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UNCTAD finds fault with recovery measures
By Ashok B Sharma

Instead of regulating the financial system, developed economies are trying to woo the very speculators who created the problem, says a report by the UN agency.

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The stimulus package has failed to inject life into developed economies

A United Nations report for the first time has taken a dig at the faulty measures being adopted so far to bail out the world economy from the financial crisis which engulfed it since August-September 2008.

The efforts of the G-20 and the national governments by doling out stimulus packages to corporate houses and financial institutions and the attempts by the central banks across the world to regulate the monetary policies have utterly failed to upturn the global economy, says the report. Now the gradual withdrawal of the stimulus package is endangering the recovery process.

After a post-crisis recovery, the world economy is slowing down from 3.9% GDP growth in 2010 to 3.1% in 2011. Not only the recovery process is not satisfactory, it is “slowing down with strong downside risks,” noted the UN Trade and Development Report – 2011 released on September 6.

The consultant economist in preparation of the report, Jayati Ghosh said, “the situation is not good for the world in years ahead”. When asked whether it meant the death of the capitalist structure, she said, “It cannot be predicted at this time. Capitalism always reinvents itself. But at this juncture government’s spending should not be curtailed. Credit should be cheaper and made available more to small scale sector and jobless youth who want to become entrepreneurs rather than to the luxury segments like construction industry. We need to create more jobs, stop speculative economy, focus on real economy and income growth of the people.”

As a remedial measure the report suggested reforms in international monetary system, transparency in commodity markets and regulation of financial institutions.

According to the report globally “two-speed recovery” is continuing – one is the real GDP at market prices and the other is the world import volume. The developing countries are driving the economy, while developing economies are driving the recovery.

The economic recovery may come to an end in developed economies as private domestic demand remains weak and supportive macroeconomic policies are being replaced by austerity measures with a view to regain the confidence of the financial markets. The developing economies have sustained their strong growth mainly based on domestic demand. However, they may face financial instability and speculative capital flows generated in developed economies. They will also not be spared by a new recession in developed countries as their export earnings would decline.

As a remedial measure the report suggested reforms in international monetary system, transparency in commodity markets and regulation of financial institutions.

According to the UNCTAD report fiscal imbalances across the world were not a driving factor but a result of the crisis. Government’s spending should not be drastically curtailed with a view to correct the fiscal imbalance. Development of real economy should take place. The IMF sponsored programmes have systematically underestimated the negative impact on GDP growth and fiscal balances.

UNCTAD Secretary-General, Supachai Panitchpakdi said monetary shocks, particularly in a system of flexible exchange rates, are much more significant and harmful.

With a view to avert future monetary shocks, the report suggests two approaches for the design of a rules-based managed floating currency regime. Such a system could be built on the adjustment of nominal exchange rates to inflation differentials or to interest rates differentials. The first principle would address more directly the need to avoid imbalances in trade flows, while the second one would be more directly related to limiting financial speculation of the kind of carry trade which typically leads to currency misalignment.

However, both approaches would lead to similar outcomes and would be able to achieve sufficient stability of the real exchange rate to enhance international trade and facilitate decision-making on fixed investment in the tradable sector; and it would be sufficiently flexible to accommodate differences in the development of interest rates across countries.

Rules-based managed floating can be practiced as a unilateral exchange rate strategy, or, with much larger scope for symmetric intervention in foreign-exchange markets, through bilateral or regional agreements. However, the greatest benefit for international financial stability would result if the rules for managed floating were applied at the multilateral level as part of global financial governance.

High commodity prices, in midst of global recession, is a worrying case. This is caused primarily due to the heavy financing of commodity markets. Herd behaviour of money managers has probably caused oil-price gyrations. It has caused hikes in prices of basic goods like food staples and energy as commodity market participants increasingly followed other financial market’s trading decisions.

Uncertainty arising from gaps in information and transparency, combined with the effects of equity market developments on commodity prices, is central to this “intentional herding”. Expansionary monetary policies may have accentuated correlations between equity, currency and commodity market developments. But these correlations had already strongly increased when financial investors started long-scale commodity investment some ten years ago.

High commodity prices, in midst of global recession, is a worrying case. This is caused primarily due to the heavy financing of commodity markets.

