OVERVIEW OF THE GLOBAL ECONOMY

OVERVIEW OF THE GLOBAL ECONOMY What is meant by the global economy? We see the term and its offshoots in newspapers and we hear about globalization on television. We see images of protesters railing against its perceived evils, while the Chairman of the Federal Reserve Bank praises it for economic growth here in the US and also abroad. Well, the first thing to do is to define what we in this course mean by the global economy. There are a variety of definitions, all of which have at their core, the economic interactions among the community of nations. In this chapter=s overview of the global economy we have two major tasks. First is a description of the community of nations and peoples who are its citizens. We will become more familiar with this community as we do our journals. The second task is a description of the economic interactions that occur between nations. These include international trade in goods and services, the international flow of financial capital, investments by multinational corporations, migration of workers, The proverb of the three blind men examining an elephant acts as a metaphor for the global economy. Each man touching a different part of the elephant, leg, trunk and tail, has a very different impression of what is an elephant. The same is true about the global economy. Countries and regions are economically very different from each other. Its defining characteristic is the wide disparities in economic achievement and consequent standards of living. A well know institution, the World Bank, has used a taxonomy or classification scheme ranking the nations of the world based on average income. The notion is that average income is a measure of the standard of living. While instructive and convenient this method is not without its problems. Average income is determined by evaluating the value of the goods and services produced in a country (GDP) divided by the country=s population. There are two major problems with this approach. First it does not take into consideration how a country=s income is distributed. could be more or less equally distributed or it could be concentrated in the bank accounts of a small group of elite rich while the vast majority is poor. In the first case, average income can be a valid measure, while in the second it falls short. The second problem with this taxonomy is that it requires a common currency to evaluate income. In general, US dollars are used for this purpose. But income produced in France is in Euros, while in Mexico it is measured in Pesos, and so on. In order to arrive at a common currency for comparison purposes we need to convert other countries currencies into US dollars. The question is which exchange rate to use for this process. The common everyday exchange rates quoted in the newspaper may not, and usually do not, reflect the actual value of a country=s currency in terms of the goods and services it can purchase. In other words, it does not take the cost of living into account. Be that as it may, it is time to explore the elephant. OVERVIEW Page 1

The starting point for this examination is a collection of statistics found in the World Bank Development Report 2003, WDR. As previously noted, the World Bank provides data on various economic and socio-demographic aspects for the countries of the world. The student can access this information at the World Bank=s World Development Report 2003 web page at the above link. This section of the WDR contains seven tables of statistics. We will be most interested in the first table, Table 1 Size of the Economy on pages 252-253. As the table s name suggests, this table provides statistics for each country detailing various dimensions of its size. We will focus on population and Gross National, an economic measure closely related to GDP. At the bottom of page 253 you see that these countries have been aggregated into both income categories: high income, middle income and low income groups, and on geographic basis. Each group will be discussed in turn by referring to Table 1. Table 1. Categories Popula -tion millions Official X-Rate PPP X-Rate % of total Gross National billions GNI per capita dollars Gross National GNI per capita Population PPP World 6201 31483.9 5080 46952 7570 100% 100% 100% Low 2495 1071.7 430 5092 2040 40% 3% 11% Middle 2742 5033.3 1840 15431 5630 44% 16% 33% Lower 2411 3352.4 1390 12378 5130 39% 11% 26% Upper 331 1667.9 5040 3050 9220 5% 5% 6% High 965 25383.7 26310 26622 27590 16% 81% 57% This table presents data on countries population and their Gross National, both in total and on a per capita (per person average) basis. As noted earlier that we need a common currency for comparisons, we use two sets of exchange rates (X-Rate). The official exchange rate is the actual one that is used to convert currencies. The columns for the official exchange rate compare incomes as if the different countries currencies where actually converted to US dollars in financial markets. The second set of columns uses PPP, or purchasing power parity, exchange rates. These are a hypothetical set of exchange rates that, as their name suggests, take into account the difference in the cost of living across countries. If per capita income in official exchange rates is significant higher than PPP, then the cost of living relative to the US is high in that country, e.g. Japan. The opposite is also true, if PPP is significantly higher than official per capita income, then the cost of living is low as compared to the US. Notice that PPP and Official per capita income are the same for the US. The third set of columns presents the data as percentages. OVERVIEW Page 2

