How Countries

Compete:
Strategy,
St t St
Structure
t
and Government
in the Global Economy

Professor Richard Vietor

Harvard Business School
May 3, 2010

Markets have become global

Globalization, underway for more than half a century, is

a process of economic integration and cultural
homogenization across national borders. Fostered by
advances in transportation and communication
technologies after World War II and a eight rounds of
trade negotiations under GATT, trade has grown at
twice the rate of world GDP. Floating exchange rates,
sovereign lending and the liberalization of capital
accounts have accelerated this process.

Today, nearly 73,000 multinational corporations

manage more than 880,000 multinational subsidiaries.
© Richard Vietor

1
 Share of the World GDP 2008

$60.8 trillion

Source: IMF, 2009.

2
 Share of the World GDP 2008
Purchasing power parity adjusted

$69 trillion

* Adjusted for Purchasing Power Parity

Source: IMF, 2009

Countries compete

• Within this global market place, countries

compete for exports,
exports for foreign direct
investment and other capital resources, for
technology and managerial know-how and for
access to natural resources.
• The purpose of this competition is growth and
development – to reduce poverty, accommodate
urbanization,
b i ti create
t jjobs
b andd iincrease liliving
i
standards.

3
 “Preparing our nation to
p
compete is a goal
g that all off
us can share… In a dynamic
world economy, we are seeing
new competitors, like China
and India, and this creates
uncertainty.”
i ”
President George W. Bush
State of the Union Message, 2006

National Development Strategy

Countries have development strategies:

- either
ith explicit
li it (carefully
( f ll formulated
f l t d
and discussed by senior government
officials);
- or implicit (a loose collection of
goals and policies that merely net to
strategy, after the fact).

4
Organizational structure
• Countries – like companies – need an
organizational structure suited to
implementing the strategy;

• That structure must fit the domestic

context – the skills, assets, polity and
culture
lt off its
it people
l – and
d the
th
international context – its geography
and political relationships abroad.

The Role of Government is Crucial

• Mediates the strategy

gy
• Determines the organizational
structure
• Shapes the context by building
g g the institutions
and regulating
that shape the market

5
 Essential role of state:

• Provide security – domestic and international;

• Enforce contracts,
contracts property rights and laws;
• Back risk – incorporation, bankruptcy,
unemployment insurance, pensions, nuclear
facilities;
• Provide money;
• Manage macro-economy;
• Implement industrial policy (explicit or implicit).

Developmental Strategy of Government

• Fiscal policy
• Revenue sources
• Expenditure choices
• Deficit/Debt management
• Monetary policy
• Control money/inflation
• Regulate banking
• Control exchange rates
• Incomes policy
• Wages, prices, work rules, distribution of income
• Trade policy
• Tariffs, taxes, non-tariff barriers
• Foreign direct investment controls
• Nationalization/privatization
• Economic regulation
• Externalities (environment) and market failures
(telecom, banking, infrastructure and competition)
• Provision of subsidies

6
 Government Management of Institutions

• Corporations, partnerships, proprietorships

• Infrastructural resources
• (water, power, roads, rails, air traffic, telecom)
• Human resources
• (schools, colleges/universities, healthcare)
• Technological resources
• (patents,
( defense
f and public-science research))
• Capital resources
• (banking, securities, insurance)

Trajectories of Development

• Asian high growth

• Post Soviet restructuring of Russia and
East Europe
• Latin American recovery from debt crises
• Islamic resurgence
• African renaissance
• European integration
• Deficits and debt in Japan and the United
States

7
 Singapore – Desperation Strategy:

• Build on the entrepot advantage;

• Free trade and foreign direct investment
• Tight monetary policy
• Market exchange rates
• Forced savings
• Invest in p
public housing
g and infrastructure
• State sector –> 25% GDP
• Balanced budget (by late 80s)

Singapore’s Institutional Web

• Ministry of Trade and Industry
• Economic Development Board (EDB)
• Housing
Ho sing De
Development
elopment Board
• Jurong Town Corporation
• Temasek Holdings
• Singapore Airlines, Singapore Technologies
• Monetary Authority of Singapore (MAS)
• Central Provident Fund
• SPRING (productivity board)
• ASTAR (science and biotechnology)
• National Trade Union Congress
• Corrupt Practices Investigation Board

