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Raghuram RAJAN£ºThe Global Economic and Monetary Outlook: How Will Populist Insurrections in the West Affect the Emerging£¿

ReleaseTime£º2017-02-17    Views£º418




   Thank you, thank you very much for having me.  This is a difficult time in the afternoon to speak.  All of you have had nice lunches, so my task is to keep you awake.  I hope I will be successful, because the topic I¡¯m going to speak on is something that has all of us worried.  The populist insurrections that have taken place across the western world, the first intimation of that was the vote on Brexit.  Of course, the US election was the next step; and as our moderator suggested, we¡¯re still apprehensive about what might happen in both France and Germany.

   So I¡¯m going to talk a little bit about the reasons for the populist insurrections but more about the consequences, what we might see going forward, and what the effects might be.  I want to talk specifically about the implications for the emerging markets; and then talk about other short-term risks, the possibility that as monetary policy normalises and inflation starts gaining strength, what might we see on capital flows. 

   I want to talk about the fact that in Europe, banking is still somewhat unstable and whether that in fact may create some surprises for us in the year to come.  I think I¡¯m most worried about the possibility of geo-political risks.  Of course, we¡¯re all worried about the effects of recent events on trade; but I think we should also be worried that there are possibilities for geo-political risks. 

   Then finally, I¡¯ll come to an issue which we will debate at greater length in the panel, which is Chinese growth prospects.  I¡¯ll give you a very very short impressionistic account from an outsider.  I will emphasise again, just as Professor Merton did, we¡¯re all outsiders; and as a result, we only have impressions, that the real understanding of what¡¯s going on comes from the insiders.  I hope to have a better understanding from the panel as we talk.

   Now I want to end. There¡¯s always a danger that we get overly pessimistic at times like this about the prospects for the global economy.  I think we should keep reminding ourselves that there has been a lot that has gone well in the global economy, the most resounding example of that is the success of China, that China¡¯s performance over the last 30 years elevating one-sixth or one-fifth of mankind from a state of moderate poverty to middle class in the span of one and a half generations, I think this is something unprecedented in the world.  I think that it is examples like that that should cheer us up and say that there are aspects of the global system that are worth fighting for in the face of challenges from elsewhere.

   So given that basic introduction, perhaps let me go to the populist insurrections themselves.  It¡¯s pretty obvious that the underlying forces behind the populist insurrections have been building for some time.  In fact, I would argue they¡¯ve been even building before the financial crisis.  Clearly, what has been happening is that in a number of sectors in industrial countries, there have been job losses.  Often the most visible job losses are because of trade; for example, in the steel sector in the US or even furniture manufacturing in the US.  You can always point to a factory which has closed down and reopened elsewhere in the world, often in China.

   So, a lot of the focus has been on trade as the reason for job losses.  But if you ask an economist, they will say most of the job losses are because of automation, because of the effects of the technological revolution, and not primarily because of trade.  Now what¡¯s an example of this, what verifies this?  I think this is a statistic that economists know, that is not known more widely, which is if you look at US manufacturing, US manufacturing share of GDP has stayed at 12% since 1965.  What was it in 1965?  It was 12%.  What is it today?  It¡¯s 12%.  It¡¯s about the same over all this period.  Yet, the US says it¡¯s losing manufacturing competitiveness. 

   The truth is it¡¯s not losing manufacturing competitiveness as a whole.  What is happening is it is withdrawing from certain sectors and moving to new sectors.  So steel is no longer a big part of US manufacturing, but IT products are a big part of US manufacturing.  So, what is happening is there is a change in the sectors in which the US is represented.  That¡¯s one. 

   But perhaps more important is the fact that productivity in US manufacturing has grown, so the US has continuously lost jobs in manufacturing.  Five and a half million jobs in the first 10 years of this century, it lost five and a half million jobs in manufacturing.  That was because of technology, because productivity improved, not necessarily because trade reduces the competitiveness of US manufacturing.  Yes, it doesn¡¯t make sense to produce steel in the US in the same quantities as it used to produce in the past; it¡¯s importing steel.  But it¡¯s exporting other stuff.

