A new prescription

Print edition : April 24, 2009

Professor Joseph Stiglitz. The commission chaired by him recognises that the global crisis originated in and was triggered by developments engineered in the developed industrial countries and that poor countries and their populations are disproportionately affected by such crises.-DOUG KANTER/BLOOMBERG NEWS

PRIOR to the G-20 summit held on April 2, there was a rush of suggestions on what world governments and international institutions should do to address the global financial and economic crisis. Not all were coherent or even remotely feasible. But among the many plans to resolve the global crisis and reform the international monetary and financial system to pre-empt such crisis in the future, one stood out.

This was prepared by the Commission of Experts set up by the President of the General Assembly, Nicaraguan statesman and priest Miguel dEscoto Brockmann. The commission is chaired by Nobel laureate and Columbia University Professor Joseph Stiglitz and consists of an internationally representative and diverse group of distinguished experts.

The very fact that this plan was prepared on behalf of the United Nations with 192 member-states and would be debated at such an inclusive forum makes it noteworthy. This in itself is an advance on the efforts still under way to negotiate and formulate recovery plans in self-constituted, unrepresentative, and, therefore, partly illegitimate groupings like the G-8 and the G-20. Despite the expansion of their membership beyond the numbers indicated by their labels and selective invitations to significant non-members to sit at the table, the G-8 and the G-20 have not garnered the legitimacy that they have been seeking. This is what makes the group of experts commissioned by Father dEscoto different.

That difference, fortunately, is also visible in the tenor and substance of the commissions recommendations which begin by recognising that the crisis that engulfs the world today originated in and was triggered by developments engineered in the developed industrial countries; and that poor countries and their populations are disproportionately affected by such crises.

On the other hand, national stimulus plans, which are bound to be larger and more comprehensive in the more developed countries, might have marginal or even adverse effects in the less developed world. Thus, an inclusive recovery plan must consciously seek to take account of the externalities or effects of national strategies on other countries. Recognition of inevitable asymmetries in responses to the crisis and in the in-country and out-of-country fallout of these responses is crucial.

The commission is clear on what the proximate determinants of the crisis were. Loose monetary policy was erroneously used as a means to spur credit-financed consumption and investment as an offset for the insufficiency of aggregate demand spontaneously generated by the system. This tendency was strengthened by rising global inequality and by the pressure on developing countries to accumulate foreign exchange reserves as insurance against financial crises, which make them dependent on institutions such as the International Monetary Fund (IMF) that tend to recommend policies that precipitate or aggravate such crises.

Of course, it is not just the need for insurance that explains the distribution of global surpluses but the changed geography of global competitiveness and the fact that there are no national budget constraints on the United States because the dollar serves as the worlds reserve. The credit-financed boom in the U.S. was also facilitated by financial deregulation that not merely diluted the checks and balances that would have prevented the proliferation of credit and associated risk, but incentivised risk-taking and speculation. And finally, the liberal policy environment encouraged regulatory forbearance of a kind that led to poor corporate governance.

Importantly the commission underlines the fact that: Many of these failings... have been supported by a flawed understanding of the functioning of markets, which also contributed to the recent drive towards financial deregulation.... Globalisation too was constructed on these flawed hypotheses; and while it has brought benefits to many, it has also enabled defects in one economic system to spread quickly around the world, bringing recessions and impoverisation even to developing countries that have developed good regulatory frameworks, created effective monetary institutions, and succeeded in implementing sound fiscal policies.

To deal with the crisis resulting from this market fundamentalism, the commissions preliminary report (which is a summary of its analysis and a statement of its recommendations) begins by making clear that it must pursue multiple objectives. It must advocate immediate measures that can ensure recovery from the crisis. It must recommend reform of the monetary and financial systems and the economic structures that underlie them, which can be pursued in the medium and long term. And it must do these in ways that promote the global good, with equitable and sustainable growth, protection for the poor and the long-term redistribution of global surpluses to strengthen the less and least developed countries.

The prescriptions for recovery are influenced by the recognition that the crisis is in substantial part the result of market failure and that real economy growth that rides on a credit-financed bubble is unsustainable. Hence, recovery from the crisis requires the restoration of balance in the relative roles of the market and the state and a greater dependence on a state-financed stimulus as the basis for growth. This leads to the plea for coordinated and strong stimulus packages in all countries, which are framed in ways in which the downstream, multiplier effects are large, the impact on the poor is significant, and the global fallout large and positive.

To enhance the global effects of the stimulus, given the limited manoeuvrability of poor countries and the decline in world trade and financial flows, the commission suggests that at least 1 per cent of the spending on the stimulus packages of the developed countries should occur in developing countries. This would also pre-empt the tendency towards deflation in developing countries aimed at generating surpluses on their balance of payments, either because they cannot access foreign capital to finance deficits or because of conditions imposed when they turn to the IMF for financing their deficits.

