69008 The Road to 2020 Scenarios for a World in Crisis Simeon Djankov, Neil Gregory, Michael Klein, Facundo Martin Scenarios last updated on April 10, 2009. They are not forecasts or projections. About These Scenarios T his paper was prepared by Simeon Djankov, future might play out. Scenarios provide a framework for Neil Gregory, Michael Klein, and Facundo Martin. debate, leading to better policy making and strategies. The authors are, respectively, Chief Economist, They are especially useful in situations where major glob- Adviser, Vice President, and Economist in the Financial al changes are under way but there is huge uncertainty and Private Sector Development Vice Presidency of the over what may happen. Staff of the World Bank Group World Bank Group. The paper is based on a scenario are providing these scenarios to help governments and workshop held on January 20, 2009, where leading organizations prepare for an uncertain future. Being well financial and private sector development experts from prepared and open to thinking about different outcomes IFC, the International Monetary Fund, and the World Bank is much better than continually being behind the curve discussed the unfolding crisis. The findings were also and having to chase events. presented and discussed with a wide audience of World Four scenarios for the development of the world economy Bank financial sector specialists at the Financial and over a roughly 10-year horizon are presented. These are Private Sector Development Forum 2009: Markets and called Stuck in the Rut, Dirigiste Capitalism, Capitalist Crises: What Next and How? (http://rru.worldbank.org/ Blocs, and Bounceback. These are not forecasts but fpdforum/) on February 24–26, 2009. These scenarios will merely possible sequences of events. If a particular be updated from time to time as events unfold. scenario begins to emerge, policy makers can be ready This paper is a product of the staff of the Financial and with optimal strategies to deal with key issues, including Private Sector Development Vice Presidency of the World what investments may be preferable, what role different Bank Group. The scenarios described in this paper do not institutions can play, and how individual countries may necessarily reflect the views of the World Bank Group, its respond. Executive Directors, or the governments they represent. The scenarios described serve as the basis of a planning Two Fundamental Uncertainties exercise and are not to be interpreted as forecasts or The exit path out of the crisis, and subsequent global projections on the part of the World Bank Group or the development, depend on two fundamental uncertain- authors of this paper. ties. The first is whether the current crisis is a random event—a black swan—or an inherent part of a market 2020 system. Under the first view, the world is sufficiently The unfolding crisis has already featured some events resilient to pick itself up, dust itself off, and continue as that were considered unthinkable some months ago—for before. Under an alternative view, the more sophisticated example, nationalizations in the banking sector of OECD and complex the market system becomes, the more countries. More unthinkables are likely to arise. As the violent and unpredictable the crises. Hence, resolving this crisis and the crisis response by governments develop, crisis may provide a welcome relief before another—even one can hypothesize about where the world might go. bigger—crisis shows up on the horizon. The world is an increasingly violent swirl of chaos and control. The purpose of this paper is to sketch scenarios taking into account the information currently at hand. The second uncertainty is about what drives long-run In this way, scenarios can provide decision makers with growth and, in particular, whether external (to the firm) alternative views of the future. Decision makers can test finance is a big driving force for growth. One view is that their strategies against the different ways in which the without a sophisticated financial sector the real economy 1 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. does not have opportunity to develop. In other words, The answers to these uncertainties determine the growth follows finance. The alternative view is that the likelihood of alternative scenarios, as described below. development of the real economy is not predicated on There is a common element among all four scenarios: a sophisticated financial sector, and indeed that such a under each, there needs to be a mechanism to unwind sector develops only after growth has been sustained for the global fiscal imbalances that will be exacerbated in some time. In other words, finance follows growth. the crisis. 