extensively, and can take advantage of the environment created by monetary policy. Governments today can lock in very low interest rates for very long maturities to effectively open up fiscal space. Prioritised and high quality spending generates the capacity to repay the obligations in the longer term while also supporting growth today. Hard infrastructure (such as digital, energy, and transport) and soft infrastructure (including early education and innovation) have high multipliers. The right choices will catalyse business investment, which, as the Outlook of a year ago argued, is ultimately the key to propelling the economy from the low-growth trap to the high-growth path.
Potential output per capita growth for the OECD as a whole is estimated at 1% in 2016, which is between ¾ and 1 percentage point below the average in the two decades preceding the crisis. Two main factors have contributed to this decline: weak capital stock growth accounts for around one-half of the slowdown, and the rest is accounted for largely by declining total factor productivity growth.
Sluggish demand and productivity growth, low inflation, substantial downside risks and, in some areas, high unemployment call for sustained well-balanced macroeconomic policy stimulus and productivity-enhancing structural reforms. Policy needs differ across countries, reflecting differences in their cyclical position, past policy measures and resulting policy space. Adopting a more co-ordinated and comprehensive policy approach both within and across countries offers the prospect of breaking out of the low-level global growth environment.
This time last year, the OECD Forum took place on the eve of an unprecedented series of UN and G20 international summits with the potential to shape global governance for decades to come. In hindsight, 2015 proved to be an outstanding year for international collaboration, with governments around the world coming together to agree on ambitious goals to promote sustainable development, address climate change and deliver fairer more transparent international tax rules. On the eve of OECD Forum 2016, the focus shifts to the hard work of implementation , in the midst of slow and uneven recovery from the Crisis, an ongoing international refugee and migration crisis and an upsurge in acts of international terrorism.
We will be looking for answers to three overarching questions:
- How can the positive momentum of international collaboration from 2015 be carried through to the tough task of implementing the noble undertakings embodied in the various agreements?
- How can we kick start global productivity so as to deliver inclusive growth?
- How should we address the need for a new societal contract and relevant policy frameworks for an era of digitalisation?
Implementation of the SDGs, COP21 and G20 Tax Standards will require a holistic approach to inter-related economic, social and environmental issues from governments and non-governmental stakeholders alike. The Forum will address what will need to change given that the SDGs are now a global responsibility and targeted at countries at all levels of development. Civil society leaders such as Save the Children’s Helle Thorning-Schmidt, the former Danish Prime Minister are uniquely positioned to help map out what’s now required.
Successful international collaboration means all stakeholders in society working together. The role of the business community is vital in itself, as is the way it works together with government to ensure a fair deal for all. This year marks the 40th anniversary of the OECD Guidelines for Multinational Enterprises, the most comprehensive set of recommendations by government to business on Responsible Business Conduct (RBC). With the widening and deepening of globalisation, the Guidelines are more relevant than ever, but the role of business in society has evolved from the charitable and voluntary endeavours associated with Corporate Social Responsibly (CSR) to the more stringent expectations of RBC. Nobel Peace Prize Laureate Kailash Satyarthi will be sharing his insights of what can go wrong and why and how it can be corrected.
Tax is one of the clearest examples of how international collaboration is the only avenue to resolve major problems given that nationally-based tax systems are inadequate to deal with international financial flows. The OECD-G20 BEPS project equips governments with the domestic and international instruments needed to tackle the issues. Effective exchange of information between countries, allows governments to better tax capital and capital income, and in turn raises issues about the effectiveness if the redistribution of wealth especially in countries where working-age benefits have not kept pace with real wages and taxes have become less progressive.
These discussions take place against the backdrop of the leak of the Panama Papers, revealing the practices of the rich and powerful in hiding money offshore, a timely reminder of how much is still left to do to implement transparency when the gap between rich and poor is at its highest level for 30 years in most countries.
Productivity and inclusive growth
Clear and troubling evidence has emerged in recent years of the disappearance of productivity growth at a time of rising inequalities. It is natural that we should ask ourselves if these phenomena are interrelated. We can no longer assume that technological and related innovations in processes and business models will automatically lead to better economic performance and stronger productivity growth. There is no guarantee that the benefits of higher levels of growth, or higher levels of productivity in certain sectors, will be shared across the population as a whole. Indeed, there is a risk of a vicious cycle developing, with the “bottom 40%” with fewer skills and poorer access to opportunities often confined to low productivity, precarious jobs, and the informal economy. At firm-level, too, a few big fish and cutting edge winners may leave the rest behind
The Forum will examine the nexus between productivity and inequality, identifying knowledge gaps, and seeking to chart policies that both boost productivity and tackle inequality. The role of corporate finance has also been examined both in entrenching the division between the haves and the have-nots and for its potential to unleash strong productivity gains.
