Improved prospects, also more fault lines, uncertainty

With world economic growth for this year expected to exceed 3%, there are immediate improved prospects, but “further fault lines have emerged”, making prospects for developing countries more uncertain and vulnerable, warns UNCTAD's Trade and Development Report.

by Chakravarthi Raghavan

Geneva, 19 Sep 2000 -- With world economic growth for this year expected to exceed 3 percent, there are immediate improved prospects, but “further fault lines have emerged”, making prospects for developing countries more uncertain and vulnerable.

And, prospects for the developing countries could rapidly deteriorate if the twin problems of global financial and trading systems are not addressed and major industrial countries continue to set policies without regard to global consequences, the UN Conference on Trade and Development warns in its just released Trade and Development Report (TDR).

In what they describe as the “Janus-faced” world economy, UNCTAD economists express their worries and concerns about the course of the world economy, and more so that once again when it comes to a crunch, the industrial countries will resolve their problems by shifting the burden on the already-overburdened developing world.

An overview to the report says that two big global economic forces are competing for the world’s attention: the promise of a ‘new economy’ underpinned by new technologies that are exciting policy-makers including in the poorest countries, and a growing instability linked to market-driven globalization and deep worries about the impact of financial shocks on growth prospects.

“While prospects for the global economy have become increasingly more optimistic since end of 1999, the risk that global imbalances may create another financial disruption has also strengthened,” says the report. And, despite the sharply improved performance of the world economy in 1999 and early 2000, there is much uncertainty about short-term outlook and many challenges remain, say the UNCTAD economists.

The TDR in summing up prospects and forecasts says: “Most forecasts of continued global expansion are based on the ‘Goldilocks’ scenario in which the United States economy is neither too hot nor too cold, allowing Europe and Japan to grow and providing support for continued recovery in Latin America and Asia. In assessing the forecasts for accelerated global growth it is as well to remember that Goldilocks is a fairy tale.”

Trust in market forces and monetary policy alone will not carry the day and “much bolder leadership”, of the kind which heralded the last Golden Age (the post-war Keynesian era of growth and prosperity) is called for, says UNCTAD Secretary-General, Mr. Rubens Ricupero in his overview of a 78-page interim report of sorts of the TDR.

Publication dates of future TDRs has now been shifted to April every year, and in effect this year’s report is an interim, bridging one.

Aside from a survey of the global economy and prospects, the report analyzes the recovery in East Asia—reaching some opposite assessments and conclusions from the World Bank, which in its East Asia recovery report earlier this year has done a 180-degree turn on its 1993 East Asia Miracle report, and blamed the recent crisis on the very institutions and qualities of government-private sector relations that it praised just seven years ago and advised other developing countries to emulate.

The TDR also refers to the rise in oil prices and suggests that the recent sharp rise will not have a comparable impact to the oil shocks of the 1970s.

The impact of rising oil prices on global growth will be limited, and confined to oil-importing developing countries.

“However, little attention has been given to the plea of financially strained, low-income, oil-importing developing countries whose balance-of-payments have deteriorated significantly,” the report bemoans.

The assessment about the effect of the oil price rise, as Yilmaz Akyuz, the chief author of the TDR explains, is based on pure economic considerations.  Unlike in the 1970s, he adds, the oil-exporters are no longer capital surplus countries, but will be using increased oil-revenues for imports.

But this is apart from the political implications of the upsurge and protests of truckers, agriculturists and others in Europe and elsewhere, where the high local taxes on fuel and consumption have pushed the prices up, and where governments could soften the impact for consumers.

There are increasing global imbalances, with the task of adjustment falling on monetary policy alone, and with cooperation and coordination among major economic powers attuned to crisis management, rather than crisis prevention, and “failure to resolve such imbalances in an orderly manner will be most damaging to growth in developing countries,” Ricupero adds.

The chief author of the report, Mr.Yilmaz Akyuz, Officer-in-Charge of UNCTAD’s Division on Globalization and Development Strategies, says that there are large global imbalances, between the US and other major industrial nations, associated with private, rather than public-sector deficits, “making the situation all the more fragile.”

With fiscal tools no longer in the armoury of macro-economic management and with policy coordination, if at all, coming with crisis management rather than crisis prevention, “an orderly adjustment of imbalances without sacrificing growth may be too much to expect,” says the report.

“The task of adjustment to global economic balances,” says Ricupero in his overview, “is falling on monetary policy alone. This is a cause for concern. Current global macro-economic imbalances bear some disturbing resemblances to those of the 1970s and 1980s, when the absence of cooperation and coordination among the major economic powers led to systemic breakdown and hard landings. And what we have learnt about the global economy over the past few decades tells us that failure to resolve such imbalances in an orderly manner will be most damaging to growth in the developing countries.”

Assessing the uncertainties, but couching them in terms of many a ‘may’, the TDR says that it is possible that the world economy will become even more robust in the coming years, with a consolidation of global growth and increased stability. The US economy may become neither too hot nor too cold, engineering an orderly slowdown to a sustainable growth rate compatible with greater potential of new technologies, while stronger growth in Europe and Japan would relieve the US of its role as the sole engine of global growth.

