December 10, 2009

Speakers:

  • Frederick Kempe, President and CEO, Atlantic Council
  • Francis Kelly, Atlantic Council Board member; Managing Director and Head of Government Affairs Americas, Deutsche Bank
  • Robert Zoellick, President, World Bank

December 10, 2009

FREDERICK KEMPE:  Welcome to you all.  I’m Fred Kempe, president and CEO of the Atlantic Council.  There are three reasons why I’m pleased to be welcoming you for the fourth public speaking event in our series, “Mapping the Economic and Financial Future,” or perhaps, we can paraphrase that title from the comments I’ve heard and from World Bank President Bob Zoellick in the past as posing the question, what’s the new normal?  Or what do we wish the new normal to become?

The first of my first three reasons to be happy to introduce this is the importance of the series itself.  We launched this in partnership with Deutsche Bank last May.  And early on, we said we didn’t – we wished to talk only about the train wreck we were watching.  But more than anything else, we wanted to watch about – talk about medium-term and longer-term consequences.

In that spirit, this series was launched brilliantly by Deutsche Bank Chief Executive Josef Ackermann.  He focused on how the crisis was changing the social contract between governments and citizens, noting that the pendulum had swung back in favor of state involvement and market structures after the Reagan-Thatcher revolution in the 1980s.

He worried a world of less openness, thus less trade and growth.  He warned, quote, “Make no mistake, globalization is not a natural force.  It is manmade and can be destroyed by our own hands.”  That said, he expected the overall change to be less radical than the rhetoric at that time back in May would have suggested because huge public deficits put a limit on what the state can achieve regardless of political direction.

The second reason I’m delighted by this series is that it was the public launch pad for our new Global Business and Economics Program and its director, Alexei Monsarrat and his deputy, James O’Connor.  The Atlantic Council has a security agenda and a prosperity agenda.  And I believe we know how interlinked they are.

We’ve worked these issues for years, but now, we have a program of excellence built around them.  Finally, I’m delighted because there could no more appropriate speaker for this series than Robert Zoellick, one of the world’s most gifted strategic thinkers.  I’ll leave it to our board member, Frank Kelly, to introduce him more fully.

But Frank, I hope you don’t mind if I quote one of out international advisory board members who I just talked to and sitting in the front row, Ashraf Ghani.  And we were just talking in the hallway and he said you have to introduce him as the most innovative development thinker today.

But what’s truly uncanny about him, said Ashraf, is he’s also a systemic thinker and manager who knows how to implement his vision.  He’s also a great Atlanticist and in the spirit of the Atlantic Council, understands that the only great Atlanticist today has to be one who thinks globally and acts globally, which is the new agenda for the trans-Atlantic community.

So let me pass to Frank Kelly.  We talk a lot these days about soldier statesmen at the Atlantic Council.  Frank is a businessman statesman.  His distinguished career in the public and private sectors represents the sort of leader we like having at the council.  He’s Deutsche Bank’s managing director and head of government affairs and he comes to that job after a career that has included stints at Charles Schwab, Merrill-Lynch, the SEC, the Department of Justice and the Reagan and Bush 41 administrations.

Frank, I turn it to you.

FRANCIS KELLY:  Thank you, Fred.  Thank you for pointing out that I don’t hold jobs very long.  No, thank you very much and welcome to all of you for what I know will be an extremely interesting discussion with World Bank President Bob Zoellick.

Just to note, Deutsche Bank is proud to sponsor this series, Mapping the Economic and Financial Future, here at the Atlantic Council.  Over the last several months, we’ve gathered some of the trans-Atlantic community’s best minds to share their perspectives on the global turmoil we have all endured and to join in the search for solutions that rebuild a stable global economy.

The council has been able to bring together periodic speakers and periodic conference calls with important thought leaders.  Our guests have included our own CEO, Joe Ackermann, two EU commissioners, the Egyptian finance minister, former senior Treasury official and the founder and president of the Center for Global Development.

Each of these guests has examined an important element of the global, financial and economic crisis and we’re extremely pleased today to welcome Bob Zoellick.  We are looking forward to hearing Bob’s views on prospects for global growth, particularly in emerging and developing economies.

In an age of continuing integration, the fate of these countries and their people are deeply linked to our own.  Prosperity can and must be broadly and deeply shared.  Nowhere has this been more clear than the climate negotiations happening right now in Copenhagen.  A deal to address global carbon emissions hinges on the developed countries building a real partnership with the G-7, or the G-20, now.

We’ll welcome Bob’s views on this issue as well.  As one of today’s leading strategic thinkers, if not the leading strategic thinker, President Zoellick is adapted to addressing a wide range of crucial issues.  His long experience in the private sector and the government provide him with a unique perspective that cuts across the economic and political spheres.

While his accomplishments are well-known to most of you in this room, I will go ahead and just note just a few.  Particularly, he’s the 11th president of the World Bank, an institution that has risen to a number of major challenges and presented him on his watch, including fuel and food price spikes of 2008 and the dawning challenge of the global and financial and economic crisis which we’re still suffering through.

Prior to his appointment to the Bank in July, 2007, Bob served as vice chairman, international, of the Goldman Sachs group as well as managing director and chairman of the Goldman Sachs Board of International Advisors.  He’s also served as deputy secretary of State between 2005, 2006.

And before that, he served in the U.S. Cabinet as the 13th U.S. trade representative, where he helped launch the Doha Round agenda in the World Trade Organization and played an instrumental role in completing the session of China and Chinese-Taipei to the WTO.  And just as a quick note, he’s also senior positions at the Treasury Department, the White House and is executive vice president of Fannie Mae.

With his long and distinguished career, Bob is a seasoned and respected global figure.  Many would argue that he actually defines that phrase.  And on behalf of Deutsche Bank and the Atlantic Council, we are very proud to host him this evening.  Thank you and please join me welcoming Bob Zoellick.  (Applause.)

ROBERT ZOELLICK:  Well, I particularly appreciate the opportunity to be here with all of you because I’ve known, as I can see looking at many in this room, as you have as well, the Atlantic Council of the years and I think it’s a very important organization and I really want to compliment Fred.

