International Financial Crisis and its Implications for Latin America and The Caribbean United Nations Economic Commission for Latin American Countries Thirty Fourth Session
Ms. Shamshad Akhtar Assistant Secretary-General for Economic and Development of DESA, Secretary General’s Special Advisor of Economic and Finance
27 August 2012, San Salvador
Let me start by thanking Cepal for inviting me to participate in this useful event and offer remarks on the exhaustive presentations by our ECLAC colleagues Osvaldo Rosales and Juan Alberto Fuentes.
I agree with most of the diagnosis, which should not be surprising given the longstanding collaboration between DESA and ECLAC on the assessments of the global economy through the UN’s flagship report the World Economic Situation and Prospects. So what is there to add? Well first we need to recognize this round of crisis is different. As a lot has already been said on emerging trends, I will confine to a few key developments and focus mainly on the policy challenges and options.
Global economy is undoubtedly going through a complex phase. Depth and dimensions of crisis are unprecedented and it has protracted for five years and at this stage there does not seem any sign of an end to it. Recurring and moving from a crisis of commodity price volatility, bursting of housing bubbles and subprime mortgage and financial sector, today’s crisis is combination of all these developments that have now turned into crisis with attendant fiscal and sovereign debt complications. This evolving nature of crisis, its twist and turns moving from recession to recovery and taking a U-turn back to recessionary trends has triggered a lot of discomfort and uncertainty. Losses stemming from this crisis will be quite large relative to the past events, but its human aggravation is now gripping the policy makers.
As in 2008, the problems originate in the developed countries. Much of the focus is on the euro zone. And, indeed, it is in the red zone. But many of the other developed countries, including the United States, are suffering the same weaknesses, although in varying degree. There are four major weaknesses that continue to feed into each other:
- First of all, unemployment has increased staggeringly and is still on the rise;it is both cause and effect of the lack of economic recovery.
- Second, the weak economy has compounded financial fragility that has been exhibited vulnerabilities stemming from excessive risk taking and weak regulatory and supervisory enforcement. Banks, firms and households moved from overleveraging themselves to deleveraging. Continued deleveraging is holding back normal credit flows and consumer and investment demand.
- Third, the fiscal austerity responses to deal with rising public debts are further deterring economic growth, which in turn is making a return to debt sustainability all the more difficult. And
- Fourth, bank exposure to sovereign debts and the weak economy are perpetuating financial sector fragility, which in turn is spurring the continuous deleveraging.
These problems are spilling over to developing countries through weaker demand for their exports and high exchange rate and capital flow volatility and it is also exacerbating volatility in commodity markets that have become highly “financialized.”
Governments of developed countries continue to struggle to break through this vicious circle. Much of the focus is on Greece and its possible exit from the euro. But, let’s face it, whether Greece is in or out, it is going to be extremely costly either way. It will be costly for Greece, for Europe, for financial markets, and, hence, for the world at large. We should be concerned about Greece, but unfortunately bailing in or bailing out Greece alone will not do much to resolve the crisis, as the neighbours also require larger rescue dosage beyond the appetite of stronger Euro zone.
Fiscal austerity is another predominant policy direction taken by most developed countries. This seems logical in the face of rising public debt and the financial unsustainability of the generous pension funds and social entitlement schemes. But it is not helping developed countries get out of their low growth trap and it is not tackling the problem of high unemployment. It is thus fuelling the vicious circle instead of breaking away from it. For that, much more needs to be done. As detailed in our latest World Economic Situation and Prospects report, globally concerted efforts are needed on at least five fronts.
- First, fiscal policy stances will need to be changed to provide more stimulus and this needs to be coordinated internationally. Under the current conditions, simultaneous fiscal retrenchment across Europe has become self-defeating as massive public expenditure cuts are further pushing up unemployment, with negative effects on growth and fiscal revenues. Premature fiscal austerity should thus be avoided and fiscal consolidation should focus on medium-term, rather than being the prime driver of short-term adjustment. Instead, governments with still low financing costs in capital markets should allow automatic stabilizers to operate and ensure fiscal stimulus in the short run. Since fiscal space is clearly severely limited in some economies, international policy coordination will be critical. In Europe, instead of the present asymmetric adjustment through recessionary deflation—where most of the pain is concentrated on the countries in debt distress—it would entail adopting a more symmetrical and sequenced approach by encouraging countries with greater fiscal space to push for euro area-wide reflation. This will also support recovery in debt-distressed countries and ease their fiscal pains. For all economies it will create more benign conditions to implement structural reforms and medium-term fiscal consolidation plans ought to be phased in subsequently. The United States would equally need to consider such a sequenced approach. The first priority should be to boost demand in order to reduce unemployment, especially through public investment and more direct job creation. This would help households delever and boost consumption demand through income growth. Investing more in infrastructure and other measures promoting structural change, on which I will say more in a second, would underpin new drivers of growth and renewed export competitiveness in the developed economies over the medium run. This would give time for China and other emerging economies to rebalance towards greater reliance on domestic demand growth and smaller trade surpluses.
