1.3. the balance of payments ii
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GLOBAL FINANCE
Global competition for Global competition for attracting capital flowsattracting capital flows
September 2007 Michel Henry Bouchet
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I- What drives global capital flows?
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Globalization’s impact? MisconceptionMisconception: capital should flow from rich countries to
poor ones, which have less capital and offer higher returns! By borrowing abroad, LDCs should be able to boost investment and the growth rate.
FactsFacts: capital is flowing « uphill » and the US current account deficit is financed by emerging countries’ purchase of US Treasury securities
Facts: LDCs have limited capacity to absorb foreign capital, due to underdeveloped financial systems. Dynamic growth boosts saving relative to investment, hence a current account surplus (China!).
Facts: US bond yields are 2% lower than they otherwise would be, thanks to the purchase of US securities by China and other EMCs. If these countries loose their appetite for US assets, bond yields could jump and the dollar plunge!
Source: IMF/Prasad-Rajan, 2006
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US Current account deficit in US$ billion
-900
-800
-700
-600
-500
-400
-300
-200
-100
0
1992 1994 1996 1998 2000 2002 2004 2006
-7% PBI US Treasury, IMF
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Global competition in financial markets
DEFICIT
SURPLUSSURPLUS
?
-$800 billion= $2200 million/day
?
?
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Who finances whom?Current account balances of OECD and EMCs
(billions of US$)
-800
-600
-400
-200
0
200
400
600
800
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
OECD
EMCs
Source: FMI/2006
Asian crisis
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Why do EMCs show such large CA surpluses and rising reserves?
1982 debt crisis + 1994 Tequila crisis + 1997 Asia crisis + 1998 Russian crisis + 2001
Argentina crisis Strong IMF-monitored adjustment + economic
and trade liberalization Devaluation + Boost in investment ratio= trade
and current account surpluses Improvement in debt indicators!
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Successful economic adjustment:Improvement in EMCs’ solvency ratios (drop in Debt/X %)
0
20
40
60
80
100
120
140
160
180
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Ratio
Source: FMI/2007
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SPREAD EMBI+ (1998 -2006)
0
200
400
600
800
1000
1200
1400
Dic
98
Mar
99
Jun9
9
Sep
99
Dic
99
Mar
00
Jun0
0
Sep
00
Dic
00
Mar
01
Jun0
1
Sep
01
Dic
01
Mar
02
Jun0
2
Sep
02
Dic
02
Mar
03
Jun0
3
Sep
03
Dic
03
Mar
04
Jun0
4
Sep
04
Dic
04
Mar
05
Jun0
5
Sep
05
Dic
05
Mar
06
EMBI+ Global EMBI+ Latinoamérica EMBI+ Perú EMBI+ México EMBI+ Chile
México consigue el Grado de Inversión
Embi+ Mexico
Current account surpluses + Global liquidity:Sharp drop in the cost of borrowing of EMCs
BCRP, Banco Central de Chile
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II- Global competition in financial markets
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Globalization Index = « Top 20 »
1. Singapore 2. Ireland 3. Switzerland 4. USA 5. Netherland 6. Canada 7. Denmark 8. Sweden 9. Austria 12. UK 18. France 19. Malaysia 20. Slovenia
26. Spain 34. Chile 42. Mexico 47. Argentina 51. Colombia 53. Peru 54. China 55. Venezuela 57. Brazil 61. India
ATKearney
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The 30 most attractive EMCs for
FDI
1. India2. Russia3. Vietnam4. Ukraine5. China6. Chile7. Latvia8. Slovenia9. Croacia10. Turkey11. Tunisia12. Tailandia13. Korea14. Malaysia15. Macedonia16. UAE17. Arabia Saudita18. Slovakia19. México20. Egypt21. Bulgaria22. Rumania23. Hungary24. Taiwan25. Bosnia26. Lituania27. Brasil28. Morroco29. Colombia30. Kazajstan
Economic + political riskMarket Potential
AT Kearney GRDI 2006
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The most attractive EMCs in 2006
HIGHRisk
LOWRisk
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Identifying the next leaders?