I think he’s really moving it fast up the agenda and doing some very interesting work and so I wanted to try to be of modest support as the Atlantic Council, which had done a lot of work on the security side, also engages the economic side.  And my only pause when I saw Frank as I came in is that I had the wonderful opportunity not long ago to speak to the top 250 or so Deutsche Bank managers and I almost did a double-take and thought I was in the wrong place when I saw Frank here.

But it was actually, it’s a fantastic group.  I think what Fred asked me to do is just to get things going a little bit with some overview comments and then I think we take this to a little bit more of an interview format.  So I thought what I would do is give you a brief overview on the economic outlook as I see it.

Of course, financial markets have broken the fall and that’s good because you see the basis for some recovery.  But you also see something that I’ve been cautioned about from the start, which is that this crisis is likely to come in waves and you have to keep your watch out.  So for example, some of the effects with Dubai ports have obviously led financiers to take a closer look at credits over time.

And you can see some of this going on if you look at some of the spreads in the EU market where some of the countries that have bigger deficits are a little bit, sort of more under pressure.  But the good news is that you’re seeing a gradual economic recovery, particular strengths in parts of Asia.

But what I find helpful for the work that I do, but in general, for others as well, is to try to anticipate some of the risks that might be out there.  You may be able to do something about them or at a minimum, watch to see if they intensify.  And tonight, I’d like to briefly identify five.

First, I think it’s most likely that in the United States and much of Europe, you’re going to see persistent high unemployment.  And what that is going to mean, is that while you’ve had a certain wave of bad loan effects that started with this crisis, particularly in the mortgage area, now, you’re going to see some continued troublesome credits in areas such as consumer loans, credit card loans, mortgages, not because of the problem mortgages that people started out with, but if you got 10-percent unemployment, it’s just going to be harder for people to pay their mortgages.

And an ancillary point that you see particularly in the United States is some of the commercial real estate markets are exceptionally soft.  So you can see the flow back effects of this depending on the structure of a bank’s business.  So if you’re in the banking sector, more in the retail side, you’ve got to expect more in the nature of problem loans.

But it also means you see some very high profits in banks that are in general, financial markets without this sort of portfolio.  Second risk is anytime you have large-scale unemployment, you have to keep your eye out for protectionism.  So far, there’s been large number of protectionist actions but relatively small in size.

So it’s what I describe as a low-grade fever, not a full influenza.  But playing with protectionism is always playing with fire.  And so one of the dangers is, if you get into 2010 and you start to see the political pressures that could happen in different countries for people to do things to protect local markets, it can start to spiral.

So that’s an important reason why I have always felt in the trade area, it’s best to have an offensive agenda.  If you’re simply in a defensive posture, you’re always going to be trying to resist those that are trying to close markets.  My experience is it’s better to be trying to set the agenda by what markets you’re going to try to open.  And that brings us back to the importance of a push on the Doha Round.

Third, an issue that I think a number of people will be watching in 2010, it’s really hard to get a sense of prediction, is a lot of the stimulus money in the United States and in other countries really runs through the middle of 2010.  In fact, a good part of it is still to be spent.

And that means that sometime during the course of next year, you’re going to have to see the handoff from the public sector spending to the private sector.  And that will depend on people’s assumptions about consumption coming back, but also the investment outlook.  And this generalized quality that’s hard to get your fingertips or hands around, which is an overall sense of business confidence.

And fourth, as part of that, obviously in the United States and the global economy, traditionally, the U.S. consumer has been the source of resurgent demand.  And I think that’s unlikely to be the case this time for the simple reason that U.S. consumers are de-leveraging, they’re paying down debt.  They’re rebuilding their savings.

And so one of the big question marks is what can be an alternative source of demand and that’s one of the things that actually identifies some of the important role of the World Bank because in this crisis, unlike some earlier ones, you have a number of developing countries that have paid down debt.  They have relatively good fiscal positions and they do have the ability to expand demand if they can get the financing.  And that’s a lot of what we’ve been doing.

The fifth risk is one that I wrote piece on in the Financial Times a couple weeks ago and that’s of asset price bubbles.  And I was partly in that piece, trying to caution people because we all try to learn the lessons of the past and you can see a lot of discussion about trying to avoid some of the mistakes of the ’30s, the lack of central banks providing liquidity, avoiding protectionism, taking the appropriate fiscal policy actions.

But you’ll always have to check to see whether something has changed in the international environment.  And in this case, I think one of the changes is there’s a lot of liquidity.  If you talk to people in the financial markets – because what central banks did is they used the tool they had to deal with the problem of the day which was the risk of counterpart failures.

Now, that was a need to build confidence and in a sense, the tool didn’t fit exactly, but that’s the tool they had.  So they provided immense liquidity, not only through traditional monetary policy, but through some very innovative steps, I think important and creative steps in terms of buying assets, what some people have talked about is a quantitative easy.

I think from the Federal Reserves’ point of view, they just wanted to make sure that these markets continue to be working.  But it’s created a situation where as you start to see a recovery in some markets, particularly in East Asia, the question is, where will all this money go?  So you hear people talking about the return of Keynesianism.

Well, that’s true, but Milton Friedman isn’t totally gone either.  If you got all this money, where’s it going to go?  And my own sense is that for a number of reasons, you’re not going to see companies be able to increase prices.  So traditional product price inflation is unlikely.  You’re not going to be able to see unions or labor forces be able to really push for great wage increases.

But you could see money start to move into asset markets.  And you had some evidence of this if you look at some of the real estate and some of the other markets, particularly in East Asia.  Now this is, makes a difficult choice for central banks.  You could see Australia was one of the first that already raised its interest rates.

That would be the traditional way to deal with this problem.  But if you raise your interest rates, it’s like going to draw capital.  It’s going to appreciate your currency, make it harder for you to have export-led growth.  And this is something that many of the countries in Southeast Asia are particularly sensitive to because in part, they also have to look at their competitive position with China.

