The global economic collapse’s long-term impacts on developing countries
The most severe global financial crisis since the Great Depression has wreaked havoc on the world economy. Even with an expected recovery in the second half of 2009, the United Nations estimates that world gross product (WGP) will likely fall by 2.6 per cent for the year. Some calm has returned to global financial markets since the second quarter of 2009, with equity prices rebounding and risk premiums narrowing. World international trade has begun to grow again. Industrial production in many parts of the world has shown signs of recovery.
Encouraging as these recent trends may be, global economic conditions are still very fragile. Credit conditions remain tight in major developed economies, where most financial institutions are still in the process of de-leveraging, consolidating and cleansing their balance sheets. In most economies, domestic demand remains weak at best and requires continued policy support. Increasing unemployment, idle factories, disorderly adjustment of the global imbalances, along with a number of other factors, including an intensification of the H1N1 influenza pandemic, pose important downside risks to global recovery.
The world economy is projected to recover in 2010, but most likely at a pace below 2 per cent. The global recession will translate into a fall in world per-capita income by 3.7 per cent in 2009, with sharp declines not only in developed economies but also in a large number of developing countries: at least 60 developing countries (of 107 countries for which data are available) are expected to suffer declining per-capita income in 2009 and tens of millions more people likely will remain poor or fall into poverty. A substantial slowdown in progress towards the other Millennium Development Goals (MDGs) is expected as well, especially in those countries that were not on track to meet most of the MDGs even prior to the crisis, such as a number of economies in sub-Saharan Africa. Some of the adverse impacts could be long-lasting, damaging the basis of human development, in such areas as maternal and infant mortality, education enrollment and completion rates, women’s employment and access to public services.
Establishing an international counter-cyclical framework
Since late 2008, massive public funding of about 30 per cent of WGP has been made available, mostly by developed economies, to recapitalize banks, taking partial or full Government ownership of ailing financial institutions and providing ample guarantees on bank deposits and other financial assets. The governments of many countries have also adopted fiscal stimulus packages, totalling about $2.8 trillion, or about 4 per cent of WGP, for 2009-2011. While these policy measures have facilitated a tentative recovery of the global economy, the restoration of robust and sustainable growth in the world economy requires dealing with additional policy challenges.
As noted in the communiqué of the G20 leaders in Pittsburgh, the premature withdrawal of monetary and fiscal stimuli poses a significant risk. Despite a rebound in production, employment growth continues to be weak, and will likely remain so in 2010. Both the financial sector and the real economy are still fragile, requiring continued strong policy support. There are legitimate concerns about the fast deteriorating fiscal positions in some major economies. However, past crises show that the most successful cases are where fiscal consolidation took place during a sustained recovery of the economy and related boosts in public revenue, while failures occurred where fiscal stimulus measures were too weak or withdrawn too soon, leading to aborted recoveries alongside mounting public indebtedness.
Thus, an ‘exit strategy’ should retain a countercyclical policy framework, with stimulus measures only phased out after unemployment rates have come down to acceptable levels. In order to reduce uncertainties and to anchor market expectations, it will be desirable for policymakers worldwide to agree on a set of credible guidelines for phasing out stimulus measures after the global economy has recovered. It is important to coordinate these guidelines internationally, to avoid inconsistency and negative cross-border policy spillover effects, which could delay, or even derail, the recovery of the world economy. Given the systemic defects of the current global reserve system, a poorly executed exit strategy will exacerbate exchange rate instability.
More international efforts are needed to ensure adequate transfer of resources to developing countries, particularly to the most vulnerable low-income economies. Most developing countries lack the resources to undertake the needed counter-cyclical measures for mitigating the impact of the global financial crisis on their economies. Of the $1.1 trillion international financing packages under the auspices of the G-20, only $750 billion has been delivered and only in terms of contributions to IMF resources. Only $50 billion was earmarked for supporting social protection, boosting trade and safeguarding development in low-income countries, but this promise has only been partially fulfilled. In this regard, given the possible long-lasting impact on low-income countries, it is also critical for the international community to deliver on ODA commitments. To meet the 2005 Gleneagles commitments, ODA flows from OECD/DAC countries should increase by $35 billion to reach at least $155 billion by 2010. Of this increase, $20 billion should go to Africa. The crisis cannot be an excuse not to deliver; rather, it should be a reason to accelerate on commitments, given the increased external financing needs in the poorest countries.
