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UNCTAD
calls for immediate actions to reverse deflation 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 institutions. 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 adequately. 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 Japan. 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 demand. 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 modulations". 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.
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