TWN Info Service on Finance and Development (Dec11/02)
16 December 2011
Third World Network

Dear friends and colleagues,

Below is the written statement of the intervention made by TWN at the recently held 5th High-Level Dialogue on Financing for Development in the United Nations in New York. It was delivered at a roundtable on “the reform of the international monetary and financial system and its implication for development” on 8 December 2011. TWN’s statement focuses on the structural changes needed in the global reserve system, the importance of strengthening national policy space by regulating volatile capital flows and the threat to growth and long-term development posed by fiscal austerity measures that contract economies and jobs.

TWN asserts that instead of a herd-like shift toward austerity policies across developed and many developing countries, a fundamental reorientation toward expansionary macroeconomics is urgently needed today. This includes the prioritization of employment in the mandate of central banks, and the political will to spend public money to strengthen social sectors, such as health, education and social safety nets. Given that countercyclical policies are a key catalyst in solving the unemployment crisis in developed countries, the current political consensus on austerity is unduly restrictive at a time when the recovery from the crisis is still in jeopardy.

Mounting reserve accumulation in the interest of self-insurance in developing countries constitutes a perverse net flow of resources from the South to the North, with an annual carry cost estimated at $130 billion, a sum which exceeds total official development assistance to developing countries. This number is even higher if the opportunity cost of foregone domestic use is quantified. Policy actions to address the insurance-based nature of the current reserve system, which creates wide global imbalances between surplus and deficit countries, would address ways to revamp the US dollar-based reserve system and policy options to reduce the reserve needs of developing countries. One proposal that has been put on the table as being the most feasible politically and institutionally, is that of a greater role for SDRs in the reserve system.

With regard to capital control measures, the IMF, and the Financial Stability Board, along with other bodies, should try to reduce the stigma, and macroeconomic preconditions, attached to capital account regulations and protect countries ability to deploy them.

With best wishes,
Third World Network

TWN contribution to the 5th High-Level Dialogue of the

General Assembly on Financing for Development

(New York, 7-8 December 2011)
Roundtable 1 on “The reform of the international monetary and financial
system and its implications for development”

It is now clear that the world is slipping, or has already slipped, into a new economic downturn. A double-dip recession is a looming threat, in particular because of the European debt crisis and a weak US economy, and because the essential tools that helped the world recover from the 2008-9 recession, fiscal stimulus and expansionary monetary policy, are not being carried out in the developed countries.

In this context of a lack of policy coordination, and action, developing countries could face serious problems. They need to ensure that they are not caught as helpless victims to the new crisis. Developing countries should, among other actions, prepare themselves with policy responses to reduce the impact of a new crisis, including a reversal in capital flows and a concomitant decline in currency values and a sharp fall in exports, including in commodity prices and world demand for goods.

Developing countries should also review their previous development strategies to see if they are still valid or whether changes are needed to respond to the changed international situation. In particular, developing countries that have relied heavily on exports to lead their growth may now find a decline in demand, especially from the developed countries. They need to examine how to rely more on domestic demand and on regional South-South cooperation.[1]

And, on the global front, developing countries should take an active part in the discussions on reform of the international financial and monetary system, as well as on the coordination of macro-economic policies of systemically important countries. Developing countries are adversely affected by the dysfunctional global system, and therefore have an interest in its reform. Unfortunately there is an absence of an appropriate system of global economic governance that enables all developing countries to participate, both within the Bretton Woods Institutions and the G20. Thus, calling for a democratic and inclusive governance system, while redundant, is still urgent and necessary.

Two key areas within the international monetary system that require systemic reform are the reserve system and global imbalances. And in the international financial system, two critical policy actions are that of capital flow regulation and expansionary macroeconomic policies for arriving at global economic recovery.

Global imbalances and the reserve system: policy options and proposals

The absence of a global regime to prevent and mitigate financial crises and a reluctance by many developing countries to resort to the IMF for financial assistance, after adverse experiences with Fund loan conditions in earlier crises, has led emerging market and developing countries to accumulate vast sums of foreign reserves as an act of ‘self-insurance’. The rationale is that when shocks such as financial crises instigate capital flight, foreign exchange stocks can be used to prevent the currency from depreciating.[2]

In the wake of the global financial crisis, this insurance incentive has been reinforced in a context of persistent uncertainty and fear in the global economy. Mounting reserve accumulation in developing countries constitutes a perverse net flow of resources from the South to the North. And it is costly, both in terms of global imbalances, and in social costs on a national level, as resources sit dormant in low-yielding assets, primarily US Treasury bills and bonds which currently yield record-low interest, rather than being used for productive investments and development financing domestically.