To help us continue questioning assumptions about how the economy works and how we analyse these workings, we will welcome speakers such as Diane Coyle who asks whether traditional measures of productivity are suited to today’s “weightless” economy and César Hidalgo, who argues that understanding the nature of economic growth requires us to transcend the social sciences to include the natural sciences of information, networks, and complexity. Award-winning author Paul Mason will present his vision a future of “Postcapitalism” and the internationally renowned Chilean architect Alejandro Aravena will open our eyes to the contribution to be made to productivity and inclusive growth by architecture.
The social sciences still provide a useful lens through which to address key issues, though, and we will be looking at access to quality jobs when the workforce is ageing but 75 million young people are unemployed worldwide. Similarly, tackling gender inequality is central to increasing productivity and inclusiveness, so we will focus on the role of women in the workplace, girls and women in Science, Technology, Engineering and Maths (STEM), and the social, cultural, legal, and political barriers to gender equality and the consequences of these. How appropriate then that Forum favourite, Michele Bachelet should return in her capacity as President of Chile and Chair of the 2016 OECD Ministerial Meeting.
Migrants are another social group with specific needs and rights. The Forum will also tackle the sensitive issue of the economic, social and political impact of the sudden, large influx of immigrants and refugees into Europe and how best to meet the integration challenge.
Digitalisation of Society
The digitalisation of nearly every facet of the economy and society has become increasingly apparent in recent years. While this revolution holds many promises to spur innovation, increase productivity and improve services, it creates new dilemmas not least the fact that policy frameworks developed in a pre-digital era are not fit for digital purpose and that many people feel marginalised or threatened by accelerated change. It poses fundamental questions regarding the sort of society we want in this digital age and societal contract to deliver it.
Our IdeaFactory on the Digitalisation of Society will provide valuable impetus to a new OECD project on the Digitalisation of the Economy & Society. We will address the changing role of the State as well as the ethical, social and technical dilemmas digitalisation provokes. In the context of “The Digital World & the Future of Work” we will explore strategies to adapt the skills taught in education and training systems to the changing needs of today’s and tomorrow’s employees and employers, providing input to our project on the Future of Work. With the help of humanoid robot Pepper, we will look closely at the future role of robots, artificial intelligence and increasing reliance on algorithms in transforming daily life, work, and social interaction.
Innovation is not just about technologies. It also includes new ways of doing things, and the “circular economy” can play a crucial role in delivering on COP21 by decoupling economic growth and job creation from the exploitation of natural resources. Key actors such as Nick Stern will examine how to reduce pressure on precious finite resources from a global population that will reach 9 billion by 2030, a third of whom will be middle-class consumers.
Better Life Index & Economic Outlook
Wellbeing has been at the heart of the Forum since we first presented the OECD Better Life Index in 2011. The latest edition of the Index that empowers people to compare countries’ performance in wellbeing according to what is most important to them, unveiled on 31 May, will feature 38 countries including 2 newcomers, South Africa and Latvia, our newest member. Now in its 5th year, the Index has well over 8 million visitors from all corners of the globe, who are responding with their wellbeing priorities in ever greater numbers: in 2016 the top 3 priorities are Life Satisfaction, Health and Education. Income is ranked 9th out of our 11 dimensions of wellbeing. Analysis for those countries where citizens have shared their preferences with us most is available here.
Whilst the Index promotes our aspiration to measure our future development in a more holistic way, the OECD will be the focus of attention of the world’s media when we present our latest Economic Outlook, forecasting the prospects for the global economy on 1 June.
Join the debate
The rational, evidence-based discussion and compromise needed to define and implement the best ways to improve our societies and economies is often lacking in political discourse, whether in the context of the elections, the reforms or the referenda that will shape the future for generations to come. Against this backdrop, the Forum will challenge the world’s policymakers and policy-shapers to imagine and help realise a future where far more “Productive Economies” deliver in such a way as to effect far more “Inclusive Societies”. We also extend this challenge to you. Join the debate!
Juzhong Zhuang, Deputy Chief Economist and Deputy Director General, and Ganeshan Wignaraja, Advisor in the Economic Research and Regional Cooperation Department, Asian Development Bank
A gloomy outlook is enveloping the world’s economies. There are concerns too that countries are failing to sufficiently focus on long term policy responses to reverse the decline in global growth. Some argue that the global growth slowdown may be permanent, highlighting the danger of a period of chronically low growth, or what economists term “secular stagnation.”