8
 Singapore – Results!
• Real GDP growth – 7.5% for 37 years;
• Savingsg 51% GDP;; Investment 38%
• X&M = 3xGDP
• Inflation –> 2.1%
• Balanced budget
• Current account 23% GDP
• GDP/capita (PPP) - $41,000

Lee Hsien Loong’s New Strategy

• Cut taxes to 20%; 18%

• Higher value-added tax - balance budget?
• Move to higher value-added exports?
• Attract intellectual talent?
• Refocus on biomedicine?
• Deal with Chinese (and Indian) competition?

9
 The global crisis was tough on trade….
• GDP down -2.1% ‘09
• Investment down -3.1%
• Inflation down 0 in ’09
• Exports down -20%
• Imports down -22%
• Trade balance down -> (at $31 billion)
• Current account -> down slightly 12.5%/GDP
• Unemplo ment up from 2.2%
Unemployment 2 2% ->
> 3.4%
3 4%
• Gov’t surplus 1.5% -> -2.7%

Singapore

10
 China – a Greater Challenge
• $200 per capita
• Closed,, Communist economyy
• Inefficient collective agriculture
• State-owned enterprise
• 987 million people
• “Cultural Revolution”

Deng’s Pragmatic Liberalization

• One-child policy
• Agriculture – household responsibility system
• TVEs – Township & village enterprises
• SEZs – Special economic zones
• SOEs – management responsibility system;
then privatization
• G
Gradual price decontrol
• Tax reform (1994)
• Currency reform (1994)
• WTO - 2001

11
 China - Results
• 9.4% real GDP growth
• Investment 44%; Savings 50%
• Consumption down to 35%
• Exports 3% -> 35%
• Imports 3% -> 28%
• Inflation 3.5 -> 2.0%
• p y
Unemployment – 9+%
• Balance of trade $360 bil; current account $440 bil.
• Cumulative FDI - $900 bil

Structure of China’s Industrial Output

(percent of total value)

12
 China Industrial Production: Value Added
(yearly percent change)

17

15

13

11

5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Complied with data from the Economist Intelligence Unit.

China inflation
(yearly percent change)

30

25

20

15

10

0
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
‐5

Source: Complied with data from the Economist Intelligence Unit.

13
 November 9th Stimulus Plan – Rmb 4 trn ($586 billion)

China’s Growth
Nominal GDP, Real GDP, CPI
45
Nominal GDP
40
Real GDP
35
CPI
Percent Change

30

25

20

15

10

0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
‐5

Source: Complied with data from the Economist Intelligence Unit.

14
 Trade Balance

Source: Complied with data from the Economist Intelligence Unit.

Renminbi/Dollar Exchange Rate and U.S. Merchandise Trade

Balance with China (inverted scale, millions $$)

$$ Millions Rmb/$
0 10

9
‐50,000
8

7
‐100,000
6

‐150,000 5

4
‐200,000
3

2
‐250,000
1

‐300,000 0
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Trade Balance (left axis) Exchange Rate (right axis)

Source: Compiled with data from Economist Intelligence Unit Country Reports, (various years), http://countryanalysis.eiu.com/country_reports, accessed March 2010.

15
 China’s Foreign-Exchange Reserves
(US$millions)

China – Great Performance, but...

• Tightly managed economic liberalization;
• Institutional reform still lagging (e.g., SOEs,
b k ffederalist
banks, d li t relations);
l ti )
• Externalities mounting (e.g., environment,
under-employment, corruption, food and
energy dependence);
• Income distribution, rural population chafing…
• WTO – partial implementation;
• Trade surplus with US (still $232 bn)– sustainable?
• Unemployment up by 20 million – back down?
• Next round – economic/political balance?

16
 India – Failed Import Substitution

• Hindu rate of growth – 3.5% per year (with

population growing 2.5% per year)
• 50% of output owned by public sector;
• 100% of banks and insurance firms;
• Highest tariffs, capacity licensing, imports
allocated and price controls;
• “Sick units”
nits” protected
protected;
• Widespread corruption.