On the basis of average historical spreads between the borrowing rate and return earned on reserves, the annual carry cost of reserves to developing countries can be estimated at $130 billion.[3] This constitutes a net transfer of resources to reserve issuing countries, notably the US, and exceeds total official development assistance to developing countries. This number is even higher if the opportunity cost of foregone domestic use is quantified.

Policy actions to address the insurance-based nature of the current reserve system, which creates wide global imbalances between surplus and deficit countries, would address ways to revamp the US dollar-based reserve system and policy options to reduce the reserve needs of developing countries.[4]

Some policy options include: (i) capital controls, particularly over short-term surges of capital, in the logic that it may be better to arrest volatile capital from entering the economy than to insure their potential loss with expensive reserves; (ii) fair economic surveillance of the developed countries where powerful financial markets orchestrate the size and direction of international capital flows; (iii) orderly debt workout mechanisms, including temporary debt standstills and exchange controls, in order to reduce the need for liquidity when capital flight occurs; and, (iv) collectivizing reserve insurance through regional financial pools, such as the Chiang Mai Initiative, a reserve pool of $120 billion among ASEAN+3 countries which meets their temporary liquidity needs.

Significant international debate has brewed on how the world economy should move away from the current reserves system, anchored to the US dollar, to a reserve system based on multiple currencies, or on a composite international currency, such as the Special Drawing Right (SDR). One proposal that has been put on the table as being the most feasible politically and institutionally, is that of a greater role for SDRs in the reserve system. Supported by the UN Commission of Experts appointed by the 63rd PGA in 2009, SDRs would distribute the benefits of reserve creation more broadly across the globe, and would not entail costs unless they are used.

This is the basis of the Chinese Central Bank governor’s support for making the SDR more important.[5] Some initial steps could include providing greater amounts of SDRs to developing countries reserves, and for low-income countries, to reduce or eliminate the costs of converting SDRs into hard currency. The use of SDRs for a range of purposes, including for medium- or long-term public investments, should be asserted and defended on an international level.

Capital controls: the G20 consensus and the IMF’s mandate

In the context of the slow recovery in developed countries and the Federal Reserve’s quantitative easing, where hundreds of billion in liquidity was created, investors across the world flocked to developing countries, and in particular emerging market economies like Brazil, South Korea, Taiwan and Indonesia. Then, in recent months, they flocked out of those emerging countries, showing once again how volatile and dangerous such flows are.[6] Whereas capital inflows came with destabilizing pressures such as currency appreciation and asset price bubbles, reciprocal outflows trigger currency depreciations and balance of payments and loan servicing problems. This can lead to a global financial contagion, as seen in the Asian financial crisis of 1997-98.

Capital controls can provide a significant method for developing countries to protect themselves from a new financial crisis, while reducing global imbalances. National policy space is strengthened when states can garner some degree of checks and balances over the volatile whims of unregulated global capital.

Effective controls can buffer economies from external shocks, free up capital for productive investment in the real economy, and subsidize the cost of foreign exchange accumulation. If applied in the form of taxes on inflows, capital controls can provide a subsidy to offset the cost of reserve accumulation. A tax on the foreign purchases of bonds, equities, and derivatives, would reduce the amount of reserves needed in emerging markets while simultaneously funding reserve accumulation costs by the very capital flows that create the costs.

Last month’s G20 summit in Cannes offered an enormously significant victory which went largely unreported. While the G20 has not made progress in most areas, their working group on capital flows, led by Germany and Brazil, produced a report titled "G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences." It concludes that "there is no 'one-size fits all' approach or rigid definition of conditions for the use of capital flow management measures," and in direct opposition to the IMF’s verdict that controls should be a temporary last-resort measure, the G20 report stated that such measures should not be solely seen as a last resort.[7] In his final speech, French president Sarkozy also said that “the use of capital controls is now accepted as a measure of stabilization, and this is very important."[8]

In contrast, the IMF asserts that capital controls should be used only after measures such as building up reserves, letting currencies appreciate and cutting budget deficits are first carried out.[9] The IMF’s efforts to extend its mandate to police and harmonize regulations is inappropriate, as countries in diverse stages of development need national policy space to design measures that fit unique country circumstances, and ensure support for domestic financial systems and the real economy. The IMF, and the Financial Stability Board, along with other bodies, should try to reduce the stigma attached to capital account regulations and protect countries ability to deploy them.

The downward spiral of austerity threatens global economic recovery

Pro-cyclical fiscal austerity measures that contract the economy by dampening demand, employment and income pose a grave threat to growth as well as long-term development. As such, the vilification of public expenditure and investment impedes world economic recovery and forebodes a devastating downward spiral where “tightening the belt” becomes counterproductive both locally and globally.