While secular stagnation for the global economy is still a debated hypothesis, for developing Asia, a downbeat view of its economies and policies is clearly overdone. While the growth has slowed, it is still robust. At 6.5% annually over the last 5 years, it remained the fastest growing region in the world. By comparison, developing countries outside Asia grew 3.4% and advanced countries only 1.6% annually during the same period.
Yes, developing Asia’s growth is noticeably slower. In the decade up to 2010, annual average growth reached 7.6%. Our most recent forecasts project regional growth to edge down to 5.7% over the next two years.
This, however, does not portend a secular decline in the region’s growth rates.
Lingering crisis-related factors partly explain this slowdown. Weak global demand has reduced exports from the region’s open economies including those with strong links in global value chains. Furthermore, the flagging global recovery and growth moderation in the People’s Republic of China’s (PRC) have softened global commodity prices and constrained the growth of commodity-exporters including many Central Asian countries.
There are important structural factors too. A recent ADB study shows that developing Asia’s potential growth – or growth consistent with stable inflation – slowed from 7.4% annually in the seven years before the global financial crisis to 7.1% in the seven years after the crisis, due to a combination of falling growth in the size of labour force – related to demographics – and in labour productivity.
The reality is that when we look at Asian economies today we see several reasons for optimism.
First, while the PRC’s growth deceleration may continue, it is likely to be gradual. The key to sustain PRC’s growth at a robust pace is to maintain solid productivity growth through a greater focus on innovation and industrial upgrading, to offset the impact of declining working-age population. This is indeed among priorities of PRC’s new Five-Year Plan (2016-2020). Its on-going shift in growth model from heavy reliance on manufacturing exports and investment towards domestic consumption and the service sector will make growth more balanced and therefore more sustainable. ADB projects the PRC to grow 6.5% in 2016 compared with 6.9% in 2015.
Second, many other Asian economies continue to grow strongly, benefiting from reform efforts. Over time, developing Asia’s growth is likely to be driven by multiple growth centers. Across South and Southeast Asia we have upgraded recent growth forecasts, including major economies such as Bangladesh, India, Indonesia, Pakistan, and the Philippines. India, for example, is the fastest growing major economy and has developed a comparative advantage in services particularly information technology services. The country is presently attempting to foster manufacturing development and linkages to global value chains through a Make in India Program. Likewise, Indonesia is attempting to shift away from a dependence on natural resources into manufacturing development. Growing at 7-8% annually, Cambodia, Lao People’s Democratic Republic, and Myanmar continue to catch up with the rest of the Association of Southeast Asian Nations (ASEAN).
The PRC’s structural transformation also offers new opportunities to other economies, as the country gradually withdraws from low-cost, labor-intensive manufacturing industries and its growing middle class demands more quality consumer goods.
Third, regional economies have learnt valuable lessons from the Asian financial crisis and taken steps to reduce financial vulnerability and bolster resilience to external shocks. Across developing Asia, macroeconomic management has improved, and authorities have intensified the use of macroprudential policies and strengthened the oversight of corporates and financial institutions. Regional integration is increasingly linking markets and production through the spread of global value chains, free trade agreements, foreign direct investment, and greater mobility of skills.
Fourth, the region still has large room for catch-up with advanced countries. In 2015, developing Asia’s average per capita GDP was only $4,796, compared with the global average of $10,139 and an OECD average of $35,768. Indeed, most of the economies in the Asia-Pacific region are still classified as low- and lower-middle-income economies. Notably, Singapore; the Republic of Korea; Taipei, China; and Hong Kong, China grew at about 7-9% in the 1960s to the 1980s before they became newly-industrialized economies.
Last but not the least, many Asian countries—PRC, India, Indonesia, and many more—are scaling up reform efforts in trade and investment regimes, macroeconomic management and public finance, financial regulation, and public sector governance. These reforms will continue to reduce impediments to efficient resource allocation, improve technical and managerial efficiency, enhance an economy’s ability to respond to shocks, and lay the foundations for greater private investment and innovation.
In recent decades, structural reforms that addressed specific domestic constraints have been key drivers of rapid economic growth in developing Asia, and they will remain so in the years ahead. ADB’s research concludes that policies that close half of the gaps with globally best practices in tertiary education, labour market flexibility, institutional quality, and trade openness and financial integration could raise developing Asia’s potential growth by nearly 1 percentage point annually over the next ten years.
