The United Nations Conference on Trade
and Development (UNCTAD) is expected to offer distinct analyses and insights
into the problems afflicting developing countries and the global economy
in general. If therefore, one were to scan through only the Overview that
reads like a nuanced crossover between rhetoric neo-liberal and heterodox
views in the current economic policy discourse, the Trade and Development
Report (TDR) 2006 published by the UNCTAD would have come as a disappointment.
Even so, one would have just concluded that it was only symptomatic of
the woes of our times. But, fortunately, going beyond the boundaries drawn
by rhetoric, TDR 2006 does provide an insightful discussion of several
fundamental contradictions within the current growth paradigm and the
subsequent challenges facing developing countries in industrial, trade
and macroeconomic policymaking. Titled 'Global Partnership and National
Policies for Development', the Report thus revolves around the following
two central themes: (1) the urgent need for economic policymaking to move
beyond the Washington Consensus and the "inbuilt" and "implanted"
constraints imposed on this by neo-liberal policies and institutions;
and (2) the growing imbalances in the world economy.
The Report starts by pointing out that how the present phase of relatively
fast growth in developing countries, driven by strong global demand originating
mainly in the United States as before and amplified by the rapid expansion
of the large Chinese economy, has also benefited from rising prices and
continuing strong demand for primary commodities.
Against the backdrop of these positive prospects for growth, it highlights
the recent turbulence in emerging market financial markets reflected in
increasing volatility in stock, commodities and currency markets as well
as in short-term capital outflows from some emerging markets (several
East European countries as well as South Africa and Turkey). Even though
in some cases, these episodes show similarities to the typical speculative
cycle experienced in the Asian as well as in the Latin American or Russian
crises of the 1990s, the current turbulence is limited only to some areas
and to a number of countries with rather high current-account deficits.
The conclusion is that most emerging-market economies appear to be in
a position of strength owing to their current account surpluses and therefore,
the risk of a financial crisis on a global scale originating in the developing
world is relatively small.
This appears to be a rather naïve conclusion. No amount of foreign
exchange reserves may prove sufficient to support a concerted speculative
attack on an emerging market currency as the East Asian crises of the
late 1990s showed. Further, most financial crises in the past were regional
in the sense that it directly involved only countries of a specific region.
But each of these regional crises has had significant global impact of
one form or the other, including global recessions, due to very fact that
financial and trade liberalization have increased the interlinkages between
countries across regions. Thus, there is also a significant risk of contagion
because several countries share similar vulnerabilities and common creditors.
Even as it underestimates the risks associated with an imminent large-scale
financial crisis, the report cautions that prospects for growth in the
coming years should be weighed against the increasing imbalances in the
world economy, as their correction could have serious repercussions for
developing countries.
Global Imbalances as a Systemic Problem
It is indeed significant that the UNCTAD has chosen to highlight concerns
about growing global economic imbalances that have been repeatedly raised
by several economists and analysts in the last few years.
Even though the previous year's TDR also addressed the issue of growing
global economic imbalances, TDR 2006 has built a robust theoretical analysis
in Chapter I, through a detailed critique of the "static" savings-investment
gap framework on which orthodox policy prescriptions are based.
The fact is that given the severe experience with financial crises associated
with capital account liberalisation and a hands-off approach to exchange
rate management, most countries affected by the crises in Asia and in
Latin America have accumulated large current account surpluses. In fact,
the South and East Asian countries recorded a large surplus on their current
accounts (4.6 per cent of GDP) in 2005; and only ten of these 22 countries
were in deficit. The Latin American region as a whole was also in surplus,
in the order of 1.3 per cent of GDP.
