UNCTAD calls for immediate actions to reverse deflation

The UNCTAD's Trade and Development Report 1998 has raised the
spectre of a world economy in recession and points to the
systemic nature of financial crises, of which the Asian
crisis is only one. The Report advocates, among others,
growth-based policies by the major economic powers, and an
automatic standstill principle on debt servicing and capital
controls in developing countries to manage the crisis.

by Chakravarthi Raghavan

GENEVA: The world economy is teetering on the edge of, if not
well into, recession or worse, and this calls for immediate
actions by the three largest economies - the United States,
Europe and Japan - to reverse global deflation and promote
reflation and recovery, the UN Conference on Trade and
Development (UNCTAD) said on 16 September in its just published
Trade and Development Report 1998 (TDR).

In the report, the main theme of which is "International
Financial Instability and the World Economy" and which
addresses the issues of financial crisis, how to manage it
better when it happens and how to prevent it, UNCTAD blames the
Asian crisis, and its current outcome of once prosperous
economies being "derailed" and future prospects set back by
volatile financial flows, on the reckless way these economies
were pressured into financial liberalization, and the misguided
policy advice forced on them when the crisis broke.

The report provides strong support for exchange and capital
controls in place in developing countries.

In a separate part, the TDR focuses also on African
development, and advocates some rethinking by the international
community. The analysis brings out the failures of the
structural adjustment programmes, due to both failure to
implement and, even more importantly, badly designed programmes
and policies. The TDR advocates, among others, drastic steps to
lift the external debt burden (bilateral, private and
multilateral), new development policies that would reinforce
the state's role including in such areas as reformed commodity
marketing boards, and giving African countries leeway in terms
of the WTO rules.

On the financial issues, the TDR does not identify the
"initiatives" it is objecting to. But the G-24 papers and the
views expressed at an UNCTAD seminar in May by, among others,
Canadian academic Gerald Helleiner, who heads the G-24
technical assistance project, bring out that these initiatives
to restrict developing-country options cover a whole range of
moves, each of which has the same motivation and intended
result: multilateral rules on investment via the draft
Multilateral Agreement on Investment at the OECD, the efforts
to write such rules at the WTO, whether as a multilateral
investment agreement promoted by the EU or its UNCTAD variant
of a possible multilateral framework on investment, capital
convertibility at the IMF, or some aspects of the WTO agreement
on financial services liberalization.

Automatic standstill

The report advocates at a global level some rules akin to
Chapter 11 of the US bankruptcy code, and in particular the
automatic standstill principle, to enable countries facing
currency attacks, and in stipulated situations on reserves and
so on, to impose unilateral standstill, similar to the
safeguard action allowed under the GATT. They should then be
able to approach an independent international panel to justify
their case and get further relief.

But the IMF as now constituted, the TDR adds, cannot play
such a role both because of a conflict of interest, being
itself a creditor, and also because its governance structure
gives weight to the views of creditors over those of debtors.

The financial crisis in Asia has already cost the world
economy 1% of world output or some $260 billion, equivalent to
the annual income of sub-Saharan Africa, and "prospects for the
years ahead are extremely uncertain, but the risks are on the
downside," says UNCTAD Secretary-General Rubens Ricupero in an
overview of the report which he released at a Geneva press
conference on 15 September. "Further policy errors might well
drive the world economy into a world recession," he adds.

Repeatedly over the years, UNCTAD has been warning of the
dangers in the world economy, Ricupero said at his press
conference. "In the 1980s, we warned about the impossibility
of solving the Latin American debt crisis without a write-down
of the principal and interest arrears. This ultimately became
a part of the Brady plan. At the beginning of the 1990s, we
cautioned that the decade would be characterized by financial
turmoil, and rightly predicted the Mexican crisis as also the
unsustainability of current account deficits in Thailand and
Malaysia. After belittling these, the so-called mainstream
world of financial institutions, economists and politicians
finally agree with our analysis, forced by the tyranny of the
reality of facts."