Undue pessimism about developing Asia’s growth is misplaced. With reforms and their effective implementation, the region can and will continue to drive global growth.
The size of the reversal of the supercycle is bigger than you think: And too big to be dealt with by monetary policy in advanced economies
Adrian Blundell-Wignall, Director, OECD Directorate for Financial and Enterprise Affairs, Special Advisor to the Secretary-General on Financial Markets
The real economy will always seem to be disconnected from the financial economy during periods when the need for structural change is so overwhelming that it can hardly be otherwise. We have had the easiest monetary policy of any historical era outside of hyperinflations, and productivity fails to grow, economic activity is weak (particularly in Europe and China) and there is no sign of inflation. The 2016 edition of the OECD Business and Finance Outlook addresses the three main causes of this:
- The size and impact of the reversal of the supercycle centred on emerging economies.
- The problems with company productivity and growth in a global excess capacity situation.
- Forcing a zero time value for money onto investors distorts financial investment and works against long-term investment.
We focus on the first of these in this first taste of the 2016 Outlook to be released on 9 June 2016.
Many commentators simply do not seem to understand the sheer size of the supercycle now in reversal.
Two different economic systems butting are up against each other. The group of emerging economies, now comprising around half of the world economy, is not open and (via financial repression) has built up massive savings over a short period of time. These savings have been forced into investment with a heavy role of state industrial policy. Indeed, some very large economies are behaving as though they too can develop just like the small Asian Tigers in the post–1945 period. The other group of more open market based economies is responding to the reversal of the supercycle and other structural factors (such as the failure in some regions to deal with huge bank non-performing loan problems up front) mainly with monetary policy. But little is happening.
This is not so surprising. How big was this saving and investment rise? The sum of the world’s national saving (and investment) since the early 2000s has risen a startling 225%. Most of this occurred in a single country, China.
This investment in emerging market economies (EMEs) has created massive overcapacity in the supercyle sectors, like steel, aluminium, cement, energy (particularly fossil fuels), transport (especially shipping), utilities and similar.
How do we know this other than by industry anecdotes and anti-dumping duties being imposed on emerging country’s exports, such as steel and aluminium?
Excess capacity: ROE-COE and ROE-COK in advanced and emerging economies.
Declining in advanced economies; out of control in emerging economies.
The ROE-COK is negative in EME companies, and spectacularly so versus the COE (which means managers can’t add value for shareholders). This is pulling down ROEs in advanced countries too.
Just how big is this supercycle investment? If only one point is to be taken from this year’s Outlook, let it be this: the size of investment related to the supercycle is much bigger than you think and its reversal is having an impact that monetary policy in advanced countries cannot hope to cope with.
Let’s look at the facts from the world’s largest companies. The figure below shows global capital expenditure by sector. The energy and materials sectors alone account for 40% of the total. This is now in decline with links to many other sectors.
Source: OECD calculations, Bloomberg.
The energy and materials sectors alone rose to 40% of capital spending of the 11,000 biggest global companies (shown in blue and grey). These are huge sectors. Energy consists of oil, gas, drilling, oil and gas equipment and services, exploration, refining, storage, transportation, coal and consumable fuels. Materials consists of chemicals, fertilisers, industrial gases, construction materials, metal and glass containers, paper packaging, aluminium, diversified materials and mining, gold, precious metals and minerals, forest products and paper products.
If industrials and utilities (for the energy to drive all this) are added, the numbers rise to 60%. The supercycle sectors have a huge derived demand for inputs and services from other sectors, so that the linkages go even further than this.
Now, capital spending in all of these sectors and their demand for goods and services from other sectors is in decline. Chinese growth collapsed in 2014-2015, and, from late 2015, it is repeating the mistakes of 2009; it is embarking on a new real estate shantytown rebuild funded by state-owned enterprise bank credit.
What does this do? Once more it raises demand in the supercycle sectors and delays the much needed creative destruction phase. Local government steel, cement, aluminium and other factories in each province (all too big to fail) have no incentive to exit.
The reversal of the supercycle and the sheer size of what is happening is such a massive headwind that it is overpowering easy monetary policy.
Monetary policy has nothing to say about the sectoral misallocation of resources and excess capacity in the global industrial sectors; and certainly not in countries largely cut off from the discipline of openness and market forces.
The Outlook analyses this in some detail and then delves into the problems with company productivity in the excess capacity world since the crisis. It looks at what the companies that adjusted to the shock of the crisis did in terms of key corporate finance decisions, which helped them to negotiate this difficult post-crisis world. These companies are compared to those that didn’t adjust and are now part of the problem. It then looks at the portfolio consequences of setting a zero time value for money.
