New Economist

OECD Economic Outlook: "not that bad in view of the recent shocks"

The OECD released its latest Economic Outlook today. Though some fear that falling house prices and the global credit crunch might drive the US into a recession, that view is not shared in Paris. Their US forecast expects weakness in the US housing sector to drag down growth in the near term but it "is unlikely to trigger a recession". GDP growth is forecast to 2.0% in 2008. Private consumption will be weak - but public and non-residential investment should remain quite perky, and the cheap US dollar will see net exports add to growth next year just as it they have this year. Here's their summmary of the US outlook:

Healthy gains in private consumption have helped to keep GDP growth above trend thus far this year. However, the correction in residential construction is likely to accelerate over the near term, and housing wealth could decline which, together with weaker labour market conditions, could lead to lower consumption growth over time. GDP should therefore slow to a pace below potential in 2008 and then recover in 2009, although there are considerable downside risks.

This assessment is broadly in line with recent Federal Reserve and private sector forecasts. An outside risk of recession, to be sure - but not considered that likely. (For another recent official US economic overview, see yesterday's Congressional testimony by CBO Director Peter R. Orszag).

But what about the overall economic outlook? You can watch a webcast of the news conference by OECD's acting Chief Economist Jorgen Elmeskov here. Or just read his 18 page handout (PDF), which contained this precis:

Several shocks have hit OECD economies recently: financial turmoil, cooling housing markets, and higher prices of energy and other commodities. Fortunately, they have occurred at a time when growth was being supported by high employment that boosts income and consumption; by high profits and strong balance sheets that underpin investment and resilience in the face of financial losses and tighter credit; and by still buoyant world trade driven by robust growth in emerging economies. Hence, although near-term growth has been revised down virtually everywhere in the OECD area, the baseline scenario depicted in this Economic Outlook is actually not that bad in view of the recent shocks.

Of course, as the accompanying chartset makes very clear, there are still plenty of reasons to be concerned. Energy and commodity prices have surged, headline inflation has picked up, credit conditions are tight, house prices are decelerating, consumer confidence is softening, and job creation is slowing. Against that, fiscal positions have improved and world trade is buoyant.

It's not the end of the world, but it's not exactly time to crack open the champers either. Or as Elmeskov put it at the news conference: “It’s not a recession but obviously it’s not going to feel all that great either.”

Globalisation - has the tide of opinion turned?

Reading recent debates about economic inequality in the United States, one senses the tide of opinion amongst both academic economists and the 'commentariat' has shifted. Concern is mounting, as are calls for action - even from traditionally orthodox sources. A similar trends now seems to be happening with the globalisation debate - and the two are not unrelated. Let's look at a few recent examples.

First, academic economists are becoming more concerned - and I don't just mean Paul Krugman or Joe Stiglitz. Former Council of Economic Advisers Matthew Slaughter and co-author Kenneth F. Scheve call for A New Deal for Globalization in the latest issue of Foreign Affairs magazine. Here's the abstract:

Globalization has brought huge overall benefits, but earnings for most U.S. workers -- even those with college degrees -- have been falling recently; inequality is greater now than at any other time in the last 70 years. Whatever the cause, the result has been a surge in protectionism. To save globalization, policymakers must spread its gains more widely. The best way to do that is by redistributing income.

The authors make explicit the link to living standards:

U.S. policy is becoming more protectionist because the American public is becoming more protectionist, and this shift in attitudes is a result of stagnant or falling incomes. Public support for engagement with the world economy is strongly linked to labor-market performance, and for most workers labor-market performance has been poor.

Second, respected global newspapers which in the past have stoutly defended the benefits of free trade and globalisation are now acknowledging the need to address the downsides as well. A recent Wall Street Journal piece by David Wessell, The Case for Taxing Globalization's Big Winners, which cited the Slaughter and Scheve paper, concludes:

What to do? To preserve political support for the globalization dividend, spread the benefits more broadly by taxing winners more and losers less.  ...Counting on the inevitability of globalization is imprudent; politics and policy can interfere. Expecting market forces to reverse the recent trend toward ever-bigger winnings for those at the top is unwise; the forces are too strong.

Taxing winners isn't without risk; as Mr. Summers says, globalization makes it easier for them to "pick up their marbles and go somewhere else." But using the tax code to slice the apple more evenly is far more palatable than trying to hold back globalization with policies that risk shrinking the economic apple.

