Trade, finance systems in conflict, don’t support development

Not only are the current international trade and financial arrangements incompatible, a paper by the UNCTAD secretariat has pointed out, but each contains systemic biases and asymmetries which militate against economic development.

GENEVA: There is now a dichotomy between the international trade and finance systems, which, instead of being mutually supportive, are now  working against each other, and neither of them is supportive of development.

There is thus a need to bring about greater coherence and ensure that international arrangements in the spheres of trade, finance, debt, investment and technology mutually reinforce each other to support equitable, rapid and sustainable growth and development.

This is the basic message of an issues note of the secretariat of the United Nations Conference on Trade and Development (UNCTAD), which also notes that the attempts at coherence cannot  be addressed and resolved within the World Trade Organization and the International Monetary Fund because of the clear agreed demarcations of jurisdiction between the two institutions, and only the United Nations, in particular UNCTAD, which is mandated to deal with trade and development, provide a proper forum  for addressing these issues.

The secretariat note (which is posted on UNCTAD’s website) was prepared for the Interactive Debates and Policy Dialogue as a part of the mid-term exercise at the 19th Special Session of UNCTAD’s Trade and Development Board due to meet in Bangkok from 29 April.

The note, prepared by the secretariat’s division on Globalization and Development Strategies, calls for rethinking development strategies and reshaping globalization in search of greater coherence.

“Any attempt to set up an international trading system on the basis of an assumption that everything else is working perfectly well, including in particular the finance system, can only produce a sub-optimal solution,” according to Yilmaz Akyüz, director of the division.

If exchange rates distort trade prices and flows, free trade cannot provide the best allocation of resources, and in such a situation subsidies and tariffs alone can be a corrective, the paper points out.

The problem of lack of coherence has to be dealt with, and this cannot be done at the IMF or the WTO because of the clear demarcation of jurisdiction between the two institutions. The international arrangements on trade, debt and finance are based on a false dichotomy and only the UN provides a forum to deal with such things.

Systemic shortcomings

The developments in the world economy since UNCTAD’s tenth session (UNCTAD X) at Bangkok in 2000 and the current uncertainties surrounding economic prospects, in the secretariat’s view, confirm that most developing countries suffer from structural weaknesses that increase their vulnerability to external shocks. The weaknesses, UNCTAD says, arise in part from the modalities of their participation in the international trading and financial systems. However, the current global arrangements cannot be relied upon to ensure financial and monetary stability and sustain an expansion of employment, output and trade capable of lifting all boats together.

The earlier initiatives taken since the outbreak of the East Asian crisis for the reform of the international financial architecture have not been effective in preventing new crises. The Argentine crisis shows the fragility of recourse to “simple rules”. Measures adopted for better management of financial crises appear to be largely ineffective in preventing deep recessions and sharp increases in poverty in countries facing rapid exit of capital. The lack of effective institutional arrangements for orderly debt workout procedures continues to create difficulties and uncertainties.

Notwithstanding the concerted monetary policy responses to the 11 September events, there has been little coordination of macroeconomic policies among major industrial countries to provide for a rapid and balanced expansion of global demand and avert the buildup of further trade imbalances and protectionist pressures.

And while the Doha Ministerial meeting of the WTO last year acknowledged many of the concerns of developing countries first expressed at the 1999 Ministerial in Seattle, there are considerable uncertainties surrounding efforts at translating an expanded negotiation agenda into a genuine development agenda.

What is at stake is how to ensure that current arrangements in the different economic spheres of trade, finance, debt, investment and technology mutually reinforce each other in support of equitable, rapid and sustainable growth and development. In the current world of increased interdependence, no country can put its house in order regardless of conditions outside. This is true not only for developing but for industrial economies too.

The postwar systems of Bretton Woods and Havana placed a priority on policy coherence and coordination on finance, trade and development. Despite various shortcomings in the arrangements, the world economy did attain strong growth combined with full employment in industrial countries until the late 1960s. But the shortcomings of the architecture were increasingly apparent in the late 1960s and led to its demise. While there was clearly a need for reform of the multilateral arrangements, since the breakdown of the Bretton Woods system, the pendulum has swung too far and the international trading and finance systems have evolved in too disorderly a way.

The international financial and trading systems have evolved in a way that favours private capital flows over official flows, exchange rate flexibility over stability, austerity over reflation, adjustment over financing, and creditors over debtors. The international trade system has moved to a single-tier system of rights and obligations, with developing countries generally having the same level of obligations as the industrialized countries, while the commitment for full employment has weakened and been replaced by a focus on price stability. Trade liberalization and expansion have been put in front of economic growth and full employment, thereby rekindling mercantilist agendas.

False dichotomy

As a result of all these elements, points out the UNCTAD note, trade flows, instead of being governed by comparative advantage, are distorted by unstable and misaligned exchange rates, “weakening the theoretical arguments for trade liberalization.”

UNCTAD economists say that the misaligned and fluctuating exchange rates are behind much of the trade conflicts in the steel, shipbuilding and other sectors.

Adds the secretariat note, “Indeed, it can be argued, perversely, that in a world where exchange rates distort trade flows and global resource allocation, tariffs and subsidies may assume corrective roles.”

“This problem is ignored,” says the secretariat, “in current global arrangements which are based on a false dichotomy between trade and finance.”