To support this globally coordinated effort at recovery and a subsequent globally coordinated effort at monitoring and supervising the financial and real sectors, the commission makes the case for a new set of democratic and participatory institutions, including an inter-governmental expert panel to advise the relevant U. N. bodies. These institutions are to include a Global Economic Council equivalent to the General Assembly and the Security Council that meets annually at the Heads of State level. The latter would promote development, secure consistency and coherence in the policy goals of the major international organisations and support consensus building among governments on efficient and effective solutions for issues of global economic governance.

Needless to say, the problem the commission grapples with is complex. For example, the difficulty in opting for a coordinated fiscal stimulus is that it could aggravate global imbalances in two ways.

First, it could enlarge current account surpluses in countries such as China while worsening current account deficits in the U.S. Second, the benefits of expansion in poorer countries may leak out abroad resulting in a widening of their current account deficits. If, in response to the first of these imbalances, developed countries such as the U.S. opt for protectionism, the benefits of the coordinated stimulus would be far less and far more unequally distributed than would otherwise be the case.

Hence, advanced industrial countries should observe their pledges not to undertake protectionist actions, while allowing poor countries to adopt measures that give them the space to opt for counter-cyclical policies. The transfer of around 1 per cent of spending out of global stimulus packages to poorer developing countries can help here as well.

Spending a part of the money in developing countries not only ensures global coherence and reinforces the stimulus, but could, through import demands, reduce the deficit in developed countries such as the U.S. In fact, in addition to this 1 per cent, it is necessary to identify and operationalise new and stable sources of funding for developing countries that could be disbursed quickly without inappropriate conditionality.

While these immediate and short-term measures are being implemented, the work of restructuring the global financial and economic architecture must begin, suggests the commission. For example, policies adopted and subsidies provided to restore stability in the financial system of the developed countries could lead to a reduction in capital flows to developing countries and even a return flow of capital to the former. This must be countered to the extent possible. Making such distinctions when the crisis affects developed countries significantly, even if the crisis is caused by their own failures, is indeed radical.

However, the most radical proposal put forth by the commission is a new Global Reserve System with a unit such as the IMF-hosted Special Drawing Right (SDR) as its anchor. The system is defined as a greatly expanded SDR, with regular or cyclically adjusted emissions calibrated to the size of reserve accumulations. In other words, countries with larger reserves would be eligible for larger SDR allocations they can invest in. This alternative to the dollar would of course need an increase in the quotas and voting strength of countries such as China, challenging the leadership of the U.S. in more ways than one. The U.S. would lose control of the global financial architecture and the dollar would lose its position of supremacy.

There are, however, a number of global advantages to this. The departure from the dollar reserve system ridden with uncertainties of the kind revealed by the 1997 crisis would reduce the need for countries to insure themselves with huge reserve holdings.

Countries would also not be forced to hold their reserves in dollar denominated assets, which results in lending by developing countries to the developed at extremely low rates of interest. And this would reduce the push that such enforced lending gives to credit financed investment, consumption and speculation in the U.S. that precipitated the current crisis.

There are a number of unanswered questions with regard to the feasibility of the SDR serving as the global unit of account and store of value. These relate to the determinants of the value of the SDR which would be a reserve currency not backed by a single state, the organisation that would serve as the clearing house for international transactions denominated in SDRs and the rules and procedures that would govern the periodicity and size of emissions of the reserve unit. But the fact that an international commission of this pedigree has flagged the need to move away from the dollar, as is now being suggested by many other analysts and players, is a major step forward.

But there is more work at hand. It is obviously also necessary to begin the work of restructuring the financial sector with a move away from an excessively liberalised and self-regulated system to one in which elements of structural regulation are once again embedded. The details of the nature of deregulation that is being recommended by the commission would feature in the full report.

But the contours are clear: institutions are to be prevented from growing to sizes that generate systemic risks and make them too big to fail; financial instruments and practices are to be vetted by a Financial Products Safety Commission to curb excessive risk accumulation; core depository institutions are to be once again tightly regulated as under Glass-Steagall and prevented from diversifying into risky activities; non-banking institutions, including hedge funds and private equity firms, are to be brought under supervision; derivatives trading is to be regulated with a substantially reduced role for over-the-counter transactions and controls on the nature of products generated; credit rating agencies are to be monitored; and democratically constituted global institutions such as a Global Financial Regulatory Authority and a Global Competition Authority would take on the responsibilities of governing global finance.

Given the sweep and the as yet unfathomed depth of the crisis, even this menu of policies may be just the beginning. But it possibly is one set of recommendations that is most global in perspective and adequately goes the distance needed to make a difference when addressing the biggest crisis capitalism has experienced since the 1930s.

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