2 simeon dJanKov, neil GreGory, michael Klein, Facundo martin scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. Four Possible Scenarios The four scenarios differ along two main dimensions, the The scenario Stuck in the Rut envisages a dozen years degree of regulation in the economy and the stance of slow growth, worldwide, and another global crisis toward international trade and investment flows: coming around 2020 (table 1). Dirigiste Capitalism antici- pates a divided world, with flat growth in rich countries 1. Stuck in the Rut—restricted trade and heavy and brisk catch-up growth in emerging markets. In this regulation scenario, China catches up to the United States in total 2. Dirigiste Capitalism—open trade but heavy regula- GDP (at purchasing power parity) by 2020. In Capitalist tion and increased state ownership of the econo- Blocs, the world economic system falls into several my, particularly the financial sector regional blocs, but by 2020 it becomes evident that global 3. Capitalist Blocs—initially restricted trade, but trade and investment dominate a divided world, and the markets with flexible regulation World Trade Organization (WTO) is used to consolidate a global open market. In Bounceback, the recovery is brisk 4. Bounceback—open trade and regulation similar and the world regains its pre-2008 economic shape, but to pre-2008 levels with heavier regulation in the financial sector. the road to 2020: scenarios For a World in crisis 3 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. Table 1. Outcomes of Four Scenarios, 2011–20 Table 2. Growth Scenarios Average annual GDP growth (%) Type of Table Stuck in ofDirigiste 1. Outcomes Four Scenarios, 2011–20 Capitalist Table 2. Growth Scenarios the Stuck Dirigiste outcome Type of Rut in Capitalism Capitalist Blocs Bounceback Average annual Dirigiste Stuck in GDP growth (%) Capitalism the Rut Stuck in Dirigiste Capitalist Blocs Bounceback GDP growth outcome the Rut Medium Low Capitalism Blocs Bounceback Medium High the Rut Capitalism Capitalist Blocs Bounceback GDP growth Low Medium Medium High US, 2009 US, 2009 -5 -5 -3-3 -3 -3 -2 -2 Growth GrowthMedium Medium Low Low Low Low High High US, 2010 -3 -1 0 3 volatility volatility Trade growth Low US, 2010 -3 -1 0 3 High Medium High World, 1.3 2.6 2.6 4.1 Trade growthShape Low L-shaped High for of L-shaped U-shaped Medium V-shaped High World, 2011–201.3 2.6 2.6 4.1 US, 2011–20 0.5 1 1.5 3 slowdown developed countries; 2011–20 Shape of U-shaped for for L-shaped L-shaped most emerging economies U-shaped V-shaped EU, 2011–20 0 0.5 1 2 slowdown developed countries; US, 2011–20 Japan, 0.5 0 10.5 1 1.5 1.5 3 2011–20 U-shaped for most EU, 2011–20 Latin America, 0 1 0.5 2.5 2 (AFTA, 4; 1 5 2 emerging economies 2011–20 Mercosur, 1) Japan, 0 Eastern Europe, 2 0.5 3.5 3.5 1 5 1.5 Across all scenarios, Africa has one of the highest 2011–20 2011–20 growth rates of any region or large economy (table 2). Latin America, Middle East,1 2011–20 2 2.5 3 4 2 (AFTA, 4; 5 5 Japan, closely followed by Western Europe, has the low- 2011–20 Asia, 2011–20 2.5 5 Mercosur, 1) 4 6 Africa, 4.5 7.5 7 8 est. Eastern Europe does better than Western Europe, Eastern Europe, 2011–20 2 3.5 3.5 5 but does not achieve the 6% average growth of the last 2011–20 China, 4 7 6 8.5 2011–20 decade. This is because credit is less readily available, Middle East, India, 2 2 35 3.5 4 6 5 and growth comes primarily from economic activities 2011–20 2011–20 moving east. China’s growth is faster than that of any Asia, 2011–20 Note: AFTA = American Free Trade5Agreement. 2.5 4 6 other large economy. Africa, 4.5 7.5 7 8 2011–20 The scenarios are meant to be descriptive and not China, 4 7 6 8.5 suggestive of which 2020 future is most likely. However, 2011–20 they can be used to gauge perceptions of where the India, 2 5 3.5 6 world is going and to formulate strategies based on 2011–20 which scenario emerges. Note: AFTA = American Free Trade Agreement. 4 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. 1. Stuck in the Rut SCENARIO I n January 2009, the US economy enters a period of the Dow and Nikkei reaching 6,000, the FTSE 3,400, by hope, driven by the post-inauguration glow. The sec- July 2009. ond fiscal stimulus package ($800 billion) is approved in February 2009. Funding for the International Monetary A Run to Cash Fund (IMF) triples. In October 2009, a large US life insurer fails to pay claims and goes bankrupt. Baby boomers run to cash and there However, Eastern Europe is reeling. Several Eastern is a big fall in stock markets. The Dow reaches 4,000. European economies are in a freefall. The Latvian Banks are in deeper trouble than expected, with bad government resigns in February. The IMF package for assets totaling $2.5 trillion (even after the various Ukraine is close to collapse. Romania gets an IMF write-downs in 2008 and early 2009). package in March, and the ratings of nearly all Eastern European economies fall another notch or two. Confidence falls to bottom levels, and by early 2010 unemployment in the US rises to 12%. Real GDP falls By June, people in the United States start thinking that 5% in 2009 and 3% in 2010. Various rescue packages get “it’s not going to work� (too little, too late in dealing with designed. But policy making is behind the curve—every problems in the real economy), and the political honey- successive rescue package is less effective than the moon ends abruptly. Aggregate demand starts falling previous one. “Buy Domestic� signs appear in every again and more high-profile businesses fail (Starbucks country, with large demonstrations against imports in and GM close down). Equity markets continue sliding, India, France, and Greece. 