India after 1991

Washington Consensus…gradually

• Fiscal policy – deficit reduction;

• Monetary policy – tightened;
• Exchange rates – floated;
• Capacity licensing – removed;
• Price controls – removed;
• Tariffs lowered;
• Privatization begun;
• Foreign direct investment allowed;
• Spending on infrastructure and education
increased.

17
 India’s Results:
Year-to-year percentage growth in gross domestic product, and government deficit and
current account deficit as percent of GDP; all figures for year ending March 31

Government Current
%
GDP Growth %
Deficit % Account Deficit

Note: Fiscal deficit is the difference between revenues and spending; current account balance is the
broadest measure of goods, service and money that crosses a country’s border, with a deficit indicating
more imports than exports.
* estimated
Source: Compiled from Center for Monitoring the Indian Economy; HSBC securities; Jardine Flaming India Broking Ltd. © Richard Vietor

Foreign Investment in India Since 1991

35

30
Direct
25
Portfolio
Billions $$

20

15

10

0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
‐5

‐10

‐15

Source: Complied with data from the Economist Intelligence Unit.

18
 Corruption 2009
(0 = most corrupt 10 = least corrupt)

0 1 2 3 4 5 6 7 8 9 10

Singapore (3)

Japan (17)

United States (19)

South Africa (55)

Turkey (61)

Italy (63)

Saudi Arabia (63)

China (79)

India (84)

Mexico (89)

Russia (146)

Note: rank among other countries is in parentheses

Source: Compiled from Transparency International, 2009 Corruption Perceptions Index , www. transparencyinternational.org.

Coalition Politics in India – May 2009

19
 India’s Exchange Rate
(Indian Rupee/U.S. Dollar, inverted scale)

Source: Complied with data from the Economist Intelligence Unit.

Mexico and Latin America

(debt, structural adjustment, and micro-reform)

Old Strategy
• Import substitution strategies with resource-led
growth
• High tariffs, limited FDI, large public sectors,
fiscal deficits, monetization, fixed exchange
rates
Revised Strategy
• Debt leveraged growth, 1974-1982;
• Debt crises & IMF bailouts

20
Economic Liberalization Strategy – 1982-1996

• Devaluations
• Fiscal and monetary control
• Tariffs down -> NAFTA
• Privatizations – domestic & foreign
• FDI – maquiladoras
• Wage controls
• Brady plan debt reductions
• But, overvaluation, current account
deficits and foreign debt up – second
“tequila” crisis.

Mexico Recovery
(real GDP)

21
 Political Liberalization Strategy under Vincente Fox
(2000-2006)

• Macro-economy stable – now microeconomic

and institutional reform;
• Fix pensions;
• Poverty, education, income distribution, labor
law, oil and gas sector, environment;
• Control crime and drugsg
• And China competition threatening maquilas!
• But PAN a minority party…little accomplished.

22
 More Effective Reform under
Felipe Calderon (2006

• Drug war – 10,000 arrested; 20 leaders;

• Pension reform – retirement age up; defined
benefits defined contributions;
• Electoral reform – shorter campaigns, limit to
media spending;
• Fiscal reform – corporate flat tax, collection
efficiencies revenue up 2%;
• Pemex – limited financial flexibility;
• Next – electoral reform – re-elections

BUT …FINANCIAL CRISIS…

23
24
25
 Latin American Recovery?
•Mexico – democratizing and economic reform – privatized, well-managed
fiscal and monetary stability, and NAFTA dependent; now, crime and economic
efficiency;
•Argentina – stable government ? Will Argentina inflate? Will it become
competitive? Will default have lasting ill-effects?
•Brazil – Can institutional reform continue, with effective debt management,
pension reform and income redistribution- will Lula alleviate corruption and
manage responsibly?