   Now the other aspect of this populist insurrection and the focus on trade and manufacturing is it also misses out that the industrial countries have increasingly become better at trade in services.  This is actually a study that Shang-Jin Wei did when he was at the (International Monetary) Fund showing that the US was the biggest exporter of services in the world.  The US may in fact worry about manufacturing and not being competitive about manufacturing, and that¡¯s something we talked about just now; but in services, it exports very high-value services.  Services like legal services, services like financial services.  Therefore, if the US focuses on trying to straighten out manufacturing to preserve jobs that are no longer competitive, there is a risk that it may set off a trade conflict which impinges on its tremendous advantage on exporting services.  That is a concern, and that¡¯s something we¡¯ll come back to.

   So the first point is that increasingly, these populist insurrections are driven by moderately educated workers who are seeing either that they¡¯ve already lost their jobs in some of the manufacturing areas or there¡¯s a threat that they will lose their jobs; and worried about this, certainly they¡¯re pressing for some sort of remedy.

   It¡¯s also   anti-elite.  One of the post financial crisis worries has been that the elite don¡¯t know what they¡¯re doing.  Now first, who are the elite?  The elite are probably anybody in this room, anybody with a higher degree, anybody with a PhD is the elite.  But these are the guys who run the financial system, these are the guys who are at the top levels of various corporations, these are the people in higher levels of government, these are the people who meet at Davos, these are the people who meet at the BIS meetings in Basel.  So the argument is that these are the people who led us into the financial crisis, and which one of them suffered as a result? 

   The popular view is that the bankers who did so much damage, not only that no senior bankers go to jail, but after the financial crisis, they were back to earning huge bonuses.  So the broader argument, which has been capitalised by people like Donald Trump or Bernie Sanders, is the people in Washington and New York look after themselves.  They looked after their bankers, they made sure nobody went to jail.  This was because the system is dominated by the elite.  The people they don¡¯t look after is people like you, meaning the steel worker, the coal miner, the moderately educated middle class who are very fearful that they¡¯re at risk of losing their jobs and so on.

   So the movement has become strongly anti-elitist, which also means that they have a very great distaste for experts because the experts don¡¯t know what they¡¯re doing.  They¡¯re the guys who led us into the financial crisis, so why should we pay any attention to them?  Let us now listen to the non-experts because they may have ideas that are more sensible.  Now there may be some truth in that view, but it¡¯s a very dangerous view because then you go down paths which may be problematic.  We¡¯ll come to that in a second. 

   The third aspect of these movements is they typically look back to an age when the country was less diverse; less immigrants; more conservative; and more, shall we say, comfortable for the majority community.  So there is a sense these were the good times, and everything that¡¯s happened since then is driven by these cosmopolitan elite who have made us more multicultural, who emphasise diversity, who bring in all sorts of people into the country including illegal immigrants; and that has created tremendous problems for the country.  Let us go back to the older times.

   This is a kind of view you hear echoed by even leaders like the Prime Minister of the UK, Theresa May, who is looking to go back to a more comfortable time.  Of course, when people look back, they always look at the nice things of those times.  They rarely remember all the bad things of those times.  So it is a view that is particularly dangerous because it doesn¡¯t accept the fact that the past was also very problematic, and therefore implies polices that are probably bad for the economy as a whole.

   With this very brief sketch of the kinds of views that are on display here, let me turn to the kinds of policies that are emerging or that might emerge from these insurrections.  First, because many of these are leaders who believe they have a direct contact, a direct connection to the people, they want policies that have immediate visible impact on the people.  So, a lot of these leaders propose visible projects like big infrastructure projects.  Now infrastructure, in fact, may be warranted in the United States where a lot of the infrastructure needs perhaps repair, rebuilding, improvement.  Any of you who¡¯ve been through some of these US airports, LaGuardia or Kennedy, knows there is scope for improvement. 