5 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. Developed countries reduce aid flows to Sub-Saharan unstable. The Gulf Cooperation Council (GCC) countries Africa. Some conflicts persist, such as the situation suffer from low oil prices, and even Saudi Arabia feels the in the Horn of Africa and the Darfur and north-south need for a fiscal adjustment after three years of oil prices conflicts in Sudan. around $40–50 a barrel. Applications to business schools plummet; law school China’s aging population is more worried about applications are on the rise. The US Congress mandates inadequate social safety nets, which pushes up its sav- “modesty� courses in the business school curriculum; ings rate even higher. The country experiences falling “Modern Marxism� is the most popular class at INSEAD consumption, particularly of imported products. This and the London Business School. Public policy schools triggers a battery of protectionist measures around the see their admissions triple. world. In protest, China leaves the WTO in May 2011 and Brazil and India quickly follow. There is a revival of the Meanwhile, Europe suffers from a dramatic decline in Chiang Mai Initiative, which calls for deep integration demand from the US and unemployment reaches 15% between the economies of the Association of Southeast (over 20% in Spain). Lengthening unemployment lines Asian Nations (ASEAN) and China, Japan, and the across Europe lead to sporadic rioting in Toulouse, Republic of Korea. The proposal is approved. Manchester, and Hamburg during the summer of 2010, while violence against ethnic minorities increases. Latin America and Asia suffer from continual decline Wildcat strikes against immigrant labor spread from in commodity prices and lower demand for manufactured the United Kingdom across continental Europe. The goods. Latin America, the Philippines, and many coun- European Union becomes less open to free movements of tries in the North Africa region are hit by lower remittanc- labor and significantly toughens immigration policies. es from the US and the EU. Many migrant workers return, putting extra burden on local labor markets. The Bailouts Fail Several prominent multinationals shed subsidiaries The IMF programs in Ukraine and Romania fail. This abroad in return for tax concessions in their domes- puts higher pressure on Austrian, Italian, and German tic market. The pattern is set by Ford, which sells its banks, with several—most notably Raiffeisen Bank and European subsidiaries to the Tata Group. Carrefour sells UniCredit—walking away from their Eastern European its subsidiaries around the world to concentrate on the subsidiaries. Eastern European and CIS countries feel expanding EU market. a severe hard landing given the sudden stop in capital inflows financing their large current account deficits. The McKinsey Global Institute publishes a report on “the end of globalization as we know it.� New York Times In this scenario, a second IMF package for Ukraine fails columnist Tom Friedman publishes a new book titled The to stop output from falling, and in August 2010 a new, World Is Round After All. populist government is elected. After a second Turkish package in September 2010, the World Bank runs out of Financial institutions remain in bad shape, with a large cash to help troubled economies. For the next several amount of bad assets still on their balance sheets, and years, calls to replenish its financing remain unheeded. unable to resume lending broadly. Real estate prices have continued falling after their peak in 2007, reaching 45% of In February 2011, Indonesia goes bust. This triggers mid-2007 levels by December 2011. a chain of sovereign bankruptcies, including midsize emerging economies like South Africa and Argentina. Corporate scandals arise in nearly every country as “capitalist greed� is blamed for the falling economy. North African countries, together with Jordan and In several high-profile cases, former CEOs receive prison Lebanon, suffer from lower remittances and trade given sentences. China imprisons five CEOs for fraud. the recession in the EU. Even if they benefit from lower oil prices, they have tremendous trouble dealing with a In January 2012, the US and the UK are downgraded to growing population of young and unemployed. Political AA, Italy and Greece to BBB, because of the mounting demands increase and most of the regimes become contingent liabilities resulting from the banking sector 6 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. support. The US has consistently run a 10% budget deficit Heavy metal music makes a comeback. AC/DC’s (once Freddie Mac and Fannie Mae are consolidated in), album Dirty Deeds Done Dirt Cheap goes platinum in which looks increasingly unsustainable. its reissue. Far-right groups launch attacks against migrants across In 2018, the bicentennial of Marx’s birth is celebrated Western Europe and Slovakia. In Bulgaria, the far-right around the world. nationalists sweep the February 2012 elections. In 2019, for the first year ever, China records a fall in The maker of Bombay Sapphire gin becomes the the working-age population. The demographic pyramid world’s largest publicly listed company in terms of means that China will have an OECD-type population with market capitalization. a developing country income level. In this scenario, President Obama does not run for In 2020, the US experiences a severe financial crisis. The reelection in 2012, as his approval ratings have fallen to outstanding gross public debt has reached 220% of GDP, single digits. For the first time in US history, an indepen- a level previously reached only in Lebanon. Standard & dent candidate wins the presidential election. Poor’s rates the US “single A.