Managing financial integration: Some policy options
In the face of the intransigence of the developed countries on the question of international financial reform, what are the policy options open to developing countries? In the second part of this talk on globalisation, Dr Yilmaz Akyuz suggests some possible courses of action for developing countries.
I WOULD like to talk about globalisation: what it means and what to do about it. My understanding of globalisation as a process is that it is different from integration. Mankind has always traded. Mankind did not discover trade, capital flows and foreign investment in the last 10 years. What is it that is special about globalisation when we have always had integration? In fact, in the years leading to World War I, there was actually more freedom in trade than now.
It is important to identify that the difference now is the quantity and pace. It is a critical point. The post-war process of integration was a voluntary process. Countries participated at their own pace, and external policies were adopted as they saw fit. The recent process of globalisation where developing countries are concerned has a qualitative difference. What is integration is defined by a global system that is driven by the interests of the powerful. What is integrated and liberalised is influenced by those interests.
The political power of the powerful countries (governments of the industrialised countries) and multinational corporations are the two forces and they often interact in what has been called (by Bhagwati) ‘the Wall Street and Treasury complex.’ This process is not synonymous with liberalisation. It is selective and serves the interests of the powerful. We find that financial liberalisation has gone much further than trade integration. In capital movements, we have almost full integration, but there is an asymmetry. There is freedom and mobility of capital but labour movement is still restricted. Within trade itself, there are also asymmetries. Telecommunications and information technology are fully liberalised, but agriculture continues to be protected in the European Union, and US$350 billion in subsidies is given to agriculture in the OECD countries. There are also subsidies for exports. Again, textiles were left out (of the general discipline of the multilateral trading system) for 40 years until the Uruguay Round.
There is full liberalisation in some areas and restrictions in others. Therefore it is a mistake to think that globalisation is full liberalisation. It is selective liberalisation, selected by the powerful.
The same applies to investment. The Multilateral Agreement on Investment (MAI) was to be a code of conduct for governments, for full liberalisation and the interests of investor countries.
This character of globalisation explains why the balance of costs and benefits is not random, but rather designed and selected. It is true that not all developing countries are losers and nor are all industrialised countries gainers. Nevertheless, since the process is selective, costs and benefits occur in a pre-designed way. You then have polarisation of the very rich and very poor. There is a hollowing-out of the middle class.
Simultaneously, due to liberalisation of the financial sector, the system has become very unstable. Not only finance, but trade has also become very unstable as currencies change. As new competitors emerge, there are gluts even in manufactures, leading to a decline in export prices.
This is a process which developing countries cannot control individually, and which generates inequality and instability.
The challenge for developing countries is: how to integrate into the global system? I am not suggesting self-reliance or delinking; rather, the manner of integration that has to be considered, how to manage this integration to get something from it.
East Asia failed in the management of financial liberalisation. This aspect of globalisation should have been better understood by or known to governments which should have protected themselves, especially Korea and Thailand.
In managing this integration, developing countries can act collectively, regionally and individually. The spectrum of action can be quite wide, and there is considerable policy autonomy. For example, Malaysia was different from Thailand even in crisis response.
On trade, we need the rules-based system of the World Trade Organisation to work in our favour. Developing countries lost a great deal in the Uruguay Round trade talks. The North is still protectionist. If they open up their markets, there can be US$700 billion of South-North flow of products. The South does not need hot money and short-term money, but can earn through exports at the right prices. We can only get this collectively through WTO negotiations. But developing countries, and the United Nations Conference on Trade and Development (UNCTAD) too, did not do their homework enough before going into and in the Uruguay Round.
On the regional level, there is a lot that can be done. The recent Jakarta regional meeting (to prepare for the Financing for Development conference in 2001) had some suggestions, and the European experience can be a lesson. Development is a long and painful process. ASEAN + 3 has quite a lot of potential. The bulk of trade in Europe is regional, among themselves, with only 10% traded with other countries. There is scope for this region to act collectively, and this is the best defence against globalisation, including in finance.
On the national level, regarding trade, we are now in a different situation from the 1960s. Then only 4-5 countries were export-led and they were tolerated (by the North) as they were a bulwark against communism during the Cold War. Today, everyone exports. The situation has changed. The lessons of the 1960s and 1970s from East Asia may not be appropriate anymore.
Excessive competition among developing countries is what we see today, and this could intensify especially when China is in the WTO and if Africa succeeds in labour-intensive manufacturing.