Likewise, the Financial Times recently editorialised that Globalisation needs more than PR to be sold to its losers:

Globalisation has many virtues. Chief among them, it has contributed to an unprecedented accumulation of human wealth over the past decades and has helped lift a record number of poor out of poverty.

Yet globalisation has also created losers, particularly among the middle and lower classes in rich countries. Governments need to do more to help the groups most hurt. ...Governments need to be more active in helping the losers in rich countries. Instead of trying to safeguard industries in vulnerable sectors, governments need to be more inclusive and protect citizens.

...Many people do not mind that Bill Gates or Warren Buffett are worth billions. Both earned their wealth under the set of rules that apply to most others in rich countries. But the worry is that the global market system works to the disadvantage of people in already low-paid, low-skilled jobs in developed economies.

So government policies should focus on enabling the individual to feel as confident as possible within the global system. This could be through funding additional training or other means to help those who have lost their jobs to re-enter the market quickly. It might also imply a more progressive tax system, partial wage insurance, and untying social benefits such as basic healthcare from jobs to avoid undue fears of unemployment.

Third, even international orthodox defenders-of-the-faith such as the OECD and World Trade Organisation are starting to voice doubts. WTO head Pascal Lamy, for example, has been muttering about the dark side of globalisation. According to Reuters, last week he said in Beijing:

The speed of globalisation is affecting our social fabric in a much harsher way than in previous stages of globalisation. If globalisation has benefited some individuals, it has also weakened the position of many others, in particular the weakest and poorest among us, whether in developed or developing countries.

Hence, one of the most important challenges of our generation is to ensure that the benefits of globalisation are more fairly and widely shared, and in particular that they reach more people in developing countries.

The OECD's Employment Outlook 2007, likewise, included a chapter called 'OECD workers in the global economy: increasingly vulnerable?'. You have to pay for the report, but the 4 page editorial, Addressing the globalisation paradox (PDF), provides a good summary. The accompanying press release stated:

Rather than seeing globalisation as a threat, OECD governments should focus on improving labour regulations and social protection systems to help people adapt to changing job markets. That is the message from the 2007 edition of the OECD’s annual Employment Outlook. It reviews the possibility that offshoring may have reduced the bargaining power of workers, especially low-skilled ones. Whether real or threatened, the prospect of offshoring may be increasing the vulnerability of jobs and wages in developed countries.

...Globalisation requires mobility to ensure that workers are not trapped in jobs with no future. The report praises the so-called “flexicurity” approach adopted in Austria and Denmark to address this. In Austria, for example, workers have individual savings accounts, instead of traditional severance pay schemes, that move with them as they move jobs. If they lose their job, they can choose to withdraw funds from the account or save the entitlements built up towards a future pension.

Job losers should be compensated through social protection systems which are employment-friendly, the report notes. This can be done by providing adequate benefits hand-in-hand with “activation” policies which increase re-employment opportunities. Experience of Nordic countries and Australia shows that such policies, if well-designed, improve the job prospects of laid-off workers, thereby easing their fears about globalisation.

Addressing the labour arbitrage debate, the chapter authors concede that globalisation could "permanently increase" job insecurity for workers by making their employers more vulnerable to external shocks. But Angel Gurría, OECD secretary-general, moved to calm fears by saying that people's fears of losing jobs to foreign countries were often overblown: "Without job losses people are fearing the job losses." He called for politicians and journalists to foster a well-informed discussion of the benefits and costs of globalisation. "The story has to be told better," Mr Gurría said.

The FT was unimpressed. In its leader (cited above), it agreed that "better public relations may go part of the way", but governments still need to do more to help the losers. As Dani Rodrik notes:

You know something is going on when the FT berates globalization's cheerleaders for their complacency.

All just straws in the wind, perhaps. But I think I can can hear a gale coming...

Offshoring financial services: 'Build, optimize and release'

The BBC News reports on a Deloitte study which claims an offshore boost for the UK finance sector

The shifting of UK financial services jobs to developing countries such as India and China has saved the sector about £1.5bn a year, a study suggests.

Accountants Deloitte said the number of financial jobs going overseas over the past four years had increased 18-fold. More than 75% of major financial institutions have operations overseas, compared with fewer than 10% in 2001.

Chris Gentle, associated partner for financial services at Deloitte and author of the study, said: "Financial institutions need to re-engineer business processes, or risk simply transferring offshore the legacy inefficiencies of older, onshore processes."

The Global Financial Services Offshoring Report 2007 finds signs of strong growth and growing maturity:

The offshoring industry is growing up quickly. Most major financial institutions now operate a sizeable, low-cost offshore delivery function. The industry’s cumulative cost savings for the last four years have risen sharply, propelled by an 18-fold increase in offshore headcount.

