The world economy is passing through anxious times. Hesitant recoveries and absence of a globally coordinated approach are not helping repair the damage to global economic prospects from recurrent financial crises in emerging markets, tensions in the trading system and widening income and technology gaps. Fears about the effectiveness of global economic institutions have been growing for some time, and the recent events in Cancun have done little to calm the nerves. The recriminations and mercantilist reactions which have followed the suspension of trade talks have only further highlighted the asymmetries in the international trade and financial system.
That system was fashioned after the war by a group of like-minded and economically similar nations willing to pool resources and cede some degree of policy autonomy to international regulatory bodies in return for a greater degree of economic efficiency and security. Since the collapse of Bretton Woods, a more open global economy, involving a much larger and diverse collection of economies has emerged. However, frequent financial crises and the standstill in the trading system have revealed the shortcomings and inconsistencies of the new global order. International economic policy in many fields has not grown up to the challenges posed by globalisation.
As Secretary-General Annan rightly noted in his Message to the delegates in Cancun, turning our backs on a more open economy is not the solution. Rather the task ahead is to build in fairer and more encompassing principles which give all, and especially the weakest and poorest members of the global community, a stake in the system. Greater flexibility to accommodate the different economic challenges facing countries at different levels of development will be essential for that to work. In addition, the tendency to treat the various elements of a more open international economy - trade, finance, capital, technology and labour - separately does not provide for the kind of policy framework needed to manage an increasingly interdependent world. Building the principles of fairness and interdependence into a new economic order will be difficult. But build them we must. These issues will be to the fore when UNCTAD convenes its eleventh conference in Brazil next year.
The series of negative shocks, which slowed the United States economy in 2001, have since been partly offset by robust consumer spending. However, the weaker than anticipated response of investment spending to the easing of monetary policy by the Federal Reserve, has delayed a strong rebound. And with the jobs market softening visibly this year, the worry remains that imbalances and excesses created during the 1990s could result in a long period of erratic and sluggish growth, with occasional surges and dips.
The Euro zone continues to under-perform. But with a more vigorous response to the downturn restricted by the Stability and Growth Pact, and by the concern of the European Central Bank not to open up the possibility of inflation, the pattern of recent years looks set to continue. Given that real wages have been lagging productivity for some time, the policy challenge for the region is to find ways to exploit the greater scope for expansionary monetary and fiscal action to bolster growth. Much the same challenge in Japan is complicated by mild price deflation. With nominal interest rates hovering around their technical minimum, emphasis has been given to international competitiveness and exports as the main spur to growth, with efforts focussed on preventing any real appreciation of the yen. Currency volatility and misalignments generally compound the picture.
With all the leading industrial economies struggling to return to their growth potential, adverse consequences for the developing economies, even the most resilient, are unavoidable this year. However, the picture is complicated by the different degrees of preparedness among developing regions and countries to deal with increasingly volatile conditions. The continued weakness of many commodity prices means that Africa is unlikely to repeat even the weak growth performances of the past two years. Given the lack of domestic growth impulses, current levels of development cooperation and the structural weaknesses across the region, there is now a growing consensus that it will be problematic to meet the Millennium Development Goals even under the most optimistic growth scenario for the world economy.
The weakness of global demand in the past two years has had only a limited impact on East Asia despite its dependence on exports. This is largely because U.S. import demand for these countries held out strongly (in the fiscal year ending in September China posted a bilateral trade surplus of US$ 103 billion), and also because the favourable macroeconomic and balance-of-payments positions of countries in the region have allowed room for domestic demand expansion to support growth, reinforced by intra-regional trade linkages. Nevertheless, without a sustained improvement in global conditions, it would be foolhardy for policy makers from the region not to expect future shocks upsetting growth prospects.