Ricupero welcomed and commended the speech of President
Clinton in New York on 14 September, and the G7 finance
ministers' statement out of London, and said that many of the
points there vindicated what UNCTAD had been saying for years -
and which were criticized by the same industrial powers and

International financial architecture

But, said Ricupero, immediately "we need vigorous and broadly
based growth policies." And these measures can only come from
the US, the EC and Japan; and measures are needed to enable
business in Asia to get out of the crippling debt, among other
things by lowering interest rates, expansionary fiscal policies
and a gradual way of alleviating the debt burdens.

Along with these, there is the need to address the global
aspects of crisis by adopting an international financial
architecture for the 21st century. It will require a long,
patient and orderly process, with a balanced agenda that takes
account of the interests of creditor and debtor countries. And
part of that architecture must include a system of finance and
exchange controls "which we have been advocating for quite some
time and which has now become part of the mainstream. It will
need measures to deal with short-term indebtedness and
international measures like the US bankruptcy code Chapter 11."

Focusing also on the lack of coherence and coordination
between the money and finance system on the one hand and the
trading system, with its detailed rules and a dispute
settlement mechanism, on the other, Ricupero said the lack of
balance and coherence and the failures of the money and finance
system render it impossible for the trade system to operate

The solution to these lies in a more active role for the two
largest surplus economies - the EU and Japan - which have not
been contributing to global import demand growth, but
accumulating trade surpluses over the years.

Ricupero agreed with a questioner that in some cases the
central banks of major industrial economies, particularly in
Europe, with their emphasis on monetary policy and excessive
concentration on inflation, are responsible for the current
situation. But this charge would not be true of the US Federal
Reserve, which has been acting on different guidelines -
targeting low inflation, stability of prices and economic
growth and full employment. The US Federal Reserve has provided
a good example to other central banks.

Asked about any worst-case scenarios, given the crisis in
the Japanese banking system with non-performing loans said to
be in the range of $600 billion to $1 trillion, exceeding its
total assets, and Europe's preoccupation with the Euro, UNCTAD
economist, Richard Kozul-Wright, said that no such armageddon
scenario had been envisaged, but that over the years, it has
been emphasizing that the world economy needs to grow at a
steady minimum annual 3% if a dent is to be made on
unemployment and the inequalities in the economies.

While the TDR and the overview do inject a note of caution
regarding the serious risks of recession, if not worse, in the
world economy, Ricupero sought to soften this, perhaps to
avoid a self-fulfilling prophecy, and spoke of the "sound
fundamentals" in the US and Europe, though this was not true of

Andrew Cornford, an UNCTAD economic advisor, said the US
interest- rate policy (and lowering US interest rates) would
not only be important for US growth and capital flows, but
would also provide room for Japan to reflate without its
currency going into a free fall. He said that with the help of
people in Japan, UNCTAD was working out scenarios involving
large-scale financial aid by Japan to the region, and that the
results would be made available soon to the press.

But the crisis in Asia cannot be explained away as a mere
isolated event or due to crony capitalism, but should be looked
at as one in a series of five or more major financial crises of
this decade, Ricupero noted.

Recalling its repeated warnings, since 1990, that the
ascendancy of finance over industry coupled with globalization
of finance was the underlying source of instability and
uncertainty in the world economy, the report underlines the
"systemic" nature of the repeated bouts of financial
instability, at roughly two-year intervals, that have
characterized the world economy in this decade.

There was the debt deflation in the US, followed by the
1992-93 European Monetary System (EMS) crisis in Europe, the
Mexican crisis of 1994-95 and the most recent crisis in East
Asia which began in early1997.

In complaining, if not accusatory, tones, the TDR says:
"Each time, the prevailing approaches have been based on the
notion of the infallibility of markets, and on an explanation
of the crisis in terms of misguided domestic policies. Turning
a blind eye to the systemic nature of financial instability is
neither responsible nor acceptable."

Threat of deflation

The threat to the world economy, Ricupero said, is no longer
inflation, but deflation, recession and unemployment and "we
need vigorous and broad-based growth policies with reduction in
interest rates in the US and elsewhere, and coordination among
the three largest economies - the US, Europe and Japan - to
stimulate growth and import demand."

