29 Jan 1998
In November 1995, speaking in Rome, Michel Camdessus said that over the previous 10 years the world had seen four major financial crises, the last of them being the Mexican crisis. He added that new, more destructive, ones would come unless the quality of the coordination of macroeconomic, financial and monetary policies was significantly improved. Since then, he and the IMF have introduced new, more stringent transparency rules, in the hope of setting up an early warning system that would help prevent further crises. Despite these improvements, Camdessus´ prediction unfortunately came true.
The context in which we should review prospects for development today is thus the one created by what is perhaps the most serious global financial crisis since the breakdown of the Bretton Woods system, as regards both its scope and its effects. Its impact is much more global than, for example, the Latin American crisis of the 1980s or the Mexican crisis of 1995. The reason is that global financial integration is nowadays more pervasive, and the East Asian countries have a much higher share of world trade and production than the former. For the first time, a financial crisis that started in a developing economy has had a profound effect on capital markets in highly industrialized countries.
The single most crucial factor affecting perspectives for development is obviously the presence of a dynamic world economy capable of accelerating growth and generating increasing flows of investment and trade. That is why the duration and severity of the Asian crisis will in the next few months ultimately determine the conditions of performance for most developing countries. In trying to assess the global impact of the crisis we see, however, considerable contradiction. On the one hand we have been told that we now live in a world where globalization has dramatically increased the integration of markets and interdependence of economies. On the other, we hear that the impact of the Asian crisis on the global economy can be expected to be negligible. Unless this kind of statement is being made only as a sort of psychological exorcism of the demons of crisis, it should be taken with a grain of salt.
One should not forget that, since 1990, the Asian countries have been responsible for 50 per cent of the increased growth in the world economy and that the Asian economies had become, together with the US, one of the major sources for global import demand, with the exception of China and Taiwan, running trade deficits with industrial countries financed in large part by private capital flows. This is probably the reason behind the increasing realism and sobriety that has lately started to dominate the views of major international organizations such as the OECD and the IMF, which recognize that the impact of the crisis will be considerable, amounting to a very significant loss of growth worldwide.
The international business and financial community, together with international organizations such as the International Monetary Fund, the World Bank, the World Trade Organization and United Nations agencies, such as UNCTAD, can -- and should -- act decisively to contain and minimize the destructive effects of the crisis. The priority should be to restore confidence and stability in currency and financial markets, a task which will depend on avoiding driving the Asian economies into a deep recession, as happened in Latin America in the eighties. For that goal, loans should be rolled over and rescheduled (as was done recently for Korea) to allow countries to service them from future export earnings and not through increased external borrowing at penalizing rates. This should be combined with the provision of external liquidity to support the exchange rate and enable a more accommodating monetary policy to be pursued while restructuring of the financial sector is under way (as the United States Federal Reserve Board did in the debt deflation of the early nineties).
A worrying aspect of the Asian situation is that the credit crunch seems to be so deep that, despite favourable exchange rates, firms are unable to export, as their access to trade credit has been curtailed. Thus, an important part of the improvement in the current account balances of Korea and Thailand so far seems to have been due to import cuts rather than export expansion. Over a longer-term horizon, however, increased exports should account for a major share of the required external adjustment.
The negative implications of the Asian crisis can already be felt in other developing regions. In Latin America, for example, the largest economy, Brazil, suffered a speculative attack which had to be fought off with a severe adjustment programme of high interest rates, budget cuts, economic contraction and sharp reduction in imports. Chile, the best performing economy of the region for over 10 years, has had to depreciate its currency by 18 per cent since October. On account of its dependence on Asia (Asian markets account for 50 per cent of Chilean copper sales), its current account deficit is expected to jump from 3.2 per cent of GDP in 1997 to as high as 5 per cent or more this year. Africa, whose growth has picked up in the last three years, could be severely hit if the declining trend in commodity prices continues as a result of falls in demand and deflationary pressures elsewhere.
There is no doubt, however, that the biggest threat ahead of us would be a protectionist backlash against trade liberalization. On the eve of the crisis, there was already a major imbalance in the world economy as virtually all major industrial countries, except the US, were expecting faster growth on the basis of increased exports. The surplus economies (Europe and Japan) were employing restrictive fiscal policies and attempting to increase their export surpluses to preserve growth. Before the Asian crisis, Europe was projected to generate a current account surplus of nearly US$ 100 billion this year, and Japan was not much behind. It is unlikely that, in the year of the Euro, Europe will be capable of stimulating domestic demand very much -- although there are a few signs of life in terms of demand, particularly in France. Japan has recently taken some steps to reflate its economy, while alleviating the drag on activity resulting from the weakness of its banking sector.
It is far from certain, though, that the measures announced so far will be of the required order of magnitude. This is worrying, because a major boost for world trade and growth can only come from the three largest economies and markets - the US, Japan and Europe. China can certainly help if it sticks to its intention of avoiding currency devaluation and of accepting to run a trade deficit. But its contribution will probably prove limited, for many of the East Asian exports compete directly with China (for instance in textiles, clothing, and cheap electronics).
This leaves the US in the dubious privileged position of being the only major locomotive in the world economy and the single important source of import demand for the rest of the planet, a sort of gigantic "black hole" that will have to swallow all the surplus exports of the world. In 1997, the US trade deficit was US$ 150 billion. But, it is estimated that the deficit could explode this year to US$ 200 billion, and may even reach as high as US$ 300 billion in 1999. From a purely economic perspective, in real terms, this would not be much higher than the US trade deficit in the mid-eighties, on the eve of the Plaza agreement. Politically, however, it could become an extremely difficult and sensitive problem to handle. Last year when both economic and political conditions were much better, it had already proven impossible to get "fast track" authorization from Congress. Now we have to count on many unfavourable trends: the US economy is slowing down; corporate profits are being reduced; there are fears of a severe correction in share values on Wall Street; a mid-term election is coming up, leave aside the judicial problems that are currently plaguing the Executive branch, at the worst possible moment.
For all these reasons, we in UNCTAD have always maintained that monetary and financial instability is the principal enemy of free trade. Perhaps the single most positive aspect of the East Asian crisis is that it has apparently halted the trend towards monetary restriction and higher interest rates in the US and Europe, and hence prevented the global deflationary gap from deepening further. Let us hope that the crisis will now spur the surplus economies to initiate domestic demand-led growth and reduce their external surplus, thereby creating a favourable external environment for growth in free trade for the East and South-East Asian countries, and everywhere else.