In Latin America the global downturn aggravated external financial difficulties, and macroeconomic policy has focussed on reducing current-account deficits and reassuring financial markets. While Asian economies generated large current-account surpluses through a rapid expansion of exports, the situation in Latin America in 2002 was reminiscent of the conditions prevailing during the debt crisis of the 1980s. The region received virtually no net inflows of private capital in 2002 after being the largest recipient in 2001, and it has had to combine a fall in output with a trade surplus and net transfers abroad, generated to a considerable extent by cuts in imports. Exports have picked up this year in some of the larger economies, although the extent to which this will contribute to sustained recovery is uncertain.
While prospects for East Asia and Africa, depend on the evolution of their external trading environment, for Latin America financial conditions are equally important. In recent months extremely high yields and improved political conditions in some countries in the region, combined with sharp declines in equity and bond yields in industrial countries, have been attracting short-term, speculative capital, leading to the appreciation of currencies at a time when global prospects are deteriorating and long-term capital inflows to the region declining. It remains to be seen, however, whether such short-term inflows mark the beginning of another strong upturn in net private capital flows to the region, as happened during the 1970s after a long period of stag-nation or in the 1990s after the debt crisis. These post-war surges in private capital flows to Latin America were driven by ad hoc responses to specific global circumstances rather than being parts of a recurrent cyclical pattern.
Much of the hope for a broader-based recovery this year rested on the Doha round of trade negotiations bolstering confidence and kick-starting global trade. These hopes have been dealt a severe blow by events in Cancun. However, the link between trade negotiations and wider macroeconomic performance is far from direct, even under the best of circumstances. Under current conditions, a rapid expansion of trade and further moves towards trade liberalization depend crucially on a rapid recovery of demand and production in the world economy rather than the other way round.
Perhaps as significantly, particularly for developing countries, the talk of a trade-led revival appears to have relied on doubtful extrapolations of trends during the 1990s. International trade surged from the late 1980s, growing considerably faster than output until the beginning of the new millennium when it fell not only behind the growth of world output but also in absolute terms. That growth of world trade was driven by a number of structural and institutional changes, which are unlikely to be repeated, at least with the same intensity. These included the rapid liberalization of imports in developing countries; the spread of international production networks and a surge in capital inflows which helped to boost trade by allowing imports to expand faster than exports in many developing countries. While similar forces could still propel an independent recovery in trade, they are unlikely to match the earlier rise, if only because they will lack the same first-mover boost.
In the face of what looks increasingly like a global glut in both labour and product markets, with too many goods chasing too few buyers and too many workers chasing too few jobs, intense price and exchange-rate competition among major exporters has been adding to instability and deflationary pressures, while many developing countries, facing tight payments positions, are being forced to curtail imports. These difficulties are similar to those that the Bretton Woods Institutions were created to resolve.
If decisive action is not taken to restore stability in financial and currency markets, and to start a global recovery there is a real threat that trade imbalances and the coexistence of continued rapid growth in some parts of the world with stagnation, decline and job losses elsewhere could deepen the existing discontent with globalisation, this could in turn trigger a political backlash and a loss of faith in markets and openness, leading to acute international economic instability with the burden falling disproportionately on the poor and underprivileged.
Avoiding this outcome is perhaps the first real test for economic policy in a post-Bretton Woods globalised world, requiring immediate attention to some of the more egregious imbalances accumulated during the 1990s:
Although the threat of a global deflationary spiral should not be exaggerated, there is a danger of a liquidity trap emerging where monetary policy becomes incapable of checking and reversing falls in output and employment. Any effective response should include a fiscal stimulus over and above that provided by automatic stabilisers. On these matters coordination among the leading countries will be the key to success.
The exchange rate adjustments that are now occurring are only likely to redistribute the deflationary gap and unemployment among countries. And without a coordinated expansionary action the international monetary and financial system is likely to remain highly unstable, resulting in sharp and unexpected movements in capital flows and exchange rates, thereby straining trade relations.
Action on the external debt of developing countries is needed, particularly on their official debt, in order to provide them with more breathing space, as well as a rapid expansion of international liquidity through various means should be an integral component of an international strategy to get global recovery back on track. In this context I wish to pay tribute to the hard work and good will that went into achieving the agreement between the IMF and the Argentine Government, a most welcome development in these difficult times.