The BRICs: « The path to 2040 » : Goldman Sachs:
Brazil, Russia, China & India’s GDP > G7 en US$
Challenge: How to forecast the « Top 10 » of 2040?
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The BRICs catching upcatching up with the G7
Goldman Sachs 2007
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Share in global GDP
0
5
10
15
20
25
30
35
1820 1870 1913 1950 1973 1998 2001 2004 2006
Chine
Inde
JaponChine= 15,4%Japon= 6,4%Inde= 6%
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The leaders of 2040?
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
Source: Goldman Sachs
GDP in billions of US$
The « BRICs »The « BRICs »
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III- The Asian challenge Strong Investment rate
High Savings rate Dynamic Productivity
Low Labour cost Current account surplus
Large Internacional reserves High liquidity and solvency indicators
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The dynamics of investment rate
15
20
25
30
35
40
45
50
1990 1995 2000 2001 2002 2003 2004 2005Perú Thailand Korea Malaysia Hungary Chile
I/GDP %
IMF, IIF
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National savings and Investment dynamics
Investment and saving rates in Thailand 1978-2005
20
25
30
35
40
I/PBI%
S/PBI%
IIF
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Share of EMCs Official Reserves in 2007
11%
36%
4%2%2%
45%
RussiaChinaIndiaBrazilMexicoOthers
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Asian crisis and Thailand’s recovery
FMI
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FDI and portfolio flows in Thailand
0
1000
2000
3000
4000
5000
6000
7000
8000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FDIPortfolio
US$ million
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CHINA Inc. : A Global supremacy strategy
Oil
Oil
US$US$
NTICFDI
MNCs
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« Made in China » and « Made by China » China IncChina Inc holds a two-fold comparative advantage to
attract foreign capital flows:
1. Labour intensive activities with very competitive labour costs: textile, shoes, garment, components…
2. High value added activites incorporating new technologies (electronics, software, NTIC…)
Key role of MNCs (majority from Asia: South Korea, Japan, Malaysia) : 60% of China’s exports stem from foreign companies and/or joint-ventures
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made inin China y made byby ChinaShare of capital origins in China’s exports
0
10
20
30
40
50
60
70
80
HIFI/Vidéo High Tech
ChinaJoint venturesEMNs
Source: Le Monde, 16/6/2006
%
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IV- Where do capital flows goIV- Where do capital flows go??
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WhoWho finances whom?Current account balances of OECD and EMCs
(billions of US$)
-800
-600
-400
-200
0
200
400
600
800
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
OECDEMCs
Source: FMI/2006
Asian crisis
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Net capital sources for emerging market countries
-100
0
100
200
300
400
500
600
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
privatepublic
IIF/IMF
US$ billion
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Net capital flow sources for Latin American countries (US$ billion)
IIF-2006
Net private flows
Net public flows
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Net private capital flows to EMCs
0
100
200
300
400
500
600
1990 1994 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
TotalAsiaLat America
Billion of US$
Source: IIF/IMF
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Net portfolio capital funds to EMCs
(US$ billion)
IIF-2006
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OECD (81%)
EMCs (19%)
ASIA (64%)
LATIN
AMERICA
(29%)GLOBAL ECONOMY
EMCs
LATIN AMERICA
MEXICO (32%)
CHILE (10%)
PERU (4%)
CHINA (80%)
ASIA
GLOBAL FDI FLOWSGLOBAL FDI FLOWS
Source: IIF, OECD
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FDI FLOWS(US$ billion)
-10 000
0
10 000
20 000
30 000
40 000
50 000
60 000
70 000
80 000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006f
Argentina Chile China,Hong Kong Korea Mexico Thailand Peru Vietnam
IIF/FMI
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Net FDI and portfolio capital flows to EMCs
0
50
100
150
200
250
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FDI
ASIA
Am Latina
US$ billion
Fuente: IMF/IIF
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Total FDI inflows in US$ trillion
Post-2003 bounceback has been driven byemerging markets. However, FDI flows to emerging markets will remain buoyant in 2006-10, averaging over US$400bn per year, but growth rates will be modest asprivatisation tails off and the global economy slows.