There is a continued need for enhanced international coordination of macroeconomic policies. This is not only needed for putting the global economy on a path to real recovery, but also to steer towards a more balanced and sustainable growth path. The recession has narrowed global imbalances in a recessionary fashion, with surplus countries losing export revenue and deficit countries seeing sharp drops in imports. However, the structural problems that caused the emergence of the wide global imbalances in the first place have not been removed. Current policy efforts for recovery could well cause a re-emergence of macroeconomic imbalances. In most surplus countries, especially in Asia, the conditions of heavy dependence on exports for growth and relatively weak domestic demand have not fundamentally changed. The continued global imbalances and mounting public indebtedness increases the risk of strong downward pressure on the dollar. Effective policy coordination will be needed to ensure that such a destabilizing scenario does not become a new drag on the global economy. The ‘Framework for Strong, Sustainable and Balanced Growth’ -- agreed to by the G-20 leaders in Pittsburgh -- will only succeed if it addresses these underlying weaknesses in the global system.
Global governance and the Bretton Woods institutions
Recognizing that the roots of the current crisis lie in failures in global governance, the United Nations Conference on the World Financial and Economic Crisis and its Impact on Development in June 2009 called for (1) “reforming and strengthening the international financial and economic system and architecture, as appropriate, to adapt to current challenges” and (2) “fostering good governance at all levels, including in the international financial institutions and financial markets.” In this regard, it recognized “the urgent need for further reform of the governance of the Bretton Woods institutions, on the basis of a fair and equitable representation of developing countries, in order to increase the credibility and accountability of these institutions.”
While the international emergency measures contributed to the ‘green shoots’ of recovery currently celebrated and appear to have “worked”, the urgency of completing requ
ired international governance reforms has been underlined by the enormous costs of these interventions, both in terms of public resources and economic distress borne by billions not party to their design and implementation. Moreover, the outcomes of the September G-20 summit in Pittsburgh highlight the political difficulties that need to be overcome in the following areas:
Voice and participation. The proposed increase in the weight of votes of emerging economies is a step in the right direction, and politically expedient with these economies’ increased financing contributions. However, much of the increases in the votes of certain emerging economies have been achieved at the expense of the votes of other developing countries, a retrogression from the agreement in September 2006 which promised these reforms in terms of increasing the overall voice of developing countries. The understanding that providing ample voting weight to potential users of Bretton Woods institutions’ resources would help guarantee the institutions’ effectiveness - a principle enshrined in the original 1944 allocation of voting weights when European countries were the prospective users - should guide vote reallocation and reforms in voting procedures - including in the determination of the number of seats in governing bodies.
Surveillance. The ongoing financial crisis underscores the need to redress the deficiencies of surveillance over mature financial markets and advanced economies and to better integrate macroeconomic and financial sector surveillance. More attention should be given to systemic financial risks, including asset price bubbles, co-variant risk concentrations across financial institutions and off-balance sheet risk exposures.
The primary long-term goal of enhanced surveillance must be to reduce global imbalances and prevent the re-emergence of those imbalances that contributed to the current crisis. This can only be accomplished if systemically important countries take a coordinated approach to fiscal and monetary policy, with the aim of shifting aggregate demand from deficit to surplus countries. Without political agreement in this area, any other measure will only be partial and inadequate. Similarly, a start with reform of the international reserve system will need to be made, since the use of a single national currency, as the main global reserve money, intrinsically leads to a mounting deficit by the country issuing that currency. There is a need to promote an adequate level of cooperation, whether under whatever auspices, towards mutually compatible policies on fiscal, monetary and exchange rate issues, including mechanisms of accountability and enforceability in the application of these policies.
International Financial Regulation. International coordination of financial regulation is indispensable for achieving the intention of G-20 countries to reshape regulatory systems to identify and address macro-prudential risks; expand the scope of regulation and oversight to all systemically important financial institutions, instruments and markets; mitigate pro-cyclicality in prudential regulation; strengthen capital, liquidity and risk management; implement new principles on executive remuneration; and improve standards on valuation and provisioning.
In a financially integrated world, regulatory effectiveness depends, in large part, on significantly enhanced international cooperation among regulators. However, current institutional arrangements to ensure that national decisions regarding regulation appropriately take into account both external and domestic consequences remain ineffective. The effort at the Pittsburgh summit to agree on compensation standards in the financial sector presents an example of the need to rise above the variety of inconsistencies and incoherence among regulatory systems across countries, which offers potentially dangerous opportunities for arbitrage and evasion. Intentions to limit the systemic risk arising from financial institutions’ size and interconnectedness will require international coordination.
Establishing international mechanisms to coordinate regulation, minimize conflicting standards, and enforce agreements, akin to the trade policy issues dealt with at the World Trade Organization, will entail an extended, but necessary process in the coming years.
