World economy on the edge
Continuing credit crunch, declining U.S. dollar, rising prices for food and fuel all point to economic downturn
The year 2008 marks a major transition in global economic and social development with the waning of the era of cheap and plentiful fossil fuels, accelerating pressures on commodity prices, particularly those of food, and worsening impacts of climate change on livelihoods and well-being as well as a slow-down in the growth of the world economy from the 3.8 per cent registered in 2007 to an estimated 1.8 per cent in 2008.
These factors are increasing inequalities and risk compromising the achievement of the internationally agreed development goals, including the Millennium Development Goals by 2015. Bold and concerted policy action by both developed and developing countries can, however, serve to improve global economic and social performance in 2008 and 2009. Additionally, a reformed international reserve system and better financial regulation and safety nets would help improve financial conditions and confidence to prevent the recurrence of similar crises.
According to the World Economic Situation and Prospects 2008 mid-year update, the global economy is teetering on the brink of a severe economic downturn. The deepening credit crisis in major developed market economies, as triggered by the continuing housing slump, the declining value of the United States dollar vis-à-vis other major currencies, persisting global imbalances, and the soaring oil and non-oil commodity prices are slowing growth of the global economy.
Without aggressive and coordinated expansionary policies, a more pessimistic scenario could occur, which could trigger a disorderly unwinding of the massive global imbalances and have drastic implications for global trade and finance. In addition, the steep rise in food and energy costs is compounding the downside risks, particularly in view of the unfolding food crisis, which poses a threat to social and political stability. The dollar may still decline another 15 per cent in value under this scenario in 2008, although slackening demand may dampen further oil price rises so as to achieve an average price of $95 per barrel for the year.
What is needed in response to this crisis is a multilaterally-coordinated stimulus package centred on the expansion of domestic demand in surplus countries, while staying within existing fiscal capacity; deep reforms in mechanisms of international financial regulation and supervision; and meeting emergency food needs, while setting longer term strategies for alleviating supply constraints and improving food security. According to Rob Vos, Director of the Development Policy and Analysis Division, “the United Nations system, including a more inclusive IMF, should take the lead in forging concerted policy action and address the food crisis.”
A concerted macroeconomic policy action plan would involve reducing global imbalances while avoiding an economic downturn, including a rebalancing of domestic demand between surplus and deficit countries and a smooth realignment of exchange rates. More importantly, the root causes of the imbalances need to be addressed to prevent their reappearance in the future, through measures such as reforming the international reserve system and strengthening financial regulation and safety nets.
A multilaterally-coordinated stimulus package for the global economy would include the expansion of domestic demand in surplus countries as well as more proactive public policies. Several industrial economies such as Japan, Germany, Switzerland, the Netherlands, Norway and Canada, as well as the emerging market economies of East Asia and the main oil exporters can help through expansionary domestic fiscal and monetary policies.
Surplus countries can gain much from using their accumulated reserves to generate income, employment and improve wealth distribution at home. For its part, caught between addressing its twin trade and fiscal deficits and the grimmer prospect of a recession that may reduce GDP by 0.2 percent in 2008, the United States has opted for expansionary domestic monetary and fiscal policies. However, the recovery of the United States economy will also need the external stimulus of increased demand for its exports from its major surplus trading partners through an expansion of their economies.
Against the backdrop of the global macroeconomic slowdown, the present food crisis presents an additional threat to human well-being. Addressing the food crisis requires internationally-concerted measures. In addition to the emergency assistance spelled out by the World Food Programme, the Food and Agriculture Organization and the Office of the Humanitarian Coordinator, major policy reforms are required in developed and developing countries to achieve a sustainable solution to the crisis. Abolishing agricultural subsidies in developed countries will probably benefit farmers in developing countries in the long run, despite causing short-term world food price increases.
The food crisis reflects both a long unheeded problem of low agricultural productivity in developing countries and the poor’s lack of access to affordable food. In the long run, increasing productivity through investments in water supply, infrastructure, improved seeds and fertilizers, education and agricultural research and development will be essential not only to deal with the present food crisis, but to allay persistent and widespread rural poverty. Improving access of producers to agricultural land, affordable inputs, and infrastructure would increase the productivity of food production and lead to significant reductions in rural poverty and better nutrition. Agriculture must, therefore, become a policy priority at both the national and international levels.
For a lasting solution to the current global economic crisis, both financial regulation and the international reserve system also need to be revised. Reforms of both national and international financial regulation and supervision are needed and policy makers need to pay more attention to preventing the harmful effects of financial exuberance.
Under present banking and finance rules, risk assessments tend to react to problems after they have occurred rather than foreseeing or forestalling them. By way of example, lenders are required to raise more capital only after liquidity problems occur rather than in anticipation of them. Current national regulations and international regulations such as the Basel II agreements, which have been crafted on risk assessment models developed by commercial banks themselves, are insufficiently geared to address contagion effects of crises across countries and markets or the herd behaviour of financial markets. Deeper regulatory reform, motivated primarily by the public interest, is urgently needed to avert future crises such as the recent sub-prime mortgage debacle and the resulting housing slump.
The international reserve system, too, is in acute need of reform. Under the current system based on the United States dollar as the reserve currency, the only way for the rest of the world to accumulate reserves is for the United States to run an external deficit. Over time, such a pattern inevitably erodes the value of the dollar, enhancing costs for countries to continue to hold vast amounts of reserves, and this may well cause a run on the dollar, probably with strong destabilizing consequences that will be felt worldwide.
The emergence of a new, supranational currency, based on scaling up Special Drawing Rights, the international unit of account based on a basket of currencies, is probably the ideal solution for redesigning the global reserve system in a stable way, but will require nimble negotiation and considerable building of political will over the long-term.
The more immediate and feasible reform would be to promote an officially-backed multi-currency reserve system. By diversifying their reserve holdings away from the dollar, many surplus countries have started to move in this direction. This concept should prove as compelling as the pursuit of a multilateral trading system. Similar to multilateral trade rules, a well-designed multilateral financial system should create equal conditions for all parties and avoid unfair competition and an asymmetric burden-sharing of exchange-rate adjustments. It should also help to increase stability in the international financial system.
The way out of the present global economic crisis will involve coordinated domestic and international policy actions in the short term and deep reform of the financial and trading system in the long term. The present crisis cries out for the type of concerted and people-centred reform that only a truly multilateral system such as that of the United Nations can spearhead. The five-year review of the International Conference on Financing for Development in Doha from 29 November to 2 December provides a golden opportunity to chart out an authentically multilateral and just reform of the international financial system.
Likewise, a successful conclusion of the Doha Round of Trade Negotiations so as to favour economic and social development in all countries through a fairer trading system, will also contribute to more stable global economy. Ultimately, it is the active involvement of citizens in developed and developing countries, concerned about the negative welfare effects of financial and commodity crises such as the present ones, that can pressure their governments to effect such systemic reforms with human well-being in mind, rather than financial interests alone. Transparent and inclusive multilateral forums, particularly those of the United Nations system, with broad multi-stakeholder involvement, can show the way.
For more information: http://www.un.org/esa/policy