� Because China no longer holds as much dollar debt, the currency collapses. Nouriel Roubini is awarded the 2013 Nobel Prize in Economics. The World Economic Forum suspends its This is a world where “nothing works.� Populism and fear annual meeting because of a lack of sponsors. And the abound. Peace is fragile, moods volatile. The light at the Forbes 400 list of the richest people in the world is edited end of the tunnel remains dim. down to the Forbes 40 for the first time in history. In 2011–20, emerging and developing economies have managed to grow at around 2.5% a year, while growth in developed countries has reached only 0.5%. Africa grows the fastest, at 4.5%, followed by China at 4%. Asia grows at a respectable 2.5%. The EU and Japan record no growth (table 3). Table 3. Growth in the Stuck in the Rut Scenario Average annual GDP growth (%) Table 3. Growth in the Stuck in the Rut Scenario US, 2009 -5 Average annual US, 2010 GDP growth (%) -3 US, 2009 -5 World, 2011–20 1.3 US, 2010 -3 US, 2011–20 World, 2011–20 1.3 0.5 EU, 2011–20 US, 2011–20 0.5 0 EU, 2011–20 0 Japan, 2011–20 2011–20 Japan, 0 0 2011–20 Latin America,Latin America, 2011–20 1 1 Eastern Europe, 2011–20 Eastern Europe, 2011–20 2 2 Middle East, 2011–20 2 Middle East, 2011–20 Asia, 2011–20 2.5 2 Asia, 2011–20 2011–20 Africa, 4.5 2.5 China, 2011–20 4 Africa, 2011–20 4.5 India, 2011–20 2 China, 2011–20 4 India, 2011–20 2 7 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. 2. Dirigiste Capitalism SCENARIO S timulus packages in OECD countries converge on private. Countries that were on the way to private a set of fiscal expansion and tax rebate policies, financial markets slow or halt reforms. protection of weak industries (for example, the car Many central banks in developing countries lose sector), directed lending, and nationalization of financial independence after the failure of regulators to deal institutions. with the crisis. The recession is deep in the liberal market economies: in Popular outrage at excessive compensation in financial the US, GDP falls 3% in 2009 and 1% in 2010 and unem- institutions leads to ad hoc, detailed interference in sala- ployment reaches 9.5%, while in the UK, GDP shrinks 4% ries for CEOs and traders in several countries (including in 2009 and 1.2% in 2010. Also, the governments in the the US, the UK, France, and Germany). US and the UK have conducted procyclical fiscal and monetary policy during the downturn, and these stimulus packages lead to higher interest rates and The End of Self-Regulation subdued growth for several years (L-shaped recovery). Disenchantment with the self-regulatory capabilities of financial markets is widespread. The prevalent view In the process of supporting the financial sector during emerges that market-based financial systems exhibit a the downturn, governments become owners of large tendency toward more violent booms and busts. parts of the sector in systems where it was mostly 8 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. In the recovery that starts in mid-2010, output growth A Void in Global Leadership precedes credit growth, as happened after all major The IMF and the World Bank have a limited role. The “sudden drops,� including the Great Depression. This traditional donors, the Europeans, have fiscal issues. gives credence to those who argue that a sophisticated There is no clear global leadership. Various talking clubs financial sector is not essential. Various forms of gov- still exist. China develops more Asian approaches (mon- ernment intervention in the financial sector are deemed etary, Chiang Mai–based; political, ASEAN Plus Three). acceptable in most countries. Development aid is dominated by the Asian Development In 2011, China continues to stimulate consumption Bank following a fourfold capital increase in through a mix of government spending and gradual January 2012. appreciation of the currency. Increases in private Russia becomes more interlinked with China, and consumption are also under way. less with Europe. Eight new gas pipelines are built to Emerging markets remain interested in open trade. China starting in 2012. This allows Russia to play the They are, after all, net exporters to the US. As emerging European Union and China against each other. Africa and markets stimulate domestic consumption, net capital Latin America depend again on resource exports to China flows to the US slow. The US savings rate turns up, with and India. consumers saving and the government trying to reduce Joseph Stiglitz gets a second Nobel Prize in Economics in debt. The US seeks exports to other countries as an 2013, for his work on market failures. engine of growth. In the end, driven by the interests of exporting countries Three approaches to reform of financial sector such as China, the world’s open trading regime survives regulation are tried in various countries. The US tries with some setbacks, while global saving-investment im- improvement of market infrastructure with some attempt balances adjust by 2015. at anticyclical measures, requiring banks to increase capital ratios during good times to “save for a rainy day.