GLOBALIZATION & ITGLOBALIZATION & ITHow will Europe and Sweden cope How will Europe and Sweden cope

with the challenges of with the challenges of the 21st century?the 21st century?

Klas EklundChief Economist SEB

SACC, Oct. 1999

GLOBALIZATIONGLOBALIZATION

• New markets: The greatest economic transformation in the history of humankind

• From trade…• …through free capital markets…• …to rapid diffusion of new technology• Means new challenges to the old

industrialized world• No control room for the MoF• Tough limits on fiscal and monetary policy

ALSO STRUCTURES CONVERGEALSO STRUCTURES CONVERGE

• The Anglo-Saxon free market model has triumphed• …over the planned economy, the welfare state and

the “Asian model”• Increasing pressure for deregulation and free

markets• Tax structures converge as tax bases turn more

mobile• Single currency in Europe…• … and currency boards and dollarization elsewhere• Cultural trends spread rapidly• Conclusion: We are truly becoming one world

IT: IT: A NEW INDUSTRIAL REVOLUTIONA NEW INDUSTRIAL REVOLUTION

• The third industrial revolution - after steam and electricity/internal combustion engine

• We ain’t seen nothin’ yet• Speed & accessibility will give new patterns of

communications and production• A “new paradigm” of growth may be

possible...• …but creative destruction will be painful• …both on the micro and macro levels

THE NEED TO RESTRUCTURETHE NEED TO RESTRUCTURE

• The network economy promotes free exchange of information

• Flatter organizations and flexibility• Low inflation• …all of which puts pressure on the rigid

European economies• …who suffer from inert labour markets, high

taxes and small nation states• EMU may help, but is not enough

EUROSCLEROSIS AND EMUEUROSCLEROSIS AND EMU

• Europe has been successful in crushing inflation - but not in promoting growth and employment

• EMU will increase economies of scale, enhance transparency, stiffen competition - and raise growth

• The euro has started weakly - but it will strengthen. And it has already created a huge bond market

• The euro-zone is not an optimal currency area. Thus risks - if markets do not become more flexible

• The long-term imperative: Cut taxes, deregulate and improve education.

A POLITICAL WILL FOR REFORMA POLITICAL WILL FOR REFORM

• Globalizations increases pressure to reform• Single market and single currency sharpen the

need• Increasing M&A activities• Tax harmonization - downwards• New policy signals

– Blair & Schröder: The third way – Even Jospin is shaping up

• Conclusion: The potential is there - as well as the obstacles

SWEDEN IN PAINSWEDEN IN PAIN

• The old Swedish model: Big business, big government, big unions

• The model cracked in the 1970’s• Slow growth, devaluations and inflation in the

80’s• 1990’s: The great water-shed: Over-heating,

currency crisis, rate hikes, banking crisis, depression, unemployment, budget chaos

• The grim realization: We are not God’s chosen people!

• Forced gradual adaptation

GRUDGING ADAPTATIONGRUDGING ADAPTATION

• 1990-91: Deregulation of credits and currency markets

• 1991: Exhaustive tax reform• 1992-94: Restructuring of banking system• From 1993: Floating exchange rate• 1994-95: Cuts of compensation levels• 1995: EU membership• 1995: Independent central bank, with inflation target• 1995-96: Fiscal tightening against the deficit• 1996: Pension reform• 1996: Budget reform, with expenditure ceilings

THE RESULTSTHE RESULTS

• Well consolidated banks• Current account surplus• Budget surplus• Low inflation• Low interest rates• Gradually diminishing unemployment• Rapid productivity growth• And now, finally: Consumption returns• But a nagging uncertainty: Are these

results sustainable?

THE POLITICAL SCENETHE POLITICAL SCENE

• SDP used to have a hegemonic position• Threatened as the model cracked, communism

collapsed and the tax ceiling was reached• SDP has gradually shifted to the middle …but without a change of rhetoric• Creates confusion among the rank and file -

and lower popular support• Poor election results• But the opposition is split between right and

left, which means SDP can still stay in power• Now: Persson leans left - for how long?

THE STRUCTURETHE STRUCTURE

• WEF: Sweden ranks high on technology, infra-structure and management. Low on public sector and taxes.

• Swedish export industry is extremely competitive• But the base and renewal of manufacturing is in doubt• A rigid labour market, stiff legislation for small firms• Mobile tax bases puts pressure on tax revenue• A growing exodus caused by high taxes, geography

and lack of highly educated people• But also inflow of investments into manufacturing• A ray of hope: Growing software and culture sectors• The financial sector: Modern and hi-tech after

deregulation - but M&A loom on the horizon

ADVANCED IT AND ADVANCED IT AND FINANCIAL SECTORSFINANCIAL SECTORS

• Sweden is one of the most wired nations on earth • Extremely successful exports of music, culture,

computer games, telecommunications and software• The financial sector’s technical sophistication is

second only to the US• Internet banking has reached further than anywhere

else• SEB: at the forefront

– Successful internet site - expanding portal– Electronic trading station– We move the market place to the customer

THE SWEDISH ECONOMY TODAY: THE SWEDISH ECONOMY TODAY: STRONG GROWTHSTRONG GROWTH

• Strong growth, driven by both exports and consumption: After a decade, private consumption rebounds

• Lower unemployment• Budget surplus suffices for both tax cuts &

debt reduction• Higher but still moderate inflation• Tighter monetary policy ahead• The risks: Fiscal policy and wages. Will

Sweden slip back into its old bad habits again?

