Hans Timmer – Economic Outlook for the South Caucasus

it’s a great honor for us it was nice to burn the chief economist for the econ region so e cos stands for Europe and Central Asia I don’t know which which part we are we may be in Europe we may be Central Asia but we are definitely taken the hands look at his Vita before the meeting he is a quantitative economist so he works a lot with data he’s from Holland originally from an institute where you work which was called central planning messaging I area south of having a bureau I can tell you that this building before it became I said used to be the planning the economic planning on Bureau of Georgia came but when the Soviet system collapsed and they were not planning any work so this place was used to you know what they did for a living they were selling the doctor of degrees and the price was three thousand dollars so if you have three thousand dollars and you want to have dr. in front of your name you came here and you pay three thousand dollars and you got it and then we came a bit later and started doing proper education and proper research that’s it well hands the floors in the floor is yours the times they are changing it’s a line from popular yeah thank you thank you so much I will try to shout all so that’s that’s easier very nice to be back in in Georgia and actually very nice to be back in this school because I’ve been here a couple of years ago and i must say of all the meetings that i’m having here it’s pretty intense program this is the one that I’m always looking forward to because when you are at the school like this at the University that’s the moment that you actually learn something much more than many of the other meetings but also it’s nice to to look at what the bright future of the country this and that impression you always get at the school indeed the times they are changing it’s it’s Bob Dylan it shows a little bit my age he wrote that song in 1963 I was born it shows our age but it’s also I think and a good title for the current economic situation and I will try to show that but let’s see whether this will will work what’s the 1960s a protest movement the young people but it was actually not a protest song it was much more than a wake-up call he was telling the parents the teachers the journalists the politicians that they have to wake up because the world has changed they cannot continue the way they live their life previously and so he described in that song and you just sold and and heard it that the water was rising and then he sings that then you better start swimming or you sink like a stone and later on there are the lines for he that gets hurt will be he who has stalled left to start adjusting to the new situation and I think that’s very appropriate a few points when you look at the current economic situation because need a wake-up call also because indeed the world economy has has moved from we had all over the world till the global financial crisis and for some countries a couple of years after that the booming growth periods but these sources of growth that fuel that global boom they have dried up and you cannot go back there and you have to realize that and the big challenge now for governments for firms for households is to find embrace and unleash new sources of work so how do you go from from here if you get up go back to to the past and then what I’m telling when I’m interact with the ministers and with governments all the time that there is not really a

unique set of policies it is not that you have a toolkit and whatever the country is whatever the circumstances are if you do that doing business indicators or what have you then everything will be fine because we have seen countries grow very fast that actually did not have these kind of very specific policy recommendation just think about China growing in ten percent a year for 30 years and and there were policies that we would not recommend in in another country’s Korea is another example but what these countries that are successful for a very long period what they all have in common is that they changed when they need to change when the circumstances change when they reach a new level of development where you need new governance then they are willing to let the past go and actually adopt and and that is what is very much needed at the moment so let’s let’s look at a little bit of data because I think we are in a very special situation at the moment so three cases first GDP growth numbers of army here and I could take any other country here in the region I could take the European Union I could take GDP growth of many other countries also but here you see the problem we had the boom period in the 2000s a very high growth year after year whatever you did every was was wonderful then you had the global financial crisis at the end of two sounds grenades negative roles all over the world in many countries at least and then you have a recovery but everybody is surprised there’s a new normal yes Cobus is not going back to where that that was and that is something that is not completely unique it is not true if you just have a cyclical downturn but if you have a global crisis after a really exceptional boom then it’s very likely that you’re not recovering back to those world friends so if you go 40 years back and so we take the 1960s the time that that song was written and then we see here for the European Union but again I could take many other examples it was really a booming period very high growth it was the end of the reconstruction in many parts of the world but if you look at Latin America it was very high growth also there and it was a period where there was a lot of coordination in any comments a lot of planning and the Netherlands Santa planning bureau you had in Latin America you had the import substitution there was not a lot of trade because after the Second World War it was very difficult to have these international connections there was hardly any capital flow across borders it was very inward looking of course you had lots of countries where you had really the central planning system very inward looking and then you have the old crisis in the beginning of the 70s and that triggers the big change but actually you could argue that this period was was running out of steam anyhow and at some point you have a trigger and then you realize that you cannot go back there in and it stops and so you had a second oil crisis also but on average the story is that you had very low growth in the in the 70s and 80s for example in Western Europe they first saw it as the cyclical slow down as the lack of demand because all the money is going with the oil exporters and they are not spending it so they try to sit it down they supported all companies there was a lot of shipbuilding in in your they supported it but yet at the end of the 80s they realized that any of the world had changed because korea had taken it all over anywhere no longer competitive and you you have to do something else i don’t know whether that’s an accident or not a coincidence but we can go again 40 years earlier and then we are in the Roaring Twenties again a period of a lot of optimism people becoming very rich because they were investing in stock markets with leverage money is very difficult to get gdp growth numbers from that dead time gdp growth was very