� Reprivatization of banks proceeds slowly in Europe. Even France, Canada, and Spain go a step further and try full- the US government still has major stakes in banks by fledged macro-prudential regulation, adjusting capital 2015. And many economies practice some form of “pro- requirements as necessary to moderate credit growth tectionism� through the financial sector (preferential sup- and leverage. China and India continue to reform some port to domestic institutions, lending targets for domestic market features, try forms of macro-prudential regula- borrowers, limits on lending abroad). tion, but maintain outright limits and prohibitions on vari- ous activities, including capital controls. At the Grammies in 2016, REM makes a huge comeback with its song “It’s the end of the world as we know it (and Developing economies follow the China-India model, I feel frantic).� The Ayn Rand fan club holds a memorial where financial markets are allowed in a framework of service, and the only person to show up is former Federal government controls, with somewhat arbitrary applica- Reserve Chairman Alan Greenspan. tion. State-owned development banks become the largest financial institutions in most emerging economies. These Innovation at the frontier is hurt by difficulties in give loans to specific industries and projects—marking restarting venture capital and capital markets more the rise of industrial policy. New state-owned agricultural broadly. In the past, the US economy has traditionally sup- banks pop up everywhere. ported new firm entry on a large scale. New firms destroyed value on average, but some entrepreneurs Efficiency in capital allocation falls significantly as were wildly successful and started new industries or lending becomes politically driven, and this is combined products. This is now gone. with increases in unemployment and in the size of the informal economy. Migration and remittances fall and The general antimarket climate has promoted more regu- business start-ups decline as a result of increases lation of innovation, for example, in biotechnology. The EU in regulation. suffers most from this development, with a “lost decade� 9 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. in the 2010s. The less cautious attitude in China and their achievements. The result is volatile low growth in Russia leads to a relative shift of innovation to emerging the US. markets. By 2019, 10 years after “the year of collapse,� China The EU grows by an average 0.5% a year in 2011–20, and and India are back to growth rates of 10% and 8%. the US by 1%, while China becomes the driver of world They can catch up by importing and adapting innovations growth by averaging 7% a year (table 4). India reverts to a (in technology and management) already made else- pre-1980s controlled economy, with a growth rate of 5% where. One consequence of the “death of distance� and showing that a democracy that tolerates financial repres- the massive changes in information systems in the world sion can also work. Other countries with space to catch is that countries can learn more, and faster, at moderate up do it at reasonable 4% rates. Africa grows the fastest, cost. As long as trade is broadly functioning, develop- at 7.5%, as emerging markets need its natural resources. ing countries can import critical components and make Latin America manages 2.5% growth. Eastern Europe major productivity leaps. grows at 3.5%. By 2020, countries learn that financial controls can go Table 4. Growth in the Dirigiste Capitalism Scenario hand in hand with promoting competition in product markets and controlled expansion of financial systems. Average annual The key to firm growth is in any case finance from GDP growth (%) retained earnings—not finance external to the firm. Table 4. Growth in the Dirigiste Capitalism Scenario US, 2009 -3 The Dirigiste Capitalism scenario features competitive Average annual US, 2010 GDP growth (%) -1 product markets, controlled financial system US, 2009 -3 development, and openness to trade combined with World, 2011–20 2.6 US, 2010 -1 US, 2011–202011–20 World, 2.6 1 severe restrictions on financial flows. US, 2011–20 1 EU, 2011–20 0.5 In 2020, China’s GDP (at purchasing power parity) EU, 2011–20 0.5 Japan, 2011–20 Japan, 2011–20 0.5 0.5 equals that of the US. At growth rates of 7% or higher, Latin America, 2011–20 Latin America, 2011–20 2.5 2.5 Chinese GDP more than doubled in the preceding decade. Eastern Europe, 2011–20 3.5 Exchange rates have adjusted, and the dollar is no longer Eastern Europe, 2011–20 Middle East, 2011–20 3 3.5 the world’s reserve currency. Central banks increasingly Asia, 2011–20 Middle East, 2011–20 5 3 Africa, 2011–20 7.5 buy the renminbi. Globally, the US and China are the clear Asia, 2011–20 5 China, 2011–20 7 rivals. G2 meetings now drive the global agenda. China Africa, 2011–20 India, 2011–20 5 7.5 negotiates the reintegration of Taiwan (China). China, 2011–20 7 This is a world where the economic development model India, 2011–20 5 is clear: follow the path of China or India. Optimism reigns in emerging markets. Darker moods persist in rich Climate change gets tackled through nuclear energy. countries. The global power shift is visible. Attempts to make macro-prudential regulation work end up with mixed success. The US experiences another crash in 2019 as the unwinding of global fiscal imbalances starts with Asia dumping US treasuries. The macro-prudential regulators manage to limit the growth of systemic financial risk, but run into practical difficulties and political pressures, which undo some of 10 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. 