Nout Wellink: No globalisation without innovation
Speech by Dr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel Committee
on Banking Supervision, at the 2007 Money and Banking Conference "Monetary Policy Under
Uncertainty", hosted by the Central Bank of Argentina, Buenos Aires, 4 June 2007.
* * *
Introduction
I grew up in a small Dutch village. Although it was not in a polder, to me the world seemed flat. It took
several years before I saw mountains for the first time and realised that the world is not flat. The
generation of my grandchildren misses this kind of experience. Flying long-distance at early age is no
longer exceptional in the more prosperous parts of the world. The world has changed dramatically in
the course of decades. Information technology has brought us many new opportunities, in particular
mobility of people, goods and ideas. I'll discuss technological progress, and what it means for the
macro economy in general, and for monetary policy in particular.
Globalisation is driven by technological change
There are at least four manifestations of technological change that have dramatically reshaped the
world over the past decades:
•
What we see in major cities are people from all over the world. What lies behind this is cheap
and fast air traffic. Competition is a driving force. So is technology, which makes air
transportation more efficient, and management skills that allow for splitting up the market in
high yielding business-class tickets and low cost fares.
•
What we see are cheap imports from China everywhere in the Western world. What lies
behind this are low transportation costs thanks to the cargo container. The cargo container
can move non-fragile goods for about 1% of retail value to anywhere in the world. In the
precontainer era, shipping costs used to be between 10 and 20% of retail value.1 Apart from low
transportation costs, additional factors are needed to explain the surge in Asian products in
Western markets. In particular the catch-up of Asian economies is creating new trading
opportunities.
•
What we see is offshoring of labour-intensive production to low-wage countries. What lies
behind this is that new technologies allow the production process to be unbundled.
Production sites are located far from target markets, both in manufacturing and in the service
industry. The share of offshored inputs in GDP can reach up to12%, as in Canada and the
Netherlands.2
•
What we see is low-skilled labour in the West feeling a cold wind of competition from cheap
labour from Asia and Central and Eastern Europe . At the same time, wages for high-skilled
labour are on the increase. What lies behind this is skill-biased technology. Automation
lowers demand for low-skilled workers, since computers offer a substitute. But computers
can also amplify natural advantages of high-skilled labour, as complements to labour. A
talented professional can serve a much larger customer base due to new ICT opportunities.
Financial engineering and management skills also tend to favour high-skilled labour.
These are just examples, illustrating that there would be no global economy without new technology.
Technology has always been the driving force for change. This was the case when the invention of the
printing press in the 15th century boosted the diffusion of ideas; and it is still the case in today's world,
where ideas are spreading much faster than twenty years ago thanks to the internet.
Macro-economic consequences
Technological change has brought the world prosperity. In recent years, output growth has been at
levels not seen since the early 70s. Not just Western economies are growing fast. China and India are
integrating in the world economy at full speed. China's average productivity growth over the last ten
years was close to 10%. Average productivity growth in emerging and developing countries has also
increased, to 5% last year.3 Despite a recent pick-up, productivity growth in Latin America is lagging
that in other emerging markets.
Although technology is a source of welfare, it can also have negative side-effects. For instance, the
unprecedented speed at which ideas are passed between people is a key achievement of the ICT
revolution. But it also allows bad ideas to travel fast, such as religious fundamentalism. I feel some
sympathy for those who fear rapid technological change. But whether we like it or not, we can't stop
technological progress. Like toothpaste, once it's out of the tube, it is hard to get it back in again. The
challenge is to make sure that new technologies bring change for the better.
There are winners and losers from technological change, at least in relative terms. The developing
world at large is benefiting from recent developments. However, some areas are losing out. On the
losing end are areas that lack connections to the container-handling network and the internet. This
applies to areas that lack crucial infrastructure, be it reliable electricity and roads, or the rule of law.
In the Western world, job security has diminished, not just for blue-collar workers. These days,
services in ICT and other high-tech sectors are offshored to low-income countries. But the number of
offshored jobs is still very modest compared to the total number of jobs lost and created. In the
Netherlands, roughly 9.000 jobs are offshored each year, whereas the annual number of job
destruction and creation is above 800.000.4 Since the ICT revolution is skill-biased, it favours
highover low-skilled labour. Fortunately, higher income inequality between high- and low-skilled workers
does not necessarily imply that low-skilled workers are worse off. The IMF has shown that recent
trends have increased the size of the pie. Cheaper inputs have lifted output and overall labour
compensation by about 6% in real terms in advanced economies over the last 25 years.5 And all
consumers benefit from lower prices.
