1 Scenarios for the World Economy Warwick J. McKibbin Centre for Applied Macroeconomic Analysis ANU, & The Lowy Institute for International Policy & The Brookings Institution Presentation to North American Die Casting Association Conference, Hawaii, 19 February 2007

2 Overview Near term outlook for the world economy Key Issues in the Medium Term  Emergence of China and India  Global trade imbalances  Energy Futures  Global Demographic Change  Pandemic influenza

11 The Emergence of China and India

12 Based on McKibbin, Thirlwell and Woo (2007) “The Emergence of China and India inot the World Economies” Lowy Institute (forthcoming)

13 Top ten countries by population

14 Top ten countries by population China and India account for more than one third of the global population. In contrast, Japan at the start of its economic takeoff was less than 4% of the global total.

15 World economic history is a tale of divergence Source: Angus Maddison, The world economy: historical statistics, 2003 See Mark Thirlwell, Before 1980s, lacklustre economic performance in Asia’s two giants

16 World economic history is a tale of divergence Source: Angus Maddison, The world economy: historical statistics, 2003 See Mark Thirlwell, Industrial Revolution and 1 st Age of Globalisation produced growing gap between advanced world and majority of Asia’s population

17 Now, the start of the Great Convergence? Source: Angus Maddison, The world economy: historical statistics, 2003 and IMF World Economic Outlook database (September 2006) Between 1980 and 2007, China is expected to close GDP per capita gap with US from 6% to 19% of US levels

18 Measurement matters: Two views of the 12 largest economies in 2005 Source: IMF World Economic Outlook April 2006 database See Mark Thirlwell,

21 Sensitivities Global Imbalances

22 Based on Lee, McKibbin and Park (2006) “Transpacific Trade Imbalances: Causes and Cures” World Economy vol 29 McKibbin and Stoeckel (2005) The United States current account deficits and world markets Lee and McKibbin (2006) “Domestic Investment and External Imbalances in East Asia”, World Economic Forum McKibbin (2006) “The Global Macroeconomic Consequences of a Demographic Transition” Asian Economic Papers, MIT Press

23 Overview What are the macroeconomic imbalances? What are the sources of current account imbalances?

24 Two Aspects of Global Imbalances Global Savings in excess of global investment which shows up as low long term real interest rates National savings and investment imbalances which show up as current account imbalances between countries  Countries with national savings greater than national investment run current account surpluses  Countries with national investment greater than national savings run current account deficits

29 Number of Real Factors and not a Single cause US current deficit is an excess of US investment relative to US saving Pull  US fiscal deficits  Decline in household saving  Strong productivity growth Push  Decline in Asian investment rates (except China)  Rising corporate and household saving in China  Oil revenue recycling by Oil Exporters

35 Conclusions on causes and cures Predominant contribution to the transpacific trade imbalance is US fiscal policy Weak Asian investment since the 97 Crisis also important for the Asian trade surpluses but less important for the transpacific balance

36 Conclusions on causes and cures US fiscal contraction and Asian fiscal expansion plus a recovery in Asian investment rates would have a significant impact on reducing each country’s overall trade position and would also reduce the Transpacific trade imbalance

37 Conclusions East Asia exchange rate revaluation has significant effects on slowing East Asia for a year but not in changing global trade balances The worsening in East Asian competitiveness plus weaker East Asian growth tends to offset each other in the spillover to other countries and have a minor impact on the relative saving and investment balances across the region.

38 Is the World Running out of Energy?

39 Implication: new drivers for global energy demand Source: BP Statistical Review of World Energy (2006) See Mark Thirlwell,

40 The world’s top ten energy consumers Source: BP Statistical Review of World Energy (2006)

41... as growing demand... Source: BP Statistical Review of World Energy (2006)

42... met constrained supply Source: IMF World Economic Outlook, September 2006: Spare capacity defined as production capacity that can be brought on line within 30 days and sustained for 90 days

43 US still dominates global oil demand Source: BP Statistical Review of World Energy (2006) US share of oil consumption roughly triple that of China

44 But China already drives consumption growth Source: BP Statistical Review of World Energy (2006), author’s calculations

45 Despite still modest per capita consumption Source: BP Statistical Review of World Energy (2006)

46 There are Alternatives Source: Cambridge Energy Research Associates, The Economist, AMP Capital Investors

47 Global Demographic Change

48 Based on McKibbin W. (2006) “The Global Macroeconomic Consequences of a Demographic Transition”,Asian Economic Papers (forthcoming) MIT Press. Also published in “G-20 Workshop on Demographic Challenges and Migration” Battini N., CallenT. And W. McKibbin (2005) “The Global Impact of Demographic Change” IMF working paper – background paper to the September 2004 World Economic Outlook

49 Overview The world is in a major demographic transition with different characteristics in different countries In some countries the labor force is shrinking (former Soviet Union and Japan) Most analyses only focus on individual countries but the global adjustment is just as important

53 Economic Impacts Aggregate saving, consumption, wealth  Composition of consumption bundles Investment rates aggregate across sectors Labor markets Government budgets => Global impacts on trade and financial flows and asset prices including real exchange rates

54 Summary Demographic change projected over the next century has a significant impact on aggregate economic variables within countries as well as economic outcomes between countries We estimate that this is adding 1% of GDP to the US current deficit and 3% of GDP to the Japanese current account surplus

55 Pandemic Influenza

56 Based on McKibbin W. and A. Sidorenko (2006) “Global Macroeconomic Consequences of Pandemic Influenza” Lowy Institute Analysis, February.

57 Approach of Study Explore 4 possible scenarios based on pandemics of the 20 th century  Mild (1968 Hong Kong Flu)  Moderate (1957 Asian Flu)  Severe (lower estimates of 1918/19 Spanish Flu)  Ultra (higher estimates of 1918/19 Spanish Flu)

58 Estimating the Impacts of a Pandemic Major shocks:  Reduction in labour force (due to mortality and illness, includes carers)  Increase in business costs (differentiated by sector);  Shift in consumer demand (away from affected sectors);  Re-evaluation of country risks

Global Deaths in millions: Mild (1.4); Moderate (14); Severe (71); Ultra (142) Source: McKibbin and Sidorenko (2006)

61 Summary Even a mild pandemic has significant costs (0.8% of global GDP or $330 billion) A repeat of the 1918/19 Spanish flu could cost up to $4.4 trillion The impacts are larger on developing countries because of larger shocks and the relocation of international capital flows to the relative safe havens of the US and Europe

62 Overall Conclusion The future of the world economy is highly uncertain with both opportunities and risks

63 Background Papers