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Incestuous globalization?The key recipients of FDI
0
10
20
30
40
50
60China
France
Germany
USA
Netherlands
UK
Spain
Canada
Ireland
Belgium
Brazil
Italy
Australia
HK
Mexico
Sweden
Japan
In US$ billion
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FDI in China
0
10
20
30
40
50
60
70
80InflowsOutflows
US$ billion
OCDE
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V- How analyzing global risk and opportunities?
The role of Rating agenciesThe role of Rating agencies (after the Asian crisis, Enron, LTCM,
Arthur Andersen, Parmelat, and the US subprime market…)
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Risk Ratings
Advantages/ ProsAdvantages/ Pros Simple cross-country
comparison comparison across time shrinks a large number
of variables into one single grade
Reliable for smooth risk evolution
Shortcomings/Cons “reductionist” oversimplistic risk of self-fulfilling
prophecy little predictive value weighted average tends to
bury salient trends Gives “market consensus”
often made of herd instinct
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Moody’, Fitch, S&P’s, Coface
Objective: assessing willingness + capacity
to repay a debt at maturity
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Investment grade vs speculative investment
Moody's S & P
Investment grade
AaaAaA
Baa
AAAAAA
BBB
Speculative risk ("Junk Bonds")
BaB
CaaCaC
BBB
CCCCCC
Default D
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LT & ST Ratings of Moody’s
L.T. S.T.
Investment grade
Aaa; Aa; A
Baa, BaFrom Prime 1 to
Prime 3
Speculative investment
B; Caa; Ca; C Subprime
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Rating Moody’s
Countries Rating
Argentina B3
Perú Ba2
Chile Baa1
Brazil Ba3
México Baa1
Túnisia Baa2
Venezuela B2
Colombia Ba2
Russia Baa2 (stable)
2007
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BRASIL
PERU
COLOMBIA
MEXICO
CHILE
RATING MOODY´S (mid- 2007)
Investment grade
Fuente: Scotiabank/Moody’s
Baa1
Baa1
Ba2
Ba3
Ba3
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How does S&P build its Rating?
10 Parameters:
Political risk, Economic structures, Growth potential, fiscal flexibility, budget balance,
debt ratios, Inflation, external liquidity, public and private external debt (liquidity
and solvency)
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Rating of S&PL.T. S.T.
Investment grade
AAA; AA; A
BBB; BB;A1; A2; A3
Speculative investment
B; CCC; C; SD; D B; C; SD; D
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ARGENTINA
VENEZUELA
COLOMBIA
BRASIL
PERU
MEXICO
CHILE
Investment grade
B
BB-
BB
BB
BB+
BBB
A
Source: S&P
RATING S&P LT
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RATING FITCH
Source: Fitch IBCA
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OECD Country risk classification in 2007
1 2 3 4 5 6 7
Chile Israel Algeria
Morocco
Peru Albania Bolivia
Haiti
Hungary South Africa
Bulgaria Turkey Pakistan Cameroon
Niger
Nigeria
Trinidad & Tobago
Thailand Russia Vietnam Brazil Argentina
Kuwait Mexico Guatemala Gabon
RCI
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COFACE 140 countries Country rating definition:
Investment grade A1= steady economic and political situation A2= weak default probability A3= adverse circumstances may lead to worsening payment
record A4= patchy payment record could be worsened by adverse
econmic/politicval developments Speculative grade:
B= unsteady economic and poltical environment C= bad payment record D= high risk profile and very bad payment record
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Coface credit Rating (2007) Canada= A1 Australia= A1 USA= A1 Japan= A1 Korea= A2 Chile = A2
Thailand= A3 China= A3 India= A3 Poland= A3 Mexico= A4 Morocco= A4 Algeria= A4 Romania=A4
Egypt= B Brazil= B Russia= B Turkey= B Vietnam= B Congo= C Ukraine= C
Venezuela= C Argentina= D
Turkménistan= D Chad= D RCI= D
Nigeria= D
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Ratings09/2007
Countries Rating
Argentina C
Perú B
Bolivia D
Brazil A4
Chile A2
China A3
Russia B
Cuba D
North Korea D
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KOREA: Index of payment arrears 1993-2006(base 1995 = 100)
COFACE
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VI-Shortcomings of rating agencies?