And of course, the China – RMB has come down through its connection with the dollar as the dollar has declined in value.  So what I was partly trying to do in this piece was talk about other tools that you can see that possible used and some of the – actually, news reporting I saw this morning, I just came from India and Japan, was focusing on some of the things that, for example, China’s trying to do to restrict credit in other fashion.

Now, having said these risks, from the perspective of the developing world, one needs to recognize there’s already been a terrible human toll.  We estimate that the events have already pushed some 90 million people back to extreme poverty.  We define that as under a dollar and a quarter a day.  We estimate that some 30 to 50,000 babies will be dying in sub-Saharan Africa that otherwise wouldn’t.

And you see cutbacks all across different development programs, whether they be HIV/AIDS programs or other types of support.  And this just underscores my concern that as we look going to 2010 and you consider potential future waves of effects, we have to be well-armed and positioned to try to deal with dangers which we might anticipate to a degree, but some which we cannot even foresee today.

And in that context, I thought I’d just share with you a few recent impressions that I’ve had from some of the sessions I’ve attended.  In November, I attended the G-20 Finance Minister’s meeting in St. Andrews and then went on to the APEC meeting in Singapore.  And maybe it was the time or jetlag, but I was much struck by the very different tone of these meetings.

Now, in the G-20, of course you have countries from all over the world, but you have a large number of European states, about eight or 9 European representatives.  And the focus of a lot of the European financial regulators or financial officials was very much focused on issues such as compensation, bonuses, tax havens, the regulatory structure.

All very important issue, as you see in today’s paper, very politically powerful issues in many of these countries.  But I noted an interesting contrast when I was in Singapore, where there was a much greater focus on a potential growth agenda.

So the logic that came not only from those in Southeast Asia, Korea, but also Australia, its economy is so tied to the Asia-Pacific region was if growth is likely to be slower going forward, what can we do in the way of structure reforms?  Even, what can we do in the way of deregulation of some of the service industries to be able to create a greater growth possibility?

So the Koreans were talking about things such as services deregulation that, at least from a trade persons perspective, were quite unusual, but it was a recognition that they may need to do this to introduce the productivity.  A lot of discussion about infrastructure bottlenecks.

And this isn’t only the developing countries.  The Australians have a very ambitious infrastructure program.  And I’ll come back to this because one of the fine – issues that or lessons that we learned from the ’90s watching China was that infrastructure can be very important for creating jobs, but also creating improved productivity in the future.

It’s a lot of what China did in the late ’90s and if you visit China and you see the roads in the ports and others, it’s partly related to their productivity boom.  I was in India last week and India, of course, is a wonderful example of an emerging economy.  It covers the very, very poor and many people don’t recognize, still, how poor India is.

The per capita income is still about $1,000.  But it also covers some of the greatest cutting edge companies in the world.  I had a chance to see Tata’s new car, which they’re selling for between two and $3,000 and it’s a very well-engineered car.  I can sit in the backseat.  It meets all the European and U.S. crash tests, and it’s a sign of, in a sense, what you’re going to see with Indian manufacturing as well as the service industry.

The bigger picture, from a strategic economic perspective, is what you see emerging with the Chinas and the Indias and, I believe, the Brazils and Southeast Asias and others, is the possibility of creating multiple poles of growth in the future, and that this can be one of the sources of demand to get us out of this international problem, but also, as you look towards a future system, if you have investments today to increase productivity, to overcome some of these bottlenecks, it can change and make, in my view, a healthier international economic system.

In addition to the infrastructure issue, another key lesson that we learned from the ’90s was the importance of combining the macroeconomic stabilization with social development agenda.  What we saw, very sadly, in East Asia, Latin America and many other countries is that the lack of attention to nutrition programs, basic education programs, frankly, meant that you could lose a generation because with, particularly at the very early ages of childhood, if you don’t get proper nutrition – we now have the statistical evidence – it holds back income and development and learning and physical potential for a whole life.

So one of the things that we’ve been able to do is draw some lessons from different countries’ experience, depending on their capacity, of targeted effective safety nets.  In the case of Brazil and Mexico, for under a half of 1 percent of GDP, they have pretty good targeted programs for these conditional cash transfer programs, the Bolsa Familia in Brazil and the Oportunidades program in Mexico.

Now, in some countries in sub-Saharan Africa, those types of conditional cash transfer programs where you give cash to the poorest families on the conditions that they send their kids to school or you get health checkups, that, frankly, requires a greater sense of institutional capacity than many countries have.  So we’ve worked with partners such as the World Food Programme and UNICEF and others on the school feeding programs, the food-for-work programs.

So part of the point here is one of the lessons learned from the ’90s is not only the need to deal with a financial stabilization but the potential for job and productivity increases with infrastructure, the role for the social safety nets and, critically, a focus on the private sector development.

What this is also suggesting – and I certainly saw this, again, in India – is something that really is a transformation from even 10 years ago, which is the great possibilities for South-South development.

You obviously see the stories of Chinese investment in sub-Saharan Africa in resources and infrastructure.  I’ve had some discussions with some reporters where we’ve talked about the increasing interest in China in perhaps moving some of the low-value manufacturing industry to sub-Saharan Africa.  This could be a breakthrough that you really haven’t seen in sub-Saharan Africa, which opens up the door to the type of growth that you had in East Asia, starting with Japan, 50 or 60 years ago.

And of course, as part of this, as people mention Copenhagen is trying to start to make sure that you can take advantage for creating energy sources, which are critical in every country, but do it in a low-carbon growth path.

Takes us to the World Bank group.  Just to give you a rough sense of the scale of our activity, working from IDA, which is what we use as grants and low-interest loans for the 79 poorest countries; IBRD, which is our lending for the low-middle income and middle income countries; and IFC, which is for our private sector.  Through the 12 months that ended September 30th, we did about $70 billion worth of business.  And we see no sign of that demand letting up; in fact, it continues to increase.

For the poorest countries, of course this crisis started with food and fuel prices before the financial sector.  And this is an important lesson because, depending on what happens with some of these liquidity issues and commodity markets, I think we have to be prepared for potential for some food price increases next year if you get some problems among individual markets.

