Info Service on Finance and Development (Oct12/05)
The South Centre statement highlights three main areas that concern developing countries in the global economy:
1) Global economic slowdown following policy failures in developed economies
Lack of progress in reforming the international financial architecture
3) Policy tools to regulate and control capital flows are important
Global economic slowdown following policy failures in developed economies
The world economy is no less fragile today than in 2009. Erratic and sluggish growth in the US is being aggravated by a new bout of recession in several European economies.
Contrary to the prognostications in the 2000s, developing economies are not cyclically decoupled from advanced economies. Growth is slowing down everywhere in the South including in major economies which initially proved resilient to adverse fallouts from advanced economies, including China and India. Their outlook is clouded by significant downside risks. After spreading from US to EU, the probability has significantly increased that severe economic crises will strike developing countries next. The main difference is that, compared to their situation in 2007-08, the policy space of developing countries to respond with domestic measures to a new crisis is now severely impaired.
The threat to the global economy is grounded in policy failures in crisis management in developed economies. Authorities in the Eurozone, the UK, and US, have failed to put in place policies that reconcile the need for short-term fiscal stimulus with a credible program for long-term consolidation. Instead, fiscal austerity measures have become the priority to assuage private financial markets temporarily even though such policies at this juncture further derail the recovery of demand and growth.
Developed economies have also have not decisively addressed the debt overhang which obstructs economic recovery. The US Troubled Asset Relief Program (TARP) rescued big financial institutions but did not address the problem of foreclosures in the household and consumer sector and did not lead to restarting bank lending or reducing unemployment. The European Central Bank’s financing responses have not provided adequate debt relief to debtor countries, leading European debtor countries to retrench everywhere.
Developed economies have relied excessively on monetary policy (both interest rate cuts and quantitative easing). In the first place, these policies have not proven effective in addressing over-indebtedness and demand retrenchment. In the second place, these policies impose unwelcome liquidity and exchange rate appreciation pressures and dangerous “hot money” surges in developing countries.
Strengthening capital account tools in developing countries
The issue of the use of policy tools to regulate and control capital flows in the capital account has assumed renewed importance in view of recent developments and in view of the increasing effects of the global crisis on developing countries. The recent extensive use by developed countries of quantitative easing continues to impose vulnerabilities in developing countries and makes more urgent a more detailed and sophisticated understanding of the role of effective and permanent capital account management tools. At the same time, deteriorating growth prospects in some developing countries are already sparking significant capital outflows for which effective controls are also required.
It is important to recognize that under the IMF Articles of Agreement such policies are the prerogative of all members. It is important that IMF staff research on this topic work with this prerogative in mind. Capital account regulatory tools are necessary for three reasons: (1) as means of responding to balance of payments crises; (2) for the purpose of regaining and maintaining countercyclical macroeconomic policy space; and (3) as an element of national policies toward industrial development and the establishment of a constructive domestic financial sector. Recent IMF staff research has begun to recognize the appropriateness of controls only for the first purpose, that is, in situations of balance-of-payments crises, but, even then, only as a last resort. This approach is inadequate and thus also inappropriate.
The view that eventually all capital account controls should ultimately be removed has little research support. The economics literature, confirmed by more recent studies, does not indicate any clear relationship between capital account liberalization, economic growth, and financial stability. Older research which warned against the instability and perverse influences on exchange rates and domestic interest rates from capital flows driven by portfolio incentives of external actors have been painfully confirmed by actual experience since the 1990s.
An implication of a view that capital account regulations are permanent tools of economic policy is that governments must establish and maintain staff capabilities to implement such regulations. Governments need also to be prepared to continually amend regulatory approaches in response to the continuing evolution of private agents’ tactics to evade them. Multilateral institutions must improve their own capacity to assist developing country governments in implementing such tools.
Lack of progress in reforming the international financial architecture
There has been little progress and action on the consensus that emerged from the onset of the global crisis on the urgency of extensive reforms in the international financial architecture. The international system must ensure that countries take into account the impact of their policies on others. There must also be a credible and effective system of decision-making at the global level for policy coordination and accountability.
We note recent changes to improve the analytical content of policy surveillance and the quality of Article IV reports, including greater attention to international spillovers and a wider range of policies. However, multilateral arrangements still lack effective mechanisms to prevent systemically important countries, notably the reserve issuing countries, from pursuing beggar-my-neighbor macroeconomic, financial and exchange rate policies.
There is a need for an integrated approach to restructuring governance at the IMF especially aimed at increasing the voice and say of developing countries. Such an approach must combine the reform of the Board with updated quota assignments and formula, and basic votes to better reflect the current global economic structure and the purposes for which the IMF was established. Serious consideration of the use of qualified majorities in key decisions is essential.
The IMF’s participation in the Eurozone crisis response has given rise to new questions about the role of the institution. After the East Asian crisis of the 1990s, the IMF’s crisis derived from extensive doubts about the suitability of its analyses and crisis advice. Now questions of the IMF’s credibility and impartiality are being raised by the call on its cooperative resources by members with prodigious voting weight and management influence. A substantial proportion of IMF resources are now exposed to European crisis resolution efforts.
To defend the IMF’s credibility and effectiveness, the quota reform outcome will need to achieve three things. First, in light of the generally agreed under-representation of developing countries as group, it should result in a clear increase in voting weights for developing countries as a group, and not depend on reallocation of weights among developing countries. Second, there should be adequate and considered discussion of the quota formula, even if it means not meeting the impending deadline for completion. Third, the resulting quota formula should be in consonance with generally agreed principles of good corporate governance.
Response of developing countries to the worsening crisis
In the past few years, developed countries have proven ineffective in addressing the roots of the crisis. We believe that the current period of economic turmoil and uncertainty poses a serious challenge to developing countries to play a leading role in working toward and realizing the wide ranging reforms in international policy and governance that the times require. These pressing issues include the reform of the governance of the international financial institutions, addressing global imbalances, new international debt arbitration and debt restructuring mechanisms, a review of the international reserves system, and a framework of analysis and action to enable adequate global effective demand towards a balanced and durable economic recovery.
In this context, the international financial and monetary system needs to be reformed to be more responsive to the growing problems facing developing countries arising from the adverse trends in the global economy, especially since they are not responsible for the deteriorating global economic conditions. Issues that were raised by developing countries and international organisations supporting them during the 2008-2010 crisis have re-emerged. These include the need to address new external shocks such as falling merchandise exports, declining international services revenues including remittances, reduced capital inflows and their reversal to outflows, the need in several developing countries to avoid new debt crises, the absence of an equitable international debt arbitration and debt restructuring mechanism, and the provision of international financing with appropriate terms to developing countries facing external financing shortfalls.
We believe that the G24 has a critical role to play in providing leadership for the developing countries in their efforts to address the adverse effects of the worsening global financial and economic situation and to reform the international architecture. The South Centre would be pleased to work together with the G24 in this regard.