   However, these things take time, and the electorate is impatient.  There is a view that the US under the new administration will start building out infrastructure in a big way.  My sense is that is somewhat optimistic because any infrastructure project requires time to plan, time to build, and it will take time for this to happen.  It is not something we¡¯re going to see in the immediate, but this is something that¡¯s on the agenda.

   But part of this pressure to deliver quickly also means that the populist movement is much more for freeing entities of regulatory burdens, especially if these are intended to meet international requirements or international agreements.  So for example, there is a view that on climate change, the US has been too forthcoming so perhaps it should back off.  But related to this is the view that perhaps clean air regulation has been too rigorously enforced and has created a number of problems for the auto industry for example.  So let us put regulators in charge who understand that they don¡¯t have to be so forceful on clean air regulation, that they will dial back. 

   So the new administration is in the process of appointing a variety of heads of various regulatory bodies who seem to be less forceful in terms of enforcing the regulations that those bodies are historically supposed to enforce, and perhaps there¡¯ll also be some pulling back on the regulatory front from Congress. 

   So with this, there has been a certain amount of life in the markets, in the financial markets, the stock markets because they believe that this deregulatory environment will help businesses.  Again and again, you hear from small and medium businesses that the last eight years under the Obama administration has been very difficult for them because regulations have been very rigorously enforced.  So this pullback on the enforcement of regulations, that is promised with the new administration, may in fact be seen as a good thing for small and medium enterprises, which is one reason you see stock prices for small and medium enterprises increase.

   Now of course with any pullback of regulation, there¡¯s always a concern you may pull back too far.  So today, the markets are celebrating because there is a scope for pulling back of some of the excess regulation.  The question, of course, is how far does it go and at what point does it get excessive.

   Now the emphasis on the immediate also creates potential risk that if for example the administration focuses on manufacturing jobs which are very hard to bring back to the US, and puts in place trade restrictions, you know tariffs and so on, to protect the manufacturing jobs, could it have much more serious effects on things like service exports which are very big from the industrial countries.  So the worry here is while focussing on the visible, which is part of the campaign promises, you do damage to other parts of the economy which are less visible, which are areas which benefit equally, and create longer-term problems. 

   Similarly, the one view that economists have if in fact the threat of imposing large tariffs on imports comes about is that the cost to the consumer of consumption will go up tremendously.  So while you might be benefiting US producers, and even that is a question, in fact you will be hurting the US consumer.  So the worry is the administration should pay more attention to both sides, not just the production side but also the consumption side; the same worker who is now hurt and worried that he¡¯s going to lose his job is also the worker who goes to Wal-Mart to buy very cheap goods which are imported from many countries of the world including China.  The US would not be able to afford the $28 DVD machine that is bought from imports.  If you manufacture the same thing in the US, it would cost considerably more.

   Similarly, the US should remember that the iPhone 7 Plus, which costs about $850 in the US store, is made by Foxconn and the price that Foxconn charges Apple for that is about $300.  So, $550 comes from value-added services in the US plus Apple¡¯s profit.  That if in fact the US then tries to get manufacturing done back in the United States, it may be significantly costlier; and profit margins will fall considerably, as well as prices will go up if those goods have to be manufactured.  I think this is an understanding which certainly economists have.  It is certainly an understanding that we hope going forward the administration will express more, and the kind of threats that have been made in the election campaign hopefully will not materialise to that extent in actual practice.

   The third element is that there¡¯s a very strong push against immigration.  This is more so in Europe, more against illegal immigration in the US.  The worry, of course, in many countries in Europe is that immigration is swamping the local culture, and it is bringing people who don¡¯t understand what the local culture is about, and who are taking local jobs.  This was a factor in the Brexit campaign, it is a factor in the French campaign. 