UNCTAD has always been worried about commodity prices. The fall in the terms of trade is not only in commodities now but also in manufactured goods which developing countries produce. Most developing-country manufacturing exports behave like commodities: unstable prices, with someone always behind so that you have to constantly keep ahead.
The labour issue will become a South-South issue very soon, not just a North-South issue.
No country is immune to currency crises in a world of capital mobility. In the 1980s, the US dollar collapsed, from 270 yen to 140 yen. There have been large swings in the euro-yen exchange rate in the last 12 months. In 1992/3 there was a currency crisis in Europe. Large swings of 30-40% in exchange rates are not unique to developing countries; even the US, Japan and EU are vulnerable. The difference is when it leads to financial bankruptcy, default and recession. Currency crises in industrialised countries do not translate in this way. But in developing countries, a currency turmoil often translates into a financial crisis and recession.
The main reason is that developing countries are debtors and their foreign assets are in the red. Taiwan was in the black, and that was why it was protected. If you are in the black, the foreign assets gain; when you are in the red, you lose.
Secondly, developing countries are small. Capital going in and out can cause havoc. One or two institutional investors can leave and the developing country concerned is in trouble.
Thirdly, developing countries are more dollarised than industrialised countries, and the share of dollars in bank deposits is greater in the South than in the North.
Fourthly, in the stock market the typical foreign penetration is 40-50% in developing countries, compared to less than 10% in industrialised countries. Again, this makes developing countries more vulnerable.
Fifthly, trade shocks also translate into financial turmoil in developing countries because of balance-of-payments problems, and because foreign exchange is a big part of the GDP.
Lastly, every major financial crisis in developing countries is associated with sharp swings among the industrialised countries’ currencies (yen, euro and dollar), their liquidity position and interest rates.
What can be done? Developing countries are vulnerable and indebted, so how can we manage integration into the financial system?
We cannot delink from the financial system as we need finance in order to trade. We have to integrate, but manage it well, so that we do not get into trouble. There can be action at three levels: collective, regional and individual.
Firstly, on collective action. Developing countries need to be more forceful in the International Monetary Fund. The G24 (the Group of 24, a grouping of developing-country members of the IMF and World Bank) can be powerful as the collective vote of its members is more than that of the US. There is a need to bring greater multilateral discipline on US interest rates and financial policy. Now the industrialised countries are exempted from following disciplines in finance, for example, in changing their interest rates. In the area of trade, due to rules in the WTO, the US cannot just raise tariffs, but in finance there are no such rules so they can change interest rates, even though this may have a greater impact on developing countries.
In the WTO negotiations on the General Agreement on Trade in Services (GATS), developing countries must be much more forceful and should think about an agreement to regulate currency trading. Various groups (NGOs and some governments) are advocating measures such as the Tobin Tax.
Secondly, on regional action: there is scope here to establish collective regional mechanisms. If we look at the European experience, when the Bretton Woods fixed exchange rate system collapsed, Europe went for a regional monetary arrangement, and now there is the euro. It is very important to note that they did not float their currencies freely amongst themselves.
Regional surveillance arrangements, regional cooperation and a regional lender-of-last-resort facility (with Japan, perhaps) should be examined. The usefulness of swaps is limited in a REGIONAL crisis, when many currencies are under attack, though they can work for a crisis affecting an individual country.
There are steps that can be built on, and the recent Jakarta conference identified some. This is a long and tedious process but it is time to start.
Thirdly, individual action. Individually, what can a country do? Not much.
Prudential regulation and management by themselves cannot prevent a crisis. It can contain the damage but will not prevent it. In Malaysia in 1997, the Basle requirements were met; the country had more reserves than short-term debt. But this did not stop the ringgit and stock market from falling sharply.
Other measures can include restricting borrowing by corporations so that only exporters can borrow internationally. But as long as the country is subject to trade shocks, the companies that borrow are vulnerable.
Another measure is to restrict foreigners’ entry to the domestic capital markets, and keep them out of the government bond market.
So there are policy options to alleviate currency turmoil. But as long as you are an international debtor, with a dollarised economy and freedom of capital movement, it is very difficult to stop a currency crisis from translating into a financial crisis.
Still, a large number of developing countries are not willing to use the policy options that they have. Malaysia used those options, and was not hurt as much.
Therefore, countries should turn to regional defence mechanisms, and the reform of the global financial architecture is important, as domestic measures can be limited.
The above are excerpts from a public lecture by Dr Yilmaz Akyuz at the Malaysian Securities Commission on 9 August 2000. The lecture was delivered at the invitation of the Ministry of Foreign Affairs, Malaysia.