Bleak world economic situation and prospects
The combination of the collapse of global private sector spending and investment with inadequacies in the responses by national authorities makes a global depression – a prolonged period of collapse in production, employment, and trade – a real possibility. The current crisis is already causing visible setbacks in progress towards the Millennium Development Goals and other internationally agreed development goals. The crisis has the potential to fuel social unrest and if prolonged will pose a significant threat to global peace and security.
The UN expects world gross product (WGP) to fall by about 2.3 per cent in 2009, compared with the modest growth of 2.1 per cent in 2008 and higher average growth in the years prior to the crisis. All major developed economies have fallen into a deep and protracted recession, which is being transmitted rapidly to developing countries through international trade and financial channels. Having opened up their economies over the past two decades, most developing countries are being hurt disproportionately as world trade has fallen precipitously, prices of primary commodities have collapsed, international tourism has dropped significantly, remittance flows are falling, capital flows have reversed sharply, trade credit has dried up and the cost of external borrowing has increased substantially.
In numerous publications over the last several years, before this financial crisis, the UN has pointed to the accumulation of massive global imbalances as unsustainable. The UN has long advocated international macroeconomic policy coordination to adjust such global imbalances in an orderly manner, thereby avoiding an abrupt slowdown in the world economy and the serious consequences it would have on an over-extended international financial system.
Sustaining growth in developing countries
Developing countries – whose policies did not lead to this crisis – are facing tremendous challenges in financing their balance of payments and in maintaining sustainable growth, as many confront sharp declines in their growth and exports. Unemployment is rising at an alarming pace and global poverty rates are increasing, while government revenues are falling. All this severely constrains the policy capacity in many developing countries to mitigate the social impact of the crisis.
The most important assistance that the international community can provide to developing countries is to expand the policy space available to national authorities. This will permit them to design and adopt appropriate policies to respond to the collapse in trade and private investment, undertake social policies to protect the poor and increase the stability of their economies. The international donor community and multilateral institutions have to fundamentally abandon the prevailing approach oriented toward constraining government interventions to make them accountable to private markets, and instead move to strengthen public sector capabilities in developing countries.
Adequate international liquidity and development financing will need to be made available to developing countries to cope with the immediate effects of the crisis and to engage in fiscal stimulus measures aligned with long-term development priorities, including accelerating progress towards the MDGs, facilitating diversification of economic activities to improve stability, enhancing food security, and reducing the vulnerability of growth to global warming. In a period when the major threat is deflation, expanded fiscal space in all countries is technically appropriate; preconditions and conditionalities which constrict fiscal capability must be avoided. The “Group of 20” leaders recognized this need. The additional resources they have pledged to make available for this purpose are clearly a step in the right direction, but fall well short of covering the financing needs of developing countries. The UN estimates that at least $1 trillion over the 2009-2010 biennium will be needed for developing countries alone, whereas only a small fraction of the resources pledged at the London summit will be made available to these countries.
Further, given the clear priority of sustaining growth in developing countries in the face of external shocks, which is also consistent with rebalancing global demand, enhanced financing from multilateral agencies should not be accompanied by onerous, pro-cyclical, policy conditionality. The need to protect low-income countries, in particular, from external economic shocks, including the recent increases in food prices – such as through improved or new compensatory financing mechanisms that can provide resources quickly - is urgent.
Call for unprecedented international cooperation to sustain global growth and regulate finance
As crisis clouds gathered in Spring 2008, the United Nations called for launching a substantial multilateral effort at “international cooperation to sustain global growth and to regulate finance . . . to moderate the depth of the global slowdown and to safeguard economic development efforts.” The international community has had great difficulty in responding adequately to this threat and, in Autumn 2008, we were compelled to note that “individual country policies – both to do nothing and to undertake drastic measures to rescue their domestic financial sectors – have inflicted new vulnerabilities on other economies and have been attended by international political recriminations, reminiscent of the 1930s, when only ad hoc processes for coordinated action existed.” Absent well-coordinated and adequate responses, trade volumes have collapsed as the US dollar has appreciated, reflecting the disorderly adjustment underway.
