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Study Tour for students from the University of International Business and Economics

(Beijing)

Geneva, 26 September 2011TRADE AND DEVELOPMENT REPORT

2011:

Post-Crisis Policy Challenges

in the World EconomyJörg Mayer

UNCTAD

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Main messages

• Economic recovery is losing steam, particularly in advanced economies

• A shift from fiscal stimulus towards fiscal tightening at this time is self-defeating – fiscal space is a largely endogenous variable

• Comprehensive financial reform is needed more than ever – unambitious efforts initiated after the crisis have failed

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Global economic recovery is slowing down, with strong downside risks

2.6

8.6

1.7

0.3

5.4 5.4

-2.1

-3.6

-6.7

2.5

3.9

2.5

4.1

7.4

3.1

1.8

4.4

6.3

8.0

4.0

-8

-6

-4

-2

0

2

4

6

8

10

World Developed countries South-East Europe and CIS Developing countries

2007 2008 2009 2010 2011 (forecast)

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“Two-speed” recovery pattern continues

Note: Linear trends correspond to 2002–2007.

Real GDP at market prices, 2002–2011 (Index numbers, 2002 = 100)

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Developing countries cannot lead the global recovery

• They have insufficient weight, relatively low absorptive capacity and cannot issue international currencies

• Most large emerging economies face demanding domestic adjustment needs which require significant domestic resources

• They also face significant external risks because of continued economic weakness in developed economies and the lack of significant reforms in international financial markets – they are vulnerable to decline in trade volume and sharply fluctuating primary commodity prices

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Global imbalances remain a risk to sustained economic recovery

• Post-crisis unwinding has been short-lived

• Country-specific evolution depends on whether domestic demand (BRIC) or net exports (Germany, Japan) drive recovery

• Exchange-rate movements have sometimes enlarged imbalances

-1500

-1000

-500

0

500

1000

1500

2005 2006 2007 2008 2009 2010 2011

Germany

Japan

Fuel-exporting countries

China

Other developing andtransition economies

European Union excl.Germany

United States

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Premature fiscal tighteningis counterproductive

• The best strategy for reducing public debt ratios is to promote growth and maintain low interest rates

• Fiscal space is a largely endogenous variable• Fiscal retrenchment is likely to be self defeating,

as it affects GDP growth and reduces fiscal revenues

• ‘Functional finance’: changing the composition of revenues and expenditure can further extent fiscal stimulus and maximize multiplier effects

• Fiscal expansion tends to be most effective if– higher spending takes precedence over tax cuts– spending targets infrastructure and social

transfers– tax cuts target lower income groups

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Developing countries’ post crisis increase in public debt was relatively

smallRatio of public debt to GDP, selected income groups, 1970–2010 (Median, in per cent)

IMF-sponsored programmes systematically underestimate their negative impact on GDP growth and

fiscal balances

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Proactive incomes policy is a key element of growth-friendly

macroeconomic policies• Wages should grow in line with

productivity growth (plus an inflation target) to pave the way for a steady expansion of domestic demand as a basis for expanding investment while containing cost-push inflation risks

• An individual country may strengthen its international competitiveness through wage compression – but a simultaneous pursuit of this strategy by many countries causes deflationary pressure

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Financial deregulation was one of the main factors leading to the global

crisis• Financial deregulation:

– Led to a large, opaque and undercapitalized “shadow banking system”

– Concentrated the traditional banking segment in a few “too big to fail” (and “too powerful to regulate”) institutions

– Reduced diversity of financial system and increased systemic risk

• While government regulation has weakened, its lender-of-last-resort support to the financial system has increased, and even extends to the shadow banking system

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Financial reform agenda remains uncompleted

• Strong re-regulation is urgently needed. It must:

– Be tighter with the “too-big-to-fail” institutions– Cover the “shadow banking” and avoid regulatory arbitrage– Incorporate a macro-prudential dimension, with anti-cyclical

capital requirements and capital controls

• In addition, the financial system must be restructured

– Re-regulation alone will not orient credit to real investment or make it accessible to small and medium-sized firms

– Banking restructuring should aim at more diverse financial systems, with a bigger role for public and cooperative institutions

– Giant institutions must be sized down– The activities of commercial and investment banking

should be clearly separated, in order to reduce the risk of contagion

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Commodity prices have recovered amidst high volatility

Monthly evolution of selected commodity prices, January 2002–May 2011

(Price indices, 2000 = 100)

Many explanations are available for recent commodity price movements

• Changes in fundamentals

– Demand: rapid income growth in emerging economies (intensity of use; dietary habits); biofuels

– Supply: increased production cost; earlier low rates of investment

• Increased participation of financial investors who treat commodities as an asset class

– Index investors (passive, long positions in range of commodities)

– Money managers (active, short and long positions in specific or range of commodities)

Financial investment continues to riseAUM/global GDP ratio doubled in 2005–07 and rose 4-fold in

2008–10Commodity investment, assets under management, 2005–2011 ($bn)

0

50

100

150

200

250

300

350

400

450

2005 2006 2007 2008 2009 2010-1stquarter

2010-2ndquarter

2010-3rdquarter

2010-4thquarter

2011-1stquarter

2011-2ndquarter

Index investment Other investment

Why does financialization matter?

• Financialization risks impairing appropriate functioning of commodity exchanges

• Uncertainty (price trends disconnected from fundamentals; high volatility) deters investment and supply growth

• Financialized commodity markets may cause pre-mature macroeconomic tightening and declining demand

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Policy recommendations to improve commodity market

functioning• Increase transparency in physical and

derivatives markets

• Arrange for internationally coordinated tighter regulation of financial investors

• Consider occasional direct intervention to avert price collapses and deflate price bubbles

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Exchange rates have become disconnected from macroeconomic fundamentals

Real effective exchange rate, selected countries, January 2000–May 2011(Index numbers, 2005 = 100, CPI based)

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Leaving currencies entirely to market forces entails considerable risks for both the global financial system and the multilateral trading

system• Instead, a rules-based managed floating can deliver

– Sufficient stability of real exchange rate to enhance international trade and support fixed investment in the tradable sector

– Sufficient flexibility of exchange rate to accommodate differences in cross-country developments of unit labour costs or inflation

• Such a system could be based in two approaches:

– Adjustment of nominal exchange rates to inflation differentials – emphasizes need to avoid trade imbalances

– Adjustment of nominal exchange rates to interest rate differentials – emphasizes limiting currency speculation

• Rules-based managed floating may be practiced unilaterally, regionally or (preferably) multilaterally

Thank you!joerg.mayer@unctad.org

(http://www.unctad.org)