18th January, 5 pm- 8 pm
The speakers in the IDEAs session on Resisting Imperialism: Financial Fragility and Trade Volatility included Prof. Amiya Kumar Bagchi from the Institute of Development Studies Kolkata; Prof. Zhiyuan Cui from East Asian Institute, National University of Singapore and Wissenschaftskolleg Zu, Berlin; Prof. C.P. Chandrasekhar from Jawaharlal Nehru University, New Delhi; Prof. Sushil Khanna from Indian Institute of Management, Kolkata; Prof. Sunanda Sen from Academy of Third World Studies, Jamia Millia, New Delhi; and Prof. Erinc Yeldan from Bilkent University, Turkey. Prof. Korkut Boratav from Turkey chaired the session.
The session began after grieving the demise of Krishna Raj, the editor of Economic and Political Weekly on 16th January in the night. Prof. Amiya Bagchi was the first among the speakers and he spoke on the need to take up the final project of overthrowing imperialism not only internationally, but also in every nation, and how Krishna Raj's death would put a dampener to the struggle. He said that in his speech he would primarily concentrate on what finance means and what the evolution of the financial system has done for the world.
There is the need to distinguish between money as simple means of exchange and money as finance. Money or all varieties of medium which act as surrogate sub-money, both directly as well as indirectly, would be considered. In all societies for which we have written records (like China, India before Buddhist times, and Europe) there had been a role for money, but never has that role been that of finance. But finance in the sense of mobilizing control over money, and means of controlling assets, goods, and finally people is basically a capitalist innovation although earlier also there had been some financial dealers. But the power over people and assets of the latter was strictly limited. As long as money played the role of medium of exchange it did not command much power over people or assets. One of the basic ways in which finance has been used in the modern capitalist world is that the value of the object does not lie in how you value it; it is valued at how other people value.
Professor Bagchi drew instances from history where speculative activity led to a total collapse of economies in different countries of the world. Prominent among these were the tulipmania in the Netherlands in the 17th century, the banking crisis in the United Kingdom and the indigo crisis in Bengal, as well as the cotton crisis in Bombay, all of them in the 19th century. Recent examples of such crises are the collapse of the Barings Bank in the 1990s and the failure of a firm with liabilities close to US $90 billion which had Myron Scholes and Robert Merton, Nobel laureates and two of the devisors of the option pricing formula, as partners and directors in charge of long-term capital management.
This is the kind of situation that financial markets have created all over the world that has led to a series of financial crises like the Asian financial crisis, preceded by the Mexican financial crisis. It has led to greater wealth for only a handful of people. The UTI bubble was created by the government in India three years back and a few large companies, like the Reliance, made money out of it. The Government of India deliberately advised UTI, which was the biggest mutual fund, to invest in companies many of which never even existed in the stock market. This is the kind of defrauding that has gone on in the name of financial liberalization.
The British in colonial times extracted a huge revenue from its colonies including India. Between 1870 and 1914 of the total stock of British investment all over the world something like 70-80 per cent was accounted for by only the Indian surplus. As bubbles in the financial sector will burst someday, the financial sector has used the weapons of war, of colonialism and imperialism to get hold over real assets. That is what again we are facing now.
Prof. C.P. Chandrasekhar was the next speaker in the session. He said that the Ministry of Finance accepts that the financial sector is one sector where market signals that are available to the firms and the ability of private agents of taking market signals are the least, and the risks of market failure are the greatest. So we have a history of failure of the financial sector right through the period in which finance has become a major part of the institution of capitalism. This is the reason why even the apparently most open economies like the United States, Japan and the United Kingdom have highly regulated financial systems in place.
The 1970s witnessed the first concerns over financial fragility in recent times which was characterized by the complete dismantling of the system of regulations which operated on the financial firms and these concerns grew during the next two decades. Substantial liberalization of interest rates, removal of the Chinese walls that separated the financial sectors and introduction of new financial instruments and the evolution of hedge and stock markets were salient features of this phase.