Fiscal stimulus plans – mostly from developed and some major developing countries and totalling some $2.6 trillion or 4 per cent of WGP – have been announced and are being implemented. On 2 April in London, the “Group of 20” announced $1.1 trillion in crisis financing, though most of this was not additional, would mainly strengthen IMF financing, and would not enhance developing countries’ ability to respond adequately to the crisis. Implementation is to be spread over several years, between 2009 and 2011. This falls short of what is needed, especially if stimulus efforts are not coordinated adequately and, as indicated, most developing countries cannot undertake such stimulus measures. To close the emerging output gap, a stimulus of at least 3 per cent of WGP per annum would be required.
The duration and depth of the crisis are likely to worsen should the stimulus and liquidity restoration measures only gain traction slowly; meanwhile, large amounts of tax-payer money are on the line. Uncertainty about the financial impacts could then be a source of renewed turmoil, misalignment of exchange rates and further disorderly adjustment of global imbalances. Concerted action will thus require a broader framework for international macroeconomic policy coordination to respond to such risks.
Avoiding retreats into protectionism should be part of this framework. Yet, strong pronouncements for a “level playing field” ring hollow unless there is recognition of different country capabilities in production and trade. Inadequate recognition of these differences in the proposals under negotiation in the WTO Doha trade talks continues to undermine efforts toward a developmental outcome. Now, developed country rescue packages and conditionalities imposed on developing countries threaten to aggravate this situation.
Overt protectionism includes tariffs and non-tariff barriers, such as government procurement restrictions, contained in some stimulus packages. Because of the complex provisions and coverage of international trade and investment agreements, seemingly “symmetric” provisions (e.g. exceptions to the application of provisions to countries covered by particular WTO or other international agreements) can have markedly asymmetric effects. Subsidies, implicit and explicit, can be just as distorting to open and fair trade. To the extent that such measures may be deemed unavoidable, efforts need to be made to finance additional support for developing countries to mitigate the impact of the crisis as well as of both open and hidden subsidies (such as government support through bailout packages and guarantees for financial assets), in order to avoid further distortions.
The crisis has exposed serious defects in financial regulation and supervision. At their April 2009 summit, the “Group of 20” leaders recognized the indispensability of international coherence in efforts to strengthen transparency and accountability, enhance sound regulation and promote integrity in financial markets. There is a broad and growing consensus that deregulation, pro-cyclical regulatory approaches and “self-regulation” by market participants has served to undermine rather than strengthen the global financial system.
We have previously decried that many regulatory standards, such as Basle II on capital adequacy of banking institutions, have been designed with little participation by developing countries, are not suited to the institutional realities of these countries, and undermine rather than promote more inclusive, counter-cyclical, development financing. These standards constrain developing countries’ access to international finance. Developing countries need to be full participants in regulatory policy setting, not least to protect themselves from the harmful effects of external financial developments, as in the current situation.
Making progress in strengthening global governance
More than anything else, the global magnitude of this crisis exposes a systemic failure in global economic governance. Reform efforts are being pursued, at present, in various ad-hoc groups, including non-UN system venues, most prominently in the two summits bringing together the “Group of 20”,in Washington, D.C. and in London. As agreed in the Doha Declaration on Financing for Development of December 2008, Member States will hold a United Nations conference on the world financial and economic crisis and its impact on development, in New York on 1-3 June 2009.