Part of this is the stocks issue; part of this is a market like rice that is rather thinly traded and can be triggered by problems in terms of – in the case of India, the rice production has come down; the Philippines at times has gone out for tenders and had some challenges being able to fill those. That started the first burst in food prices and we’ve had some sort of careful things we have to watch sort of in recent months.

And so it’s not something I’m trying to – would predict today, but from a development perspective, we have to try to be ready for this return.  That’s one reason why we created a rapid-response facility for food; because we took some of our funds and some of the funds from some of our donors so that we could move much more quickly than we normally would to be able to support school feeding programs or, for small farmers, the seeds or some of the fertilizers.

That has led partly to a broader recognition globally of the need for a food security agenda.  This is one of the points that President Obama emphasized at the Italy G-7 meeting.  And of course, we worked with the U.S. and others to try to solidify that and move it forward at the G-20 meeting in Pittsburgh.

I’ve mentioned infrastructure and targeted safety mats.  In the private sector area, our private sector arm, IFC, has been very innovative in trying to come up with facilities that meet client needs in our developing country clients, but also with potential investors.  One of the first was microfinance.

Many of you interested in the field of development are keenly sensitive to the role that microfinance can play, but many microfinance institutions are not deposit-taking institutions; they rely on cross-border financial flows.  So they were losing finance quite quickly as credit pulled back, so we worked actually with KFW in Germany and some others to put together a liquidity facility to make sure they could continue to get funding.

Trade finance:  It was terrible that you saw the drop in trade because of demand, but in many developing countries they couldn’t get the loans to be able – even for relatively non-risky credits of trade finance had dried up.  So we worked with the private banking sector to leverage some of our funds, government funds and others to create rotating trade finance.

Bank capitalization:  Obviously, if you’ve seen banks that have to get recapitalized in the developing world, what happens in the developing world?  And in many cases, in some of the medium-size countries, there really was no source of finance.  So Japan put in $2 billion, IFC put in $1 billion and we’re tried to work with some of the medium-size banks that would be important for supporting small business and trade finance and other things to keep credit going in the developing country sector.

Public-private infrastructure:  Again, one of the interesting phenomenon around the world is that if you look at some of the private sector investment in infrastructure projects in the United States, like the Indiana Tollway, they become very, very politically sensitive topics.  Mayor Daley in Chicago has actually been quite innovative in this.  If you go to India, public-private infrastructure is now commonplace.  It’s seen as of course you can’t fund all this in public sector money.  But a number of these private sector projects’ credit dried up very quickly so we tried to create a facility to keep some of them going.  And one that’s particularly interesting is if you look at the credit markets in the developing world, an area that has been slowest to come back is financing for the private sector.  So some of the private sector firms that ran into difficulties, we have now – are creating an initiative to try to buy their distressed debt and help them restructure some of the loans so as to help to get the private sector back in place.

And that leads to another innovation that I’m particularly intrigued about for the longer term, which is through IFC we’ve created an asset management corporation subsidiary.  And some of you may recall, a year or two ago, I’d mentioned the possibility of reaching out to sovereign funds to be able to tap some of those capital sources for investment in the developing world.

Well, we saw something interesting happen after this crisis, and that is a number of sovereign funds and pension funds recognized that investments in developed markets could be risky, too.  They saw good growth prospects in the developing world but they didn’t really know where to invest.  They didn’t have the information, couldn’t bear the transactions costs, and, fortunately through IFC, which operates in over 100 countries, we have a good track record of not just loans but equity investments and good performance.

So we created this asset management corporation to be able to tap some of the investment from sovereign funds and pension funds directly for sub-Saharan Africa.  And we actually hope to be able to, sort of, close our first fund with about $500 million pretty soon.  And I think before long, we could get it up to $1 billion easily.

To do all these things, we were fortunate – the World Bank came into this crisis very well-capitalized – and we’ve tried to stretch that capital because for the case of IBRD and IFC, we have to borrow in international financial markets to be able to lend or invest.  The World Bank had not had a capital increase in 20 years.

In fact, in the wonderful ironies of fate, the last time this happened, I was working with Secretary Baker at the Treasury Department and I had to do it from that side, so now I get to do it from this side.  So somebody has a cruel idea of humor up there!

And we had a decision at our annual meeting in Istanbul in October to make a determination about a capital increase by the time of our spring meeting.  So that’s one reason I was a little bit late.  I was being just like a good old trade representative; I was already up talking to people in the Congress to try to prepare the way for this.

We are finding very good demand, but another aspect it relates to perhaps some of the larger questions in foreign policy, whether trade or climate change or development, is that we’ve been doing this capital increase as part of a larger financial resource package, and so we’ve been working closely with the contributions from developing countries.  And one thing that I’m particularly proud of is that if we’re able to secure the support for this, we’ll probably have at least half the financing from the developing countries so that with donor countries from the developed world where taxpayers feel stress, this is not one that’s all on their back.

So part of what I’ve tried to provide here is an overview of how we’ve responded to the crisis.  But for many of you that are interested in some of the broader issues of political economy or even security issues, part of the challenge that the World Bank is facing is how do we take this grand institution that was created at the end of the post-World War II period and modernize it for a very different world?  How do you modernize multilateralism?

So whether it’s focusing on the challenges of the poorest countries in sub-Saharan Africa, whether it’s a focus on conflict states or post-conflict states – so Ashraf Ghani is obviously an expert in this in the case of Afghanistan; very much in the news – and it’s an area where we’ve been trying to do some more intensive work with a broader range of partners, recognizing that these issues require an integration of security, development, governance and ultimately building legitimacy.

The role of the middle-income countries – and here, in particular, when I came to the bank there was some discussion about, well, maybe you should just focus on the poorest countries.  I felt if you were going to have an effective multilateral institution, the worst thing to do was to abandon the role with some of the middle-income countries because it’s hard to think of a problem in the world, whether it be climate change or trade or, frankly, South-South development, where you don’t want to integrate these countries as – to coin a term – responsible stakeholders in the system.  So part of what I’m trying to do with China and India, or Mexico or Egypt and others, is to make sure that we can build a multilateral system where all share in the responsibilities and the benefits.