Firms have been allowed to do all the things which will make them take greater risks: offer higher returns to depositors, invest in high risk areas like the real estate market and the stock market and, of course, invest in financial assets, which involves essentially trading all the risks associated with other assets in the form of new assets like mortgage securities. Creation of new forms of assets such as derivatives and trading in these in order to get high returns constitute the first form of financial fragility.
The second source of fear is the fact that the fragility or the systemic risks which now seem to characterize the financial system in the metropolitan countries would spin over into the developing countries because the latter are in part being pushed by the Bretton Woods Institutions and the international financial institutions and in part voluntarily trying to accept the process of liberalization in order to use the opportunity created by the burgeoning of finance. This kind of exploitation leads to bankruptcy of national governments in developing countries.
While the evidence of fragility in developing countries is obvious, except in a few cases like the one of the Barings Bank, metropolitan centres of capital have not been victims of such loot. Besides, there is also a pressure on developing countries to repay even when the debt has been incurred by private agencies. This has happened substantially in Southeast Asia. To finance these repayments national governments have to float bonds at rates of interest higher than those prevailing in the market.
The South Korean government had to convert short-term private debts into long-term government bonds at 250 basis points above the prevailing interest rates to fund restructuring of companies in the country which were in trouble during the Southeast Asian crisis. A financial collapse would lead to a socialization of losses of corporate funds. While financial fragility means that the system is highly vulnerable and prone to failure, the international financial institutions do not get affected because states and finance capital have combined to actually transfer these risks to people in developing countries, to government in developing countries, and to people in the developed metropolitan countries themselves. That really is the consequence of the increase in fragility that the mobility of finance has involved.
The third panelist in the session was Prof. Sushil Khanna. He spoke on the issue of trade and trade fragility. Today trade as a proportion of output has become far more important. Since the Second World War trade is rising at least twice as fast as the rise in output and 20 per cent of total output today is traded across borders. However, this proportion is no higher than what it used to be before World War I.
Mainstream economic theory tells us that trade is good. Trade leads to gains and allows the consumer to expand consumption. However the case is not that simple. The basic difference between trade today and trade a century ago is that a hundred years ago trade was mostly inter-firm. But today large part of the world trade is intra-firm. According to 1995 UN estimates roughly one-third of world trade (US $4.5 trillion in that year) was intra-firm. Another one-third was controlled by large firms (5000 big MNCs). Most large firms belong to the triad (US-EU-Japan). Even though developing countries are trying to raise exports a very large part of the world trade is not open. It is closed to those firms and producers which are not part of any network which are dominated by some big MNC. And closed trade is on the rise. There are large differentials between prices at which MNCs buy from their own subsidiaries in other countries and at which they buy from other companies. The only way to go around is to constantly lower the prices.
The start of the volatility of exchange rates can be traced to 1973, when the US dollar went off the gold standard. Then foreign exchange transactions were 8 or 9 times larger than the world trade. During the mid-1980s it was 60 times, and now foreign exchange transactions amount to 150 times the world trade. Foreign exchange transactions in the world market today are hardly linked to real economic activities, namely exports and imports.
Banking became less important during the 1980s and stock markets gained prominence. Roughly over two-thirds of all financial flows which go to developing countries today are portfolio flows and not direct foreign investments. Currently India is one of the favourite destinations following the stock market boom and there are large short-term capital flows into the country. But this leads to a very high volatility in the stock exchange market, forces an appreciation of the rupee, and a consequent impact on exports which become less competitive and an import surge as imports now become cheaper. On the whole there is a bubble in the stock market. Southeast Asia had seen such unprecedented bubbles erupting, and India might find itself in a similar situation sooner or later.
In order to hedge against such shocks and capital flight, countries like India stockpile foreign exchange reserves. Earlier a stock of foreign exchange required to purchase 3-5 months' import requirements was considered adequate. Now the Governor of the Reserve Bank of India says that even US $100 billion might not suffice. Currently the RBI holds around US $100 billion. In addition to this our banks hold foreign assets, our companies hold foreign assets, as does our exporters who often hold their earnings abroad for upto six months. If one includes these amounts, the total amount of foreign exchange held would exceed US $150 billion. These are invested in western countries. This helps rich countries to bridge their massive import deficits and trade deficits and has made the third world today more vulnerable than ever before to exchange rate volatility.