UNCTAD report has suggested a number of policy responses to improve commodity market functioning, increasing transparency in physical and derivatives markets, as well as internationally coordinated tighter regulation of financial investors – for instance, by imposing position limits or a transaction tax. The authors of the report also say that market surveillance authorities could be mandated to intervene directly in exchange trading on an occasional basis by buying or selling derivatives contracts with a view to averting price collapses or deflating price bubbles. Such intervention could be considered a measure of last resort to address the occurrence of speculative bubbles if reforms aimed at achieving greater market transparency and tighter market regulation were either not in place or proved ineffective.

Finally, the report argues that financial deregulation has been one of the main factors leading to the global financial and economic crisis of 2008. It favoured the emergence of a large, unregulated and under-capitalised shadow banking system, while traditional banking shifted from reliance on deposits to financing from capital markets, and from lending to trading. The loss of diversity of the financial system and uniformity of agents' behaviour fuelled destabilizing speculation, accentuated pro-cyclical trends and eventually led to systemic crises. The re-regulation of the financial system is necessary to prevent the repetition of these crises. However, the attempts made so far has been slow and inadequate to cover the shadow banking system and to cope with a highly concentrated financial sector that is dominated by a small number of gigantic institutions.

Regulation must be tighter with the "too-big-to-fail" institutions and incorporate a macro-prudential dimension, including anti-cyclical capital requirements and the recourse to capital controls for coping with volatile capital flows. However, even if the financial sector were to be better regulated, it would not automatically drive growth and employment or make credit accessible to small and medium-sized firms or the population at large. In addition to a better regulation, the financial sector needs to be restructured in order to reduce the risk of systemic crises and to improve its economic and social utility. Financial restructuring should aim at more diverse national financial systems, with a bigger role for public and cooperative institutions, a sizing down of giant institutions and a clear separation between the activities of investment and commercial banking.

The report warns that some international agreements such as the General Agreement on Trade and Services (GATS), several bilateral trade agreements (BTA) and bilateral investment treaties (BITs) include provisions related to payments, transfers and financial services that may limit not only the application of capital controls, but also other measures aimed at re-regulating or restructuring financial systems. Such measures could be considered as infringing previous commitments on financial liberalisation.

Ashok B Sharma  |  ashokbsharma@gmail.com

Ashok B Sharma is a commentator on agriculture and trade policy related issues.

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 Other Articles by Ashok B Sharma in
Global Development  > Global Economy > Global Financial Crisis

Crisis before capitalism
Wednesday, August 10, 2011

As lingering financial crisis in the developed world is casting its shadow on the developing countries, it is time to look beyond capitalism for sustainable and equitable development.
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The bad news is that corruption has not only sustained but has grown in size and stature in the country. With scams being a regular feature, seventy per cent respondents in a survey have rightfully opined that corruption has continued to increase in India. One in every two interviewed admit having paid a bribe for availing public services during last one year. Transparency International's latest survey reveals that the political parties top the chart for the most corrupt public institutions, followed by police force and legislatures. No wonder, India continues to make new records on the global corruption arena!

The shocking revelation is that the health and education sectors haven't remained untouched by this phenomenon. With 5th and 6th positions respectively for these sectors on the public perception chart on corruption, corruption has crept insidiously into these sectors of hope for the masses. With bureaucracy being fourth in the list of corrupt institutions in the country, corruption seems to have been non-formally institutionalized with little hope if public services would ever be effective in the country. With economic growth having literally institutionalized corruption, are we now expecting corrupt to be socially responsible - a different CSR.

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Not giving 'aid' to India is one thing but calling it 'rich' is quite another. If one in three of the world's malnourished children live in India, what does average daily income of $3 indicate? It perhaps means that there is a relative decline in poverty - people are 'less poor' than what they used to be in the past. But having crossed the World Bank arbitrary threshold of $2 a day does not absolve the 'developed' countries of their obligation to part with 0.7 per cent of their Gross National Income in development aid. Should this three-decade old figure not be revised?  

An interesting debate in UK's House of Commons delved on future of development assistance by the British Government. While prioritizing limited resources has been a concern, there has been no denying the fact that development aid must be guided towards tangible gains over a short period of time to start with. There are difficult choices for elected governments to make - should they invest in long-term primary education or in short-term university scholarships? Which of these will bring gains and trigger long-term transformation in the society. As politicians continue to be divided on the matter, poverty persists!!   

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