volatile so I’ll come to that in in a moment but then you had the great aggressions for years in a row of negative growth this is the example of the United States and on average the 30s had much lower growth than the than the 20s and lots of awful things started happening in the in surgeries and people had to rethink again where to put where to go now that sounds a little bit dramatic these these big examples but I really believe that we are in a time like that and that has all kinds of important consequences and when you start thinking about finding new sources of growth we doing things that you rethinking things then you can get it right and you can get it wrong and this is an example where they got it wrong so this is GDP growth in Japan fascinating work in the in the 50s and 60s they become the industrial powerhouse of the world what China is now very successful in conquering the world markets but basically growing in the in the industry sector at some point that drives up because at some point you have almost all the the markets you have closed the gap with the technological frontier and then it’s much more difficult to move that that frontier and and so increasingly in Japan there were a lot of savings instead of investing it productively they started investing it in existing real estate and then at the end of the the 80s that led to a big financial crisis banking crisis and then again you had another step down and very low growth and clearly Japan was a country that did not find in of growth and you can argue it was there but they didn’t want to find it because if you look at their service sector productivity was very well it was a very closed sector a lot of protection of small services and on average the the technology level or the productivity level in the service sector was only fifty percent of the work or what it was in in the United States so if they had it opened up then more investment would come in and you wouldn’t have another source of drawers but for political reasons they didn’t want to do that and whatever they try to is fiscal stimulus they couldn’t go back to their homes period but then another example where I think you can get it right and here we are looking we continue to look at GDP numbers GDP growth starting in the 60s structural growth rates for high-income countries and then for the rest of the world the go and build income countries and again you see the very high growth in the 60s that then came down was really like it is at the moment a global phenomena suddenly very low close but then you see at the end of the eighties beginning of the 90s something changed in the developing a world they started changing their policies and so across the developing world you start seeing that they were opening their borders they were starting reducing the the terrors they allowed financial flows to to come here and link to that because that’s the only way you can do that they started changing America nama policies independent central banks in the 90s even in most of the African countries independent central banks and at all resulted in not only high but accelerating growth all over the developing world not because the whole world was growing but because they found a new way of starting work now we will not go forever and these circumstances will change again but it shows that if you have the forward-looking policy is you start thinking how can we do things differently then then you might be successful so the observation is that after such a big global crisis the world is not the same again and and you shouldn’t think too long about the past so let’s think about the Great Depression the 19th