Over 2006, average total headcount offshore doubled to six percent of total group staff. More than half of all financial institutions surveyed are now saving more than 40 percent for each business process offshored.

But there's more to come: as the industry grows, offshoring and sourcing decisions should not be "based purely on cost arbitrage grounds":

In future, the best offshoring strategies cannot be based solely on financial gains from labor arbitrage. Otherwise the legacy inefficiencies of older, onshore processes may simply be transferred offshore.

...Enter Phase II: The DTT GFSI group’s analysis has identified three phases to an offshoring journey for financial services institutions: Build, Optimize and Release. Organizations can realize the full value from their offshore operations only when all three phases are complete.

As financial institutions enter the second offshoring phase, their efforts are on streamlining migrated business processes. The impact of this application on best practices is becoming evident across all financial services. A select group of financial institutions – offshoring’s stars – has successfully deployed aggressive offshoring strategies, resulting in the transfer of more than five percent of group headcount offshore and achieving bottom line savings in excess of 40 percent. In some instances these savings have been equivalent to three percent of their total cost base. Other institutions, that have failed to apply the best practices have, in some instances, experienced a decline in their operational performance. This has put their prospects of realizing full future value from their offshoring operations at risk.

Deloitte's are clearly using this report to tout for business. But the trends they point to are no less real for that. Six per cent of staff may not sound that much, but if it has doubled in just four years it could easily double again.

OECD: making the most of globalisation

Apologies for yet another post about the OECD Economic Outlook, but I've overlooked another special chapter in No. 81. This one is about globalisation: Making the most of globalisation (PDF). It is the best summary of the issue I have seen in quite a while (although the recent IMF chapter cited below is also worth a look).

This chapter provides a synthesis of the work undertaken by the Economics Department on the economic effects of globalisation, while also draws on other OECD and non-OECD research.1 It begins with an overview of the main trends that have characterised the globalisation process. The second section then describes its potential effects on employment and wages. Globalisation also has had an impact on inflation and has been accompanied by distinctive trends in international capital flows, which are discussed in the third section. The chapter concludes by examining the benefits and challenges that globalisation creates for economic policy.

Some of it will be reasonably familar to readers, other parts less so. There are some great charts too.

The piece ends with what must be considered something of an understatement:

There is some way to go, in terms of policy settings, before the full benefits of globalisation are achieved.

Quite!

The joys of fiscal consolidation

'Fiscal consolidation'. Who but an economist could love such a clunky, unsexy phrase? But then, I am an economist; and so is the OECD. Their latest Economic Outlook includes a special chapter on: Fiscal consolidation: lessons from past experiences (PDF). The authors argue that alhough "fiscal consolidation is required in most OECD countries", it "remains a challenge' for many of them. Translation: they're spending too much and/or not taxing enough. The chapter looks for some lessons from on a dataset covering a large number of OECD fiscal consolidation episodes starting in the late 1970s. Here are their main findings, along with my own summary titles:

1. Facing a crisis helps

Consolidations were larger when the initial situation was difficult: Large initial deficits and high interest rates have been important in prompting fiscal adjustment and boosting the overall size of consolidation. These results may reflect that public awareness of fiscal problems and needs can help in overcoming resistance to consolidation, a hypothesis which is also supported by the observation that qualification for euro area membership significantly increased the probability of starting consolidation. The policy implication would be that consolidation may be helped by the provision of transparent information and analysis of the fiscal situation.

2. Spending cuts work better than tax hikes

Expenditure based consolidations tended to be larger and last longer: An emphasis on cutting current expenditures has been associated with overall larger consolidation and a large weight on social spending cuts increased the chances of stabilising the debt-to-GDP ratio. This could be because expenditure cuts, as opposed to revenue increases, are more likely to trigger lower interest rates and a sympathetic response of private saving, helping to bolster activity. But it could also reflect that governments more determined to consolidate are more willing to cut current expenditures, including social spending, possibly thereby also demonstrating a commitment that makes substantial consolidation more feasible.

3. Fiscal rules can help...

Countries with fiscal rules achieved better results: Fiscal rules with embedded expenditure targets tended to be associated with larger and longer adjustments, and higher success rates. This could in principle reflect that well designed fiscal rules are effective or, alternatively, that governments committed to prudent fiscal management are more likely to institute a rule.