The high income group is made up of the industrial and oil-rich nations. For the most part, these nations are the western industrial democracies of North America, Western Europe, Japan and Australia. To qualify as a high-income nation, a country must have a per capita GNP of at least $9,076. As Table 1 shows, the group=s average income is $25,383 per person. The countries of this group account for 81% of the world=s output of 31.5 trillion dollars. In terms of the world=s population, they account for only 16%. The World Bank divides the middle income group into upper and lower middle income. It is made up of nations from every region of the world. One of the newest entrants to this ranking, moving up from low-income status, is China. Considering the reoccurring famines and widespread poverty in its recent past, this is a significant achievement. Most Latin American and Caribbean countries are included, as are most South-East Asian nations. Many of the newly democratic Eastern European countries, such as Poland and Hungary are members as is Russia. While a few Sub-Saharan African countries qualify, most fall short. To qualify a country=s per capita GNP ranges between $736 and $9075. The average for a group is $1840 per person. This accounts for approximately 16% of global output. This group has the largest number of nations with its population accounting for 44% of the world's total. The vast majority of these people live in lower-middle income countries. The remaining nations are classified as low income. While this group also includes countries from most regions of the world, the bulk of them are concentrated in Sub-Saharan Africa and South Asia. As you can guess, countries in this group have a per capita GNP less than $735 or a little more than $2 a day. The average is a paltry $430 per person. While this group accounts for 40% of the world s population it only produces 3% of its output. This is a remarkable and sad statistic. What is almost as startling is if we combine low income and lowermiddle income countries. Combined they account for 79% (40%+39%) of the world s population, while only accounting for 14% (3%+11%) of the value of its output. With a little rearranging, we can calculate that for this group as a whole, four out of every five people on earth, the average income would be about $900 per person per year, at little less than $2.50 a day. Clearly, one defining characteristic of the global economy is the very wide gap between the few rich and the multitude of poor. Instead of income classification, we can look at the similarities and differences between the various regions of the world. Geographical regions are usually made up of countries that have similar cultures, religions, economic achievements and share many of the same problems. The course will include regional descriptions. The regions of the world include North America, OVERVIEW Page 3

The locations of high income can be found in the Western European, Australian, East Asian (Japan) and North American regions. Middle and low income countries, combined are called the developing world, are located in East Asia and the other regions of the world. Table 2 Geographic Distribution of Latin America and the Caribbean, Western Europe, Eastern Europe and Central Asia, Sub- Saharan Africa, North Africa and the Middle East, South Asia, East Asia, and Australia and Oceania. Look for the hyperlink at the top of the reading list for a map. Population millions Official X-Rate PPP X-Rate % of total Gross National GNI per capita Gross National GNI per capita Population PPP East Asia 1838 1740.5 950 7640 4160 30% 6% 16% East Europe and Central Asia 476 1030.2 2160 3188 6690 8% 3% 7% Latin America 527 1726.5 3280 3556 6750 8% 5% 8% Middle East 306 670 2230 1657 5410 5% 2% 4% South Asia 1401 640.5 460 3352 2390 23% 2% 7% Sub- Saharan Africa 688 306.5 450 1116 1620 11% 1% 2% Table 2 provides an overview of the size both in terms of GNP and population of the regions making up the developing world, in essence excluding the high income nations. South Asia located on the Indian Subcontinent is made up by the countries of India, Pakistan, Bangladesh and the island nation of Sri Lanka is the world=s second poorest region in per capita terms. The crushing size of the region=s population plays an important role in its inability to achieve higher levels of income. The poorest region is Sub-Saharan Africa. While the rest of the world has progressed in the past forty years, Sub-Saharan Africa has had declines in percapita incomes and standards of living. In other words, the average African was better off thirty years ago then he/she would be today. This region has been plagued by political instability suffering numerous civil conflicts since the period of decolonization. The greatest threat to this region today is the HIV/AIDS epidemic, particularly in southern Africa where in some countries the infection rate is estimated to be approaching 40% of the adult population. Together these two regions account for approximately one in three people on Earth. OVERVIEW Page 4

At the other end of the range are the Middle countries of Latin America, Eastern Europe and Central Asia, and North Africa and the Middle East. Their incomes per capita are significantly higher than those of South Asia and Sub-Saharan Africa. Unfortunately, they collectively account for only a little over 20% of the world=s population. Disturbing political and social trends are present in North Africa and the Middle East resulting in civil conflict. The rise of Islamic fundamentalism and secular resistance has undermined social stability in many countries in the region. As for Eastern Europe and Central Asia, economic and political turmoil continue unabated as these nations continue to make the transition from Communist to Market economies. In Russia the standard of living for the typical Russian appears to have stabilized after falling for almost a decade since the overthrow of the communist government of the USSR. Latin America in the past two decade continues to be buffeted by international financial markets, The International Debt Crisis of the 1980s, a decade commonly referred to as the Alost decade@ resulted from recirculation of petrol dollars by the banking system. More recently Latin American has suffered the contagion effects of skittish international capital flows. Economic and political reform has born fruit for some in this region, but the inequality in the distribution of income, the most skewed in the world, has left many living in extreme poverty. The last region of the developing world to be discussed is East Asia. This region has offered the greatest promise as many nations experience double digit economic growth rates, most notably China. In the 1980s four countries, Republic of Korea, Singapore, Republic of China (Taiwan), and Hong Kong, termed the Asian Tigers, were held up to the rest of the developing world as examples of how to overcome economic stagnation and mass poverty. For example, Korea in the 1950s was considered one of the world=s poorest countries. War torn and divided into two, Korean per capita income was among the lowest in the world. One generation later, in a period of thirty years, Korea joined the ranks of the high income countries. Other nations in the region followed the Asian Tigers example, focusing on export performance and high levels of government involvement in their economies. Thailand, Malaysia and Indonesia, at the beginning of the 1990s, began to experience growth rates equal to those of the Asian Tigers. Unfortunately, in the summer of 1997, things began to unravel as the East Asian Financial Crisis reversed many gains made in this region. However, the region has bounced back, posting a 6.7% growth rate for the period 2001-2. If this rate of growth was sustainable, the size of the regions=s economy would double approximately every ten years. The relatively low per capita income in this region, $950, is explained by the fact that both China and Indonesia are members of this region. China=s population is enormous, exceeding 1.2 billion, or more than four times the third most populous country, the US. China=s economic performance has been phenomenal this decade but they started out very poor and whatever gains that have been made are spread out over a fifth of the world=s people. Indonesia is the fourth most populous country and much like OVERVIEW Page 5