The Doha Declaration underscored “that the Bretton Woods institutions must be comprehensively reformed so that they can more adequately reflect changing economic weights in the world economy and be more responsive to current and future challenges.” The “Group of 20” April declaration called for bold actions to restore the effectiveness and legitimacy of these institutions. Recent IMF reports acknowledge previous mistakes as a basis for reform. The ongoing IMF review of its lending role, which could simplify conditionality and include quicker disbursements more proportionate to the scale of the external shocks, is also promising. However, the pace of reforms thus far has not been sufficient to enable the effective responses demanded by the crisis from the Bretton Woods institutions. Moreover, there are gaps in the international system that these institutions are not fulfilling, which could require either expanding their mandates, if appropriate, or establishing new institutions. These kinds of decisions are inevitably of a political nature and logically cannot be resolved exclusively through internal processes of these institutions. It is therefore important to identify the parameters which can guide the world community in addressing the fundamental decisions it must take in the period ahead.
First, while caucuses often play an important part in making progress in difficult political decisions, they cannot substitute for actual decision-making, even if such caucuses are held concurrently with meetings of official bodies in the same location. Any consensus will have to be taken up and decided on by politically inclusive and thus legitimate bodies.
Second, reform efforts should be shaped by the fundamental purposes of the international system. Such purposes inspired the design of the Bretton Woods institutions in 1944 and are articulated in their founding documents. A modern restating of these purposes is found in the Monterrey Consensus of 2002: “to eradicate poverty, achieve sustained economic growth and promote sustainable development” in order to “advance to a fully inclusive and equitable global economic system.”
Third, future reforms should provide sufficient balance between spurring innovation and protecting systemic integrity. In recent years, partly as an accommodation to intellectual fashion and due to the impact of debt crises and commodity price volatility on the state in developing countries, global system rules have paid insufficient attention to systemic stability.
Fourth, global mechanisms must strike a balance between representation of all affected parties, particularly those significantly affected, and impartiality, consistent with modern principles of good governance and to avoid conflicts of interest. Weaknesses in IMF surveillance reflect the failure to sufficiently achieve impartiality. As noted before, the Paris Club mechanism for addressing sovereign debt problems suffers from insufficient representation of all stakeholders, as well as from conflicts of interest.
Fifth, multilateral institutions must balance specialization and coordination. The post-World War II system design called for specialized agencies coordinated through the United Nations. In practice, coordination has been inadequate and agencies have moved into areas beyond their specialization – such as the World Bank’s role in promoting structural adjustment, including trade liberalization.
Rebalancing demand with additional development finance for reorienting investment to address climate change
There is a need to effectively implement the broad international consensus in favor of protecting the most vulnerable from the costs of the crisis. The UN is establishing a system-wide vulnerability monitoring and alert mechanism. The “Group of 20” April declaration requested the UN to establish effective mechanisms to monitor the impact of the crisis on the poorest and most vulnerable. The same group of countries noted that over a trillion dollars would be committed to deal with the international dimensions of the crisis. This commitment must be rapidly put into action, including ensuring that a large enough share of the additional resources will flow to developing countries. In this regard, the World Bank’s call for increased development financing is valuable.
It is important, however, to embed these efforts in a broader and longer perspective of rebalancing global demand in order to place world economic recovery on a firm and sustainable path. As the tentative indications of a bottoming out appear in large economies, it is clear that a recovery that relies only on inadequately coordinated stimulus spending could well lead to a renewed widening of the unsustainable global imbalances, triggering renewed financial instability affecting growth worldwide. This would further jeopardize achieving long-term development goals.
It is therefore in the interest of all countries to promote robust investment growth in the developing world, and for the global community to seize this opportunity to channel such an investment push into addressing climate change objectives. Relying on private investment and other voluntary approaches is not promising in the immediate period; the collapse of carbon market prices in the context of the economic downturn underscores that such approaches cannot be an adequate response in addressing a long-term problem. Governments, cooperating on the basis of equitable burden-sharing, will have to take the lead in undertaking a global new deal in climate investment and implementing new regulatory regimes to provide effective incentives for private investment. The minimum level of investment in renewable energy as well as infrastructure and technology required to tackle and adapt to climate change is estimated to be at least one per cent of global output. Achieving a decisive outcome in the Copenhagen summit in December is indispensable for establishing accountable and transparent international cooperation mechanisms for a more adequate and effective climate change response.