Global Trends by Martin Khor

Monday 30 May 2011

Bracing for a world of uncertainty

There is great uncertainty about the future of the world economy and developing countries should prepare now for the next crises, according to prominent experts as a finance seminar in Geneva last week.


The world economy will be going through a period of uncertainty and turbulence in the next few years and the developing countries should prepare to face this challenge and avoid being overwhelmed.

Several experts gave this warning at a workshop on options for developing countries in the global financial turbulence held in Geneva on 25 May.

If the lessons of the last financial crisis are not acted on through coordinated global action, there will be a bigger crisis soon, and an even bigger one after that, warned Yilmaz Akyuz, Chief Economist of the South Centre.

The world we face in the next 10 years will be different, with the developed countries facing massive public debts, said Y.V. Reddy, former Governor of the Reserve Bank of India.  From the developing countries’ viewpoint, there will be a lot of uncertainties, and they must prepare themselves to face the uncertain future.

Agreeing with this, the former Governor of Nigeria’s Central Bank, Charles Soludo, said the key lesson for the developing countries is that they have to prepare now for the next crisis, which is caused by coordination failure at the global level. .  When that happens, commodity prices are likely to collapse, and many poor countries may face new debt crises.

The workshop, organized by the South Centre in cooperation with the Malaysian-based Third World Network, was held at the International Labour Organisation and attended by a hundred diplomats, scholars, and representatives of NGOs and international agencies.

Its aim was to take stock of the global financial situation and the implications and policy options for developing countries.

Akyuz said that the developed economies face a slowdown in the next few years, with the United States having to respond to their deficits, several European countries in debt crises, and the steam going out of their previous reflationary fiscal and monetary policies.

Asian countries will be able to continue with their economic growth but at a moderate rate as most of them are not so vulnerable to currency or balance of payments problems.  However the situation will be less orderly in Latin America and Africa, which are vulnerable to changes in global conditions and commodity markets.

Akyuz warned that there may be balance of payments crises in some major developing countries that are dependent on international capital flows, which may reverse.

There is risk of fiscal and sovereign debt crises in some developed countries. And the sluggish growth and high unemployment in the North will increase tension in the trading system, with higher risk of protectionism.

Systemic reforms are needed in global finance, added Akyuz.  There is a lack of multilateral discipline on financial, macro-economic and exchange rate policies of major countries. 

There is an absence of control of financial markets, capital flows and speculation.  And the G20 has failed so far to address these systemic issues.

According to Akyuz, globalization had been oversold to developing countries, which were asked to fully integrate into the global financial markets.  The lesson is that developing countries should rethink their integration into the world economy.  They should seek strategic integration (in areas and ways that are beneficial) but not full integration.       

Soludo commented he was intrigued by the scenario outlined and asked what would happen if the systemic problems are not tackled. Akyuz replied that we can then expect another crisis, and without reforms an even bigger crisis after that, and the possibility of conflicts.

In Soludo’s view, the financial crisis was triggered by coordination failures at the global level, and there will be more crises if this is not addressed.  He gave three scenarios of what could happen.

First, there would be greater global policy coordination, with a world economic council setting rules for finance, disciplining major countries and establishing an independent panel for resolving debt crises.

Second, the present situation continues without global governance, each country sets its own policies, but there is regulation of financial institutions with cross-border effects, and a fund is set up to provide financing to developing countries hit by external shocks.

In the third scenario, there is only talk of reforms but no global action.  Each country then tries to protect itself against a future crisis, by building foreign reserves, in a race to the bottom.  This may be supplemented by regional financial measures.

Reddy commented that there had been too much of shadow banking in the past without the knowledge of whether the institutions and financial instruments are safe or toxic.  The problems of financial institutions being “too big to fail” or “too powerful to regulate” remain.

In developing countries, it is necessary to design a financial system that not only avoids instability but also promotes development.  Since the markets do not ensure stability or development, governments have to take charge and they must not give up the space for public policy.

Therefore countries must be allowed to have the policy space.  It is important that there be diversity of policies.  In the developed countries, the financial institutions were practicing the same model and making the same mistakes, and this led to a failure affecting the system.  Those regulators that did not follow this model were able to avoid a crisis.

Up to now, the developing countries had been reactive in the global debates on finance.  Reddy urged researchers and policy makers to examine the realities in developing countries and to be pro-active in voicing their views on global and national policies.

Malaysian researcher and former banker, Lim Mah Hui, made four policy proposals for Asian countries.

First, Asia should not follow the Anglo-Saxon model of finance but bring back the role of the financial sector as serving serve the real economy. Second, Asian countries should rebalance their economic growth by reducing their export dependence and also reducing income inequalities.

Third, Asian countries should reinvest their savings in the region.  The foreign reserves should be invested in the region itself rather than being channeled to the West only to be recycled from there to Asia.

Fourth, in view of the volatility of capital flows, Asian countries should be prepared to make use of capital controls to avoid the adverse effects.