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World Economic Outlook - April 2005 Other issues of the World Economic Outlook Research at the IMF  |
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Transcripts of video presentations
on the analytical chapters of the April 2005 World Economic Outlook Workers' Remittances and Economic Development Workers' remittances are transfers made by migrant workers to family and friends in their country of origin. Remittances are a key source of foreign exchange for developing countries. In 2003, remittances amounted to about $100 billion a year. This is the equivalent of about half of the total capital inflows. Given the magnitude of remittances, it is clear that they can play an important role in improving economic prospects in developing countries. Yet to date there has been little systematic, cross-country analysis of the determinants and impact of remittances. Our essay is an attempt to fill this void. Let me give you some background. Remittances to developing countries have grown steadily over the past 30 years. For many developing countries, remittances constitute the single-largest source of foreign exchange, exceeding export revenues, official aid, FDI, and other private capital inflows. For instance, Mexico currently receives about $15 billion in remittances per year. In smaller economies, such as many Caribbean countries, remittances often exceed 10 percent of GDP. Moreover, remittances have proved remarkably resilient in the face of economic downturns, unlike exports and private capital flows. I should note that the U.S. is currently the main source of remittances (accounting for over $30 billion in 2003). Outflows from the U.S. have almost quadrupled over the last 15 years. In part, this reflects the recent rapid immigration into the U.S. What this suggests is that remittances are likely to continue growing as populations in industrialized countries age, and migration pressures from developing to advanced economies rise. Overall, our analysis finds that remittances play an important role in boosting growth rates, maintaining macroeconomic stability, and reducing poverty in developing countries. Remittances allow households to step up expenditure on basic consumption, housing, and education. They are often used to set up small businesses, and they can help promote financial development in cash-based economies. Unlike aid or natural resource revenues, remittances do not have systematic adverse effects on a country's competitiveness. However, we do find that governments need to adopt certain policies to encourage remittances and maximize the benefits they yield. In particular, transaction costs for remittances often amount to 5-10 percent or even more of the amount transferred. These costs could be reduced, for instance through greater competition. Also, governments should be wary of many types of economic restrictions, for instance on foreign-exchange flows. Such restrictions may both discourage remittances and shift them outside the formal financial system. I hope my brief remarks stimulated your interest. Many of you will want to find out more about remittances; I trust you will enjoy reading the essay! Output Volatility in Emerging Market and Developing Countries Let me start by providing some background. Fluctuations in output growth (in short: output volatility) are nearly three times as large in developing countries as they are in industrial countries. Indeed, for countries in sub-Saharan Africa and Latin America-the regions with the highest volatility-this difference vis a vis industrial countries is even more pronounced. This is important because output volatility harms long-term economic performance and makes poverty reduction more difficult. The effect of output volatility on growth is large. For example, if output volatility in developing countries had been at the same level as in industrial countries in 2003, per capita growth in the developing countries would have been about half a percentage point higher than the actual outturn of 5.5 percent. For sub-Saharan Africa, the growth impact would have been even larger raising annual per capita growth by 0.6 percentage points to 2.3 percent. Policies that reduce output fluctuations are a crucial element of ongoing global efforts to improve growth and reduce poverty. This would assist the efforts of the world's poorest countries to meet the Millennium Development Goals. The main motivation for writing this essay was to examine the causes of output volatility in low and middle income countries, and to assess the impact of better policies on volatility. The essay uses an innovative technique to breakdown output fluctuations into those caused by global, regional, and country-specific economic events. This allows a more precise investigation of the factors that drive volatility. A key finding of the essay is that a large share of output volatility in developing countries is attributable to country-specific events, and therefore it can be influenced by domestic policymakers. For example, country-specific factors explain more than 60 percent of output volatility in most developing countries, compared to only 40 percent in industrial countries. Indeed, in sub-Saharan Africa and the Middle East and North Africa, around 80 percent of output volatility is due to country-specific events. The essay's findings suggest three main policy conclusions. These are as follows:
That concludes the discussion of my essay. I hope you enjoy reading it. Globalization and External Imbalances Let me start with the central messages of the chapter. Globalization has created the scope for less costly correction of current global imbalances, that is, smaller changes in real exchange rates and less effect on output growth, if financial market conditions remain favorable and investors continue to accumulate U.S. assets. However, if investor preferences change, there are now greater risks of a more abrupt and costly adjustment, which would involve a sharp depreciation of the U.S. dollar, higher interest rates, and weaker output growth. On balance, therefore, global imbalances still remain a concern. Let me now turn to the analysis behind these messages. Why is there scope for less costly adjustment? Both financial and real factors matter in this respect. On the financial side, large and persistent current account surpluses or deficits can be corrected more gradually with globalization because investors are now more willing to hold foreign assets in their portfolios. The real effects of exchange rate changes can thus play out over a longer time period, which help to reduce the magnitude of their overall change during adjustment. On the real side, the key are two implications of the recent rapid expansion of international trade due to a broad fall in trading costs. First, the more even distribution of trade flows across the world contributes to more broad-based burden sharing among countries, which limits the need for adjustment in each country. Second, output levels in major economic blocs are now more equal in size, and the financing of the U.S.deficit requires relatively smaller surpluses elsewhere. Both effects help because real exchange rates, interest rates, and growth have to adjust less during the correction. Finally, the fact that monetary policies today are more effective and credible also helps. The reason is that stabilizing inflation during the adjustment, which entails relatively faster domestic demand growth outside the United