Global public goods:  Obviously this week, a big topic is climate change.  I will be heading off to Copenhagen next week, and we’ve tried to demonstrate what can be done through some climate investment funds in terms of leveraging other sources of money to show in practical ways, whether it be technology or adaptation or forestation.

And I guess what also drives much of this, as sort of a final word about one of the challenges we have at the bank, is that in describing what we do, one of our ongoing handicaps is that we’re called “bank.”  And so people keep thinking our primary function is putting out money.  And that’s not the way that I see it and talk about it with our staff.

When we actually operate best, we’re combining three different elements.  We are trying to look at a problem and apply knowledge and learning from other countries, whether it be social safety nets, infrastructure, so to be able to reach across the world and take examples.

Secondly, while $70 billion is nothing to scoff at, it’s still modest in terms of overall sums in the market.  So what you really want to try to do is develop projects that will have larger effects in building markets and institutions in capacity.  It may be carbon markets, it may be microfinance markets, it may be local currency bond markets, it may be the institutional capacity in countries, as in India for public-private infrastructure, but you need to try to think how you’re going to leverage the investment in a broader fashion.

And third, what does distinguish this from the OECD or universities, we do have money, and we’re trying to be continually innovative in the different ways that we deploy that.  But our challenge as an institution is always trying to think how we can continually upgrade our game in terms of those three different activities.

So sort of a fair start and now you can go where you’d like.  (Applause.)

MR. KEMPE:  Thank you, Bob.  That was terrific, and already a lot of food for thought.  I’m going to ask a couple of initial questions and then pass on to the audience.

People talk about this period, the financial crisis, as an inflection point.  And it may be too early to answer this, but if you were to bet how history will view this crisis as an inflection point, and if so, an inflection point to what?  What died with the financial crisis; what has changed?  And if you’d just pick out a couple of aspects that you think are most important to think about.

MR. ZOELLICK:  Well, I gave a speech at SAIS – I’m losing track of time – about a month or so ago that I called “After the Crisis.”  And it was my first effort to take a cut at this.  And I started out – and it particularly for this audience may be interesting – is looking at what might be some of the either perceptions or realities of influence and power.  And so one that I – obviously, is that people are talking about the role of the emerging markets and the emerging powers – the Chinas and the Indias – and shift of location.

In the case of the United States, many people assumed, well, because this crisis really emanated from the United States, that this would end up weakening the United States.  I challenge that hypothesis somewhat.  I actually feel that one of the United States’ innate strength is its ability to take on problems to reinvent itself.  But I pose the issues that I think have to be examined to try to address that.

Another one that has been a little bit under the radar screen, but – I just mentioned I flew back from India and Japan – I was just in Tokyo.  One of the biggest shifts in post-war history just took place by having an opposition party seize real power.  It’s happened a couple times before in Japan.  And the implications of this for Japanese politics and the role of how Japanese policymaking is quite significant, and probably not as watched here as much as it should.

Just to give you a small little piece, traditionally, the Japanese policymaking system was a combination of ministers on the top, general LDP policy and the very strong world of bureaucracy.  The DPJ government has challenged this role of bureaucracy and it has, for example, brought in a series of parliamentary vice ministers, whose role traditionally was more limited.  And they’re trying to make them much more like, sort of, under secretaries would be in a U.S. system.  And, frankly, I had a special lunch with some of them from the finance and foreign ministry; very impressive people, a younger generation and it’s going to be very interesting to see how that adjusts and shifts the policy process.

So we could go through the different countries, but then another dimension that I tried to touch on was some of the institutional effects.  I’ve touched on the world trading system and one reason I believe it’s very important to get the Doha Round done is the Doha agenda really reflects the trade agenda as of the late ’90s and the early 2000s.  And we now have a whole set of other issues that really get increased to prominence – how trade relates to the environment and carbon issue.  In a sense, the service sector has continued to be far, far behind the overall sort of liberalization process; I touch a little bit on some of the work we’re doing in terms of trade facilitation and logistics and others, and how this could open to another set of possibilities.

Other areas are, frankly, institutions such as the role of central banking, which I’ve touched on a little bit.  So I think –

MR. KEMPE:  But capitalism itself will move to the state or move away from the market, protectionism –

MR. ZOELLICK:  Well, that’s the interesting part.

MR. KEMPE:  Things haven’t changed quite as dramatically as one thought they might have.

MR. ZOELLICK:  Yeah, what’s actually interesting is you haven’t seen this crisis spark a rejection of capitalism and markets.  However, what it clearly has done is opened the door to additional thinking of the role of state and markets.  And this is partly by looking at the success of some of the developing country system.  It’s also by recognizing how some of the developed countries act.  And I think this debate – it’s actually an area that, as we think about our research agenda for the World Bank, we’re trying to put increased prominence.

And it’s not that there’s any simple formula.  I mean, one of the lessons of development is that it has to be customized for each country, it has to have ownership.  But it opens the door to some of the things that Ashraf has done in the context of fragile states, which is the role of the institutional development, how it fits with markets.  That is a whole area that I actually think this crisis, in a sense, has broken away some of the constrictors of thinking that came up over 10 or 20 years.  That makes it rather exciting intellectually.

MR. KEMPE:  Thank you.  Now, from the grand to the more prosaic, which is 2010.  You spoke of your FT piece and the problem of asset bubbles.  I have a friend who used to sign e-mails, always make new mistakes.

And I guess what I would wonder is as you look forward, imagine being here when subprime was on the way to being a bubble, and then helping to launch a crisis.  Is that what you’re saying about the asset bubble in Asia?  Is there a possibility that the debt problem that we’re seeing in Dubai can have broader implications to lead us downhill?  What is your outlook for 2010 and what are the landmines that we’re not paying attention to?

MR. ZOELLICK:  Well, I think through the five risks, I tried to identify some of the landmines.  But let’s focus on the asset price issue.  What I’m trying to draw attention to here is that many, but not all, central banks prior to this crisis felt – with some fairness – that the ability to predict when you have an asset price bubble and act on it was so difficult and raised such dangers that the better course was to let the bubbles burst and then clean it up.  That view has clearly – (chuckles) – lost ground in the context of this crisis.