To keep labour market effects in check, employability is a key policy issue. Flexible employees can
adapt to new circumstances that technology brings about. Governments can offer a helping hand by
improving education, and by providing a social security system that encourages people to move from
one job to another. In some countries, social security schemes may be so generous that they deter
efforts to seek new employment. But the slogan "the lower, the better" goes much too far. In Latin
America, for instance, social security schemes alleviate income inequality. If the benefits of economic
growth are widely shared, support for economic reform can be expected to be broader than otherwise.
Monetary policy
The challenge for monetary policy is to adapt to the new environment. Fortunately, central banks have
much more room for manoeuvre now than they had when Arthur Burns was appointed as Fed
Chairman by President Richard Nixon back in 1970 with the words: [quote] "I respect his
independence; however, I hope that independently he will conclude that my views are the ones that
should be followed" [unquote]. Also downward pressure on inflation by cheap imports from low-income
countries has made central bankers' life in the Western world a bit easier than in the past. Prices for
clothes and big ticket items such as cars and personal computers have declined. Computers became
a lot cheaper if one takes into account quality improvements. The overall downward pressure on
inflation has allowed for lower monetary policy interest rates, at least in the short term.
In the longer term, the real equilibrium interest rate might rise. This would be the case if the world
would have moved to a permanently higher trend rate of productivity growth. The jury is still out on
whether this is true. Other things equal, a higher real equilibrium interest rate implies that monetary
policy interest rates also have to move to a higher level, consistent with the new equilibrium.
So, a major issue is to determine the trend rate of productivity growth. From a monetary policy point of
view the question can be rephrased as: What is the level of growth at which the economy can operate
without generating higher inflation? It is always difficult to determine the speed limits of an economy,
but in times of change this is even more challenging. One development makes it particularly hard. That
is the move from an industrial to a post-industrial society. In the 1950s, 30% of the US labour force
was employed in manufacturing. Now the number is 10%. We have moved to a service oriented
society. In the service industry, capacity utilisation cannot be measured by counting idle capacity in
factories. Besides, productivity growth can only be estimated in an imprecise way. Usually, total factor
productivity is used as the key measure. It is determined as a residual: productivity growth is the
increase in value added that cannot be explained by the volume of inputs used. This measure is very
rough. All in all, potential output and its growth rate is more difficult to determine than it was in an
industrial economy.
Uncertainty about potential output translates into uncertainty about the output gap between potential
and actual output. It has always been tricky to base monetary policy on output gaps. Research by
Orphanides suggests that the Great Inflation was to a large extent due to mismeasurement of potential
output and the output gap.6 It appears virtually impossible to determine output gaps in real time. They
can only be measured in a reliable way ex post, with the benefit of hindsight. "Life can only be
understood backwards, but it must be lived forewards" as the Danish philosopher Kierkegaard said.
This is certainly true for monetary policy, with its medium term objectives. How to cope with this? I've
learnt a couple of things since I thought the world was flat. One is that the objectives of monetary
policy should be modest. Fine-tuning economic growth has always been a too ambitious goal in a
world with long and variable lags in monetary transmission. A clear focus on low and stable inflation
can safeguard central banks against the temptation of activism. Given current uncertainties, monetary
authorities must be particularly cautious in interpreting the output gap. They have to remain firm in
reaction to actual inflation and other relatively reliable indicators of inflation risks, such as excessive
wage growth.
As a side remark, I add that, in theory, capital account liberalisation and trade openness warrant a
sharper focus of monetary policy on price stability rather than output stabilisation.7 International capital
mobility, as well as broader access to financial markets, creates new opportunities for households to
smooth consumption over the years. Free international trade allows for specialisation in domestic
production. As a result, it might be possible to disentangle consumption and production to a higher
extent than in the past. In other words, households can cushion changes in production without
intervention by the central bank.
I would like to conclude with a warning. A focus on price stability is more complicated than it sounds.
Low and stable consumer price inflation is no reason for complacency. In spite of consumer price
stability, asset price inflation may signal underlying imbalances, such as an overoptimistic risk
assessment by financial market participants that keeps long-term interest rates at unwarranted low
levels. Monetary policymakers must be forward-looking, and assess possible divergences between
real and nominal factors in the area of monetary aggregates, credit and asset markets. How this
should be done in practice is a difficult question that deserves further elaboration. I won't answer it
now. Time is running out. Sometimes it is better to stop before one has finished.