While current surpluses do not necessarily result in increasing foreign
exchange reserves, there are overall balance of payments surpluses in
these countries. Some countries (like India) now have current deficits,
but larger capital account surpluses. The stark fact, which is closely
related, is that many of these developing countries are reinvesting these
huge amounts of foreign exchange reserves mainly in securities such as
government bonds in the rich countries. In particular, as has been highlighted
by other authors, global savings flow primarily in the direction of the
largest and richest developed country, the United States and its government
bonds. Ironically, this is true even for many developing countries that
have positive net capital inflows (like India and China) who then store
it in reserves that are invested in the US, etc.
The Report suggests that having learned that reliance on foreign savings
rarely pays off as a sustainable development strategy, a growing number
of developing countries have shifted to an alternative strategy that relies
on trade surpluses as the engine for investment and growth. Since this
strategy requires them to defend strategically favourable post-crisis
competitive positions, they have unilaterally pegged their currency vis-à-vis
the dollar at a slightly undervalued level.
However, the report does not address the channels through which this trade
surplus is being generated in developing countries. As argued by Chandrasekhar
and Ghosh (2005), there are two reasons why this could have occurred:
crisis-induced deflation that restricted imports and generated a current
account surplus, or unusual success as an exporter of goods and/or importer
of foreign capital. While China and India may be countries that fall in
the latter category, most other developing countries recorded surpluses
by following deflationary policies and restricting domestic investment
to below potential. Thus, the remarkable extent of capital outflow from
the developing world came about not because of any real increase in savings
rates in the aggregate (as the orthodox "savings glut" argument
goes), but because investment rates have not gone up commensurately. The
period of most significant increase in net lending abroad by Asian NICs,
for example, was when domestic savings rates were actually falling, because
investment rates were falling even faster. On the other hand, increases
in domestic savings rates in other developing countries dominantly reflect
fiscal consolidation and expenditure cutbacks by their governments. Growth
is curtailed through deflation so that, even with a higher import-to-GDP
ratio resulting from trade liberalisation, imports are kept at levels
that imply a trade surplus.
This crucial link between the current account surpluses being generated
by the emerging markets and the contractionary fiscal policies they adopt
out of the compulsions of neo-liberal policy framework is one that the
report fails to explore.
Further, reliance on trade surpluses as an engine of growth by all or
most developing countries as the report argues cannot succeed for all,
basically because of the race-to-the bottom with competitive export pricing
and the reduction in export revenues this implies. Again, as TDR itself
highlights, such a strategy can only function as long as there is at least
one country in the global economy that accepts running the corresponding
trade deficit. Clearly, the US seems to fit these attributes of an economy
which will accept running large and rising trade deficits. But the problem
is that the possibility of a slowdown in the United States economy looks
increasingly likely. There is the prospect that this would entail further
dollar depreciation, which would tend to restore competitiveness
and, together with the economic slowdown, would help re-balance the United
States economy. But, given the existing structure and concentrated dependence
of global growth on demand stimuli from the United States, a marked slowdown
in the US growth could quite easily unravel the momentum seen in developing
countries in recent times.
But there is another problem with the argument of developing countries'
reliance on trade surpluses. Whether it is one or more economies that
will help balance trade across the globe, the point is that on the exporting
countries' side, there are several supply-side and demand side constraints
that come in the way while countries try to export their way to economic
growth. Ironically, the subsequent chapters of the report are in fact
devoted to detailed discussions of these very constraints facing developing
countries' export-led development project.
National Development Policy Choices and Constraints
Another contribution of the TDR relates to national development strategies.
It is noted that the Washington Consensus approach to development represented
a shift away from the focus on capital accumulation to an almost exclusive
reliance on improved efficiency in factor allocation generated by market
forces. The latter was based on the belief that capital accumulation,
the basic precondition both for output growth and economic restructuring
would follow automatically from improved allocation of existing resources.
This expectation was rarely met. Thus, the savings-led approach favoured
by the mainstream view in economics is misleading.
If markets do not automatically deliver positive and stable growth rates
of real income and catching up, then the dynamic view, highlighting the
incentive of temporary monopoly rents for pioneering investors, is more
than ever relevant for the development of the system as a whole. The report
thus calls for active government policies to encourage investment and
technological progress in support of a dynamic process of growth and structural
change that benefits from – rather than being constrained by – integration
into the world economy.
