TWN Info Service on Finance and Development (Feb12/01)
14 February 2012
Third World Network

From finance-driven to development-led globalisation
Published in SUNS #7305 dated 9 February 2012

Geneva, 8 Feb (Kanaga Raja) -- The head of the United Nations Conference on Trade and Development (UNCTAD) on Tuesday urged a shift from finance-driven globalisation, characterising "the dominant pattern of international economic relations during the past three decades", to one that is development-led in order "to turn tentative recovery into an inclusive and sustainable future".

In his report to the upcoming UNCTAD-XIII quadrennial conference, to be held in Doha, Qatar from 21-26 April 2012, Secretary-General Dr Supachai Panitchpakdi said that reforming the global financial system would be the place to begin, and that this time around, the rebalancing will need a "global new deal" that can "lift all boats" in both developed and developing countries alike.

According to UNCTAD, the report by Dr Supachai, titled "Development-led globalisation: Towards sustainable and inclusive development paths" and contained in document UNCTAD(XIII)/1, is intended as a substantive contribution to the UNCTAD-XIII conference, whose theme is "Development-centred globalisation".

The report has been set out in three parts, the first on finance-driven globalisation and its limits, the second on rebalancing the global economy through sustainable and inclusive development, and the third on the political economy of development.

The report argues amongst others that finance-driven globalisation (FDG) has failed to harness the creative forces of markets in support of broad-based growth, while giving greater sway to their more destabilizing and destructive tendencies.

Noting that for long periods of FDG, most developing countries posted lower per capita growth than advanced countries, the report says that these trends give little support to calls to stick to business-as-usual, since one of the paradoxes of FDG is that emerging success stories have adopted proactive development strategies which are, in many respects, at odds with the dominant strand of economic thinking.

The challenge for policymakers is to put inclusive development firmly at the forefront of the policy agenda. The inter-related nature of the components of inclusive development will add significantly to the burdens of this task. Still, it remains possible to set out policy measures at the national, regional and global level to rebalance the world economy, transcend FDG, turn recent growth spurts into sustainable development paths, and ensure that the gains are enjoyed by all sections of society, particularly the poorest and most vulnerable. This, in essence, is the challenge of development-led globalisation (DLG), says the report.

The report further says that the rebalancing challenges at the heart of DLG will need a global new deal involving a large and diverse group of economies, and must reflect the ongoing shifts in the distribution of economic power and political influence among countries.

"Unfortunately, the degree of trust among countries that is needed in order to manage appropriate collective responses and actions and deliver reliable development cooperation for the most disadvantaged members of the international community has been gradually eroded during FDG and has been hit even harder as a result of the financial crisis, and is in urgent need of repair."

The report notes that the idea of a global New Deal alludes to the rebalancing efforts that a number of countries undertook during the 1930s in response to a deeply destructive financial crisis. In the case of the United States, a series of interconnected public investments in energy, agriculture, and social infrastructure, along with strong regulation of financial and labour markets and expansionary macroeconomic policy, laid the foundation not only for a return to full employment but for a strong industrial take-off in some of the most underdeveloped parts of the country, crowding in substantial private investment and building local markets through a virtuous growth circle.

"Today's global New Deal should also look to lift all boats, through support for productive investment, economic diversification and expanding markets... It is imperative, therefore, for international measures to be designed in such a way that they complement or strengthen state capacities to deliver on national objectives and meet the needs of their constituencies," the report stresses.

With respect to a global new deal, the report says that "taming finance" is the place to begin rebalancing the global economy. A much more ambitious reform agenda for the international financial system is clearly necessary if it is to bring about lasting stability and support the shift to a truly development-led globalisation, it adds.

According to the report, this reform agenda should include elements such as measures to align and stabilize exchange rates, particularly among the G-3 currencies, which are urgently needed. This will likely involve moving away from a dollar-based payments system, stronger surveillance of the macroeconomic policies of reserve currency countries, the promotion of capital controls, and the possible use of exchange rate target zones.

Furthermore, a more balanced approach to sovereign debt restructuring is needed, including arrangements spreading the burden of adjustment more equitably between borrowers and private sector creditors, as well as a pruning back of the policy conditionalities that have mushroomed around adjustment and crisis lending. These have imposed a deflationary bias on borrowing countries and reduced the policy space to manage crises and launch sustainable recoveries.