Now, the Canadian central bank, actually, as it looked at price levels, actually had factored in some asset prices. I think the ECB had done the same.  But having identified this as a problem is far from saying you know how to deal with the solution because if you go back and see some efforts earlier – you know, Chairman Greenspan at one point talked about irrational exuberance and he was trying to warn but it didn’t bring the market down.  And of course, it’s not so easy as a central banker, if you feel that resources are being underutilized, to raise interest rates.  So in a sense, look at the question I posed for East Asia. If they are seeing asset bubbles, should they raise interest rates?

But I was trying to put another piece in the mix, which is I think people are going to have to go back to using some of the tools that, perhaps, slipped in usage, at least in the U.S. – margin requirements, ways to, perhaps, if you see particular problems in certain asset markets, whether you might restrict the credit from banks in this.

Now, in a place like Singapore, you have another option.  You can increase the supply side by increasing some of the land that’s available.  And this goes to connect the asset price bubble with the growth agenda.

You know, part of what I found so striking in an Asian context versus the general mood that you hear in Europe and the U.S. – and North America’s somewhere in between – is the sense of if we’re facing slow growth prospects, what do we have to do structurally to try to advance broader growth?  And I think that’s a healthy input.

MR. KEMPE:  Thank you.  I think I’ll turn at this point to the audience.  I see Ashraf Ghani has a question.  I’ve already said who you are, the former minister of finance of Afghanistan, but for others, if you could identify yourself as you ask your attention.

Q:  Thank you for a brilliant presentation.  What’s the risk of not agreeing on the rules of the game that will exacerbate the five risks that you’ve identified?

MR. ZOELLICK:  Well, I think you’re going to see varying degrees of agreement across a set of policy areas.  And so the good news was that the G-20, which as many people here know, was actually created 10 years ago for finance ministers and was a generalized talk shop, kind of, moved into a different role about policy coordination.  And in the context of crisis, where everybody was staring into the abyss, led people to come together on some fundamental issues.

I think that the core challenge for the G-20, one of the core challenges, would be as you move beyond crisis, will people still feel that sense of need to try to cooperate in solutions?  That doesn’t mean one-size-fits-all solutions.  And one reason that I wrote the piece on asset price bubbles was that, coming out of the G-20 meeting, I was a little disturbed that people weren’t putting enough anticipatory items on the agenda.  And I think this was one item they need to anticipate.

I think another way of answering that, Ashraf, is in the financial regulatory area, which is one that has got, obviously, the most critical focus, there’s another multilateral innovation that came out of this crisis which was the Financial Stability Forum, which was a loose group chaired by Mario Draghi, the very effective head of the central bank of Italy, has now been expanded to become a financial stability board so it includes developing as well as developed countries.

And it really has a mandate to try to come up with general principles and conventions, whether it be compensation, whether it be capital, whether it be liquidity and other issues.  My own sense, and if you’ve got – since this is the Atlantic Council – with European experience, one knows even how hard this is in a European context to come up with a common – (inaudible).

But also, I think, if you’re going to do it globally the aim shouldn’t be a common set of rules, it should be a common set of principles – but then some monitoring some systems.  So one other aspect of the G-20 that we’ll have to see how it works, was the IMF and, to a degree, the World Bank, were commissioned to monitor and report on various issues about imbalances and problems in the economy.

Now, the first effort at this that I saw, about six months ago, was one by the IMF that had been asked to, in a sense, forecast potential problems.  And it was fascinating because they did a really good PowerPoint presentation to a relatively closed group of finance ministers and the first reaction for some of the finance ministers was, oh my gosh, you can’t put that out there because it points to this problem or that problem.

So exactly what the IMF had been chastised for not doing, it did, and everybody said, oh you don’t want to report that.  So this is going to be the challenge in an intergovernmental system.  But I think the broader issue and this is, I guess, where I’d leave the theme – what really has changed over the past 10 years is – I was with the G-7 at some of its earlier points and the era’s clearly passed the G-7.  That as a group is not going to be – cover enough significant role of economic policymaking.  So whether it’s climate change, whether it’s trade, whether it’s financial system the question is, can you take this intergovernmental system and create some mechanisms to make it more likely that the key economies will get closer to agreement while not leaving others out.

And that’s important because if I think about how I would structure the G-20 system, I think one has to be careful about making it too heavy – secretariats, big working groups.  The G-20 should use the existing institutional structure – the World Bank, the IMF, the WTO, the Financial Stability Board, which not only taps the expertise but actually broadens the inclusions because we’re a G-186.

MR. KEMPE:  Well, that will force us to overcome human nature, but I hope you’re right.  Did I see you – Ana Palacio, former Spanish foreign minister?

Q:  Following up on this issue, to what extent a better voice and representation and just capital distribution at the World Bank and at the fund would help in this direction?  That the Bretton Woods institutions really, A, represent the 21st century world and, B, are more effective and have higher legitimacy because from a different perspective, one can read the G-20 as being a supraboard of the Bank and the fund.  And frankly, you touch upon legitimacy.  I think it’s not good for the system because it fails in terms of legitimacy.

MR. KEMPE:  And let me lay on two specifics on top of that.  One of them is, you’ve talked about a change of voting for emerging markets at the bank and percentages, which is fine.  Another side of this is should the person who replaces you not be an American?  Should you be the last American – well, not necessarily because through another system you could have someone chosen through merit – not in that you – of course, chosen for merit – (laughter).  We know that.  But –

MR. ZOELLICK:  Dominique Strauss-Kahn and I always slightly bristle at this because we like to feel there’s some merit in our choice but – (laughter) – modest though it may be.

MR. KEMPE:  It was so nice to have had you as a friend of the Atlantic Council – (laughter) – but you get my point is this has been a U.S. position and IMF has been a European position, is it time to end that?