Against the backdrop of external constraints on development, and given
the experience with reforms over the past 15 years as well as recent developments
in economic theory concerning the creation of new areas of comparative
advantage, the Report makes a strong case for the adoption of proactive
trade and industrial policies. Supportive national economic policies advocated
by this interpretation focus on strengthening the dynamic forces of markets
related to information externalities, coordination externalities and dynamic
economies of scale. The form of trade integration envisaged represents
a mix of import substitution through temporary protection and export promotion
using temporary subsidies. Contrary to orthodox dogma, fiscal incentives,
directed public credit and subsidies are cited as measures that lower
the cost of innovative investment and enable capital accumulation for
sustained growth.
However, the Report makes the point that that in order to foster diversification
and technological upgrading, subsidies should be given only to investment
that is undertaken to discover the cost function of new goods or new modes
of production in the respective economy. The argument is that such policies
should not be employed as defence mechanisms to support industries where
production and employment are threatened the most by foreign competitors
that have successfully upgraded their production. For example, the Report
suggests that this general principle does not support selective trade
protection or other selective support measures that many developed countries
are still applying in agriculture or in labour-intensive manufacturing
sectors such as the clothing industry.
There is a problem if this argument is applied in the case of agriculture
in many developing and less developed countries. It is generally accepted
that farming and associated activities constitute more than just production
activities in these countries, and that they are a source of livelihood
and food security for millions in the countryside. This distinction should
have been mentioned by the report while discussing the applicability of
this general principle. The second area which this general principle does
not support is a large number of contemporary industrial policy measures
which focus on attracting FDI and related export-oriented activities,
where domestic production already exists.
Even as it advocates the need for proactive trade and industrial polices,
the Report recognises and highlights the reduced degree of freedom that
remains for policy implementation as a result of global production and
financial integration. The Report makes a distinction between de facto
("inbuilt") constraints that result from policy decisions relating
to the form and degree of a country's integration into the international
economy and de jure ("implanted") constraints on national policy
autonomy that are the result of commitments to obligations and acceptance
of rules set by international economic governance systems and institutions.
But, it can be seen that this distinction between de jure and de facto
constraints is more conceptual than real. Multilateral (as well as regional/bilateral)
agreements are very much part and parcel of a country's decision to integrate
with the world economy through trade and financial liberalization. Thus,
they are largely inseparable processes that overlap and reinforce each
other. Thus, for all practical purposes, this distinction hardly matters
for developing countries' policy choices.
Most notable among de facto constraints is the loss of the ability to
use the exchange rate as an effective instrument for external adjustment,
or the interest rate as an instrument for influencing domestic demand
and credit conditions, because of a reliance on private capital inflows
to finance trade deficits following the opening up of the capital account.
Indeed, this is what leads to the lack of coherence between the prevailing
macroeconomic environment and microeconomic measures directed to expanding
productive capacity and improving productivity. In order to provide a
favourable macroeconomic framework, monetary policy has to take on a much
broader responsibility than is stipulated by orthodox theory. In order
to avoid excessive adjustment of interest rates and exchange rates with
attendant adverse effects on the real economy, a more flexible and efficient
approach for inflation control might be to consider the use of "supply
side" tools including, for example, government influence on income
negotiations and/or the redefinition of the inflation target depending
on the origins of the inflationary pressure.
While discussing "de jure" constraints, the Report shows how
the various WTO rules have made it far more difficult for developing countries
to combine outward orientation with the policy instruments that the mature
and late industrializers employed to promote economic diversification
and technological upgrading. The Subsidies and Countervailing Measures
(SCM) agreement is a good illustration of how WTO rules and commitments
that are equally binding, legally, impose more binding constraints on
developing countries economically. Even as countries still have the possibility
to pursue policies (Article 8-type subsidies) relating to the provision
of public funds in support of R&D and innovation activities, such
subsidies are of primary concern to developed countries in their quest
to develop high-tech capabilities and technological innovations. Further,
subsidies impose a cost on public budgets, which developed countries can
afford more easily than developing countries.