3. Capitalist Blocs SCENARIO D uring the second half of 2009, extensive govern- ment support stabilizes the banking systems of G7 economies. Deleveraging continues, under the watchful eye of bank boards heavily influenced by the wishes of governments that are now majority The Rise of Protectionism Government support packages include a range of trade protection and subsidy measures that end up before the WTO. These include consumer subsidies in the US to buy more energy-efficient cars and appliances, shareholders or outright owners. In the United States, which apply only to US-manufactured products, and France, Germany, Japan, and the United Kingdom, banks domestic procurement rules for infrastructure projects are directed to give priority to domestic lending over such as new railcars in France. cross-border lending, and to specific industries. In this scenario, successive G20 summits achieve limited Immigration enforcement is stepped up in the US, progress. Despite commitments to global coordination, including through high-visibility mass deportations from governments remain afraid of committing taxpayers’ California to Mexico. money to support financial institutions and consumption in other countries. Government-sponsored housing associations grow rapidly in the US, buying up vacant properties to rent Investor appetite to hold US treasuries wanes as the as homeownership declines and renting increases in long-term fiscal deficit weighs heavily on market senti- popularity. ment. As confidence in domestic assets recovers outside 11 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. the US during 2010, US long-term interest rates begin a The EU succeeds in sanctioning members that attempt to steady march upward despite continued quantitative eas- introduce discriminatory subsidy measures, helped by the ing that keeps short-term rates down. implicit threat of withdrawal of European Central Bank support for assets of domestic banking systems, but the Adjustments to mortgage contracts shield US borrowers number of trade disputes before the WTO skyrockets. from the impact of higher interest rates, but US busi- nesses face higher long-term borrowing costs, partly The arbitration system breaks down. Throughout 2011, offset by more generous tax concessions to encourage in- the EU and the new American Free Trade Agreement vestment. The US dollar declines sharply in August 2010 (AFTA)—made up of the North American Free Trade as a result of a reversal in the capital account—caused by Agreement (NAFTA), the Central American Free Trade lower demand for US treasuries and outflows of hedge Agreement (CAFTA), and the Andean Pact—are engaged fund and pension fund capital seeking higher returns in in extensive tit-for-tat bilateral trade sanctions.1 The WTO emerging markets. president resigns in protest. There is no agreement on a replacement for over a year. Emerging market equity prices stage a sharp recovery in October 2010 as China, India, Russia, and the Gulf states In February 2011, a new, pro-Russian government is redirect foreign exchange reserves and sovereign wealth elected in Ukraine and signs a EuroAsia Union agreement funds to support domestic equities. Cross-border capital with Russia. Armenia, Belarus and the Kyrgyz Republic flows remain low, and foreign direct investment (FDI) soon join. Russia signs new military and economic flows stay close to home—90% of new FDI is within the cooperation agreements with Kazakhstan, Tajikistan, EU and accession countries like Croatia and the former and Uzbekistan. Yugoslav Republic of Macedonia. Commodity prices recover slowly from April 2011 on, providing some relief to Russia as well as to Africa, A Breaking Point in the Balkans the Middle East, and Latin America. Renewed Chinese But the fiscal costs of supporting domestic banking investment in African extractive industries helps African systems weigh most heavily on smaller EU countries. growth, which remains sluggish in other sectors, at The breaking point comes in December 2010, when the 2% a year, insufficient to make headway in reducing pov- parliament of Greece fails to ratify the second EU rescue erty. In the Gulf states, the cranes remain still, and Dubai package, worth $60 billion. This package comes with skyscrapers half built. Political tensions in the Middle stringent conditions on financial sector and public sector East continue to impede regional economic cooperation. reforms, which are deemed political suicide by members The economy is stagnant. of parliament. At a major summit to launch the Asian Monetary Fund Worries quickly spread across Europe. Several Greek in June 2011, ASEAN members agree on a common banks with large operations across Eastern Europe walk external tariff and measures to increase intraregional away from their foreign subsidiaries, causing bank runs trade. The following year, ASEAN signs a free trade in Bulgaria and the Balkans. As a result, Raiffeisen Bank agreement with the African Union as China continues comes close to bankruptcy and the Austrian government to invest heavily in Africa and increases its influence on is able to rescue only its domestic operations. domestic politics. Other European banks also pull back from lending in Oliver