By altering relative competitive positions of various industries across countries, currency movements unrelated to economic fundamentals have the potential to trigger trade frictions and protectionism, undermining the international trading system. Exchange rate misalignments have played an important role in recent trade disputes over steel and shipping.

The shifts in international capital flows are also creating sharp swings in trade flows and boom-bust cycles in economic activity, with financial booms leading to excessive expansion of investment, production and trade in particular sectors.

The financial flows and crises make not only importing but exporting more difficult, even after large devaluations and improvements in competitiveness, while trade shocks lead to increased debt burdens and reduced capital flows as they feed into higher risk spreads.

The postwar arrangements were founded on the belief that adverse influences emanating from trade, finance and debt should not be countered through measures sacrificing growth and development.

Under the present arrangements, however, developing countries find themselves obliged almost invariably to absorb such influences through domestic retrenchment. Current rules of the trading system do not also allow much room to developing countries to undertake import cuts on a selective basis so as to minimize adverse effects on capacity utilization, capital accumulation and poverty.

Biases against development

Apart from these, the current arrangements in trade, finance, debt, investment and technology contain systemic biases and asymmetries concerning development.

Despite the general acceptance of the theory of free trade, the international division of labour is influenced by commercial policies favouring products and markets where the advanced countries have a competitive edge. High tariffs, tariff escalation and  subsidies in agriculture and fisheries are applied against products which offer potential for export diversification by developing countries. Nor is the panorama of protection any different  in industrial products, including footwear, clothing and textiles. The abuse of anti-dumping procedures and product standards against successful developing-country exporters also creates further obstacles.

There is also inconsistency between the policy advice given by multilateral institutions to developing countries (for  import liberalization and export-oriented growth strategies, and reflected in conditionalities attached to the institutions’ lending) and the continued protectionism in some industrial countries’ markets for dynamic agricultural and labour-intensive products. And, through the promotion of unilateral trade liberalization beyond WTO commitments, developing countries are deprived of the means to gain concessions on market access in subsequent trade negotiations.

For most developing countries, the current workings of the international trade and finance systems do not provide sufficient resources to enable them to achieve the rapid and sustained growth needed to reach various poverty alleviation targets set by the international community for the new millennium.

Full implementation of commitments by most developing countries undertaken during the Uruguay Round, together with continued restrictions on market access in some major industrial countries, are generating payments deficits that cannot be financed on a sustained and reliable basis by international capital markets, UNCTAD points out. Official financing is no longer available on a scale to fill this gap. Even the outcome of the recent Conference on Financing for Development (FfD)  does not remove this inconsistency. The additional aid pledges  made in the context of the FfD meeting fell short of amounts needed to close the resource gap, which requires the doubling of official aid.  This implies that many developing countries may have to accept slow growth that is unlikely to make much of a dent on poverty.

On the other hand, efforts to accelerate growth by greater reliance on private financial flows can make matters worse by creating instability and boom-bust cycles, which harm the productive investment needed to improve trade performance.

The existing arrangements do not allow sufficient policy space to developing countries to overcome their longer-term payments constraint by pursuing targeted trade, industrial and technology policies and thus increasing their export capacity in more dynamic sectors.

“The current policy orthodoxy and global arrangements have the result of kicking away the ladder by which today’s advanced countries attained their present levels of economic development by denying developing countries many of the policy instruments that were widely and successfully used in the past.”

In a  world of increased interdependence, there should be a minimum degree of consistency and coherence between national and international policies. Indeed, multilateral rules and commitments circumscribe the policies that countries may apply within their national borders because of their global ramifications.  Such multilateral  discipline is particularly important for countries whose economic policies have strong influence on the rest of the world.  Although global checks and balances have been introduced in some sectors such as trade, they are not always effective vis-a-vis governments in major industrial countries which often come under political pressures to protect domestic sectors.

Moreover, for such countries, similar checks and balances are absent or inadequate in a number of areas, including macroeconomic and financial policies which are known to generate even stronger global repercussions than trade policies. By contrast, macroeconomic and structural policies in most developing countries are subject to tighter surveillance in the multilateral financial institutions, even though the global impact of their national policies is much weaker.

The objectives pursued by the architects of the postwar international economic order, namely a broad-based, rapid and sustained growth and development conducive to greater international economic integration, continue to be equally valid today.

Achievement of these goals now involves meeting even more complex policy challenges to ensure consistency and coherence among various components of the international economy as well as between these components and economic development.

However, despite the increased recognition that the growth in global interdependence poses greater problems regarding the coherence, complementarity and coordination of global economic policy-making, the mechanisms and institutions put in place over the past three decades have not been adequate to this challenge.  Proposals in the current context of globalization should thus start with an attempt to address these problems, inter alia, through the appropriate parts of the UN system, within which UNCTAD has a unique role to play in this respect.

For all countries to be able to enjoy the benefits of globalization, the complex policy challenges which arise, particularly at the global macroeconomic level, from the growing interdependence of the various spheres of economic activity, including particularly trade, finance and investment, and the downside risks which this interdependence sometimes carries, need to be met.

UNCTAD, as the focal point within the UN for the integrated treatment of trade and development and the interrelated issues in the areas of finance, technology, investment and sustainable development, is eminently placed to examine these issues and to build consensus for reformulation of policies from a development perspective. (SUNS5102)

From Third World Economics No. 278 (1-15 April 2002)