According to the report, regional or bilateral agreements with large developed
countries offer substantial benefits to developing-country members as
they usually provide greater market access than multilateral agreements,
and often include a wider range of products than traditional trade preference
schemes such as the Generalized System of Preferences (GSP). Moreover,
their adoption is generally expected to lead to additional FDI. But empirical
studies on existing US bilateral free trade agreements (FTAs) involving
developing countries have shown that both greater market access and more
FDI-led exports under such preferential trade agreements are largely an
illusion. Further,
greater integration often involves additional steps towards regulatory
disciplines, and thus further constrains the de jure ability of developing
countries to adopt appropriate national regulatory and development policies,
particularly with regard to FDI and intellectual property rights. This
could make it even more difficult to develop the supply capacity needed
to take advantage of improved export opportunities. Thus, the analysis
in fact ends on a pessimistic note on developing country prospects.
Where are the Solutions?
The Report advocates that in order to assuage the situation and to enable
all developing countries to reach the Millennium Development Goals (MDGs),
the global partnership for development, stipulated in Goal 8 of the MDGs,
needs to be strengthened further. However, it is pointed out that the
current system of global economic governance does not seem to be satisfactory
because of two overlapping asymmetries. First, unlike in the trade arena,
current international monetary and financial arrangements are not organized
around a multilateral rules-based system that applies a specific set of
core principles to all participants. This asymmetry has particularly strong
adverse effects on developing countries according to the Report, because
self-centred national monetary and financial policies can have much more
damaging effects than those caused by trade and trade-related policies.
Second, the multilateral rules and commitments governing international
economic relations are, in legal terms, equally binding for all participants,
but in economic terms they are biased towards an accommodation of the
requirements of the national economic strategies of developed countries.
There is a direct corollary to this: the institution that is in charge
of promoting exchange-rate stability and of avoiding excessive and prolonged
payments disequilibria is unable to impose meaningful disciplines on the
policies of those economies that run the most significant external imbalances
and whose exchange-rate volatility has the most significant negative impact
on the international economy.
It follows that while the Report calls for a global partnership for development
that ensures the right balance between sovereignty in national economic
policymaking on the one hand and multilateral disciplines and collective
governance on the other, this can hardly be achieved in the real economic
policymaking arena. When rules, in which developing countries have little
say, are being formulated and become part of their "obligations",
evidently very little flexibility is actually afforded to developing and
less developed countries to undertake institutional reform in the manner
suggested by the Report. The conditions for development and the agenda
are already set. Therefore, the global partnership for development should
first and foremost ensure effective developing country participation in
international policymaking that impacts their development strategies.
The Report stops short of calling for this critical challenge facing the
global development project. In fact, this lack of developing country participation
in global economic policymaking is precisely the reason why UNCTAD ironically
has to talk of "the urgent need to move beyond Washington Consensus"
nearly two decades after it has been discredited in Latin America's lost
decade.
It is indeed crucial to ensure actual developing country participation
in rule-making before we insist on a "multilateral rules-based system"
in finance as in the case of trade. Otherwise, we would be compromising
for more instances of Special and Differential Treatment (S&DT) provisions
that have no teeth; or ending up with ever more instances of serious and
adverse development consequences of "multilateral rules" imposed
from the top. The latter is being envisaged, for instance, in the case
of the revised capital adequacy norms for banks prescribed by Basel II.
The need of the hour therefore is an aggressive expansion of enlightened
developing country engagement in international policymaking institutions
and agencies, and to ensure that the march towards global harmonisation
of economic policies can be checked so as to maintain adequate policy
space for each country's development needs.