Growth of GDP % Inflation Cur acct (%/GDP

2008 2009 2010 2008 2009 2010 2008 2009 2010

Mexico 1.3 -7.3 3.3 5.1 5.4 3.5 -1.4 -1.2 -1.3

Argentina 6.8 -2.5 1.5 8.6 5.6 5.0 1.4 4.4 4.9

Brazil 5.1 -0.7 3.5 5.7 4.8 4.1 -1.8 -1.3 -1.9

Chile 3.2 -1.7 4.0 8.7 2.0 2.3 -2.0 0.7 -0.4

Colombia 2.5 -0.3 2.5 7.0 4.6 3.7 -2.8 -2.9 -3.1

Venezuela 4.8 -2.0 -0.4 30.4 29.5 30.0 12.3 1.8 5.4

Islamic Resurgence/Saudi Arabia

Annual GDP Growth
Percent

26
 Saudi Arabia – Economic Issues
until Oil Prices Rose
• Slow economic growth (1.8% per year),
except for past three years – high oil prices;
• Government budgets – irregular deficits/debt
• Defense, debt service and education
• Unemployment –> 13+%
• Low inflation
g Trade surpluses
• Huge p
• Current account deficits (until 2000): large
surpluses since.

Saudi Arabia: Gross Domestic Product

Percent Share of GDP

27
 Saudi Development Strategy
• Reduce fiscal deficits
• Open up foreign investment
FDI law,
l gas initiative
i iti ti
• Build infrastructure
• Finance domestically
• Privatization
• Fund education
• Maintain low inflation
• Saudization
• Reduce production of oil by 1,500,000 mmbd;
• Expand production capacity to 11.5 mmbd)
• Abdullah Plan – Middle East Peace

Real and Nominal Crude Oil Prices

1970-2009

140
Nominal
120
Real (1999)

100

80

60

40

20

0
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: Complied with data from the Economist Intelligence Unit.

28
OPEC Spare Production Capacity
(millions of barrels per day)

Oil Fueled Inflation into Double Digits

29
 Saudi Arabia since 2005
• Raid economic growth (up to 6.4% per year) –
now back to 0.8%
• Huge Government surpluses, debt down to
24%/GDP
• Defense, education and infrastructure, including
four new cities
• Unemployment –> 7-8%
• Inflation up to 9%; back down to 4%
• Huge Trade surpluses
• Current account surplus - $450 billion in
Sovereign Wealth Reserves

Build-up in Reserves; Draw-down in Crisis

30
 Africa Recovery

1995 GDP(bil$) GDP Growth 90-95 GDP Growth 2006

Kenya 9.1 1.4 6.0

Tanzania 3.6 3.2 5.9
Congo 14.4 1.8 5.1
Zambia 4.0 -0.2 6.0
Zimbabwe 6.5 1.0 -5.1
Malawi 1.5 0.7 8.4
Uganda 5.6 6.6 5.4
Angola 0.5 -4.5 15.3
Botswana 02
0.2 42
4.2 42
4.2
Mozambique 0.4 7.1 7.9
Namibia 0.4 3.8 4.5
South Africa 136.0 0.6 5.0
Lesotho 1.0 7.5 1.6

Map source: http://www.politicalresources.net/africa-map.htm

GEAR – Growth, Equality and Redistribution

• Fiscal policy (deficit reduction)

• Monetary policy (constant real exchange rate)
• Privatization – now stopped
• Two-pronged industrial policy
• Lower tariffs - WTO
• T
Two-tier
ti wage policyli - failed
f il d
• Now Black Empowerment

31
 South Africa

Selected Components of the Balance on the Current Account

(% of GDP)

32
 Strong Domestic Demand Opened a
Persistent Saving-Investment Gap

South African Social Issues:

• Unemployment: 23.2%
• Infrastructure: electricity, plumbing, telephone,
housing;
• Education: 32% illiterate
• Crime: 26,000 homicides;1 felony/21 people
• AIDS: 19% - 24% of adult population

© Richard Vietor

33
 South Africa

South African National Government Budget Balance

(% of GDP)

34
Black Economic Empowerment Act 2003

• Address slow pace of change in economic equity

(gap in income inequality among blacks growing
(GINI up from .59
59 to .63)
63)
• BEE: hiring, training, promotion, ownership &
control;
• Charters – voluntary commitments – in mining,
finance, information technology so far;
• FINANCIAL CHARTER
• 25% senior mgt, 50% middle mgt. by 2008
• 50% black-owned procurement;
• Financial services for 80% of population;
• 25% black ownership by 2010;
• 33% of the board should be black

Brazil, Argentina, Chile, Mexico,

South Africa, Malaysia and
Turkey…if not

• Low cost
• Differentiation
• Focus

“Stuck in the Middle”?