According to the chief author of the report, Yilmaz Akyuz,
the deflationary impact of the crisis is much deeper than
accepted by orthodoxy, and the impact on developing countries
is much more serious than on industrial countries. "For the
first time in many years, developing countries will grow less
than industrial countries, and growth in the South will be half
of that in 1997." And since the report was written two months
ago, the prospects in fact have worsened, says Akyuz. The
effects of the Asian crisis are being transmitted via two
channels, financial markets and trade.

Though international financial institutions claim there
would be no major declines in capital flows, the TDR is much
more cautious. Akyuz points out that since the writing of the
report, the tendency of capital to withdraw from emerging
markets and the flight to quality have become much more
visible. There are also the effects in relation to
international trade as the channel of influence: not only on
direct exports to the Asian region, but also on commodity
earnings and prices, both oil and non-oil, which have plunged
to very low levels.

While the initial effects on industrial countries have been
favourable, as a result of sharp terms-of-trade gains and the
decline in commodity prices, these very factors have reduced
export earnings in the South, and, along with the appreciation
in value of the US dollar, will reduce exports. "The US
consumer cannot be expected to finance consumption for ever
from out of assets; also, the US fiscal surplus will act as a
drag on the economy, with no stimulus from the trade side. This
will slow down the US economy considerably in the second half
of the year, and coupled with financial factors we may see a
'rough landing' in the US economy," warns Akyuz.

"And with two growth poles, that of the US and developing
Asia, removed, Japan in recession and Europe unable to attain
a demand stimulated growth, the world economy is well into
recession, and the prospects can worsen if there are further
bouts of financial instability in the emerging markets."

Worst-case scenario

Written two months ago, the TDR says: "Perhaps the worst
possible outcome of the crisis is further bouts of financial
instability in emerging markets, a large correction of equity
prices in the major industrial countries, together with a sharp
slowdown in the US economy, prolonged recession in East Asian
Newly Industrializing Economies (NIEs) and Japan, and increased
trade imbalances in the major industrial countries. Any such
outcome would put increased pressure on banking systems in the
developed world. The result might not only be a world economy
in deep recession, but also a re-emergence of trade conflicts
that could wreak havoc. If that is to be avoided, countries in
surplus, namely Japan and the members of the European Union,
must increase their contribution to world demand, and
deflationary policies in East Asia must be reversed."

Akyuz notes that some of the elements of this worst-case
scenario are already appearing - further instability in
emerging markets, in Russia, correction in equity prices,
slowdown in the US economy, deepening recession in East Asia
and Japan, and increase in trade imbalances among major
industrial countries. And the risks of all these are now more
probable than envisaged in the report.

Strong recovery of domestic demand is needed in Japan to
provide an expanding market for other Asian economies, says the
report, which however, departs from the current orthodox
prescriptions (of the US, the other G7 countries and the IMF)
by suggesting that Japan could achieve more by providing
considerable external finance to the Asian countries through
long-term lending. It would most likely have a greater impact
on growth in Japan itself, as well as in the NIEs, than a
domestic fiscal package of equal magnitude, since the money
would be largely recycled to Japan through increased import

Analyzing the trade effects of the crisis, the report
underlines the need for open markets to enable the Asian
countries to have net exports to resume pre-crisis growth, but
notes that this could cause serious strains on the
international trading system. There are already increasing
pressures for protective actions, including through resort to
discriminatory anti-dumping measures, safeguards and/or "quota

The conditionality policy packages forced on these
countries, with "demands" for unilateral trade concessions as
a price for assistance, the TDR warns, will weaken the basic
concept of the WTO system, namely "balance and mutual
advantage" in trade concessions. "Resort to discriminatory
trade remedies such as anti-dumping duties should be subject
to increased surveillance. In addition consideration should be
given to allowing affected countries to benefit from possible
extension of provisions for differential and more favourable
treatment in the WTO agreements, such as in the Agreement on
Subsidies and Countervailing Measures." (Third World Economics
No. 193, 16-30 September 1998)

Chakravarthi Raghavan is the Chief Editor of the South-North
Development Monitor (SUNS)from which the above article first appeared.