Hart wins the Nobel Prize in Economics in 2013, for Eastern Europe. Governments in Eastern Europe are his work on incomplete contracts and optimal bankruptcy unable to prevent a flight of deposits to EU banks, leading regimes. An archaeologist finds a handwritten book, to a collapse of domestic currencies. The EU agrees to accelerated membership in the EU and the European Monetary Union for Albania, Bosnia, Croatia, FYR 1 This formation of AFTA is triggered by the increased fear Macedonia, Montenegro, and Serbia, and the euro is of drug trafficking from Mexico, which compels US officials made legal tender. to provide support to the Mexican government and increase economic ties. 12 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. believed to have been penned 230 years earlier by Adam Table 5. Growth in the Capitalist Blocs Scenario Smith, titled The Weathering of Nations. Average Table 5. Growth in the Capitalist Blocs Scenario annual The regional fragmentation has not allowed time for GDP growth (%) Average annual US, 2009 GDP growth (%) -3 the imposition of dirigiste measures in the real econo- US, 2009 -3 mies of most regions. Instead, AFTA remains a largely US, 2010 US, 2010 0 0 free market economy, with the remaining regional group- World, 2011–20 2011–20 World, 2.6 2.6 ings varying in terms of state control over the economy. US, 2011–20 US, 2011–20 1.5 1.5 Regional currencies are increasingly used as reserve EU, 2011–20 1 EU, 2011–20 Japan, 2011–20 1 1 money, with the dollar, euro, ruble, and renminbi becoming the four major currencies. Japan, 2011–20 America, 2011–20 Latin 1 4 (AFTA), 1 (Mercosur) Eastern Europe, 2011–20 3.5 2011–20 Latin America,Middle East, 2011–20 4 (AFTA), 1 (Mercosur) 4 Financial markets are repressed, with growing trade Eastern Europe, 2011–20 Asia, 2011–20 4 3.5 and capital restrictions. The World Bank and the IMF Africa, 2011–20 7 Middle East, 2011–20 4 are marginalized. Instead, regional development banks China, 2011–20 6 become powerful, and regional monetary funds, Asia, 2011–20India, 2011–20 3.5 4 fashioned after the Asian Monetary Fund, are set up. Africa, 2011–20 7 China, 2011–20 6 In banking, regional franchises develop. These support India, 2011–20 3.5 small international teams that syndicate select issues. Latin America remains splintered, lacking regional In 2015, India and China sign a historic peace agree- leadership and a willingness to cooperate on economic ment, leading to the construction of a trans-Himalayan policy. Growth recovers along with commodity prices, but railway linking the two countries directly. Bilateral trade remains sluggish at 2% a year in 2011–20. Latin America increases rapidly as Indian programmers start taking grows at two speeds: countries inside AFTA grow at a Chinese language classes, Chinese motorists flock to buy respectable 4% a year thanks to increased trade with the the Tata Nano (now assembled in western China rather US, while countries on the outside grow more slowly at than India), and Indian consumers load up on Chinese flat 1% a year. screen TVs. The global economy is back on a steady growth path of Growth in the Asian region recovers slowly, helped by around 2.5% a year, with distinct differences in growth continued growth in China and India of 6% and 3.5% a among regional cooperation blocs: ASEAN countries grow at a healthy 4%, Africa at 7%, Latin America at 2%, year (table 5). Regional growth averages 4% a year during North America and Western Europe at 1–1.5%, Eastern 2011–20. China’s growth is held back by bad asset prob- Europe at 3.5%. Within regions, countries that have lems in its financial sector stemming from the indiscrimi- gained access to new markets through the expansion of nate lending of 2008 and 2009. Africa grows the fastest, regional trade blocs do relatively better than others. at 7%. Eastern Europe grows at 3.5%, on the back of industries (chemicals, plastics, glass, car parts) moving In 2018, an innovation in the biotechnology sector east from Belgium, Germany, the Netherlands, and Italy. creates a boom in Russia. Chinese and American firms quickly buy patents to the new technology and spur high growth in their countries too. After a decade of fragmented trade and investment, free markets prevail globally. Countries remember the benefits of multilateral trade and investment. The WTO is revived and the Bucharest Trade Round is launched in 2020. This is a world where it has become clear that “there is no alternative� to market-friendly development. Hope returns. US leadership continues, and the need for multilateralism has been reaffirmed. 13 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. 