China has experienced economic growth. Unlike China who has for the most part weathered the Asian Financial Crisis, Indonesia has been the hardest hit of all the affected Asian countries. Many of the gains it made in the first half of the decade were subsequently lost. Moving Beyond Per Capita Differences The differences between the countries in the World Bank=s income taxonomy extend beyond difference in per capita income. Very real differences exist in the social and economic structures across these income groups. How people earn a living and where they live are key distinctions. Low income countries= economies are dominated by peasant farming, with most people living in rural areas. Families for the most part are self-sufficient. Farmers access to land can be very limited. The quality of land is most likely poor. The tools and technology used in its cultivation are at best primitive. Agriculture is dependent upon the rains. Too much or too little rain can be disastrous. Housing is made from available natural materials, such as mud brick. Water is not readily available and may carry many water borne diseases. Fuel for cooking is becoming increasingly scarce as trees that are being cut down are not being replanted. Without a social security program or incomes high enough to generate any significant savings, parents rely on their children to take care of them in their old age. Infant mortality rates are 100 times that in high income countries, so families have numerous children. Population growth puts ever increasing pressure on the few resources available. Life is extremely hard. Death comes early. As we move into the ranks of the middle income country group, each country starts to industrialize. Local entrepreneurs or multinational corporations build factories offering the promise of wage income and a standard of living far better then the quiet desperation found on the farm. People migrate to urban areas, eventually swelling the populations of major urban areas. Cities become mega-cities. Mexico City is now one of the world=s most populous at over 20 million inhabitants. Not all, in fact very few, find employment in the newly industrializing sector of the urban areas. Most migrants escaping rural poverty find urban poverty. Shanty towns arise. Crowded conditions and lack of sanitation give rise to disease. Employment is found in the informal sector of the urban economy hawking petty merchandise as street vendors or pedaling Pedi cabs to the point of exhaustion. Industrialization, if the political and economic environment is conducive, continues. Investments are made not only in factories but in creating a skilled labor force. Education becomes widespread. Eventually the country grows providing greater opportunity to more and more of its citizens. As incomes rise, so do savings and investment creating a virtuous cycle leading to ever greater incomes. Before long the country enters the high income ranks. The pitfalls along the way are numerous. The greatest deterrent is political and social stability. Without stability there is no investment, and without investment there is no growth. OVERVIEW Page 6

The following set of tables present statistics detailing these differences between income groups. As can be seen from Table 3, movement up the income scale leads to a transformation from an agrarian society to an industrial/service society. In low income countries the vast majority of the work are employed in agriculture, primarily as previously mentioned, as peasant farmers. Obviously, most of the population lives in rural areas outside the reach of most government programs such as education and health clinics. As industrialization begins to gain momentum, as in middle income countries, people leave the farms to seek employment in the urban areas. As Table 3 attests, most find employment not in industry but in the service sector. Here in the informal economy the services provided are low valued added activities such as street vending. Industrialization continues as countries move into the high income ranks. The rural areas start to become depopulated as the majority of people migrate to live in urban areas. The service sector absorbs most of the labor force, but the nature of the services range from retailing to medicine. Table 3. Labor force participation rates and economic structure (weighted averages - 1990) agriculture industry service low income 69 15 16 middle income 32 27 41 high income 5 31 64 World Development Report 1997 Quality of life indicators other than per capita income tell the same story. Two important facets of quality of life include health and education. Table 4 contrasts achievements in these areas across the three income groups. Referring back to our proverbial elephant the global economy is very different depending upon which region of the world being examined. A small minority has achieved a standard of living that is only a distant dream for the vast majority of the world=s population. OVERVIEW Page 7

Table 4 1997 Adult Illiteracy Female Male Infant Mortality Rate per 1,000 births Life Expectancy Low income Middle income 42% 22% 97 64 16% 10% 42 72 High income less than 5% less than 5% 7 77 Source: World Development Report 1999/2000 With all the variety which exists between the world=s regions how can we claim that a global economy exists and if it does how? The global economy provides linkages between the regions and nations of the world in a system of economic relationships. These relationships involve the exchange of goods and services, financial flows across borders, exchanging different nations' currencies, movement of people in search of better standards of living. If the global economy is defined as the economic interactions of among the community of nations, then global economic issues deal with issues and controversies surrounding these economic interactions. OVERVIEW Page 8