In this “ideal scenario”, oil prices and interest rates will level off and the dollar will be gradually realigned. And renewed capital flows, along with continued domestic reforms and spread of new technologies will begin to deliver the promised fruits of globalization to developing countries.

“However,” says the TDR, “there is also a recognition that the wreckage from the Asian crisis will not be cleared away by simple incantations to the new economy, and that making good on the promises of globalization will call for considerable policy effort."

“Not only are the root causes that led to fear of economic recession during 1998-1999 still present, but also further fault lines have emerged, [and] any unexpected movements could have damaging consequences not only for industrial economies but also, and of greater concern, for developing countries."

“Prospects for the latter could rapidly deteriorate if the major industrial countries continue to set their policies without regard to their global repercussions on trade and capital flows.”

Says the report: “A combination of dwindling private savings, rising private debt, mounting current-account deficits and the bubble in technology stocks, while providing a Keynesian fillip to the US economy, has been sustained by the continuing attractiveness of dollar-denominated assets to non-residents. But this situation cannot continue indefinitely. The factors accelerating growth in the US have also reduced the effectiveness of monetary policy in engineering a soft-landing: higher interest rates have so far served to attract more capital from abroad, thereby fuelling asset prices and adding to effective demand, the strength of the dollar and the deficit.”

While there have been hopes that the EU will soon replace the US as a global growth engine, even under a scenario of accelerated growth, Europe is unlikely to provide a comparable demand surplus - since its growth is export-driven, helped by a weak euro.

Apart from the difficulties and tensions within euro-land between fast-growing and slow-growing economies and the problems posed for the European Central Bank, as well as the consolidation of the dollar’s status as a reserve currency, the situation is not helped by the “hypnotic hold” which the notion of a non-accelerating-inflation rate of unemployment (NAIRU) still has over European macro-economic policy - even though this theory that high unemployment is structural and cannot be brought down without accelerating inflation has been discredited by the US experience, where expansionary policies have fuelled productivity growth.

The experience of the past shows that large imbalances in external payments and capital, between the US and other major industrial countries, could pose serious threats to global growth and stability, since willingness of investors in surplus countries to hold dollar-denominated assets could come to an abrupt end.

“Thus, as in previous episodes, the danger is that a policy impasse will end with much more abrupt changes than are either needed or desirable. Such an outcome would be of grave concern to developing countries, since their economic fundamentals are hyper-sensitive to movements in foreign interest rates and capital flows, and their exports would be seriously affected by the slowdown in growth.”

The vulnerability of developing countries to policy shifts in major industrial countries would depend on their own state of health.

Surveying the scene in the developing world, the TDR notes that conditions in Latin America have deteriorated further—with growing trade deficits and falling capital inflows throughout the region signalling “signs of a continent in trouble”.

There were differences within the region. Mexico had posted a relatively strong performance, thanks to its close ties to the US, as did some Central American and Caribbean countries. Heavy-handed policy responses to the threat of financial integration tipped the balance elsewhere, plunging countries into recession. Things could have been much worse if Brazil had not weathered the storm, but Argentina’s defense of its dollar-peg took a much heavier toll, with output falling 3%.

In Asia, India and China continue to post above-average performance, with India having an industry-led growth, despite the situation in the agricultural sector (fall in output due to weather conditions).

China, while benefiting from the recovery in the Asian region in 1999, had a 7% growth rate, the slowest in a decade. Short-term easing of monetary and fiscal policies to boost demand failed to stimulate private consumption, and policy makers are looking for a new growth path. Accession to the WTO may help, but if accession necessitates a devaluation of its currency - to protect less competitive domestic enterprises, particularly state-owned ones - other countries in the region are likely to be affected.

Africa has again been unable in 1999 to match the growth of 1996. And for sub-Saharan Africa, the basic policy challenges remain on how to overcome savings and foreign exchange constraints and raise investment to achieve an annual 6% growth rate.

“Despite a rapid recovery from depressed conditions in 1998,” says Ricupero in the overview, “external vulnerability is still a looming menace to growth prospects in the developing world. Concerted efforts by developing countries to become full participants in an increasingly inter-dependent global economy continue to be stymied by biases and asymmetries in the trading and financial system."

“There are too many exporters struggling to gain access to markets of rich countries, and the kind of extreme price movements previously suffered by commodity producers have also begun to upset the plans of manufacturers. A reluctance to move towards a new round of multilateral trade negotiations that took into consideration the development needs of poorer countries, including the problems they confront in implementing commitments in the Uruguay Round, was apparent in Seattle; and the trade imbalances among major industrial countries simply adds to the anxieties of the developing world. Even after years of hard-won domestic reforms, developing countries are still dependent on highly volatile capital flows to support growth.

“Growth prospects of developing countries will depend on how these concerns are addressed. In an increasingly interdependent global financial and trading system, it is clear that trust in market forces and monetary policy alone will not carry the day. Increased international cooperation and dialogue will be needed if the full potential of new technologies to bridge the growing gap between the rich and poor is to be realized. This calls for much bolder leadership, of the kind which heralded in the Golden Age.”-SUNS4743

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

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