4. ...but need careful design

Designing effective rules raises several issues: Fiscal rules need to be adapted to country specific institutions and political systems, but, based on experience across countries, certain common design features seem important for their effectiveness. These include the need to combine transparency with sufficient flexibility to face cyclical (and other) shocks, a wide coverage across various budget items and effective enforcement mechanisms.

The Economist also discusses this chapter, in its post Words of warning:

With a Kantian flourish, Jean-Philippe Cotis, the OECD's chief economist, argues that sticking to tight spending plans should be governments' “categorical imperative”. In fact, the organisation expects no further reduction in cyclically adjusted deficits in the next two years. It thinks America's will rise. And the historical record, presented in a special chapter of the Outlook, is not encouraging.

The chapter looks at 85 budget-tightening efforts undertaken since 1978 and tries to identify the conditions associated with success. Deficit cuts based on reduced spending have tended to be deeper and longer-lasting than those founded—as in the past couple of years—on increased revenues. That may be because lower spending leads to lower interest rates and hence stimulates economic activity. But it may be because it demonstrates a determination to limit the budget. When tax revenues go up, demands for new spending can be hard to resist—so that when revenues go down again, a new hole in the budget opens up.

Several countries have adopted rules designed to keep themselves on the fiscal straight and narrow. These usually place bounds on budget balances. However, the OECD finds they have more effect if combined with rules to limit expenditure—so that extra revenues are not automatically spent, as they might be if the fiscal balance were all that mattered. Balanced-budget rules not linked to expenditure limits, such as America's Gramm-Rudman-Hollings act of 1985 and the European Union's Stability and Growth Pact, have been less successful. Of course, it is hard to know whether fiscal rules stiffen finance ministers' spines or whether they are adopted by governments that already have the necessary political will.

Either way, the OECD's warning is a timely one. Though state counting-houses may be full now, it is not hard to imagine how they might be drained. The demands of an ageing population look staggering, unless today's systems are reformed. In Greece the combined toll of health care, long-term care and pensions is expected to amount to 7.5% of GDP by 2025 and 16.8% by 2050. In Portugal the expected burden is 6.1% by 2025, rising to 15.5% by 2050.

The Outlook has one more gloomy finding for budget hawks. Not surprisingly, governments are more likely to tighten their belts when budget deficits and interest rates are high—at times, in other words, precisely unlike these.

OECD: The song remains (much) the same

The OECD released its draft semi-annual Economic Outlook today. It contained few surprises, sticking to the view that "the US slowdown was not heralding a period of worldwide economic weakness" and expecting a 'smooth' rebalancing, "with Europe taking over the baton from the United States in driving OECD growth".

The "benign" central forecast is for OECD economic growth of around 2.7% this year (upwardly revised from last November's 2.5% estimate). This would be a notch below 2006's OECD growth of 3.0%, but impressive nonetheless.

US growth will slow from 3.1% last year to a downwardly revised 2.1% thus year. In his presentation and summary of the report, Chief Economist Jean-Philippe Cotis admitted there were downside risks from the "tricky" situation in the United States, where an over-extended housing market has slowed the economy. The slowdown "may be of a broader nature, and may involve a mild form of stagflation, with weaker trend productivity growth and output growth translating into more overheating".

But the central scenario is for continued robust growth, not for the US to slump and drag down other economies with it. The slowing US economy is expected to be more than offset by upwardly revised growth forecasts for Japan, the UK, Australia and the eurozone - particularly Germany and Italy.

What was new in this report was a heightened concern about inflation. As the Financial Times report by Scheherazade Daneshkhu, OECD warns on risk of higher inflation, says:

Jean-Philippe Cotis, chief economist, said inflation in the US had been “more persistent than expected” while in many other OECD countries, notably continantal Europe and the UK: “The amount of residual economic slack is also uncertain....This constitutes a challenge for central banks which, on both sides of the Atlantic, should probably err on the side of tightness.

...It identified “many signs of strong underlying global inflation pressures which could yet feed through into headline inflation”. These reflected increases in commodity prices and the fact that the inflation rate for intermediate industrial goods in most OECD countries had picked up, a surge in shipping costs over the past year and rises in the price of food relative to other consumer prices across most OECD countries.

The strong demand was also a reflection of robust economic expansion, which the OECD expected to continue. It forecast above-average economic growth this year and next in the OECD area due to upbeat business expectations, consumer confidence and “ongoing buoyancy in emerging market economies and favourable financial conditions.”

For those wanting to read the whole thing, a copy of the entire 253 page report can be found here (PDF).