GDP GROWTHGDP GROWTH

0098969492908886848280

5

4

3

2

1

0

-1

-2

-3

5

4

3

2

1

0

-1

-2

-3

Källor: SCB, SEB

ProcentProcent

SEB

Prognos

FORECASTSFORECASTS

1998 1999 2000 2001GDP 2,6 4,0 3,8 3,5Export 6,9 6,6 6,1 4,5Private consumption 2,4 3,1 4,4 4,1Savings rate 3,8 2,7 2,4 3,3Unemployment 6,5 5,5 5,0 4,5Wage costs 3,8 3,8 4,4 4,6Current account 1,9 1,4 1,1 0,6Inflation (CPI) 0,4 0,4 1,9 2,8Genl govt balance 1,9 2,6 3,0 2,5

BUDGET DEFICIT/SURPLUSBUDGET DEFICIT/SURPLUS

0098969492908886848280

10

5

0

-5

-10

-15

10

5

0

-5

-10

-15

Sources: N.I.E.R. SEB

SEBForecast

Per centPer cent

Financial savingsSavings without tax cuts

FISCAL POLICYFISCAL POLICY(bln SEK)(bln SEK)

20002001

Earned income allowance 8 20Adjustment of threshold 1,5 1,5Lower tax on rental prop. 0,8 0,8“Expert” tax 0,04 0,04Double taxation 0 7Wealth tax 0 3Local government grants 5 10Other 5 8TOTAL ca 20 ca

50

PRO-CYCLICAL FISCAL POLICYPRO-CYCLICAL FISCAL POLICY

• Also after tax cuts, there will be a rapid amortization of debt

• Fiscal policy becomes more expansionary in a period of strong consumption-lead growth.

• The policy mix is risky - but still, tax cuts are needed

• Conclusion: The pressure on the Riksbank is increasing

• But with a floating exchange rate the Riksbank is free to counteract inflationary pressures

WHAT OUGHT TO BE DONE?WHAT OUGHT TO BE DONE?

• Dampen consumption growth:– Tax cuts to stimulate savings (capital income & wealth

taxation)• Increase potential GDP growth & and capacity:

– Improve business climate, stimulate investments (double taxation & coperate taxation

• Increase labour force: – Stronger incentives to work (duration and level of

unemployment benefit levels, marginal taxes, union strength etc)

• Long term:– Tax reform to stimulate entrepreneurs, higher quality

in education• Conclusion: Structural problems not dealt with

fully

INFLATIONINFLATION

• Inflation will rise:– Strong global and domestic demand– Tight labour market– Expansionary fiscal policy– Low real yields

• But not as much as it used to:– Global and technological pressure– Monetary regime more credible– Transmission mechanism more efficient– Structural improvements

• Pipeline indicators benign• Conclusion: Inflation increases - but not

much

MONETARY POLICYMONETARY POLICY

• The Riksbank is uncertain– Optimistic inflation propensity– More dependant on pipeline indicators

• The Riksbank will be cautious – Takes time to change forecast– Pedagogical problems– Symmetric target– Uncertainties regarding fiscal policy– … and the Executive Board is split

• Pre-emptive, careful move later this autumn, but next year gradual tightening will follow

• Substantial tightening needed (275 bps)

REPO RATE FORECASTREPO RATE FORECAST

Repo rate, Sweden Repo rate, EMU (Germany before 1999)

Source EcoWin

96 97 98 99 00 01

Pe

r ce

nt

2

3

4

5

6

7

8

9

Pe

r ce

nt

2

3

4

5

6

7

8

9

Forecast SEB

INFLATION FORECASTINFLATION FORECAST

Consumer prices Underlying inflation, UND1X

Source EcoWin

90 91 92 93 94 95 96 97 98 99 00 01

Pe

r ce

nt

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Pe

r ce

nt

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

SEB

Forecast

SHORT REAL RATESHORT REAL RATE

(3 month treasury bills - households inflationary expectations)

Source EcoWin

94 95 96 97 98 99 00 01

Per

cent

1

2

3

4

5

6

7

Per

cent

1

2

3

4

5

6

7

Forecast SEB

EMU MEMBERSHIP POSTPONEDEMU MEMBERSHIP POSTPONED

• Sweden outside the first member group, for domestic political reasons

• Prime Ministerial fast track last winter became blind alley after SDP defeat in EU parliamentary elections

• Party leadership governed by tactical considerations - but in the long term membership is unavoidable

• SDP will say: “Yes, but later” (UK Labour position)• Earliest decision in 2002 election or later referendum• Conclusion: ERM off the agenda for now• Floating exchange rate will stay

FINANCIAL MARKETSFINANCIAL MARKETS

• Stronger krona– High growth, expansionary fiscal policy and

tighter monetary policy – Credible economic regime– The krona is undervalued

• Stable bond yield spread to Germany– Sweden outside EMU, slightly higher inflation– but strong fundamentals

• The yield curve will flatten - next year– Riksbank timing is crucial

THE KRONATHE KRONA

010099989796

135

130

125

120

115

110

135

130

125

120

115

110

Source: SEB

Forecast SEB

IndexIndex

THE YIELD CURVETHE YIELD CURVE

01009998979695

12

10

8

6

4

2

12

10

8

6

4

2

Per cent Per cent

Sources: Datastream, SEB

Forecast SEB

10-year benchmark3-month treasury bills

SWEDISH RISKSSWEDISH RISKS

• The window of opportunity may not be exploited

• Structural transformation may be stopped• Even more expansionary fiscal policy• Too high wage increases• The Riksbank reacts too little and too late

But even so, Sweden looks strong - at least for the foreseeable future...