On dealing with debt, the report proposes a temporary standstill, whether debt is public or private, and regardless of whether the servicing difficulties are due to solvency or liquidity problems (a distinction which is not always clear-cut). In order to avoid conflicts of interest, the standstill should be decided unilaterally by the debtor country and sanctioned by an independent panel, rather than by the IMF, since the countries affected are among the shareholders of the Fund, which is itself also a creditor. Sanction should provide an automatic stay on creditor litigation.

In a preface to his report, Dr Supachai noted that in his report to UNCTAD-XII
(2008, Accra, Ghana), he had warned that despite an unprecedented global boom over the previous five years, significant risks and vulnerabilities threatened growth prospects and could undermine moves towards a more equitable and effective global partnership for development. In particular, he said he had argued that "putting liberalized markets and flexible prices at centre stage has proved to be insufficient in the light of the complex challenges that the new generation of globalization poses".

At that time, said Dr Supachai, "I was swimming against the tide of conventional thinking. Even though there were clouds on the economic horizon, notably the housing market in the United States and (closely related) concerns about global imbalances, the consensus forecast was for fair economic weather sustained by strong market fundamentals. Indeed, at the time that I was writing, the International Monetary Fund (IMF) was raising its global growth projections."

Financial turbulence hit in August 2007, and the collapse of Northern Rock in February 2008 and Bear Stearns in March 2008 revealed serious stresses in the financial markets. Concerns over sub-prime lending in the United States housing markets intensified in the middle of 2008. But it was the bankruptcy of Lehman Brothers in September that triggered a crisis that few had anticipated or even imagined possible, exposing the full extent of global financial fragility. Credit markets froze and equity prices collapsed. Leading financial institutions failed, while many others turned to their governments for support. The speed of contagion was breathtaking, and the sense of panic in the financial markets and among policymakers was palpable.

According to the UNCTAD Secretary-General, the first lesson to draw from the crisis is that leaving markets to regulate themselves is both ineffectual and costly. Bailing out financial institutions has already run into trillions of dollars, and despite unprecedented fiscal and monetary responses, the global economy experienced its first contraction since the Great Depression. An estimated 10 per cent of global output was lost between 2008 and 2010, and tens of millions of jobs were destroyed. According to estimates by the International Labour Organization (ILO), 200 million people are currently unemployed worldwide.

"A second lesson is that when a large number of economies collapse so dramatically, there must have been underlying weaknesses and fragilities missed or ignored by policymakers prior to the crisis. No one doubts the creative impulse of market forces, but the private pursuit of short-term gain can sometimes result in insufficient productive investment and concentrate the rewards with the favoured few. The risks are particularly pronounced when financial markets detach themselves from the real economy, tying wealth creation to the rapid accumulation of debt and rising asset prices rather than to steady productivity improvements and increasing incomes, and channelling innovation to financial engineering rather than to technological progress. Such a growth strategy is likely to be neither stable nor fair."

A third lesson, said Dr Supachai, is that when things do fall apart, the state remains the only institution capable of mobilizing the resources needed to confront large and systemic threats.

"The idea that the nation state had somehow outlived its usefulness in a borderless world was never very serious. Since the state is pivotal to establishing an inclusive social contract and strengthening participatory politics, it is both imprudent and unrealistic to reduce or bypass its role in managing economic development and change. The more worrying trend in recent years has been the growing influence of financial markets in bending public policy and resources to their own needs and interests - leading a former IMF chief economist to warn of ‘a quiet coup' - including in the post-crisis period."

He added that even as a tentative recovery has set in, the imbalances that arose during the previous boom, particularly in advanced countries, have proved very difficult to overcome. The private debt overhang remains a drag in many countries, while the combined effect of financial bailouts and recession has led to rising public deficits, triggering sovereign debt crises in some countries and stalling the recovery in others. Everywhere, employment creation has lagged behind, raising the threat of jobless growth and the spectre of protectionist responses.

"This provides a fourth lesson from the crisis, namely that in an interdependent world, countries cannot be expected to tackle destabilizing threats and imbalances on their own. And yet, to date, effective rebalancing strategies have not materialized at the multilateral level."

The extensive deregulation of the financial sector in the advanced countries, the dismantling of controls on cross-border financial activities, and the ensuing surge in capital flows marked a radical break with the post-war international policy framework. The rapid ascent of financial interests has eroded the checks and balances that had previously helped channel market forces into the kind of creative and productive activities needed for long-term growth, and has instead encouraged short-term, and at times destructive, behaviour by banks, businesses, and households. Ideological support came from the efficient market hypothesis, which made the case for a hands-off policy approach applicable to all economic circumstances and challenges.