- The second and related challenge for all countries will be to redesign fiscal policy—and economic policies more broadly—in order to strengthen the impact on employment and promote structural change for green, and thus, more sustainable economic growth. Developed countries now put most emphasis on structural reforms of their health care and pension systems and labour markets. These are important for the medium run, but they are undertaken in the context of fiscal austerity and thus provide little immediate push to economic growth. Not only for the sake of giving appropriate follow-up to Rio+20, but also to strengthen the short-term recovery much more should be done to stimulate green growth through fiscal incentives and investments in infrastructure and new technologies. Lessons can be learnt from several developing countries, such as the Republic of Korea, which have successfully provided economic stimulus through green infrastructure investment and energy-saving incentives. This has been found to generate strong employment effects, suggesting investing in green growth can be a win-win solution. We will discuss such strategies at greater length tomorrow and CEPAL’s document on structural change provides excellent ideas for what this would imply in Latin America and the Caribbean. These proposals should not be seen as strategies for the long-run, but thought through as integral part of the immediate responses to stave off the looming global downturn.
- Third, global financial market instability, emphasized by both Osvaldo and Juan Alberto, needs to be attacked at its root causes. This challenge comes in two parts. The first part is to find greater synergy between monetary and fiscal stimulus. Continuation of expansionary monetary policies among developed countries will be needed, but negative spillover effects onto capital flow and exchange rate volatility need to be contained. This will require reaching agreement at the international level on the magnitude, speed and timing of quantitative easing policies within a broader framework of targets to redress the global imbalances. The second part of the challenge is to accelerate regulatory reforms of financial sector. This will be essential to avoid systemic risks and excessive risk taking in order to break away from low growth trap and financial fragility in developed countries and high capital flow volatility for developing countries. Steps have been taken in some of the national jurisdiction, but implementation is lagging behind. Moreover, insufficient coordination between national bodies appears to result in a regulatory patchwork. Global financial stability is unlikely to be achieved in the absence of a comprehensive, binding and internationally coordinated framework. This is needed to limit regulatory arbitrage, which includes shifting high-risk activities from more to less strictly regulated environments. Among other measures, such a framework should include strict limits on positions that financial investors can take in commodity futures and derivatives markets that may also help stem
- The fourth challenge is to ensure that sufficient resources are made available to developing countries, especially those possessing limited fiscal space and facing large development needs. Substantial resources will be needed to accelerate progress towards the achievement of the Millennium Development Goals and for investments in sustainable and resilient growth. Fiscal austerity among donor countries has alsoled to a reduction in aid budgets. Fiscal adjustment should not come at the expense of development and donors should deliver on existing aid commitments. For the future, we will need to consider mechanisms that delink international development financing from the business cycle. International taxation (such as airline levies, currency transaction taxes or carbon taxes) would be one option to provide more stable resources for development cooperation and fighting climate change. In the this year’s World Economic and Social Survey, another flagship report of DESA, we elaborate on how these options could be put in practice.
- My fifth and final recommendation is that we also need a reform of the global reserve system to help break away from the present problems, as well as for safeguarding global financial stability in the future. Last year, emerging and developing countries added another $1 trillion to their reserves. While a buffer to external shocks, reserve accumulation in these magnitudes has high opportunity costs and it also constitutes a deflationary bias to global demand, and as such it is further holding back the recovery. It also implies that, in the aggregate, developing countries continue to transfer large sums of financial resources to the rich countries, rather than the other way around as implied by my previous recommendation. For a benign and sustainable global rebalancing the world would need better mechanisms to pool reserves internationally, through the IMF and regional mechanisms, as well as by enhancing the role of Special Drawing Rights (SDRs) as international liquidity. Doing so will reduce dependence on the dollar as the major reserve currency, while providing greater exchange rate stability, and a stronger global financial safety net.
- In closing, let me repeat where I started: these are not just five possible options. They need to go hand in hand. Only by enacting in a concerted manner on all these fronts we can avoid another recession, while making a start with a benign and sustainable rebalancing of the world economy. This will not be easy politically, but muddling through will be even more difficult as we can already see in many European countries. I am glad to see that CEPAL is trying to push the policy dialogues in the region in the right direction. In doing so, I hope, we will all recognizethat we are in this together and can persuade our leaders to jump over their own shadows and fundamentally change course for the better of the world.