   The problem, of course, is that immigration while it has short-term costs, may have long-term benefits because after all many European populations are ageing.  If somebody has to work to provide social security for those ageing populations, it may have to be not just the children of today¡¯s French people but also immigrants who come in to help support the economy over time.  This is certainly a big issue in Germany where the population is ageing quite fast, and so the short-term view that these are people who take our jobs doesn¡¯t reconcile with the long-term need to have immigration support existing population growth as you get more and more people ageing and leaving the workforce.

   So there are some concerns about the populist view that it focuses on the immediate, focuses on the visible, but ignores the deeper effects on the economy.  One would hope that as the populists come to power, some of these deeper effects are in fact part of their consideration set.

   The third aspect I think that one should note is because of this direct connection with the people, because they come from groups that don¡¯t respect the experts, there is much less of a respect amongst the populace for tradition, for institutions, for multilateral agreements and so on.  One example is central banks.  A lot of the populist movements think central banks are full of the elite, they¡¯re full of people with PhDs who speak a language that nobody else understands.  As a result, they are uncontrolled, they do things that don¡¯t have popular support or a popular mandate. 

   So again and again, you see talk against the central banks emanating from the populist groups - that we must bring them under control, they must work for the people.  In the US for example, there were accusations that the Federal Reserve was keeping interest rates too low for too long, and that would be remedied when Mr Trump came to power.  In the UK, I think Prime Minister Theresa May has expressed some concern about the Bank of England again staying too low too long, and that has hurt savers. 

   So, there are arguments.  In Germany, there are increasing arguments.  Part of the problem is the central banks have occupied over time a much bigger space than normal, as they¡¯ve become the only game in town and the political establishment has been paralysed.  But the political establishment doesn¡¯t like central banks occupying that space.  They feel that space should belong to them.  As a result, when central banks occupy that space, there is a reaction; more so if in fact the central banks are these elitist institutions.  That¡¯s a worry going forward as these populist reactions take place.

   It is particularly worrisome, as we¡¯ll talk a little later, inflation is starting to pick up and central bank independence is extremely important at these times.  So the political move to curb central bank independence is probably coming at the worst time possible, when in fact you want independent central banks who can act against potential inflationary pressures as we go forward.

   A third effect is the possible remarks on debt that have emerged - that if in fact you¡¯re not particularly worried about the institutions, you may not be particularly worried about the sanctity of debt.  That¡¯s something that is again worrisome - that whether in fact the populists, through their programmes, will increase the level of debt in industrial countries because they simply don¡¯t believe that this debt is sacrosanct, it has to be serviced.  They want to take a little bit of punt on that.

   Finally, this attitude towards international agreements because the populist movement is more nationally focussed, more domestically focussed; and every country views that it has been hurt by international agreements and doesn¡¯t emphasise the benefits it has got.  Many of them want to withdraw from the international arena.  If everybody wants to withdraw from the international arena and we have international problems, such as climate change, who is going to take up the mantle of fighting for international agreements here? 

   That¡¯s something that I think is very important, especially in China because China, being the second largest or the largest economy in the world, has a vital stake in international agreements being respected, in the old liberal order being maintained even as these populist insurrections play out.  So I think a big question is - will the emerging markets step up to defend the current international order, the rules-based international order, and shape it more over time even as the industrial countries withdraw or back off?

   Now the final point I want to make is I¡¯ve said a lot of things about what the views of the populists are, and a lot of it is based on comments made during election campaigns.  The truth is nobody knows how much the comments made during those campaigns will actually play out in reality, what was election time rhetoric and what will actually emerge.  You can make some guesses by looking at those who have been appointed to the administration, but it¡¯s not clear that in fact what was done in election time will actually play out in reality. 

   There¡¯s an American saying, ¡°you campaign in poetry and govern in prose¡±.  In other words, the campaign can be much more exciting and volatile; but when it comes to governing, you have to be much more sober.  If that actually plays out this time, then in fact I think we are in for a much less volatile time than some of the commentaries suggest.