Just this week the OECD released its report on global inequality, which illustrates how income inequality has increased and deepened across many developed and developing countries, and how this trend has been engendered by dilemmas such as the lack of access to education and labor flexibility policies.[10]

A fundamental reorientation of macroeconomic policy goals is urgently needed today. This includes the prioritization of employment in the mandate of central banks, and a greater acceptance for higher fiscal expenditure, in the recognition that spending does not necessarily translate into an equivalent increase in the fiscal deficit if revenues in the real economy of production and income is also generated.[11] Given that countercyclical policies are particularly important for combating unemployment crisis in developed countries, the global political consensus on macroeconomic policies is unduly restrictive at a time when the recovery from the crisis is still in jeopardy.

The current leadership of the IMF has acknowledged that too much austerity is risking jobs and growth, and the Fund staff’s report to the G20 suggested that developed countries “have scope to slow their current pace of consolidation, if offset by a commitment of additional tightening later.”[12]

However, Fund loans and policy advice to developing countries continue to promote fiscal retrenchment. In a study released this year, UNICEF analysis confirms that the scope of austerity is severe and widening quickly, with 70 developing countries reducing total expenditures by nearly 3% of GDP, on average, during 2010, and 91 developing countries will curb spending in 2012.[13]

A reading into IMF country reports reveal that the following adjustment measures are widely recommended by the Fund: (i) cutting or capping the wage bill (in 56 countries); (ii) phasing out or removing subsidies, predominately fuel, but also electricity and food items (in 56 countries); (iii) reducing social protection programmes (in 34 countries); (iv) reforming pensions (in 28 countries); and, (v) increasing consumption taxes on basic goods (e.g. value added taxes) that the poor tend to consume (in 53 countries).

However, a menu of policy options is available for policymakers to boost social and economic investments for the recovery of the real economy. Such options, which vary in importance for different countries include expansionary macroeconomic policies, budget re-allocation to social sectors, debt restructuring, taxing higher-income earners and the private sector (including a financial transactions tax), cash transfers, North-South and South-South transfers, targeting illicit financial flows and using reserves.

[1] Khor, Martin, “Bracing for a New Global Economic Crisis,” South Centre Bulletin, Fall 2011, Geneva, www.southcentre.org <http://www.southcentre.org> .

[2] Gallagher, Kevin P., “Beyond the G-20: Mitigating the Costs of Global Imbalances in the Absence of Global Coordination,” 28 October 2011, http://www.globalpolicyjournal.com/articles/world-economy-trade-and-finance/beyond-g-20-mitigating-costs-global-imbalances-absence-glo-0.

[3] Ambrose and Muchhala, “Fruits of the Crisis: Leveraging the financial and economic crisis of 2008-2009 to secure new resources for development and reform the global reserve system,” Action Aid and Third World Network, Geneva, January 2010, http://www.twnside.org.sg/title2/finance/docs/sdr_reserve_final.pdf.

[4] Akyüz, YIlmaz, “Why the IMF and the International Monetary System Need More Than Cosmetic Reform,” Research Paper No. 32, South Centre, Geneva, November 2010, http://www.southcentre.org <http://www.southcentre.org/> .

[5] Williamson, John, “Key Issues in International Monetary System Reform,” in Friedrich Ebert Stiftung, New Directions for International Financial and Monetary Policy, New York, September 2011, http://www.fes-globalization.org/new_york/new-directions-for-international-financial-monetary-policy-reducing-inequality-for-shared-societies/ .

[6] Ocampo, José Antonio, “The G-20’s Helpful Silence on Capital Controls <http://www.project-syndicate.org/commentary/ocampo10/English> ,” 30 October 2011

[7] Group of 20, “G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences,” 15 October 2011, http://www.mofa.go.jp/policy/economy/g20_summit/2011/pdfs/annex05.pdf.

[8] See http://www.yesicannes.com/yesicannes/G20_president_sarkozy_final_adress.html.

[9] International Monetary Fund (IMF), “Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework,” Washington, D.C., 14 February 2011, http://www.imf.org/external/np/pp/eng/2011/021411a.pdf.

[10] Organisation for Economic Cooperation and Development (OECD), “Divided We Stand: Why Inequality Keeps Rising,” Paris, 5 December, 2011, http://www.oecd.org/document/51/0,3746,en_2649_33933_49147827_1_1_1_1,00.html.

[11] United Nations Conference on Trade and Development (UNCTAD), Trade and Development Report 2011, Geneva, http://www.unctad.org/.

[12] International Monetary Fund (IMF), “Global Economic Prospects and Policy Challenges,” 9-10 July 2011, http://www.imf.org/external/np/g20/pdf/070911.pdf.

[13] UNICEF, “Austerity Measures Threaten Children and Poor Households,” September 2011, http://www.unicef.org/socialpolicy/files/Austerity_Measures_Threaten_Children.pdf.