MR. ZOELLICK:  Okay.  Let’s start with Ana’s point.  I think the so called Voice Reforms are critically important but they’re not sufficient.  And just to give people a little sense of this, with Ana’s help we actually finished the first phase of a Voice Reform where we added a 25th chair, an extra chair, for sub-Saharan Africa.  And we made voting shift so that the Part II countries, developing and countries in transition, were up to 44 percent.  But one of the things that we got done at the G-20, and I’ll come back to this – and then ratified by the development committee at our annual meeting – was to try to add at least 3 percent by the spring meeting.  So it’d be up to 47 percent plus.

Now, the reason I say it’s not sufficient is that what’s probably more important than voting shares is actually seats at the table.  And the way the board works is – it’s not like, oh, I’ve got an extra one-tenth of 1 percent voting share it’s, kind of, who’s speaking out?  And then one reason we added a seat for sub-Saharan Africa was that the sub-Saharan African countries are particularly underrepresented.  This is an issue for Europe, as Ana notes.  We have about eight or nine, depending on the rotation, European members of that board.  You have one American, you have one Japanese – and as one of my very strong, staunchly European friends said once, this is always a problem whether it’s the G-20, the G-7, our board – either the Europeans say the same thing eight times, in which case people get bored, or they’re saying eight different things, in which case people wonder why they don’t come together on some common position.

So that’s a very big issue for Europe.  In addition to the vote and the seats, there’s a lot we can do in the institution.  And this moves to your point.  What was in the decisions we talked about have to be made by the shareholders and so management helps prod but we don’t actually – we don’t control that decision.  But what is within our control are, sort of, bringing more developing country people into the Bank, bringing them at higher levels.  Frankly, another point that I felt that the percentage of women in higher levels at the Bank was actually much lower than it should have been in institution.  So there’s a lot of transformation of that nature.  It also depends on how you do business.

A little bit if you think about what I was saying up there, it was treating developing countries as clients.  And this requires some change in, in sometimes, the thinking of people at the Bank.  We have a very strong analytical capability, but one of the things I’m trying to work on is, it’s not enough to come to the table and analyze a problem, you have to solve the problem.  And sometimes the first, best analytical solution may not be the best problem solution given the political economy of the country.  So part of it is how you develop those relationships with the partners, which often require a broader sense of the institutional capacity and some of the other aspects.

Now, coming to your question about the president’s position – the decision of the members is to say it should be open, meritorious, every country and then it it’ll be up to the shareholders to decide how they want to implement that.  I’ll just – I’ll flag just a couple points, though, to be thinking about this.  One, let’s not forget these are ultimately political decisions.  We just watched the selection of the European Union’s presidency, okay – and the foreign minister.  Or let’s take a U.N. secretary-general.  You pick any post.  So as analysts here, let’s be fair on how this happens, okay?  And so, I’m not saying that tilts it one way or another, but let’s be honest as opposed to coming up with some idea that we’re all going to go to Korn/Ferry and come up with a fine list and so on so forth.  (Laughter.)

Now, the second thing is, and this is something more for the United States to decide – I personally believe it’s very important for the United States to play an active role in the multilateral system and that isn’t always the case, okay?  And this is, of course, with the Bush administration but let’s talk about the Obama administration and the WTO.  I mean, so let’s – this is something that covers all different administrations.  It’s always a challenge.  And so one of the factors is, you’ll have to decide how that will affect the base of support in interest in the United States.  Now, that’s not only the U.S.’s issue, that’s other countries’ issues as well.

So my point on this is at the end of the day – and your slip was actually indicative too, you see, because if you go to some merit-based process, the first thing is – well, you’ll never have another American.  Was that a merit-based process?  So you have to ask yourself, is that – if we take that switch – and it won’t be my decision, it’s the decision of others – does that mean that we now exclusively exclude Americans?  So those are going to be some difficult political questions and they’re important because they really go back to what Ana was talking about.

These are partly perceptions as well as reality.  So maybe it is time to switch.  But is it time to the, preclude for all time?  And ultimately those decisions are going to be made in a political context reflecting on what you want from the nature of the leadership of the institution.

MR. KEMPE:  Thank you.  Arnaud?

Q:  Can I infer from your point four that we are, sort of, willy-nilly, weaning ourselves away from the paradigm whereby we borrow two to $3 billion dollars a day, primarily from China, to maintain the world’s highest standard of living at a time of growing world shortages, not to mention, of course, the ability to fight trillion dollar wars?

MR. ZOELLICK:  If you increase the savings rate, it should move in that direction.  But there’s a long way to go.  And so another way is you have to – I was talking, Arnaud, about increasing the private savings.  You also have the government savings.  And so the other piece of that is, whatever your forecast is for government budget deficits.

So in the speech that I referred to about after the crisis because my real love is history and I know yours is too, Arnaud, one of the things I pointed out was most of the times when you read those books about the Napoleonic Wars, you read about the fascinating campaigns or maybe the Royal Navy at Trafalgar.  But the chapter that everybody skips over because it seems so boring, but is critically important, was the role that Pitt played in restoring the credit of Britain so that it could fight a 20 year war.

And so I was trying to draw a little historical analogy here about the fact that, and I’m not being critical of the stimulus and others, but over the long-term how the United States manages the budget deficit, how it handles its currency become critically important for that component of national strength.

MR. KEMPE:  Time for one last question.  If you could wait for the microphone and identify yourself, please.

Q:  Yes, I’m Dana Marshall with Dewey & LeBoeuf.  It’s very nice to see you again, Bob.  I have, sort of, one and a half, one and a quarter questions.  First, the real question is, if putting on your hat as say, an advisor the U.S. economy – tremendous amount of interest now focused in the job summit, the president’s speech and subsequent – the need for the United States to export more, especially Asia being the target.

Let’s stipulate that trade agreements are important.  I mean, let’s skip over that because clearly that’s important and I know that would be probably one of the first things you would say.  What’s the second thing we need to do?  What else do we need to do besides moving forward on trade liberalization?  And the quarter, half question is, the chief economist at the Bank recently said that it would be useless from the perspective of the United States government and maybe others that would be arguing that an appreciation of the Chinese currency would help to play a role in rebalancing the economy?