   So, what are the consequences of these policies?  Quickly first, it is going to be certainly reflationary; but in fact may turn out eventually to be inflationary.  The US is close to full employment, at 4.8% unemployment.  Yes, there are people who have left the US labour force, which is why participation rates are relatively low now compared to historical levels; but the people who have left the labour force may not have the skills that the labour force needs.  

   So if in fact growth is cranked up even more in the United States, it¡¯s not clear that the people who re-enter the labour force have what the jobs require, which means that wages could be pushed up even further.  So, what we saw recently in the last employment report was wages have increased by 2.9% relative to last year.  That¡¯s a pretty strong rate.  What is less clear is there¡¯s a significant amount of labour market capacity still left that is not tapped.

   A second part - so if in fact there are larger fiscal deficits, there is more demand stimulus, it¡¯s not clear there¡¯s enough supply waiting to actually accommodate that.  When you put on top of this the prospect of higher fiscal deficit because tax rates may be cut and there may be an infrastructure programme that is put in place, as well as the fact that commodity prices seem to have stabilised as global growth is starting to pick up once again, that does create the prospect of more inflationary pressures going forward.

   Now what that also implies is dollar  appreciation, especially as there¡¯s a view that the Federal Reserve will tighten more quickly.  What this does is for other countries such as the ECB and Japan, it reduces their need to become more accommodative going forward to meet their inflation target; and I¡¯ll talk about that in just a second.

   Of course, the big unknown is what the polices will be on trade, on immigration, and on cross-border investment.  Will they get tougher, for example for investment coming from across the border to buy sensitive companies in the economy?  That¡¯s unclear.  Again, we have to see how much of the election rhetoric is converted into policy.

   The hope is that some of the more stringent measures that have been proposed on trade are really bargaining ploys, that in fact when new administrations come in, they will back off and actually have a more benign resolution.  In the short run, what this means is growth, inflation, and the dollar will all benefit in the short run.  The medium run, however - until the administration makes its stance clear, there is a fair amount of uncertainty, especially for the emerging markets. 

   Now I want to point out one particular worrisome graph which is that increasingly, what we find is the world is moving against trade.  These are the net anti-trade measures across the world.  You can see even before these populist administrations came in, the measures were increasing, which is something that a number of emerging markets which have built their growth on an open trade environment have to think about how much risk is there in relying on this.

   Now, let me turn to emerging markets.  Emerging markets in the last few years have had crises of their own.  Post global financial crisis, many of them tried to crank up demand.  They tried to crank up demand by encouraging credit booms, which were aided by capital inflows.  Brazil was an example.  To some extent, China also had its own credit boom.  These helped for a while, they helped increase demand; and commodity exporters also did very well as commodity prices shot through the roof. 

   But of course in 2013 after the Fed started hinting that it was going to back off from easy monetary policy, we had the taper tantrum.  Then we¡¯ve had growth slowdowns, significant slowdowns in Brazil, in Russia, partly as a result of the commodity price collapse, and partly in a number of countries because of the high build-up in debt.  Emerging markets have tried to put their house in order, focussed on building up sustainable domestic demand and regional demand.  But I think the anticipation of adverse measures from industrial countries stemming from the populist insurrection adds one more component of uncertainty into the mix. 

   So on the one hand, we see finally some glimmer of recovery in the global economy.  Europe is doing better, the US is doing better, Japan is starting to look good; and of course China, we¡¯ll talk about in the session after this.  But in general, the world economy is picking up.  Exports also seem to be picking up once again at this point.  All this is good news for the global economy.  What spells bad news is the potential uncertainty about policies that emerge as a result of these populist insurrections, including anti-trade and anti-investment policies. 

