TWN Info Service on Finance and Development (Mar12/06)
9 March 2012
Third World Network

UNCTAD on "The paradox of finance-driven globalization"

New York, 9 March (Bhumika Muchhala) - In its first policy brief for 2012, UNCTAD says that the globalization process has been shaped by a sharp growth in the financialisation of economic activity across both developed and developing countries.

This “finance-driven globalization” has produced winners and losers in the developing world, and UNCTAD posits that diverse growth outcomes depend on the degree to which developing countries reject the dominant economic wisdom of trusting their growth prospects to financial markets.

Those countries that instead pursue heterodox and innovative policies, tailored to local conditions, allows a shift of resources to economic and social activities that are increasingly productive. On the other hand, developing countries that have embraced finance-driven globalization, have seen their ability to achieve this structural transformation greatly reduced.

Titled “The paradox of finance-driven globalization”, the policy brief asserts that the key to long-term economic success continues to depend on establishing strong links between resource mobilization and structural transformation. For this, effective policies matter in establishing the right linkages, particularly because
“productivity-enhancing structural change does not emerge spontaneously from unleashing (financial) market forces.”

Rather, positive structural change is the result of strategic government policies to “raise capital formation, strengthen productive capacities and diversify the economy.” Conversely, a narrow prioritisation of improving the efficiency of specific industries or sectors by exposing them to international competition and unregulated, pro-cyclical financial flows often has significantly adverse impacts on the economy, and country as a whole.

The entry of finance-driven globalization

UNCTAD marks the intensification of a finance-driven globalization with the time period of the early 1980s, when extensive financial deregulation and liberalization of capital flows signaled a radical break with the post-war international policy framework. For the first time in economic history, capital flows surged ahead of trade flows.

Subsequently, the proportion of national income derived from the financial sector increased across all countries and regions, and with this financial leverage (the ratio of debt to revenue) also rose. Financial leverage was supported by the proliferation of opaque financial products and markets, “shadow” financial institutions, and speculative behaviour driven solely by quick returns on assets, currencies and property. As a result, the world economy has witnessed dangerous bubbles in all these areas.

As finance expands and tightens its grip over both corporate and political governance, the measure of economic “success” has been disconnected from productive investments and job creation. It is this structural shift from the real economy to the financial economy, and the behavioural changes in economic actors (from production to speculation), that is at the kernel of finance-driven globalization.

The failure of finance-drive globalization

Conventional economic wisdom rationalized financialisation, claiming that “a combination of efficient markets and financial innovation would create a more dynamic economic environment from which all countries would benefit.” In reality, the world economy experienced an aggregate slowdown in global growth, led by the advanced countries.

Investment rates tumbled in the 1980s and as of yet have failed to return to previous levels, despite a visible shift in world income from financial market returns. The retrenchment of public-sector investment has been especially pronounced, and in most cases, private (domestic and foreign) investment has failed to fill the gap.
This failure is partly due to the fact that financialisation has had an adverse impact on household savings, through three different channels: (a) wage incomes have been squeezed; (b) banks have moved away from the business of long-term investment projects, to become heavily involved in lending to consumers and governments; and (c) trade and financial liberalization have raised the propensity to consume, including luxury goods, and have fuelled speculative purchases of real estate.

Moreover, while profit levels have often risen, financialisation has also had a damaging impact on the profit–investment nexus, by channelling retained profits into less productive activities.

In the new millennium, the financial markets in the advanced countries created a debt-driven consumption boom in order to boost domestic demand and consumption of goods and services. However, rather than “reviving productive investment, the debt-driven consumption boom created a series of closely interconnected imbalances.” Following the collapse of Lehman Brothers in 2008, the consumption boom “turned into the biggest burst since the Great Depression.”

“Winners” and “losers” from finance-driven globalization

Employing econometric modeling with regression analysis between financial globalization and output growth across a wide range of developing countries, the UNCTAD policy brief finds that there are clearly some winners and some losers, defined primarily by the causal relationship of financial globalization on economic output.

Developing country “winners” are divided into those that embraced financial globalization and those that resisted financial globalization. The former group is comprised of small island economies (such as Antigua and Barbuda, Dominica, Seychelles, and Saint Vincent and the Grenadines among others), commodity producers (such as Angola, Botswana, Chile and Qatar) and regional financial centres (namely, the four commercial cities in Lebanon, Singapore, Panama and Uruguay).

Notably absent in this group, UNCTAD points out, are countries with a strong manufacturing sector.

The latter group, developing countries that resisted financial globalization, are countries that have achieved economic growth “without substantial financial globalization.” These countries, including China, India and Vietnam, have taken diverse paths, “but their economic gains cannot be attributed to the standard policy formula associated with finance-driven globalization.”

While China and Vietnam have launched robust industrialization take-off strategies, countries like India have developed niche service and commodity industries, but still lack a substantial industrialization strategy in manufacturing.

The importance of economic structure

UNCTAD asserts that financial globalization appears to have benefited only a small group of economies. The developmental impact of finance, as suggested by the data, depends on structural changes at the national level.

The causal relationship between structural change and economic performance has been extensively analysed in the 2011 Trade and Development Report as well as in the Least Developed Countries report. Recent assessments by McMillan and Rodrik (2011) highlights that productivity growth is explained either by rising labour productivity or by a shift from low-productivity to high-productivity sectors.

However, if resources and labour move in the opposite direction (e.g. from efficient enterprises or sectors to less productive activities or unemployment) the overall impact on the economy may be negative. This differential, between productivity levels and structural shifts, tends to be small in high-income countries and greater in developing countries where the output difference between agriculture and manufacturing is significant.

Data on productivity growth and structural change in economic sectors, activity and employment show that in the 15-year period from 1990-2005, developing countries as a whole have gained from productivity growth within sectors. But where Asia differs from Latin America and Africa is that the “impact of its structural change has been positive, whereas for both Africa and Latin America it has been negative.” This is because Asia has structurally transformed from low- to high-productivity sectors to a greater degree than Latin America and Africa have.

The missing link

In most country case studies, UNCTAD has found that those countries that have been able to adopt “creative and heterodox policy innovations tailored to local conditions” have fared better in the financialisation of the world economy.

Such strategic policies involve a management of insertion into global competition and capital forces through: “high (but temporary) tariff and non-tariff barriers, publicly owned development banks, directed credit, domestic-content requirements and capital controls. In addition, some have used targeted industrial policies to diversify their economies and develop a wider range of productive activity,” which improves employment numbers and resilience to external shocks.

This development of productive capacity has often occurred in the “context of a strong regional growth dynamic,” for example, the Sino-centric production network (also known as triangular manufacturing) between China and Southeast Asia.

However, as expounded in many academic and institutional studies, there are serious consequences to financialisation (such as volatile and ungoverned capital movements, excessive commodity and food price fluctuations, rapid shifts in exchange rates and speculative boom-bust cycles that have led to chronic financial crises).

Industrial capacity has been constrained by trade liberalization, while balance of payments problems have become increasingly severe. Such alarming features of the global economic landscape is what has led to the deepest economic collapse since the Great Depression.

In conclusion, UNCTAD argues that “productivity-enhancing structural change does not emerge spontaneously from unleashing (financial) market forces, but rather is the result of concerted government policies to raise capital formation, strengthen productive capacities and diversify the economy.” Upward movement in the value chain of national and regional economies necessitate, to some degree, a strategic industrial policy, stronger regulation and policy space in trade rules.

A narrow preoccupation with improving “efficiency” through international competition and unpredictable financial flows can have a “strongly adverse impact on the performance of the economy as a whole.” +