Criticisms: * Power without accountability * Conformity bias * Sociocultural bias * Punishment of disobedient firms/countries that do not
request a rating * Procyclical bias, hence followjng the majority opinion
of market participants without any early warning signals nor predictability track record
Spill-over effect!
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Rating = poor early warning signals?
South Korea was rated as Italy and Sweden as recently as October of 1997! But has been downgraded abruptly to junk bond status during the crisis
« There were no early warnings about Korea from us or, to the best of our knowledge, from other market participants and our customers should
expect a better job from us » FICHT IBCA January 14, 1998
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After Asia: some lessons of the crisis “Any agency which rated the Republic of Korea
at the high investment grade rating of AA- (in the case of Fitch IBCA and S&Ps) or A1 (in the case of Moody’s) before the crisis, and which now rates Korea at a speculative grade B-, was clearly either wrong initially or subsequently. Clients are entitled to expect us to perform better in the future!”
Fitch IBCA January 13, 1998
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The Perceived Situation
Was the crisis anticipated by rating agencies?
June 1996 June 1997 June 1996 June 1997Indonesia BBB BBB Baa3 Baa3Korea AA- AA- A1 A1Malaysia A+ A+ A1 A1Philippines BB BB+ Ba2 Ba1Thailand A A A2 A2
Standard & Poor' s Moody' sCredit Ratings
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EUROMONEY Risk Ratingthe higher the ranking, the higher the risk
1996 1997 1998 1999 2000 2005
Korea 28 30 4242 44 29 28
Thailand 45 51 54 49 65 49
Philippines 55 57 55 53 78 75
Malaysia 33 35 5656 46 46 46
Indonesia 45 49 9191 98 107 81
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Macroeconomic success of the tigers… until 1996
Source: IMF/International Financial Statistics 1999
Changes in GDP
-2,0%
0,0%
2,0%
4,0%
6,0%
8,0%
10,0%
1992 1993 1994 1995 1996 1997
Korea IndonesiaMalaysia PhilippinesThailand
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Prudent macroeconomic management of the tigers: low inflation, low budget deficits
Fuente: IMF/ International Financial Statistics 1999
Changes in CPI
0,0%
2,0%
4,0%
6,0%
8,0%
10,0%
12,0%
1992 1993 1994 1995 1996 1997
Indonesia KoreaMalaysia PhilippinesThailand
Fiscal Balance
-2,0%
-1,0%
0,0%
1,0%
2,0%
3,0%
4,0%
1993 1994 1995 1996 1997
Indonesia KoreaMalaysia PhilippinesThailand
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Example: Russia attracts large capital inflows thanks to a strong rating
by Coface and Fitch… despite bad competitiveness and governance indicators!
Económic Freedom 122 / 157 Heritage Foundation
HDI 62 / 177 UNDP
Ease of Doing Business 70 / 155 World Bank
Credit Rating B Coface
Credit Rating BBB stable Fitch
Country risk 158 / 209 OECD
Growth Competitive Index 75 / 117 World Economic Forum
Opacity Index 46 / 59 PriceWaterhouseCoopers
CPI 126 / 158 Transparency International
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Ratings and the US subprime mortgage-backed securities market in the summer of 2007
Rating agencies responded to issuers’ rating requests and kept a AAA rating for debts whose collateral was rapidly deteriorating!
Ratings agencies failed to warn investors about the risk of complex financial instruments
Challenge: how measuring liquidity and market value risks?
