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Saturday, January 26, 2008

The turbulence factor

World economic growth in 2008 may be compromised by financial uncertainties and imbalances despite strength in Asia and Africa.

Stakes for policymakers in developed and developing countries are high in 2008. With the world economy expected to slow, governments will be faced with the challenge of avoiding a global recession and safeguarding growth against the risk of continued financial turmoil and a weakening dollar. For poor countries, strong and sustainable economic growth that is resilient to economic turbulence – while not the only condition – is pivotal to generating the resources needed to achieve the internationally agreed development goals, including the Millennium Development Goals. For industrialized countries, too, expanding economic activity is essential for grappling with long-term challenges such as population ageing and new investments needed to confront climate change.

The projection in the flagship World Economic Situation and Prospects 2008, to be released on 9 January, points to a moderation of growth for 2008 compared with 2006-2007. The drag on the world economy is mainly being driven by conditions in the United States, the world’s largest economy, whose economic and financial ills often have global consequences. The bout of instability in the financial markets precipitated by sub-prime mortgage difficulties in that country has, for instance, had global repercussions. A credit squeeze and higher risk premiums are impacting financial markets even in countries such as Indonesia that have limited sub-prime exposure.

Developing countries are vulnerable to a possible downturn of the global economy, the DESA annual forecast of short-term global and regional global economic trends finds. Growth in most emerging economies is not yet self-sustaining with these areas highly dependent on an economic environment that is shaped by the policies and performance of developed regions. In the outlook for 2008, therefore, slower growth of the United States and other developed economies may hinder the growth prospects of developing countries and economies in transition, although with considerable variability.

Strong but uneven growth
In the past few years, developing countries as a whole have performed well, exhibiting growth levels of around 7 percent. Developing countries in East Asia did remarkably well, led by China. South Asia also grew at a robust pace, led by India. African economies grew at an average 5.4 percent over the last decade with continued strength expected in 2008, according to the World Economic Situation and Prospects.

Yet, DESA’s annual report nuances, the solid performance of developing countries on the whole obscures important differences among countries with several economies performing poorly as a result of adverse weather conditions, trade shocks and civil strife. In a special event on development held by the General Assembly on 6 December, Nobel economist Joseph Stiglitz noted that growing inequality within most countries was especially worrying, implying that reductions in poverty are slower than expected. In India, for example, the prevalence of malnutrition has soared despite increased growth.

Thirteen African countries, with 25 percent of population, grew less than 3 percent from 1998 to 2006, and another 25 countries, with almost 50 percent of Africa’s population, grew between 3 percent and 5 percent. While many regions are making headway on some of the Millennium Development Goals, absolute poverty has risen over the last decade in sub-Saharan Africa. The most recent figures by the World Bank suggest that only a third of the world’s poorest countries will achieve a single Millennium Development Goal by 2015.

The need to join forces
These conditions might be exacerbated by the challenges faced by developing countries in 2008. Growing global demand for food, high energy prices, and integration of global energy and food markets through bio-fuels coupled with global warming are likely to lead to increasing food prices, Stiglitz indicated. This in turn could lead to a macroeconomic problem owing to rising inflation and, in this regard, Stiglitz cautioned developing countries against raising interest rates.

Indeed, interest rates cuts are being used to stimulate the economy in the United States, and treat the current US slowdown. But in the current context, DESA’s forecast stresses, such cuts could precipitate a further depreciation and loss of confidence in the dollar. It would be safer and more useful, says the report, to attract funds from countries with large savings and current accounts surpluses, such as China, Japan and oil producing nations, which could be accomplished through stepped-up public investment on health, education and social security.

In addition to stimulatory measures, the report suggests that governments should join forces to stave off a dollar decline that risks being steeper and more abrupt than the descent that has prevailed so far. The large current-account deficit and perceptions that the US debt position is approaching unsustainable levels have been among the major factors underlying the depreciation of the US dollar by about 35 percent against other major currencies since 2002, says the report.