Watch out for the next blogs on these topics, but above all come and discuss the full publication being launched on the 9th of June.
The launch of the 2016 OECD Business and Finance Outlook takes place at 9.30am CET on 9 June 2016. Register to participate or watch the live webcast www.oecd.org/daf/oecd-business-finance-outlook.htm
The 2016 OECD Forum on 31 May – 1 June, is entitled “Productive economies, Inclusive societies”. The Forum is organised around the three cross-cutting themes of OECD Week: inclusive growth and productivity, innovation and the digital economy, and international collaboration for implementing international agreements and standards.
What is blocking business investment and productivity growth? A fresh focus on the problems of fragmentation in the world economy
More than seven years after the global financial crisis reached its trough the world economy is still sputtering. Banking systems in advanced economies have been strengthened and recapitalised, regulatory reforms of financial systems are well into their implementation stage and monetary policy remains highly supportive. But the global environment has not been supportive as emerging market economies, notably China, have struggled with the reversal of the commodity “supercycle” that sustained the earlier boom and related excess capacity. One important result has been a failure of the business sector in advanced economies to respond with new investment and restructuring needed to generate jobs and the productivity growth that can support rising incomes and employment. These are essential components of the inclusive growth we need to address challenges like climate change and rising wealth inequality.
So what is blocking business investment and productivity growth? There are many contributors which we can summarise here as “fragmentation”: the heterogeneous policies, rules, laws and industry practices that create perverse incentives and block business efficiency and productivity growth. This is the theme of the OECD Business and Finance Outlook to be released on 9 June 2016.
Fragmentation manifests itself at all levels of the global economy, from the global macro-economy and economic systems to sectoral and micro-economic issues to legal ones. This Outlook surveys a range of cases where fragmentation creates problems and suggests priorities and directions for changes that will encourage inclusive growth.
The Outlook surveys important aspects of the broad global picture: the outlook for financial markets and influences on productivity, based on a detailed examination of the performance of 11 000 of the world’s largest listed companies. The observations point to the need to rely less on monetary easing and more on structural policy initiatives to stimulate investment and productivity growth and to encourage faster diffusion of productivity advances when they occur. Issues relating to the design of one such initiative, fiscal support for business research and development, are also covered in detail.
The Outlook also goes into greater depth to examine narrower issues where the devil is often in the details. Stock exchanges are important elements of the infrastructure for funding business investment since they not only facilitate raising new capital but add to the attractiveness of such funding by providing it with liquidity. The Outlook examines the fragmentation that has arisen from the proliferation of trading venues and issues related to ensuring fairness. It points to regulatory initiatives needed to maintain a level playing field among investors.
The emerging renewable power sector is reviewed, focusing on challenges to mobilising finance for the large expansion of the sector that will be needed as the world phases out fossil fuel-generated electricity. Many of the issues that must be addressed relate more to the framework conditions surrounding the power sector than to financial engineering. If these issues are resolved, ample capital is likely to be forthcoming to finance the needed investments. One chapter focuses on differences in life expectancy around retirement age across different socioeconomic groups and the issues they raise for the insurance industry and pension funds as well as for public policy. Rules governing access to pensions and retirement saving must be designed carefully to avoid discriminating against lower socioeconomic groups.
The Outlook also examines areas in which variations in laws and legal regimes across countries unnecessarily fragment the economic environment by treating similar activities differently. One of these is foreign bribery, where enforcement across jurisdictions covers a very wide range which creates very different economic incentives to resort to bribery. The other is investment treaties, which must be interpreted by arbitration tribunals. These tribunals effectively establish rules that modify corporate law and governance arrangements and create different classes of shareholders with different sets of rights. The current interpretation of many treaties allows covered shareholders to recover losses resulting from company damages incurred by host government actions. This in turn creates incentives that may affect companies, shareholders, creditors and capital markets, and suggests a need for consideration of how claims for such losses should be treated as a more general policy matter.
The chapters are supported by company and market data not seen before, shedding light on some of the current great policy puzzles in the world economy.
The launch of the 2016 OECD Business and Finance Outlook takes place at 9.30am CET on 9 June 2016. Register to participate or watch the live webcast www.oecd.org/daf/oecd-business-finance-outlook.htm
The 2016 OECD Forum on 31 May – 1 June, is entitled “Productive economies, Inclusive societies”. The Forum is organised around the three cross-cutting themes of OECD Week: inclusive growth and productivity, innovation and the digital economy, and international collaboration for implementing international agreements and standards. Register now, it’s free!