Since the early 1990s, against the grain of conventional economic wisdom, Dr Supachai said that UNCTAD has been arguing that the risks from the premature liberalization of trade and capital flows are significant, that the benefits are not simply there for the taking, and that a more pragmatic approach to development strategy is essential.

He noted that in 1993, UNCTAD warned of an emerging financial crisis in Mexico, in 1995, it flagged the systemic risk from growing derivatives markets, and in 1997, it was not only alert to the dangers of rapid financial liberalization in East Asia but also suggested that a combination of repeated shocks and growing inequalities could produce a backlash against globalization. In 2008, it argued that the financialisation of markets of strategic interest to developing countries had reached dangerous levels, and that it had become a more significant influence on trade and development than real economic fundamentals.

"With all this in mind, I have chosen the term finance-driven globalisation (FDG) to characterize the dominant pattern of international economic relations during the past three decades. This is intended to convey the idea that financial deregulation, concerted moves to open up the capital account, and rapidly rising international capital flows have been the main forces shaping global economic integration since the breakdown of the Bretton Woods system. Financial markets and institutions have become the masters rather than the servants of the real economy, distorting trade and investment, heightening levels of inequality, and posing a systemic threat to economic stability."

According to the Secretary-General, the latest crisis has served as a further reminder that FDG is a political project and is, therefore, the subject of legitimate discussion and debate. To date, the response has largely been one of muddling through, with ad hoc measures to mitigate the damage from economic shocks, informal partnerships to tackle global imbalances, and impromptu alliances to push for greater market transparency.

There has been progress: the G20 has added a new and more focused layer of coordination in international economic matters, and has helped to nudge the multilateral financial institutions towards (marginally) more representative governance structures and (slightly) less dogmatic advice.

However, said Dr Supachai, divisions have emerged among the advanced economies on how to reform the international financial system, with alarming signs of a reversion to "business as usual".

"Indeed, their financial sectors have already returned to many of the old practices, even as public finances deteriorate and the recovery stalls. Austerity measures are back on the agenda, and resistance to financial regulation has begun in earnest."

The UNCTAD Secretary-General noted that the rise of new growth poles in the South also heralds a significant shift in the global economic and political landscape. China has already become the world's second-largest economy and its largest exporter. India has now posted two decades of strong growth and is steadily climbing the export ladder. Growth in other large developing countries, such as Brazil and Indonesia, picked up in the second half of the last decade.

Since the Accra conference, the share of developing countries in world income has risen by more than 3 percentage points, to 30 per cent. Trade and investment patterns have shifted accordingly, and new political alliances and groupings have emerged, suggesting that a new world order is already taking shape. The resilience to, and rebound from, the crisis in parts of the developing world certainly marks an important break with the past and has raised hopes of a prolonged period of convergence ahead.

According to Dr Supachai, UNCTAD has always looked to an emerging South as being key to a more balanced global economy. "However, a degree of caution is warranted. To date, this shift has been uneven, with large differences between developing regions and among individual countries; many of the least developed countries (LDCs) have seen the income gap between them and other countries widen further during the past two decades, suggesting that polarization pressures continue to shape global economic relations."

Moreover, many emerging markets remain dependent on the leading economies and vulnerable to changes in policy and in economic conditions there. The impact of the Northern debt crisis on developing countries will need to be monitored carefully. The emerging South is still work in progress, and new forms of cooperation and partnership will be needed to consolidate recent gains and to meet the challenges ahead, he added.

Against a backdrop of economic imbalances and political tensions in interwar Europe, John Maynard Keynes called for "new policies and new instruments to adapt and control the working of economic forces, so that they do not intolerably interfere with contemporary ideas as to what is fit and proper in the interests of social stability and social justice".

A new deal did eventually emerge, but only after a push for "business as usual" had left a trail of currency disorders, wasted resources and shattered communities. Today's global economic landscape bears some unnerving similarities to the interwar years; "as then, neither muddling through nor a return to business as usual will get things back on track. The challenge is to rebalance economies in a way that is timely, sustainable and just."

This time around, said Dr Supachai, rebalancing will need a global new deal that can "lift all boats", in developed and developing countries alike. It is a basic truth that people everywhere want much the same thing: a decent job, a secure home, a safe environment, a better future for their children and a government that listens and responds to their concerns.