The international banks and the IMF ensure that with the string of conditions put on the loans to developing economies these economies can never repay these under ordinary circumstances. The borrowing countries have to slowly sell off their assets. Many public sector units are being sold off worldwide to repay debts. In Russia oilfields have been sold off to meet debt obligations. But in essence this was dollarisation of the economy. Any alternative vision for development of developing countries has to stand up against this and has to stop opening up of the security markets. There can be no modification of this view because capital will always seek avenues which will make flight easy.
Prof. Cui Zhiyuan was the next speaker in the session. He spoke on the Chinese response to the recent pressure by the US to force China to appreciate its currency, the renminbi (RMB), vis-à-vis the US dollar. Cui welcomed the US pressure to appreciate the RMB. China needs to reduce its huge foreign reserves and also its huge export tax rebate. Appreciation of a currency may also lead to a similar cycle. Bush wants China to have an open market system through which China's exchange rate should be determined. The US is trying to reduce its trade deficit and also China's huge export tax rebate. China has foreign reserves worth US $400 billion. This is mostly invested in US treasury bonds signifying a capital outflow from a developing country to a rich one. China has a regulation that any firm's foreign currency earnings through exports must be mandatorily transferred to the Chinese Central Bank. So all Chinese foreign earnings automatically become Chinese foreign reserves. Only 50 per cent of the foreign investment in China is actually invested, the rest remain as foreign exchange reserves in the hands of the Chinese Central Bank. With foreign reserves becoming a part of the Chinese Central Bank's monetary base China has this increasing pressure of becoming a bubble economy. So it would be a good thing for China to reduce its foreign exchange reserves.
China made huge purchases of equipment and technology from the US, and has announced that in three months it will reduce its export tax rebate significantly. 19 per cent of China's central government expenditure goes to pay for the export tax rebate, which is the largest share of the expenditure pie going to any particular sector. Expenditure on education accounts for only three per cent of the total expenditure of the Chinese central government. This is not an argument against promotion of exports, but against excessive efforts to boost exports at the cost of social sector spending. The lives of Chinese peasants have worsened with their incomes not only being lower than income levels in urban China, since the 1980s peasant incomes in China have witnessed a decline. In a way the US pressure on China to reduce its export tax rebate and appreciate the RMB vis-à-vis the dollar would help to raise domestic consumption in China, a good thing for the Chinese masses. That is why Cui feels that the imperialist remedy always tends to be self defeating.
Prof. Sunanda Sen spoke about what is happening in the world today. She said that globalization cannot ever be considered as an unmixed blessing. In fact there is hardly anything about globalization that benefits the masses. She depicted the picture that is faced by a typical developing country in the process of change over into a regime of financial liberalization and linked it up to what is happening in India. Can we really dub India as shining? Are the conditions in developing countries improving?
Observing developing countries as a whole one can notice three things. One is that there has been a negative transfer in terms of the net capital flow that comes to a country minus the liabilities and payments that a country has to make because of past borrowings and investments since 1997, the year of the Asian crisis. In 2002 it was almost -200 billion US dollars. The second observation is that compared to the 1970s, growth rates in the 1980s and the 1990s have been lower for most countries. Growth patterns have been more unstable in the current period. The final observation is that the gross domestic capital formation, which is another name for investment, has been far more volatile in the last two decades, the period when the gates of trade and financial liberalization have been opening up.
If one talks about a typical developing country, not the ones which only produce and export primary products or are in a semi-industrialized state, growth of exports is not rising either. When a country exports it cannot control foreign prices, foreign incomes, or even exchange rates. In particular, when a developing country exports, it can have control only over domestic prices and nothing else. If you reduce prices to make exportables saleable, it reduces income. This results in compression of GDP and deflation of the economy.