4. Bounceback SCENARIO T he increase in US retail sales in January and governments ends up being decisive in the recovery. February 2009 turns out to be a sign of good Citibank posts profits in the first quarter of 2010. The things to come. The low prices have spurred transformation of Goldman Sachs, Morgan Stanley, and consumer demand for durable goods and cars. AIG into bank holding companies allows them to gather deposits. These deposits become 25% of the portfolio by Markets hit bottom in July 2009 and start to recover May 2010. Bank lending resumes. in August. The recovery is driven by the anticipated success of the third stimulus package in the United Bank regulators pursue with new zeal the revision of States, announced in October and worth $1.1 trillion, liquidity risk management and the quality of contingency and the successful coordinated fiscal stimulus launched plans. by the G20. The insurance industry stages a fast revival, thanks to the The stimulus to aggregate demand helps the production emergence of acquisition opportunities and high demand cycle and leads to the recovery of commodity prices for retirement products. starting in October 2009. The Return to Stability and Prosperity Asset prices first stabilize and then recover. The By mid-2010, governments run campaigns on the return money waiting on the sidelines starts coming back. to stability and prosperity, using the growth trajectory Equity recapitalization of the banking sector by 14 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. before the crisis as proof that the system needs only International Cooperation Prevails tinkering and not a major overhaul (figure 1). Ample The earlier trends toward protectionism, nationalism, and production capacity means trade can ramp up quickly nationalization subside. The Doha Trade Agreement is without triggering wage or price inflation. signed in November 2012. In 2013, the World Bank’s lending falls for the first Figure 1. World GDP Per Capita (PPP), 1980–2006 time in five years, from $35 billion a year to under $15 billion. The main lending focus of the World Bank 9,000 Constant 2000 international dollars becomes climate change. Global warming is being tackled, and international cooperation increases in 8,000 many areas, as it has proved it works in dealing with the financial crisis. 7,000 The IMF is charged with conducting surveillance reviews 6,000 of all countries. The World Bank is tasked with providing capacity-building programs for effective financial regula- tion. The first such program is run in Minneapolis, home 5,000 1980 1985 1990 1995 2000 2005 of the largest US bank holding companies. Source: Authors’ calculations based on World Bank, World Development Indicators database. President Obama is reelected in a landslide in 2012. Prime Minister Gordon Brown is reelected as well, after By 2012, the bailouts end up turning into big profits for selling RBS at a large profit and producing a budget taxpayers, allowing policy makers to resume normal surplus by 2012. monetary and fiscal policies. Housing prices rise 6% on Larry Summers gets the 2013 Nobel Prize in the year. There are no more fears of lack of regulation Economics. Nassim Taleb, author of the best seller in financial markets, and there is lower leverage in the The Black Swan, publishes a new book, I Shot the new equilibrium. Financial globalization as measured by Black Swan. cross-border capital flows is half the 2007 level, at 20% of global GDP. Venezuela earns the top spot in the annual Doing Business reformer rankings in 2014, as volatile oil prices Investments in infrastructure come onstream, adding to have led to the return of a reformist government. the upturn but also raising inflationary pressures. At the Grammies in 2016, the Chinese solo artist Mei Wi The unwinding of consumer and credit card debt in the wins the most awards. US is on pace. The personal savings rate jumps from 0.6% in 2007 to 6.5% in 2010 and 8% in 2012. The US economy grows 3% a year on average in 2011–20, while the EU and Japan grow at 1.5–2% Population growth in the US triggers sustained recovery (table 6). China resumes its fast trend and grows at an in the housing market. Although subprime mortgages are average 8.5% a year in the same period, while India not available, low interest rates and lowered house prices grows at around 6%. Africa and Latin America benefit make housing affordable. from higher commodity prices, growing at 8% and 5%. Peace has also given Africa opportunity to catch up. Eastern Europe benefits from the shift of industrial production eastward, growing at 5%. 15 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections. Table 6. Growth in the Bounceback Scenario By 2020, the new financial system that develops looks similar to the pre-2007 one, but with a dominating equity Table 6. Growth in the Bounceback Scenario Average annual market and smaller banks. Reprivatization has gone well GDP growth (%) Average annual GDP growth (%) in all G7 economies, and governments now own less than US, 2009 -2 US, 2009 -2 10% of bank assets. US, 2010 US, 2010 3 3 World, 2011–20 2011–20 World, 4.1 4.1 Financial innovation is curbed, but previously US, 2011–20 US, 2011–20 3 3 boutique investment banks like Lazard soon create new EU, 2011–20 2 products and start growing fast. The products replenish EU, 2011–20 2011–20 Japan, 1.5 2 private pension funds in developed economies and move Japan, 2011–20America, 2011–20 Latin 5 1.5 money to emerging markets, where growth is now robust. Eastern Europe, 2011–20 5 Latin America, 2011–20 5 Middle East, 2011–20 5 Eastern Europe, 2011–20 5 This is a world where the crisis of 2009 is almost Asia, 2011–20 6 forgotten. Belief in the invincible market model is high. Middle East, Africa, 2011–20 2011–20 8 5 China, 2011–20 8.5 US leadership continues, amid worries about the future Asia, 2011–20 2011–20 India, 6 6 of a multipolar global system. Africa, 2011–20 8 China, 2011–20 8.5 India, 2011–20 6 16 scenarios last updated on april 10, 2009. they are not World BanK Forecasts or proJections.