1. GLOBAL ECONOMIC PROSPECTS: RESTORING GLOBAL BALANCES ABN-AMRO GLOBAL CONFERENCE Singapore September 8, 2005 Joseph E. Stiglitz Columbia University New York

2. GROWTH BUT NO EUPHORIA In 2004, global economic performance was the strongest in two decades Yet there was no global euphoria Why? Global anxiety Will the growth sustain? Will there be a resurgence in inflation? In the midst of: High level of exchange rate instability? High levels of economic tensions between the United States and China Soaring oil prices, accompanying Middle East turmoil? Fragile housing market bubbles in many countries Major economic imbalances

3. ANXIETY WELL JUSTIFIED  Growth in 2005 has been weaker than in 2004  And prospects for 2006 remain uncertain

4. MAJOR IMBALANCES, UNCERTAINTIES PERSIST AND ARE INTERLINKED  ” …that which is unsustainable will not be sustained”  U.S. trade deficit unsustainable  Source of instability in global exchange rates  Linked to huge U.S. fiscal deficit

5. PROSPECTS FOR TWIN U.S. DEFICITS  Prospects are that deficits will persist –Medicare drug benefit likely to cost US$ 2.5- 3.0 trillion more over next 20 years –Making tax cuts permanent would add US$ 1.8 trillions in next 10 years –Social security privatization would add US$ 1.5 trillion in next ten years, US$ 6 trillion in 20 years –Iraq war costs not even included –AMT (Alternative Minimum Tax) reform could easily add.5 trillion  Hard to see significant reduction in deficit

6. HOUSING BUBBLES AND ECONOMIC FRAGILITY  Growth in the U.S. economy (and some others) is largely sustained by housing sector  Home building increased from 4.25% GDP 1980- 2000 to 5.98% –Difference equals $200 billion year –Generating approximately 2 million jobs  Increase in housing prices added $7 trillion ($3 trillion if re-mortgage and inflation is taken into account) in wealth during the past five years –Adding $150 billion in spending –Generating 1.5 million jobs

7. HOUSING BUBBLES AND ECONOMIC FRAGILITY  Economy sustained both by investment in real estate, people taking money out of house (second mortgage), and capital gains  But higher interest rates and, at the very least, moderate increase in housing prices –Will dampen the ability to increase consumption at same rate, and –may even be lead to a decrease in consumption level

8. HIGHER INTEREST RATES  Fed has raised short term interest rates during the past two years, but long term interest rates have fallen –“Conundrum” –At some time in the not too distant future medium and long term interest rates will rise With rising risk premium Real interest rates returning to more normal levels Declining savings relative to investment Inflationary expectations

9. RISING OIL PRICES  Beginning to have inflationary effects  Which may dampen overall level of economic activity  Especially if central banks raise interest rates  Which they are especially prone to do with inflation targeting

10. RISING OIL PRICES  Normally, such high prices would elicit more production –Long lags in production –And uncertainty about whether prices will be sustained Middle East still competitive producer At current prices, it would pay to bring on alternative sources, technologies But if stability got restored, prices would fall, and Middle East would dominate again Means that supply response will be slow

11. RISING OIL PRICES  A strong reason why it makes sense to focus attention on conservation  And broader policies aimed at sustainable development  Development at current rates of energy and resource utilization is not sustainable  It is important that the business community show commitment to sustainable development

12. RISING OIL PRICES  Rising oil prices is leading many investors and countries to want to manage risk of energy prices  Limitations in “futures” markets—only go limited distance into the future  Necessity of buying “energy” assets—those whose prices move with oil  Makes sense for energy importing countries, like China, to buy energy assets to stabilize economy and insulate against risk  U.S. made a major mistake in dealing with the Chinese bid for Unocal –Even if some of the arguments about lack of full symmetry are correct –U.S. cannot stop China from buying energy assets elsewhere –U.S. has shown that it believes ownership/control matters

13. CHINA-U.S. INTER-DEPENDENCE  China-U.S. relations is of critical importance for global stability  Mutually beneficial  Both countries gain from the economic relationship –Americans consumer benefit from lost cost goods –Important for maintaining standards of living –Keeping inflation low –America benefits from low cost loans from China—major supplier of savings  Argument that China needs the U.S. to buy its goods and the U.S. needs China to buy its treasuries is not fully persuasive –China could expand domestic consumption, investment— it has great needs –Would other countries be as willing to hold U.S. dollars as China has been? –What are consequences of shift of deficit from China to others? –Easier to increase consumption than to decrease it

14. RMB REVALUATION  Current level of revaluation is not likely to have much effect –On trade –On speculation over further revaluation  But even much larger revaluation will not have much effect on bilateral trade deficits (with the U.S.) or global imbalances –U.S.- not China – is the underlying source of problem  The recent revaluation is not likely to provide China with respite from political pressure from the U.S. for very long

15. RMB REVALUATION  Much larger revaluation would put China in a difficult position –Lower prices in rural sectors –Rural-urban income inequality will grow– already major source of concern –Will require costly use of government revenues to offset impact on farmers  Move to peg RMB to a basket of currencies and the increased flexibility in exchange rate management make sense for China

16. INCREASING ROLE OF ASIA IN GLOBAL ECONOMY  As source of savings  As source of manufactured goods  Asia, especially the East Asian Miracle countries and India, likely to continue to be the bright stars in the global economy  Weak economic performance in the U.S., Europe however, is likely to lead to rise in protectionist sentiment –Though, as in Europe, protectionism will meet resistance –As retailers and consumers are hurt –And net, even jobs

17.  But the WTO will provide some protection from protectionism  Both China and India will need to face the problems posed by high energy prices Low gasoline prices in China Need for public transport system will exacerbate the problem Increased domestic expenditures as China weans itself away from export lead growth strategy Needs to strengthen efforts for conservation INCREASING ROLE OF ASIA IN GLOBAL ECONOMY

18. GLOBAL ECONOMIC PROSPECTS: A PESSIMISTIC VIEW  Huge global imbalances  Growing global economic uncertainties  Many potential disaster scenarios  And few potential boom scenarios  In between — economic malaise is perhaps more likely  No recession, but no boom either  The worst is over – will do better than 2001-2003, but weaker than the roaring 1990s or even 2004

19.  Naysayers have been predicting a burst for years – those who listened to their advice missed enormous gains  New economy – so talked about only few years ago – may have been exaggerated, but technological revolution is real, opening up new vistas of productivity improvements  Growth in Asia is ushering a new era and it’s just the beginning  The vast domestic markets of China and India, representing more than one-third of world population and growing over 8% annually, will fuel growth for other countries of the region  Adjustments to these new realities, and the shift in the balance, may not be easy – fueling anxiety in the “old world”  But from the perspective of Asia, with its huge savings, its growing strength in science and technology, never have prospects looked better GLOBAL ECONOMIC PROSPECTS: AN OMPTIMISTIC NOTE