35
 Japan – Deficits, Debt and Deflation

Performance Factors 1979-85 1985-91 1991- >09

Real GDP Growth 3.9% 5.1% 1.2 -> -6.2%

of which consumption 60.7 57.8 56.8
government 10.0 9.9 17.9
investment 29.6 34.0 19.4
exports 12.1 14.2 16.0
Unemployment 2.8 2.1 4.1
Savings (household) 17.0 14.9 5.1
Productivity Growth 41
4.1 29
2.9 2.7
Budget Deficit (%/GDP) 6.1-> 4.2 - - - > 1.1 -> 8.3 -> 3.8
Balance of trade (bil $$) 7 - - > 56 - - - > 77 - - - > 105 -> 167

Current account (bil $$) 1 - - > 49 - - - > 57 - - - > 248

© Richard Vietor

36
 Japan: Major Bank Profits, FY 90-99
(in trillions of yen)

Source: Fitch IBCA

Japan’s Inflation
(percent change per year)
6

‐1

‐2

‐3

Source: Complied with data from the Economist Intelligence Unit.

37
 Japan’s Price Inflation
(% change, year on year)

Japan’s Discount Rate

10

0
1973197519771978197919801981198619871989199019911992199319952001200620072008

Source: Complied with data from the Economist Intelligence Unit.

38
Japan’s Market Interest Rates

Japan’s Fiscal Deficits

39
 Public Debt of Japan
(as percent of GDP)

Source: Complied with data from the Economist Intelligence Unit.

Japan’s external balances

Three –month moving average (¥ trillion)

Source: The Economist, March 21, 2009; CEIC; BEA; Goldman Sachs.

40
 Japan Unable to Change Strategies

• Monetary policy won’t work – liquidity trap

• Fiscal ppolicy
y won’t work – deficits & debt
• Institutions need modernization
• Political gridlock – new party?
• Totally dependent on exports
• Debt/GDP 200% and rising?
• Collapse pending? Or Restructuring?
• Yen?

Japanese Yen/U.S. Dollar

(inverted scale)

41
 USA 1980 – Inefficient Markets

• GDP growth –0.3%

• Unemployment 7 7.5%
5% and rising
• Inflation 10% (cpi 12.6%)
• Trade deficit $28 billion and rising
• Productivity –0.6%
• Unit labor costs up 10.3%
• Regulated sectors inefficient
• Interest rates 19%
• Fiscal deficit 2.4% GDP
• $$ depreciating (against Y and DM)

Decontrol
• Tighten monetary policy
• Cut taxes ((25% marginal
g income tax p
plus
accelerated depreciation and itc)
• Deregulate transportation, energy
telecommunications and banking
• Let dollar rise 63%

42
 Phase One
• Deep recession (1982-83)
• Dollar appreciates
• Massive trade and current account deficits
• Huge defense expenditures
• Oil prices weaken
• US economy grows 3.4% annually
• I fl ti drops
Inflation d to
t 2.3%
2 3%
• Real interest rates eventually fall
• Massive fiscal deficits (1989-92)
• Gulf War

Phase Two
• Deficit Reduction Act (1993)
• Maximum marginal tax rates hiked (41.5%)
• Expenditures cut ($112 bil./yr)
bil /yr)
• Free trade (Uruguay Round & NAFTA)
• Investment boom
• Productivity grows 2.1%/year – mfg 4.1%
• GDP growth 4.1% per year
• Budget balanced
• Unit labor costs negative
• Dollar strengthens (’95-01)
• Savings falls to 1%, current account to -$410 bn