"UNCTAD has consistently suggested a battery of policy measures and institutional reforms at the national and the international level to support rising living standards in developing countries, build their resilience to external shocks, and help them pursue a balanced integration with the global economy. The challenge, as I outlined in my report to UNCTAD XII, was less about ‘getting prices right' and more about ‘getting development right', through a pragmatic, proactive and socially inclusive approach to macroeconomic, trade and industrial policies."

Dr Supachai stressed: "Finding the appropriate mixture of reflation, redistribution and regulatory measures to achieve these goals is now the urgent task of policymakers, at the international as much as the national level. I have chosen the term development-led globalization (DLG) to describe the principles, priorities and policies that need to be pursued to turn tentative recovery into an inclusive and sustainable future."

Reforming the financial system is the place to begin, he said. "Even before the crisis, it was clear that stable and inclusive development was incompatible with speculative market behaviour, boom-and-bust cycles, and the austerity programmes to which they invariably lead. It is telling that the emerging success stories from the South have, in large part, pursued policies that have avoided these dangers."

"Finance needs to get back to the business of providing security for people's savings and mobilizing resources for productive investment. Reforms are also needed to replace unruly and pro-cyclical capital flows with predictable and long-term development finance, to regain stability in currency markets and to support expansionary macroeconomic adjustments. Surveillance and regulation will need to be strengthened at all levels, and new institutional arrangements may need to be considered. Regional financial cooperation, despite the current difficulties in the eurozone, will, in particular, have a much larger role to play in a more balanced international architecture."

Stable monetary and financial arrangements are a precondition for making trade and investment work for inclusive growth and development. But rebalancing requires that financial and other resources be channelled towards the right kind of productive activities, said the UNCTAD head, adding that industrial development remains a priority for many developing countries because of the opportunities it provides to raise productivity and incomes, and to get the most from international trade.

"But a wider sectoral approach, including a focus on the primary sector in many LDCs, is needed in order to ensure that measures to diversify economic activity are consistent with job creation, the security of food and energy supplies, and effective responses to the climate challenge."

Talk of "picking winners" has been given an unexpected boost by the exigencies of the financial crisis, but the real challenge is to make sure that industrial policy, broadly conceived, is properly aligned with other measures needed to build inclusive development paths. Since diversified economies are the building blocks of a dynamic trading system, it is essential that trade policies and rules - at all levels - support this agenda.

An inclusive development agenda cannot depend on economic policies alone, said Dr Supachai. Under FDG, the stresses and burdens of unregulated markets have, all too often, been shifted to individuals and households and, in countries where social welfare systems exist, to government budgets. In many cases, unprecedented increases in income inequality have gone hand in hand with underfunded public services and rising levels of household indebtedness. The resulting cost to economic security and social cohesion has been enormous.

A balanced economy depends on a strong social compact which, in turn, requires a range of universal and targeted social policies, tailored to specific circumstances, to ensure that the benefits of growth are widely enjoyed and its risks are shared fairly.

According to the Secretary-General, the crisis has confirmed UNCTAD's long-standing insistence on the importance of policy space. Its role in building new and more inclusive development paths cannot be understated.

"This is needed to allow governments - particularly but not only in developing countries - to correct market failures, promote collaboration among enterprises in areas of long-term investment, manage integration with the global economy, and ensure that the rewards from doing so are evenly shared. In order to do so, states must forge a coherent and inclusive developmental vision and build a strong compact with different interest groups to better manage the conflicts and trade-offs that change inevitably brings."

He noted in his report that in order to establish a successful development path, it is essential to ensure the space to introduce a range of policies for building domestic productive capacities and local technologies, and to establish the institutions and support measures to spread the resulting gains. However, for many developing countries, policy space has been reduced under FDG and through a variety of channels.

Dr Supachai stressed the critical role of the developmental state in building balanced growth paths in an economy where the mobilization and allocation of resources relies on market forces.

"Responsibility for the choice of policies to secure a prosperous, fair and stable future remains to a large extent with national governments, institutions and constituencies. However, in our interdependent world, a more secure and inclusive global economy requires strong international leadership and carries collective responsibilities. There are hard questions to answer about whether current arrangements can help to build socially inclusive alternatives to FDG, and what governance structures might support DLG."

"UNCTAD XIII in Doha provides an opportunity for the international community to discuss these challenges in a frank, open and constructive manner," Dr Supachai concluded. +