   A second concern, which I¡¯ll come to in just a second, is the normalisation of industrial country monetary policy.  In the last few weeks across the capital markets, we¡¯ve seen capital outflows.  We¡¯ve seen capital outflows as there¡¯s a sense that the Federal Reserve will start raising interest rates and that returns in industrial countries will become stronger.  All this suggests that in emerging markets, we have to continue to focus on improving the macro situation, create an environment of macro confidence, of macro stability, and build growth within that; a lot more focus on regional and domestic demand rather than relying on industrial country demand. 

   So to summarise:  we have reflation over the short term.  Investment could remain muted.  Across the world, the biggest shortages of investment, even in industrial countries, and this investment will continue to remain muted until there¡¯s more clarity on the policies that these administrations will follow.  Once there¡¯s more clarity, we could get stronger investment. 

   You¡¯re already seeing in some areas investment start to pick back up, in oil for example where investment had been slashed; as oil prices have stabilised, you¡¯re seeing some pick-up in shale investment.  But I think we need across the board better investment, and that depends on much more clarity on policy.

   Regardless of that, I think it is clear that the tolerance of industrial countries for yet more openness is limited; and therefore emerging markets have to focus much more on regional and domestic demand than on exploiting the demand in industrial countries significantly more.  It¡¯s absolutely clear that capital flows will remain volatile, something that clearly is an issue in China also today.

   Let me turn to risk.  First monetary policy, how much more room is there for accommodation and what happens as policy turns.  Now you must remember that for the last five or six years, monetary policy has, in the view of many central bankers, been the only game in town because many countries have been paralysed by political infighting, by political conflict, fiscal policy has been relatively dormant, sometimes because they already have heavy debt loads.  But structural reforms have also been on the back burner, except with a very few exceptions like Spain.  So in this environment, the central banks have said that ¡°we¡¯re the only game in town¡±, and that ¡°there is still room to conduct policy with the hope that it will get transmitted¡±. 

   Now I have been a big critic of this view saying that there hasn¡¯t been that much room for transmission because the traditional interest rate sensitive sectors that respond when you cut interest rates, that elevate growth when you cut interest rates, those interest rate sectors haven¡¯t been responding because they¡¯re already heavily over-indebted.  You¡¯re not going to get much more mortgages taken up in the US because already a lot of households are under very heavy debt.  You¡¯re not going to get them to consume much more.  So in a sense, you¡¯re not getting the traditional boosts from low interest rates that you would otherwise get. 

   The other channel that many central bankers point to is wealth effects, that as interest rates go down, financial asset prices go up; as financial asset prices go up, the holder of those assets feels wealthier and goes out and consumes.  Another way to see this is banks hold a lot of financial assets.  As those financial assets increase in price, they get effectively recapitalised and they go out and lend. 

   The problem with this view, of course, is that if you boost it unnaturally today, when monetary policy normalises, it goes the other way, that asset prices plummet.  One of the worries going forward is increasingly that asset prices have been significantly distorted, are not truly additions to wealth at these distorted levels, and in fact there will be an adjustment as those prices come down.  This is why a number of consumers aren¡¯t going and spending that wealth effect that is in their pocket today.

   A third reason for accommodative policy is that it helps entities deleverage.  In a number of countries, the deleveraging has taken place.  In the US for example, households have brought down their debt levels; some of it by defaulting, some of it by paying it back, but now the level of debt is stabilising.  So, there¡¯s not that much more room for deleveraging on the household side. 

   But in the meantime, corporations have been building up their debt in the United States.  In an environment of easy interest rates, debt is very easy to take up.  So while you¡¯re getting deleveraging on one side, you¡¯re getting releveraging and enhanced leverage on the other.  So on net, it¡¯s not clear that this effect is also playing out.

   But I think the most important reason that central bankers in industrial countries across the world are still pressing for accommodation is they¡¯re not achieving their inflation objective.  Many say we must achieve 2% or so, and many are significantly below that.  So long as they don¡¯t achieve the inflation objective, the pressure will be on them to get more accommodative. 