43
 Phase Three – Deficits & Terrorism

• September 11th
• Afghanistan
g
• Homeland Security
• Iraq
• Four tax cuts - $1.3 tril,$100 bil,$360 bil, $156 bil.
• Fiscal surplus ($236 bn) to deficit ($455 bn)
• Savings to -0.1%
0 1%
• Debt from $5.6 to $12.0 trillion (back to 80%/GDP)
• Current account deficit to $811 billion (now $683)
• Net foreign debt to $3.4 trillion
• $$ collapsing…

United States Real GDP, 2005-2009

(quarterly, billions of chained 2000 dollars)
8

0
II III IV I II III IV I II III IV I II III IV I II III IV

‐2
2

2005 2006 2007 2008 2009

‐4

‐6

‐8
Source: Compiled with data from Economic Report of the President, 2009, 2010.

44
45
 Good News – U.S. Productivity: 1981-2009

Percent
16

14
Manufacturing
12
Nonfarm Business
10

‐2

‐4

Source: Bureau of Labor Statistics, January 2010.

Bad News – Budget Deficits

$$ bil.
400
Nixon Ford Carter Reagan Bush Clinton Bush
200

‐200

‐400

‐600

‐800

‐1000

‐1200

‐1400

‐1600
1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Source: Compiled from Economic Report of the President 2009; CBO, Budget Outlook, March 2009. © Richard Vietor

46
Very Bad News…

47
 Worse News!

Overall Global Current Account Balances in

Billions $$
2008
600

440
400 341

211
200 157
102 100
15
0
U.S. Japan Developing China Middle Russia EU UK Germany France
Asia East
-81 -64
-200

-400

-600

-706
-800
Source: IMF World Economic Outlook, April 2009

48
Sad News for the Next Generation

© Richard Vietor

49
 Central Bank Reserves
Foreign exchange
Country/Monetary
Rank reserves Figures as of
Authority
(millions of USD)
World (sum of all
— 7,178,805 --
countries)
People's Republic of
China
1 1,946,000 Dec-08
( includes Mainland China
only)
2 Japan 1,009,354 Feb-09
Eurozone
(EU member states which
- 530,666 Feb-09
have adopted the euro,
incl. ECB)
3 Russia 388,100 Mar-09
4 Republic of China 292,000 Mar-09
5 India 252,326 Mar-09
6 South Korea 206,340 Mar-09
7 Brazil 203.201 Mar-09
8 Hong Kong 186,200 Mar-09
9 Singapore 165,677 Nov-08
10 Algeria 145,363 Apr-09
11 Germany 143,518 Feb-09
12 Thailand 114,198 Mar-09
14 Italy 110,811 Feb-09
13 France 99,930 Feb-09
15 Malaysia 88,400 Mar-09
Mar 09
16 Mexico 82,100 Feb-09
17 Iran 81,000 May-08
18 Libya 79,000 Sep-07
19 United States 75,654 Apr-09
20 Switzerland 73,315 Feb-09
21 Turkey 68,600 Mar-09
22 United Kingdom 64,332 Mar-09
23 Poland 63,847 Oct-08
European Central Bank
— 62,921 Feb-08
(ECB, not owned by any
single EU member)
24 Nigeria 50,900 Jan-09
25 Indonesia 54,800 Mar-09

Good news – U.S. Dollar has weakened, some

50
 How Countries Compete
1. Governments must guarantee basic property rights;
2. Governments must maintain sound macroeconomic policies:
- Fiscal deficits cannot continue indefinitely,
- Entitlements should be limited and securely funded;
- Taxes should be somewhat redistributive and discourage
excessive consumption;
3. Strong (not necessarily independent) central banks are necessary for
non-inflationary growth;
4. Microeconomic liberalization (trade, foreign investment and
privatization) by government is eventually necessary in a competitive
global economy, but financial markets must be regulated…
5. Governments must maintain labor market flexibility to enhance
prod cti it and facilitate competiti
productivity competitiveness;
eness
6. Government must manage resource endowments carefully;
7. Governments must control corruption;
8. Governments are responsible for insuring equitable income
distribution;
9. Governments must stimulate savings and investment;
10. Governments can not allow unsustainable current account
asymmetries.

51