after that the role of the government in the economy all over the world has completely changed and it’s largely because of gains its occasion a revolution but in the 20s in most countries the expenditure of the government as percent of total expenditure in economies was probably five six percent it was very low and now it’s pretty normal to have thirty thirty five percent of all the spending coming from from the government it leads to much more stable development that you had before and everybody accepts it that that’s how you should organize an economy and attacks a lot of thinking about how the government can be efficient to the quality of service delivery but nobody questions that you should go back to the twenties with a completely so what happened after the 70s after the global after the your crises you came out of a period where countries were very successful with inward-looking policy a lot of coordination that’s very much fitted that idea of reconstruction and also but then they realized that somehow they had reached their end and so all the countries all over the world they started thinking about a more prominent role of market signals not so much by pushing back the government’s but by making sure that the market starts playing a bigger role not only internally in your own country but also across borders and that is the start of another way of the organization and this was the Cajun revolution you can argue that perhaps this was the Washington Consensus the idea that if you just leave it up to the markets that everything will well and and for developing countries that really paid off you can try so now we are where we are again a period where we meet the end of the road a little bit and I have no idea or that new world will be but it will be a new world and i just put here some ideas but they recently you see that there is more and more concerns about inequality within companies global inequality and that is becoming a problem a problem for how economies are functioning it is becoming a political economy problem also just look at elections all over the world but then you see it was often seen the other periods also you see also that the technology in some ways is changing and the countries have to adjust to that you don’t have to adjust when you are all in a boom period and whatever you do you start growing but then when you have to grow without your tail winds then you have to start thinking about those new technologies and one of the the new phenomenon is what we call the sharing economy the goobers the the fact that everybody can become more or less his or her own boss which creates enormous challenges have to rethink a social contract in societies and what you see now in many countries is basically a governments are fighting it because they have regulations that fit it very well in the old situation and that they try to protect it but the countries that will be really successful is the countries that are not bracing for what is happening but are embracing those in your development and not just by letting it go but start thinking of how do you organize an economy and a society in the world it’s a very big picture but there’s a little bit more happening than that especially relevant for for this region the timing is not exactly as the timing of the global financial crisis but it creates a similar kind of phenomenon and that is the fall in your crisis which is also a very long term big super cycle and the country is here in the region not only your producers but the countries that are in directly benefiting from that they had a huge boom because of the rising oil prices and now somebody that is over and the point is that the negative impact of the collapse in energy prices is much more pervasive as much many more consequences than people and and also ministers realize what it

does to your economy if these relative prices are changing but in the same way it also creates opportunities if you are forward-looking and if you are not offensive because now suddenly with lower energy prices you have an opportunity to diversify now you are becoming competitive in sectors that you are not competitive in because of the high oil prices it’s true for the oil exporter but I will show it is even for so it stood for Azerbaijan but it’s actually also true for Armenia and Georgia so a couple of examples for the oil exporters of how big the impact is we look all the time and everybody looks all the time at GDP numbers and that’s helpful I will argue that to understand the impact of the Fallen oil crisis GDP numbers are actually not the right measure but okay also GDP shows that the hint is pretty big recession in in Russia much lower growth in Azerbaijan and Kazakhstan 2015 very low compared to 2013 that’s exactly the period that the oil prices declined but this is the real story because this adds to the gdp growth the terms of trade gangs the fact that your real income is changing in a way different from GDP because even if you produce the same what you can buy is less because you get in the international market less money for it and your import prices are still the same so in real terms your income is declining a lot lot more that’s what people turn to straight gains or losses they were still terms of trade gains in 2013 so you could add that to the GDP growth country’s oil exporters we’re getting a sure all the time again look at what happens in 2015 and it actually continues this year I think I have a site that shows that also to look at as a page on a decline in income in one year of fifteen percent that comes after decline now probably because you have to add them up and no growth in real income in 2014 and we will show that there is an additional decline in real income in 2016 a decline of real income of fifteen percent that’s been that is way bigger than countries experience in 2009 after the global financial crisis it has all kinds of of consequences so here we see Azerbaijan another decline expected from 2016 where we expect the decline in GDP now as a consequence of all these these movements but when we are looking at the price development another decline so if you add this out there has a vagina in two years loses a porter or it’s real income and somebody has to take that burden so bad and that will be the big challenge for the policy makers on how do you absorb this discussion but then we go to Armenia and your giant 2015 and again this is gdp clones so if you only look at GDP per okay it’s not as good as it used to be but it’s still positive but then if you add another phenomenon and that is the change in the purchasing power of remittances coming into a country and you ended up you are also a measure of reeling then you see that in Armenia real income has declined also already and that you have a very negative impact in Georgia of that also and that is because these remittances are coming from countries the oil export is where the currency is depreciating and so you get that we normally look at remittances in dollars that’s not really the right measure but if you deflate it and the most logical deflator for that is the input price then you see that it is a big hit for other countries also top university we need equations and i’m from the netherlands so we have to talk about that disease somebody knows where that’s coming from that disease the 1970s you know this wasn’t a term