   Now in this situation, I think it¡¯s good that the Federal Reserve is thinking of exit, especially as the inflationary environment in the United States seems to be turning.  I think there are other reasons why exit makes a lot of sense because one should especially ask - is monetary policy still working the same direction, in the right direction?  It¡¯s not even clear after we¡¯ve had interest rates so low that the channels that are traditionally thought of are working in the right direction.  

   Typically you think, ¡°When I cut interest rates, people are going to say it doesn¡¯t make sense for me to save more, I¡¯m going to go out and buy goods in the store, I¡¯m going to go out and shop¡±.  But with populations ageing in the west, it is possible that as you cut interest rates and they see less income coming on their financial investments, they say ¡°I¡¯m not going to go out and shop.  I need to retire in five years, I don¡¯t have enough retirement savings.  The income I¡¯m getting on my existing savings are very low, I¡¯m going to go out and save some more¡±. 

   In fact, it¡¯s totally unclear whether in fact the income effect or the substitution effect, this is what the economists call this, which one dominates.  Increasingly, it¡¯s not clear that reducing interest rates is working in the right direction.  This is something that has been debated in Japan for a long time.  It is now being debated in Germany, whether interest rates, reducing them actually enhances consumption, or has the opposite effect - increases savings.

   The second reason one has to be concerned is after many years of low interest rates, it¡¯s not clear asset prices are right any more, that asset prices have been significantly distorted.  With asset prices so distorted, it¡¯s not clear monetary policy has the effect of encouraging people to invest in real assets.  In fact, the fear of asset price volatility may in fact dissuade them from taking strong decisions.

   The third reason why it¡¯s not working in the right direction is in a number of countries, rates have been so low that firms that needed to exit, that were not doing well, that had to close down, are still kept alive because the cost of capital is so low.  So for example in Europe, there is some evidence that too many firms are still in existence which should have left.  Finally, one of the concerns with ¡®low for long¡¯ is that you¡¯re really trying to deal with a problem of high leverage, of excessive asset prices, by creating yet more leverage and yet more excessive asset prices.  Whether, in fact, this is a good thing is something that is increasingly being debated.

   So given this, essentially what I believe is that normalisation is appropriate.  The Fed is moving out.  This is a good thing for the world, not a bad thing, because it will create room for other central banks to slowly normalise also and not continue finding new ways of new exotic policies to be accommodative.  What is important, I think the Fed has said again and again that it will focus on raising interest rates rather than unwinding QE. 

   There¡¯s a very interesting reason for this.  The Fed believes that if for example it raises rates and suddenly the economy weakens, it has the option of reducing rates again.  But if it goes back on QE and starts selling assets, and suddenly the economy weakens, it feels it has much less of an option to resume QE again. 

   So, what you will see going forward is an exit via raising interest rates rather than unwinding QE.  I think this is good.  This will create a virtuous exit for the global central banks from the current extremely easy monetary policy.  Of course, this will create asset price volatility.  We¡¯re not prepared, we¡¯re never prepared for tightening interest rates.  There will be some volatility, there will be some capital flows out of emerging markets.  But the question you should ask is not whether this will happen when central bank policies change, but what happens if you continue central bank policy of accommodation for a few years more and then do it then, will the damage be worse?  My sense is there is never a good time to tighten; but given how long we have been accommodative, this is probably the best time to do it.

   Let me quickly walk through two other risks and then end.  Banking in Europe - Europe is growing more strongly, but a lot of the growth is in places like Germany and too little of the growth is in places like Italy.  Italy, as was recently obvious, has weak banks that are not appropriately capitalised.  It needs to put more capital into those banks, but current European rules makes it difficult for the government to put in money, which means it has to be privately capitalised by the private sector. 