MR. ZOELLICK:  You consider that a quarter question?  (Laughter.)

Q:  I wonder if – is that to the position of the bank, is that a position statement or is it simply a statement of the chief economist?  Thank you.

MR. ZOELLICK:  Well, let’s start on your first one.  It’s a very interesting way to pose the question and I guess I would – let me start by saying this.  When I was in China in August and in India last week, I was struck by the attitude in both countries that they expected the United States to play a very ongoing role in the world economy because the United States that they knew, was a country that was dynamic – not in easily explained ways – but it had the ability to adjust to change.  And its technological capabilities, its ability to develop business models, its ability to reinvent itself was enormous.

And as you know, many people from abroad always try to understand it.  They see it, but it’s, kind of, hard to understand.  And I guess what I would say the core point is – keeping the country open – to goods, to capital, to ideas, to people.  So what underscores that is to be able to have a competitive country, you want to maintain that dynamism, that scientific capability, that technological capability, that ability to put it together in an entrepreneurial fashion.  And in my view, that’s primarily from the private sector.

So there’s a role for the public sector in a stabilizing force but the most – other than, sort of, trade agreements and open markets – I would say keeping that open-ism and dynamism is the most important thing because, frankly, all of us in Washington can try to anticipate and come up with programs but I would have never bet 20 years ago – I just took it off for this – that I would be carrying a BlackBerry, right?  So who thought of a BlackBerry then, right?  But it totally changes my life.  My wife hates it, by the way.  (Laughter.)

Then on the currency – let me tell you the point that Justin then was trying to emphasize.  If you look at China and the United States, they’re almost opposite poles in terms of consumption and savings.  So where the United States was really consuming a huge amount and not saving, China was the reverse – very, very, very high savings rate.  And these are fundamentally structural issues that both countries are going to need to address.  Now, in the Chinese case, what Justin emphasizes and I believe he’s right is that if you look at the savings rate in China, many people focus on the household savings because with the break down of state-owned enterprises, you didn’t have the traditional healthcare, you had to pay for your education, so people built savings.

But if you actually look at those numbers, the household savings rate in China, while higher than they are in the U.S., are not much higher than they are in India.  The real source of savings in China came through the state-owned enterprise sector where you had a banking system that basically paid very little for deposits and made money very cheaply available.  And companies gorged on it, had very high profits and kept it as retained earnings.  Now, where this is an opportunity is that the Chinese themselves recognize, to achieve their goal of harmonious society – that led to high profits for certain, state-owned enterprises.  It didn’t really lead to better returns for the average saver and it didn’t really lead to a financial system that would extend to the rural areas.  And it didn’t really – it sometimes created oligopolies – it didn’t really lead, for example, to more competition in services and others.

So when I was in China in August, if you talk to the people at the NDRC now, they are focusing – in their next 5-year plan – on how they can try to make this structural shift.  Now, Justin’s point, which is one where you will find economists debating both sides is what an exchange does change is that it sends a different price signal.  And his point is that the structural rigidities are so embedded, you won’t get much change automatically from the price change.  Now, over time, sure you would feel that it would send the signals.  But he’s really – the focus – and he gave the speech in Hong Kong – is that he’s saying, we have to focus on the structural agenda.

Now, the flip side of that, is the U.S. has its part too.  And in terms of what the United States is going to try to do to increase the savings rate, which is probably Arno’s question but also in the private-sector side.  So it’s an important aspect because if you look at whether emerging economies or the role of the U.S. – you have a structural imbalance.  I mean, so if you read Martin Wolf you’ll get your fill of this.  And, frankly, unless that gets addressed, you’re going to continue to create some of the inputs for the types of problems that we’ve just been living through.

MR. KEMPE:  In these last two or three minutes, we are the Atlantic Council, fit Europe into that picture.  What do they need in terms of internal rebalancing?  And you talked about inflection point and the U.S. is coming out, perhaps, better than a lot of people thought.  How about Europe?

MR. ZOELLICK:  Well, first I think the European central bank performed extremely well.  I think the respect for the euro as a currency has been improved.  Now, the allusion that I made to some of the challenges you might see in some of the countries in Europe now with their debt could put some of that at risk again.  I think the second issue – and maybe I should put it first – that really was the big issue in this crisis was this crisis came 20 years after the events of the end of the Cold War – that created a Europe whole and free and created a reintegration of Europe.

And, in a way, because Central and Eastern Europe’s growth strategy over the past 20 years had been based on an integration model, trade, movement of people, remittances, investment – many of the banks in Central and Eastern Europe were owned by Western European Banks – it was particularly vulnerable to the withdrawal of that.  And one thing that I actually am quite pleased about the role that the bank played is that we saw this quite early and you can see.

And we tried to draw attention to it when, frankly, some in Europe, I think, were a little slow on it.  To compliment the European institutions, the EBRD was not slow on this and the European Investment Bank was not slow on this.  So we did something, and this is a nice little foreign policy touch to development – I consciously worked through the EBRD and European Investment Bank and we put together a common program – so it had a European lead on it – and then, frankly, the European Commission came in in a big way and added to its resources.

So I think, in a way, Europe was tested.  And it passed the test.  It came to support its Central and Eastern European neighbors.  Now, that test isn’t over yet and the non-Euro members as you get further out and look at the problems in Ukraine and others, those are still big challenges – but I think that’s a good sign institutionally.  One last little iota is that if you believe that a growth agenda in structural reforms is important, I think it will be interesting to see what the new German government does because there’s some discussion about that in the context of politics of Berlin.  We’ll have to see how it works out.  But if Germany does try to support that, that could be quiet significant in a global context.

MR. KEMPE:  Thank you, Bob.  I’m going to thank you on behalf of the audience.  You delivered what was billed – strategic thinking, innovative development thinker, systematic thinker and all was on full display here and thanks so much for taking the time to do this.

MR. ZOELLICK:  It was my pleasure, thanks.  (Applause.)

(END)

Transcript by Federal News Service, Washington, D.C.

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