coined by The Economist because of the problem in the Netherlands when they discovered gas and the gas prices started grinding we lost competitiveness in other sectors so a very simple model to probe suppose you produce domestic boots for your domestic markets and that production is basically given that is your production capacity you’re producing also energy which you export but also more or less more or less given and then you create income that’s the sum of this that’s the volumes times the price of domestic boots and the energy prized adjournment in the global markets and then you have a very simple demand function for imports you want to to spend a fixed amount of your income on imports and we take the price of imports as numeraire in this system that is that is one simpler than that you cannot get and then you say okay in equilibrium you need equilibrium on your current accounts because you cannot continue boring or you cannot continue accumulating reserves but the value of the imports equals the value of your exports which in this very simple case is the value of your of your energy exports your own oil revenues so if you take these two equations then you get this equation and if the production capacity to produce products for the domestic market is more or less given and if your capacity the volume that you can produce of oil or gas is also more or less given then there is a one-on-one relationship between the price of your product of your domestic goods and the price of energy that is determined in the international markets now we use a little bit more complicated models than that and then it becomes a little more complicated but this is the basic idea that that if energy prices are going up and you’re exporting energy then everything in your domestic economy relative to the international crisis is becoming more expensive which means that if you would export something else also you cannot export it anymore because you have become a lot more expensive than the countries that are not exporting and it actually works in the other and so what we are doing here is we look at the price of domestic products in Russia relative to an international problem we take the price of domestic products in the United States for that and so the solid line is what actually happens over the last decade and a half and so there you see that in the period that oil prices started rising and Russia was exporting oil that at relative price if you start here doubled everything became twice as expensive as in the United States that you start here even more than that and so we thought wow very close to what you predict with simple models so let’s just do a very simple economic exercise we try to explain this relative price only from one other factor and that is the relative price of oil or prize in international markets relative to the price in the United States and then you see it at reality really follows what that very simple model predicts and then you had a brief period of the global crisis but then the ore prices started rising again so not completely it was follow me but then again and here we are forecasting out-of-sample for a little bit more than the last year and it’s almost a perfect again that’s pretty surprising it’s especially surprising when you follow the headlines and aft and and you discussed this with governments because then you saw this big fall and then everybody says over and it’s over

shooting and in financial markets you can never trust them we have a problem with our hands and then you see that was somewhere in 2014 or beginning of 2015 you saw the the the ruble strengthening again and these relative price as the result of their also strengthening again and everybody did you see all those shooting and it’s coming back and let’s not be that dramatic but it was exactly the deal at the oil prices are strengthening again and then oil prices fell and there was a depreciation of group and then it goes up again and the Larry here came up recently also there might be all kinds of reasons why people have more trust in the diary but it coincides is to write in 20 points the rise in your price and we are getting here but let’s let’s stay a little bit more with this Russian case and then you see how difficult the situation is so this is again what actually happened that red line is basically the same line that we were looking at so it’s a real appreciation in the the beginning and a real appreciation you can achieve in two ways you can have a nominal appreciation of your currency and then you have them but you can also have a stable currency and you can have tough more inflation in your own country than in the United States or the rest of the world and the result is the same and it doesn’t matter a lot it happened it will happen anyhow because these are market forces one way or the other and so here you see that in this one period most came from the other part and that is the relative inflation only at the end of the boom that was in addition to that also an appreciation of the ruble but then in the downturn of the oil crisis you don’t have a lot of choices you have really a problem at Ronnie because first of all it comes very quickly that’s always true my driver bubble it comes slowly when you have a burst and it comes quickly you can’t really achieve it with deflation it’s not how the economy works and if you want to achieve it through deflation if you want to befriend the exchange rate then you really have a big recession at your end that’s the only way that these domestic crisis will actually come down and actually the argument is that countries that try to prevent that that exchange rate because they think that is financial stability through all kinds of other mechanisms they will get that deep recession because these are market forces that is not something that you can avoid one way or the other these relative crisis will start adjusting and so that’s where you see that that decision to start floating the ruble relatively low compared to the other countries and they had a target of starting to float it but they brought it forward that was a smart decision because they could actually achieve it now that relative price change with depreciation of the rule and as a result of that you see adjustments in the Russian economy that are much more advanced than in other countries it’s it’s painful you saw that in 2015 you had some decline in GDP you at the decline of ten percent in consumption let a decline of thirty percent 30 in an import in in Russia that’s all very painful and you have to start thinking about that because it’s about sharing the burden but it is an adjustment that ultimately will give you the opportunity to start growing in anyway and that is because of the of the negotiation now this this is again are striking is always this is monthly numbers for the nominal ruble and then the brent price and you see how grossly it is folding I’m not investing in market if you want to invest in currencies this is the mechanism and three depends to be aware the moguls looked over the world yeah let’s not do that and why is another life because these are daily and even with the daily fluctuations you see foolish and so there are investors that are understanding is its mechanism you have to one other consequence i’m using way way