   In this kind of environment with weak banks as well as growth not picking up, there¡¯s always a concern that there could be concerns about bank health.  Where could those concerns come from?  One could be if there¡¯s turmoil in the euro area because of elections outcomes in France or Germany that surprise because the populists win.  A second could be that there¡¯s a lot of exposure in Europe to countries like Turkey.  So if for example, there is more volatility in Turkey, that could affect European bank balance sheets, and that could be a source of concern.

But the last issue is probably the central issue, which is the ECB today has been very accommodative in supporting all of Europe.  Increasingly as inflation picks up, especially in Germany, there will be pressure on the ECB to be less accommodative and to move towards both tapering as well as eventually to raise interest rates.  Because Europe is very varied, what is good for Germany may not be good for the periphery; and that¡¯s something to think about in the days to come as a potential risk, especially because the European banking system is not strong. 

   I¡¯ve already talked about this third concern which is geo-political risks.  We have big changes coming in the next few months.  We have elections in France and Germany.  We have the 19th National Congress of the Chinese Communist Party.  We have an untried and potentially volatile US presidency.  It¡¯s important to remember that this presidency is different from the previous one which focussed much more on the US¡¯s role in the world.  This one is much more focussed on what the world has for the US.  It¡¯s what Ian Bremmer calls self-interest. 

   In that kind of environment with so many trouble spots around the world - Syria, North Korea, terrorism, cyber-interventions - there is a worry that there is no central party who is going to bring the world together.  Increasingly as the world divides into multiple powers, each power wants to look strong, not necessarily reasonable, because that¡¯s what the electorate wants and that¡¯s what the pressure of elections may do.  So, there is a worry that there is a potential for something going wrong. 

   Let me skip this section on Chinese growth, other than saying there are tremendous changes that are happening in China.  I think the four aspects of the growth model - investment-to consumption, exports-to domestic-demand-led, industry-to services, and government directed-to market-led - these are all very important changes.  But change is difficult.  How to keep growth going while these changes are happening?  To my mind, this creates a constant pressure for the government to come back into the picture because if it leaves things alone, growth may slow down or the financial markets may be volatile.  So, there¡¯s a constant pressure to bring the government back into the picture. 

   Increasingly, I think it¡¯s expected and understood that that will in fact happen.  So I think from an outsider¡¯s perspective, and take this with all the salt that you need or put as much weight as you think it deserves, that the real challenge for China is to make the transition to the new growth model but do it in such a way that it requires less and less government intervention, because in fact that over time is what is needed for the change to fully take place.

   So let me end with just mentioning the longer-term risks.  Are we too dependent on debt-fuelled growth, especially in industrial countries?  We¡¯ve had a pattern of crises first in the emerging markets, then industrial countries, then again in the emerging markets.  Is this going to continue going forward as debt becomes a primary way we generate growth?  This is something that we have to worry about. 

   I think increasingly in the industrial countries, there have been too many promises made on debt, pensions, on healthcare.  If you look at the next chart - in a country like France, it exceeds 10 times GDP, the promises that have been made to the people in terms of pensions, healthcare, public debt, private debt.  Eventually these promises may have to be renegotiated.  The question is who bears the costs, and that is something the industrial countries have to think about.

   Finally, we¡¯ve already mentioned the populist anger on integration, markets, and technology.  Who¡¯s going to speak for the globe?  Let me end by saying all this suggests pessimism.  But I think we have to be optimistic because technology and global integration over the last 30 years has provided so many solutions.  You just have to look around Shanghai to see the kinds of solutions that have been provided in a very important country in the world. 

   One of the hopes is productivity growth may re-emerge because of all the innovation that is happening.  As we bring technology to bear, we¡¯ll solve many of the problems that are confronting us, for example the kind of pollution that has afflicted cities like Beijing, cities like Delhi, are amenable to technological solutions.  I think we can do that, I think we have to do that.  So long as we keep technological progress open and trade open, I think we can do it. 

   But there are many bright spots around the world where growth can emerge, so I think the real issue is to keep the global trading and investment system open.  For that, I hope that China will play a very important role.  Thank you. 

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