Why oil prices are not such a problem for inflation anymore

It has been apparent for some time that changing oil prices no longer pass-through to domestic prices to the same extent they once did. A new study by the central bank of Chile, Another Pass-Through Bites the Dust? Oil Prices and Inflation, provides a useful analysis and explanation of this phenomenon:

This paper presents evidence of an important decline during recent decades in the pass-through from the price of oil to the general price level. We find that this decline is a generalized fact for a large set of countries.

...we use two estimation strategies in an attempt to properly identify the effect of oil shocks on inflation. First, we estimate the traditional Phillips curve augmented to include oil and test for structural breaks in 34 countries. This methodology shows a fall in the average estimated passthrough for industrial economies and, to a lesser degree, for emerging economies.

Second, we estimate rolling vector autoregressions for a subsample of countries for which we have sufficient data. We derive impulse response functions of inflation to oil shocks and interpret the integrals as estimates of pass-through. We find that the effect of oil shocks on inflation has weakened for most of the 12 countries in the sample.

Among the factors that might help to explain this decline, we argue that the most important are a reduction in the oil intensity of economies around the world, a reduction in the exchange rate pass-through, a more favorable inflation environment, and the fact that the current oil price shock is largely the result of strong world demand. These factors help to explain not only why the current shock has had limited inflationary effects, but also why it has had limited consequences for output.

The globalisation of labour

Has globalisation hurt workers in the rich economies? The latest Economist discusses a new IMF study in its Economics Focus piece, Smaller shares, bigger slices. They conclude that globalisation has reduced labour's share of national output:

It finds that both technological change and the globalisation of labour markets have depressed labour's share in all four groups. For the 18 countries as a whole, reckons the IMF, technology has mattered more. However, there are marked differences among them.

...The effects of labour globalisation were most evident in Anglo-Saxon and small European countries. However ...In Anglo-Saxon and smaller European countries, labour-market policies have partially offset the depressing effects of technology and globalisation on labour's share, mainly by shaving the tax wedge between what workers take home and what they cost to employ. In large European countries, increases in the ratio of unemployment benefits to wages have hurt labour's prospects, probably against policymakers' intentions.

But globalisation has also boosted worker's living standards through lower inflation:

Although globalisation has reduced labour's share of the pie, it has made the whole pie bigger, raising output and productivity and lowering the prices of traded goods and services. So are workers getting smaller shares but larger slices? Yes, concludes the fund: trade has helped, largely by making imports cheaper. Across the 18 countries studied, changes in trade prices boosted average real pay by 0.24% a year.

The analysis comes from Chapter 5 of the semi-annual IMF World Economic Outlook, which has just been published. You can download the chapter, The Globalization of Labor (PDF), or watch a video of the briefing by IMF economist Florence Jaumotte, who along with Irina Tytell, was the main author.

New book online: 'Trade and employment'

A recent ILO-WTO publication by Marion Jansen and Eddy Lee, Trade and employment: Challenges for policy research, is available free online. Here is a  brief table of contents:

A. Introduction
B. Trade flows and employment: the curent context
C. Trade and employment: theory and evidence
D. Trade and inequality
E. The role of policy-makers
F. Conclusions

Here is the blurb:

This study is the outcome of collaborative research between the World Trade Organization Secretariat and the International Labour Office. It addresses an issue that is of concern to both organizations: the relationship between trade and employment. On the basis of an overview of the existing academic literature, the study provides an impartial view of what can be said, and with what degree of confidence, on the relationship between trade and employment, an often contentious issue of public debate. Its focus is on the connections between trade policies, and labour and social policies and it will be of interest to all those who are involved in this debate: academics and policy makers, economists, workers and employers, trade and union specialists.

And here is the link to the PDF (0.7 Mb).

The economics of the Stern Review

For those interested in the economics of climate change, Birmingham University's Economics department and the Institute for Energy Research and Policy are holding a one day workshop on The Economics of the Stern Review.

The purpose of this workshop is to understand why Stern emerges with policy prescriptions which appear to differ from those supplied by previous economic analyses of the climate change problem. Did earlier analyses neglect important aspects of the climate change problem which Stern has managed to address or has the economic and scientific literature upon which they relied moved on? Or is the case that the Stern Review itself is in some respects deficient? The workshop brings together leading members of the Stern Review, contributors to the Review process and economists who have been openly critical of the Stern Review.

It is billed as "an academic debate between the proponents and opponents of the Stern Review of the Economics of Climate Change". The workshop takes place on Friday 9 March at 0930-1745.