too much time because i still turn under the slide it’s not we just stopping but i actually find this fascinating stuff because this is something when i did it i didn’t realize that was happening so we are looking now at your price relative to your domestic crisis and then you see that’s the black line for Russia over that whole period was pretty stable exactly like that small model predicted so for people in Russia that was never an overpriced boom our prices never went up because all prices went up including lower price and so the only thing that happened in Russia that imports became virtue that was the view it was incredibly easy to start traveling abroad and at foreigners that would come to Moscow and I’ve done let a cop fitness what’s completely unaffordable was not unaffordable when you lived in Moscow because everything went up but not do oh Christ and so we often write these stories also that all produce some countries they are not energy-efficient and we often blame the subsidies for that and it’s true they’re often on top of that subsidies also but because of this mechanism you wouldn’t expect for all exporting countries to be very energy efficient because there is no no price signal together very different for Japan complete or important for them the oil prices went through the roof yeah and there you see all the reactions on on the demand side also and for them you have the big advantage of the declining or Christ’s so it has all kinds of consequences it is not just revenues and then we have a fiscal problem the whole structure of the economy is changing and all kinds of relative prices are changing so let’s leave Russia and go to Kazakhstan and we will come to Azerbaijan and then you come to Armenia and Georgia so we do the same exercise for a for Kazakhstan and again basically the same picture especially moving up because you can do that with inflation also you cannot prevent it that’s the Dutch disease also in Kazakhstan the price is basically doubled and Kazakhstan was no longer competitive outside of the auto sector and then they try to prevent it but they couldn’t completely during the global financial crisis and then here they really try to prevent it and so they had a policy of keeping the nominal currency constant and ultimately you will lose that and it backfires and it’s incredibly costly because first of all you use a lot of reserves so you’re losing that that basically wasted if you are doing that and then you have big fiscal problems which you can solve if you have a depreciation because now the full weight of the adjustment is coming on the on the physical side why not all the revenues have come on the physical side because I actually everybody benefited from that from that because for everybody in Kazakhstan the input became very G and then it’s very costly because you don’t create that incentive to start becoming more competitive in new sectors where ultimately the solution so another surprise at some point they have to get that up to the palace and then they give it up again and what is interesting this is out-of-sample forecasts is that that nominal exchange rate that is being created where everybody says we don’t know but financial markets they are volatile and it’s probably over shooting and it creates huge political problems because everybody blames the government or the central bank for what is happening here they don’t have it under control who the relative price it is being created is exactly what tomorrow experience that’s pretty surprising as a very young oh I thought I’m store I was talking about Kazakhstan as a region basically the same pitch even more extreme and again you end up well the market says you have to end up we use a lot of general equilibrium models for this kind of analysis not on econometric and that’s the story you cannot find it you cannot find it but then it spreads to other countries and