Rebalancing Global Demand for the Long-term. In Pittsburgh, G-20 countries called for “a pattern of growth across countries that is more sustainable and balanced, and reduce development imbalances,” a pattern we have advocated in recent years. While improved surveillance and exchange rate adjustments have important roles to play in this regard, this impact would be limited as long as domestic sources of deficits and surpluses, being sustained by global stresses, are not addressed. Exchange rate adjustments would have more predictable consequences with a reduction in dependence of the global reserve system on the US dollar.
In developed countries, the reduction of fiscal imbalances and decreased reliance on debt-financed consumption as well as reduced asset and income inequalities would be indispensable. For many developing countries, switching from dependence on export demand to domestic demand will require a fundamental reorientation of economic policy. States must recapture policy space, including the capacity to raise taxes and tariffs, to fund higher rates of social and capital investment and develop domestic industries. Their income policies should enable labour productivity increases to translate more rapidly into higher wages.
Strengthening international cooperation in tax matters
Capital mobility, in the absence of tax harmonization among countries, has contributed to regulatory and tax competition, with the result of clearly diminished capacities of tax and financial authorities to secure the information required for supervision and tax collection. The UN Financing for Development Conference in Doha in 2008, the G-20 meeting in London in April 2009 and the UN conference on the financial crisis in June 2009 all highlighted the importance of strengthening international cooperation in tax matters.
This newly strengthened effort can only be effective with the full and equitable participation of all tax jurisdictions, particularly developing countries, which are poorly represented in key tax cooperation fora such as the OECD and the G-20. Faster progress in reducing harmful tax competition and upgrading cooperation in such areas as exchange of information and transfer pricing can be achieved through universal participation of all countries.
Global reserve system for stability, accountability, and equity
In our Spring 2009 statement, we emphasized the technical advantages of a global reserve currency independent of the currency of any one economy, or region, and note the burgeoning international interest in this issue. We highlighted the advantage of such a system in reducing the inherent instability of the current approach which relies on external deficits by the country providing global reserves. In Pittsburgh last month, G-20 countries called for a new era in managing global imbalances. As we emphasized above, this objective will require adjustments to global arrangements, to allow countries to take the necessary domestic adjustments, within an international countercyclical framework. While the Pittsburgh commitments do not include any enforcement mechanism, important progress in managing imbalances can be made by reducing the reserve currency country’s “privilege” to run external deficits in order to provide international liquidity.
It is timely to emphasize that such a system also creates a more equitable method of sharing the seigniorage derived from providing global liquidity. Greater use of a truly global reserve currency, such as the IMF’s Special Drawing Rights, enables the seigniorage gained to be deployed for development purposes, as asserted in the Monterrey Consensus in 2002.
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lean energy investment strategy as a key global warming reponse
So far, the climate challenge has been dealt with mainly as an environmental problem. This needs to change decisively, if the global community is to meet the climate stabilization goals that science is asking for. Setting targets and timetables are necessary, but not sufficient in themselves, as they do not deal with the underlying development problems facing developing countries. Climate change and development have to be addressed together as the highest priorities of the international community.
The post-Kyoto experience, especially in recent years, highlights the limited role that price-based mechanisms can play in addressing climate change. Volatility in energy prices have made carbon markets quite unstable in terms of trading volumes and prices and, thus, unsuitable for providing the long-term signals needed to reorient long-term investment. Because of market instability, the impact of taxation and (removal of energy) subsidy mechanisms will be subject to the same unpredictability. Moreover, these approaches have to address the issue of compensating for their unintended distributional effects. Most importantly, the scale of the change in economic behavior required for surmounting an accumulated stock of climate risk suggests that market-based approaches, more appropriate to the marginal suppression of emission flows, will be inadequate to the global task.
A substantial and additional investment program, in the order of $250 to $500 billion a year, to encourage developing countries to employ clean energy approaches for their development is the most effective way to meet the global community’s climate objectives. As suggested in the September 2009 UN World Economic and Social Survey entitled Promoting Development, Saving the Planet, establishing mechanisms for financing these developing country investments would be the most potent and timely international response to the global warming emergency.
Generating the volume of financing to meet the climate change challenge will require summoning the necessary political commitment at the global level, in which the outcome the Copenhagen summit in December can play a critical role. Governance arrangements for climate change resources need to be fundamentally different from those under which official development assistance is currently provided. The United Nations Framework Convention on Climate Change (UNFCCC) provides the only legitimate and universally accepted framework for aggregating and equitably allocating resources on the basis of existing agreements.