States, now requires smaller interest rate changes, which reduces the output cost of adjustment. Let me now turn to the issue of why the adjustment risks are likely to have increased with globalization. To begin, it is important to recognize that globalization has neither fundamentally changed the nature of current account adjustment nor the magnitudes involved. Exchange rates and trade balances still need to adjust in response to current account imbalances and, if imbalances are large, the magnitudes remain substantial. Illustrative simulations in the chapter show that with a very gradual correction of the U.S. current account deficit over a decade, U.S. net foreign liabilities would stabilize at about 60 percent of GDP while the trade balance would have to improve by about five and a half percentage points of GDP. This adjustment is equivalent to about six hundred billion US dollars in today's prices or more than 10 percent of today's consumption of internationally traded goods and services in the United States. The very fact that adjustment magnitudes remain substantial also bears on the risks associated with the adjustment. Investors can decide to reallocate their investments away from the U.S.,say, for example, because they anticipate the U.S. dollar depreciation that accompanies the adjustment. Accordingly, the current account deficit would need to be corrected faster, which would require large initial changes in real exchange rates and interest rates compared to a correction under benign financial market conditions. The fallout is now likely more elevated than in the past because of larger gross and net foreign asset positions. What does this mean for policies? The chapter's main policy conclusion is that policy makers need to take advantage of the scope that globalization provides to facilitate adjustment and, at the same time, remain mindful of the risks associated with unexpected changes in investor preference. These objectives are most likely to be achieved by the adoption of credible medium-term fiscal and monetary policy frameworks that are consistent with achieving external and internal balance within a reasonable period of time. The reason is that this would anchor expectations of investors and, thereby, reduce the risks of reversals in their preferences. Avoiding the latter is of course a key condition for gradual adjustment. These are only some of the highlights of the chapter, and I hope you enjoy reading it. Will the Oil Market Continue to be Tight? Let me start with some background. Oil is the most important commodity traded in international markets. In 2004, it contributed about 8 percent to global trade in goods and services, and about 2.5 percent to world activity. This is more than a contribution of any other commodity. Oil is also important because it is currently the only viable source of energy for the transport sector. The availability of oil is therefore critical for smooth performance of the world economy. During most of the last decade, crude oil prices fluctuated between 15 and 25 dollars per barrel. There was ample spare capacity that could be used when oil production in some regions was interrupted. However, the oil market has over the past couple of years become tight as demand for oil has been increasing at a faster pace than oil supply. These tight conditions reflect a combination of several factors; strong global economic growth, unusually high oil demand in some countries, especially in China, and a series of supply disruptions. As a result, oil prices have increased to about 50 dollars per barrel and have also became very volatile. In our oil-market study, we look into the factors that will be determining the market developments in the medium- and long-term. The main message coming out of the analysis is that the oil market will remain tight in the coming years. High and volatile prices will continue to present a serious risk to the global economy. This is because oil demand will grow robustly, while oil supply will have a tendency to lag behind demand growth. Moreover, it seems unlikely that the market could again achieve the level of spare production capacity that was typical during the 1990s. This will leave the global economy highly vulnerable to supply disruptions. The main reason for the fast growth in oil demand will be the increasing standards of living in developing countries and emerging markets. With higher incomes, the use of oil in the business and residential sectors will be expanding. A large number of people in developing countries and emerging markets will reach the level of income at which they can afford to buy a car or another vehicle fueled by oil. All in all, we expect that non-OECD countries will contribute three quarters of the future increase in global oil consumption. China alone could contribute almost a quarter to the increase due to its fast economic growth and large population. By contrast, increases in oil production capacity will be slow. In the short term, this is because of the inevitable time lags of bringing new production on stream. However, restrictive regulatory frameworks will also prevent investment from taking off quickly. In the long term, another strategic factor will become important. About 70 percent of proven oil reserves is concentrated in the countries that are members of the Organization of Petroleum Exporting Countries, or OPEC, for short. The chapter's analysis suggests that OPEC is unlikely to raise production at a fast pace, mainly due to its market power and the costs of building new capacity. We therefore expect the long-term prices of oil to be considerably higher than the prices experienced during the past decade or two. The chapter estimates the long-term oil price between 39 and 56 dollars per barrel expressed in the prices of year 2003. This is the price range that would equilibrate the rapidly rising demand with constrained supply. For comparison, the recent significant increases in the prices of long-dated oil futures have pushed the expected real oil prices into this range. The key question is: how can policymakers deal with the risk of high and volatile oil prices? Progress should be made in several areas. First, greater transparency in the oil market, especially through improving the timeliness and quality of data on oil demand, supply, and inventories, would reduce uncertainty and volatility in the market. Second, obstacles to investment in the oil sector need to be reduced because restrictive regulatory frameworks are an important impediment to oil-sector investment in many countries. Third, efforts to slow the growth of oil consumption should continue. Increases in the efficiency with which oil is used can require substantial up front expenditures. However, countries whose import dependency is expected to rise over the coming years should consider oil-saving measures very carefully. Fourth, countries highly dependent on oil imports could consider protecting themselves from the risk of supply disruptions by gradually boosting strategic reserves. This is particularly relevant for many developing countries, where reserve ratios are currently low. Finally, both consumers and producers would benefit from engaging in a more intensive dialogue about expected market developments and policies. This would reduce the perceived risks of tight oil supplies. Moreover, this could help avoid policy actions by importers to curb long-term oil demand. This concludes my discussion of the chapter. I hope that you will enjoy reading it. |