there are many mechanisms to which it spreads but it spreads to Armenia expressed in Georgia and this is one of the mechanisms that’s the remittances coming from the oil exporting countries which are actually pretty significant as percent of GDP larger than then the Philippines and with these remittances with work is working in an oil exporting country you basically become part of that economy and the adjustment mechanisms are becoming very very similar to death economy and so surprised when you start estimating a relationship like this then you see also for Armenia that close relationship with the organized and now in Armenia you see a problem there’s a lot of arguments in Armenia against appreciation but I don’t think it’s sustainable because one way or the other this will come back as you might hope that your practice you don’t have to bother anymore but if not and George unless so there was more depreciation here was not a popular popular thing but also you can argue it’s still hanging a little bit to go where it should be and this was the story that I discussed yesterday with the new governor of the central bank the the recent appreciation that can be trust it coincides with what your prize model previous so okay let’s talk a little bit we had the 40 year cycle of the big crisis on top of that we have this this oil price for the first inclination of policymakers firms and households is to go back to the war period and that is really very stubborn in all our discussions we have that mechanism and in the political economy in the expectations everybody just assumes that if you have the right policy you just get what you use that it doesn’t work that way you can get new sources of growth but you cannot go back to where you work and so what many governments are doing when they see the economy dropping is they start with fiscal stimulus there’s nothing wrong with fiscal stimulus it’s very helpful if you have cyclical downturn if you have a structural change then it can push you in the wrong direction because often that fiscal stimulus actually is spent in the construction sector is spent but that was just a problem because you have grown in a way that all the growth came from the domestic sector especially the construction sector because countries were receiving another world revenues they were receiving a lot of remittance if they had easy access to international finance and so that were all ingredients for Dutch disease growth horse coming if you enough react to the big change in the environment where the external revenues are no longer there and you continue to invest in the non-tradable sector then you’re moving the economy direction but then if you realize that and you say okay let’s try to do something else let’s just use the relative prices and let’s spend in a way that stimulates the tradable sector then then you also have a problem because then suddenly you realize that they’re all kinds of binding constraint competitiveness policies competition policies vested interest that were not really harmful and all the money came in but now suddenly so to frame the discussion the way we talk about is is probably these are the five areas that you should start addressing and probably in that order also so first you have to rethink monetary policy just keeping a constant exchange rate easily the dollar is is untenable and then you can do a couple of other things you can have a completely free float and target inflation there’s a whole discussion in our recent economic update what inflation rate you should take their there’s one proposal to start targeting the oil price in local currency that’s

that’s a very interesting one yes that also but then when you have done that you create all kinds of vulnerabilities in the kinda in the financial sector because of the dollarisation of the financial sector so you need a plan for that how do to address that then you have to secure fiscal sustainability which is much easier if you have done those two first steps because your fiscal tensions are much less when you have a depreciation and when you get the financial sector under control the fiscal problems are much less because a big part of the fiscal problems is to contain the liabilities that you have to bail out banks but then this for the political economy is incredibly important that you can explain that this is actually a fair burden-sharing and if some people are really hurt at a vulnerable that you have policies in place to protect them and that are not certain group that gets huge profitable exchanges and that are untouched I you need really good communication system but then ultimately it is over pockets and that is realizing that the world has more fun and that is realizing that there is now an opportunity wasn’t there before to start creating in jobs in sectors that have to compete internationally way always thought that oh that’s not possible competing with China just forget it that’s not possible but now we have an opportunity and in our economic update we have a whole chapter on the impact of the changes in China on this this region and we actually come up with a very positive view that it creates all kinds of opportunities this is an exercise that we really did with our general equilibrium model just to get an idea of what all these relative price changes mean for shift in employment all the different sectors and the example of our share but we did it for many and not surprisingly you see a big decline in employment in the construction sector any way to solve that he started growing the tradable sectors so you expect growth in an effort in other agriculture that’s the processed food and in another manufacturer and actually it’s interesting when you look at the date I have it also that I had to stop at some moment with their there are many many sites coming but actually when you look at the data then in many countries here in the region last year you saw agricultural production going up farmers are now much better able to compete with imports than they used to be and even there are opportunities to start exporting and there are all kinds of contracts coming now with exports of food products to China politically sensitive in some cases also but you see that the economy is over oil is on the move you have to facilitate this is all about so here we have again so this is the direction of training because if these relative price changes not only originating here but also originated in China itself that would expect you to change only from 2013 2 2015 this is a share of China in the exports it is increasing while the share of Russia in the exports is deeply very much consistent with this whole this whole model and you see it for Georgia also was only 1% in 2013 the share of exports going to China only two years left eighty-six percent I think there’s a huge opportunity there especially when you think through all the changes in the Chinese economy where do I stop here because there’s now a whole set of slides and i will leave the presentation here it will talk about the new economy that we are seeing emerging the sharing economy the role of Digital development the digital dividend and then you see that in the region there’s still a way to go to be able to benefit from it but if you start thinking about new sources of words you cannot ignore it and you cannot continue to think how it was after that there’s a whole story of China this is all about

China with you and it’s all written up in the economic update for the region that we’re doing every six months and so you can find that on the website also but just one one one observation when i’m here in school of economics don’t underestimate the power of very simple models and very simple econometrics and it gives you a much better insight than just reading off of your day eft on the wall street journal which is also important and you should also do but to get a deep understanding of all these changes that are happening is incredibly important this is not just fancy theory this is something that is really important thank you so much