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World Bank: Doing business in 2007
7 criteria 175 countries
New company creation; employment procedure; company registration; financing mobilization; investment protection;
contract enforcement; liquidation
3 days to set up a company in Canada vs 12 days in New Zealand and 52 in Slovakia and 153 in Mozambique
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World Bank: « Doing Business » in 20071. Singapore
2. New Zealand3. USA
4. Canada5. HK6. UK
7. Denmark8. Australa9. Norway11. Japan
21. Germany35. France (44 en 2006)France (44 en 2006)
39. Spain93. China96. Russia121. Brazil134. India171. RDC
« Ease of doing business »The ranking does not take
into account the macroeconomic framework
nor organized crime
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Quality of regulatory framework matters
World Bank 2007
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Economic Freedom Rating/Fraser Institute 2006
1. Hongkong2. Singapore
3. New Zealand4. Switzerland
5. US6. Ireland
7. UK8. Canada9. Iceland
10. Luxembourg11. Australia12. Austria13. Estonia14. Finland
15. Netherland
20. Chile 24. France24. France 30. Spain 35. Korea 45. Italy
60. Mexico 60. Thailand 83. Indonesia 88. Brazil 95. China 102. Russia 124. Algeria
126. Venezuela 130. Zimbabwe
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World Economic Forum: competitiveness ranking
The Global Competitiveness Report, which examines the growth prospects of 80 countries, remains the most up-to-date and comprehensive data source available on the comparative strengths and weaknesses of leading economies of the world.
Countries in The Global Competitiveness Report are ranked by the Growth Competitiveness Index (GCI) (GCI Rankings) and the Microeconomic Competitiveness Index (MICI) (MICI Rankings), which combined encapsulate the relative strengths and weaknesses of growth within each economy.
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Davos-WEF 2007 Competitiveness IndexSwitzerland 1 Canada 16
Finland 2 Austria 17
Sweden 3 FranceFrance 18
Denmark 4 Australia 19
Singapore 5 Belgium 20
United States 6 Ireland 21
Japan 7 Luxembourg 22
Germany 8 New Zealand 23
Netherlands 9 Korea, Rep. 24
United Kingdom 10 Estonia 25
Hong Kong SAR 11 Malaysia 26
Norway 12 Chile 27
Taiwan, China 13 Spain 28
Iceland 14 Czech Republic 29
Israel 15 Tunisia 30
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Davos-WEF 2007 Competitiveness Index
Thailand= 38 China= 57
Mexico= 58 Russia= 62 Brazil= 66
Vietnam= 77 Venezuela= 88 Pakistan= 91
Bolivia= 97 Nigeria= 101
Cambodia= 103 Paraguay= 106 Cameroon= 108 Zimbabwe= 119 Ethiopia= 120 Angola= 125
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IMD Criteria
Economic Performance
(74 criteria) Macro-economic evaluation of the domestic economy.
Government Efficiency
(84 criteria) Extent to which government policies are conducive to competitiveness.
Business Efficiency
(66 criteria) Extent to which enterprises are performing in an innovative, profitable and responsible manner.
Infrastructure (90 criteria) Extent to which basic, technological, scientific and human resources meet the needs of business.
Over 300 competitiveness criteria are selected.
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IMD 2007 Competitiveness Index
1. USA 2. Singapore 3. HK 3. Luxembourg 4. Denmark 5. Switzerland 15. China 16. Germany 20. UK 24. Japan 26. Chile
27. India 28. France 29. Korea 30. Spain 33. Thailand 35. Hungary 38. Colombia 43. Russia 44. Romania 47. Mexico 55. Venezuela
BEST
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VII- What are the drivers of sustainable economic growth?
Sustainable developmentSustainable development =
Economic growth + those conditions that make it … sustainable! =
Strong infrastructures + socio-political stability + flexible institutions + good
governance… + democracy
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Correlation economic liberalization/growth
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Correlation economic freedom –human development
y = 0,7755x + 21,431
R2 = 0,4899
0
20
40
60
80
100
120
140
160
180
200
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160
Liberté Economique
IDH
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Correlation between trade openness and corruption?
Corruption et ouverture commerciale
0
20
40
60
80
100
120
140
0
20
40
60
80
100
120
CPI
Trade
Corruption CommerceCorrelation corruption – trade openness
Low trade openness
High corruption
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Correlation Human development /Corruption
y = 0,914x + 15,368
R2 = 0,5702
0
20
40
60
80
100
120
140
160
180
200
0 20 40 60 80 100 120 140 160IPC
IDH
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The monitoring of corruption by the World Bank
World Bank 2006
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World Bank: comparing the relative intensity of corruption in Latin America?
Control de la Corrupción (América Latina, 2004)
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Conclusion: How to assess sustainability of global
capital flows?
1. Economic and financial risk analysis (quantitative)
2. Socio-polítical, institutional development, and structural reforms (qualitative)