The threat of a hard landing may be further intensified by the very nature of the global reserve system which uses the national currency of the United States as the main reserve currency and instrument for international payments. Under this system, the only way for the rest of the world to accumulate dollar assets and reserves is for the United States to run an external deficit. The report recommends obtaining greater stability through “an officially backed multicurrency reserve system, reducing the likelihood of crisis where capital flight out of the major single reserve currency brings on disastrous global economic repercussions.”

Addressing global imbalances
In 2008, reserve management will be a challenge given vulnerability to a sudden depreciation of the US dollar. Should a hard landing of the dollar occur, there will likely be much greater instability in the global financial system and a disorderly unwinding of global imbalances, the DESA report forecasts. For developing countries holding a large proportion of foreign reserves in dollar-denominated assets, a sharp depreciation of the dollar would entail great financial losses.

In his presentation to the General Assembly, Stiglitz emphasized that developing countries have borne the brunt of the risk associated with the recent instability in global financial markets. The global reserve system can be considered inequitable in that developing countries lend the United States and other reserve countries trillions of dollars at low interest rates and borrow back at much higher rates. This implies an implicit subsidy to the United States, he stressed, which is greater than all of its foreign aid. Moreover, money is flowing the wrong way – from poor countries to rich – increasing the worry of a disorderly unravelling of imbalances.

The IMF has already begun multilateral consultations to deal with global monetary imbalances through concerted policy actions. The participants in this dialogue, which include the United States, Japan, the euro area, China and Saudi Arabia, seem to agree on the desirability of correcting global imbalances without jeopardizing sustained growth, and on the need to work together. The World Economic Situation and Prospects advises that such discussions should be broadened to involve developing countries, and that agreement be reached on multi-year policy adjustment schedules that can be monitored in order to make participants accountable and increase the likelihood of follow through.

Bilateral agreements can undermine multilateral trade
This year could prove to be the toughest test for developing countries in some time, according to DESA report. The slowing of the United States and other developed economies will take air out of the rising commodity prices which have buoyed developing country growth. The slowdown will undercut world trade, which in 2007 has already tailed off from the high growth rates of 2004 and 2006. Also apparent last year was greater volatility in investment flows – and emerging market economies have already had experience with investment booms that turned to busts.

“Many countries have been put under pressure to sign bilateral agreements which, hidden into trade agreements, are very much adverse to the interests of developing countries and, evidence has it that they have not promoted investment,” according to Stiglitz. Highlighting a longstanding problem for developing countries, he added that “the growth of bilateral trade agreements is undermining the multilateral trading system.” Top economist Jagdish Bhagwati, also commenting on the state of the world economy at the General Assembly special event on development, further warned that bilateral trade agreements are perpetrating the trend of imposing stringent restrictions on trading partners.

Deputy-Secretary General Asha-Rose Migiro for her part recalled developing countries’ need to have access to open, fair, equitable and non-discriminatory trading and financial systems. “It is imperative that the Doha trade negotiations conclude early and deliver on the promise to be a true development round,” she urged.

Reform of global economic governance
A problem of global economic governance may be at the root of many of these issues. The World Economic Situation and Prospects 2008 reminds us that reform of the Bretton Woods institutions – the World Bank and International Monetary Fund – remains still high on the agenda. At its 2006 annual meeting in Singapore, the IMF Board of Governors approved an agenda and timeframe for reforming voting power and governance structures to ensure better representation of developing countries and bolster the Fund’s legitimacy and relevance, which continues to be under discussion.

Meanwhile, changes at the IMF do not yet appear to have much impact on decision-making. The new head of the IMF, Dominique Strauss-Khan, was recently selected the same way as in the past despite dissatisfaction with recent choices, recalled Stiglitz. Broader participation and more transparency at the World Trade Organization are also essential but remain elusive, he added. As a consequence, multinational corporations tend to have excessive influence over global trade decisions.

The DESA forecast for 2008 concludes that without reform of global financial institutions, concerted action to confront the problem of imbalances in the world economy will likely remain “far removed from what is needed and enhance the risk of a much deeper slowdown in world economic growth.”

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