Also once a country starts exporting by reducing costs it cannot stop at that. There is a relation between long term capital inflow and exports. Following the pattern of flying geese, capital may relocate to places where labour and raw material would be cheaper as this provides for a very good export platform. When exports do well, foreign direct investment comes in; however labour does not necessarily gain as a consequence of capital inflow. Employment may even contract as a consequence of technological changes. So employment is not proportional to output. Labour is affected very badly in this race to lower production costs. In export processing zones terms are more or less dictated to labour. Unless a nation can export a minimum amount of goods it finds it increasingly difficult to address its rising import liabilities and debt liabilities. Imports can also be volatile with exchange rate volatility. So the more open an economy, greater would be its dependence on exports because of the fact that import liabilities will be increasing with the opening up of trade and the investment income liabilities will also be much greater as a consequence of all types of capital coming into the country.
Many believe that total capital account convertibility would be beneficial for countries which can employ capital judiciously and offer the highest rates of return. There would be large inflows of capital into such countries and their economies would grow. However most of such inflows into any country are through stock markets and are determined by the expected changes in exchange rate and expected changes in the rates of returns differential between that country and the rest of the world. This footloose capital can move out of any country in a few hours.
When Great Britain tried to go back to gold standard in 1925 and tried to fix the rupee at the pre-World War I rate there was an inflow of capital into Great Britain. When foreign exchange rate appreciates it attracts capital and a lot of money comes in. So foreign exchange rate appreciates further. And more capital flows in again. But this may lead to a speculative flight of capital. A lot of money is coming to India as Non-Resident Indian investment at a certain exchange rate. As the domestic currency appreciates vis-à-vis the US dollar, dollar deposits will go back. Also rupee appreciation affects exporters. Exporters get worried as exports become uncompetitive. Today software exporters are facing this threat to a significant extent. Capital inflows as portfolio investment also affect the prices of stocks and open up enormous potential for speculation. So portfolio investments affect a lot of things.
Finally, even when capital inflow comes in large amounts the government cannot relax. The foreign exchange reserve increase because the government does not want the capital flow to lead to a further appreciation of the rupee. The rupee needs to be managed so as to ensure that exports do not get adversely affected. Real rate of exchange, which determines the competitiveness of the currency, needs to be maintained at a certain level. But there exists a cost of sterilization. To sterilize the government needs to sell bonds at attractive terms. The dollar with the country's Central Bank is invested at 2-3 per cent rate of interest. This difference in interest rates at which the government offers bonds and the dollar is invested has to be borne by the government. Hence there is a huge cost of sterilization. This kind of borrowing will also increase the interest burden, and an increase in the interest burden in rupees necessitates a cut down in other expenses. There is something called the primary deficit which includes defence expenditure, interest payments and capital expenditure. Defence expenditure and interest payments cannot be reduced, so social expenditure has to bear the brunt. This directly affects the poor.
Reregulatory bodies need to be in place to look at the stock markets and prevent excessive capital flows into the market. It also should look at the exchange rate so that it is in sync with the goals of the economy.
Prof. Erinc Yeldan was the last of the six speakers in this session. He dwelt on the increasing efforts by the West to subvert the role of the state in developing countries. This is being done through the increasing influence of the WTO.
In 1973, the year that saw the first oil crisis and the debt crisis in developing countries, McKinnon and Shaw put forward their hypothesis of the so called financial repression in which they claimed that developing countries have low or limited growth because of government strangulation. The reality is entirely the opposite of what the two authors would have liked us to believe. Real interest rates actually increased, without government regulations savings got diverted for speculative purposes and what evolved is a kind of casino capitalism.
Mathematical models used as economics are mostly detached from reality. The reality today is that finance is detached from industrial activities to such an extent that for every dollar of industrial production there is twenty five dollars worth of financial activity. Short-term inflow and outflow of capital has nothing to do whatsoever with employment creation or investment that boosts production. All this capital does is to fuel speculation among the banks, the government, and the private enterprises themselves. When the bubble bursts the national economy plunges into a crisis. Real wages fall and national incomes also registered huge drops. Bank losses have to be covered by the government. When it comes to servicing banks it is good economics, when it comes to supporting then incomes of the unemployed or the working masses it is populism. This is the hypocrisy of the torch bearers of financial liberalization.
Neoliberal globalization cannot govern the world without a constant warfare and constant aggression by the hegemonic power centres in the big nations. The only way to change this is by overthrowing capitalism. As Rosa Luxemburg had so eloquently put it, 'from now on it is either socialism or barbarism'.