6:57 AM May 5, 1993
ORTHODOXY WILL INTENSIFY STAGNATION, INSTABILITY
by Kenneth Dadzie* Geneva 4 May (TWN) -- In recent months the world economy has, unfortunately, once again performed more in accordance with the expectations of the UNCTAD secretariat than the relatively optimistic projections of a number of other international institutions. The United States has begun to recover, but the growth rate is only about one-half of previous post-war recoveries. The driving force has been a fall in household savings rather than a rise in personal incomes. Savings cannot keep on falling indefinitely. Therefore, in order to sustain recovery it will be necessary to create jobs, and thus incomes, over and above what the private sector is now generating on its own. It would be regrettable if the longer-term adjustment of structural budget deficits that at long last appears to be in prospect is not accompanied by a short-term fiscal stimulus. Japan's economic performance has been especially poor by its own standards, with output stagnating or falling during the last three quarters. Last year's fiscal expansion proved inadequate. Indeed, domestic demand fell, and the response of firms has resulted in a contentious trade surplus. Moreover, little progress has been made in cleaning the balance sheets of banks so as to strengthen their ability to finance recovery. The new fiscal package is again a welcome move in the right direction, but, again, it seems unlikely to give a significant stimulus to world economic activity. Western Europe's growth last year was again one of the slowest since the mid-1970s. Growth is expected to fall in three of the four major western European countries in 1993, though the UK economy now appears moving upwards. Tight monetary policy and unprecedented high interest rates in Germany have been important factors depressing activity in the region. German interest rates were recently cut, but further reductions are needed to revive growth. Unemployment is rising sharply in the industrial world. There are now 30 million unemployed in the OECD area. Japanese companies are responding to demand deficiency by shedding labour rather than shortening working hours as in the past. Industrial rationalization in the US has boosted labour productivity, but it has also added to joblessness. All countries can, of course, increase their productivity. But all countries cannot improve their competitiveness. When they all try to, the result invariably is more recession, more unemployment all round. Unless deflation is countered by expansionary macro-economic policies, countries may well attempt to shift the burden of deflation onto their trading partners, putting further strain on the trading system. A successful conclusion of the Uruguay Round could provide a boost to the world economy. But, on the other hand, continued weakness in world economy activity will surely feed protectionism and obstruct a successful conclusion of the Round. Care should be taken to ensure that the transition to European Monetary Union is not deflationary. Strict adherence to the convergence rules on government debt and deficits would impose a massive fiscal retrenchment. Moreover, although countries with excessive debt and deficits are required to cut back,, there are no corresponding provisions for other countries to adopt expansionary fiscal measures; nor is monetary easing made mandatory. This brings us to another notable factor, the lack of economic policy coordination, even in Europe where it has a firm institutional basis. There are wide differences of view among the major industrial countries on the appropriate mix and stance of policies, especially monetary policy in Europe, and on exchange rates both among the European currencies and the dollar-yen rate. Although Japan is widely praised for its Keynesian policy, financial orthodoxy continues to prevail notwithstanding the strengthen of deflationary forces. Speculative capital movements remain a serious problem. It should be clear by now that it may not be possible to enjoy simultaneously monetary policy autonomy, free capital movements, and stable exchange rates while avoiding trade restrictions. The European Monetary System broke down largely because the major industrial countries tried to obtain this "inconsistent quartet": the inconsistency showed up in the massive speculative raids in currency markets. Would greater convergence of economy policies and performance guarantee exchange rate stability? Experience suggests not. The degree of convergence of inflation rates and monetary and fiscal policies between Germany and France has been almost unprecedented, but this has not prevented speculative attacks on the French franc. Besides, the extra degree of convergence that may be sought to stabilize exchange rates may well require countries to give up more policy autonomy than they are prepared to. The desirability of direct or indirect controls on short-term capital flows may therefore need to be reappraised. In developing countries, growth continues to be highly uneven. A number countries are firmly on a sustained growth path. But in most growth is either absent or erratic. Many recent spurts in growth have been associated with payments positions of doubtful sustainability. After many years of stabilization and adjustment, the economic performance and prospects of Africa remain very unsatisfactory. There is no doubt that strong domestic policy efforts and deep reforms are essential for sustained growth. But structural and institutional weaknesses place African economies at the mercy of factors beyond government control -- namely commodity prices, external aid and weather. The time has come to ask whether it is right to continue to view external financial assistance primarily as a device to bring about domestic policy reform. Should not aid once again be seen as a source of financing investment? Progress has been made in reducing debt burdens and improving credit-worthiness. But the debt crisis persists for over 50 developing countries (or a third of the developing nations) and several East European countries who continue to accumulate arrears and reschedule their debts. Most of them are among the poorest. For many, the enhanced Trinidad terms, are not enough. Bolder action is needed by official creditors, including the alleviation of the multilateral debt burden. Capital flows to developing countries have picked up strongly. Foreign direct investment is up. There have also been considerable private portfolio flows to a number of countries. However, these are mostly short-term and often speculative, with the potential to disturb investment, exchange rates and competitiveness. Some recipients of large-scale capital flows have seen their trade balances deteriorate rapidly because of real currency appreciation and trade liberalization. They are extremely vulnerable to an increase in world interest rates, which could reverse capital flows and trigger a balance of payments crisis. In recent years, the stake of developing countries in the mix and stance of macroeconomic policies in the major industrial countries has been substantially enhanced by their increased financial openness. This calls for a greater and more effective participation of these countries in the policy debate and coordination among the major industrial countries. Although the downturn seems to have bottomed out in Central Europe, acute problems remain in Eastern Europe, especially in the former Soviet Union which has suffered another slump in output. The old command-and-control system is collapsing but new market institutions and behaviour cannot spring up overnight. Similarly, integrating the economies into the world economy will take time, though the disintegration of COMECON occurred rapidly. The transition should therefore be phased rather than sought all-at-once through "shock treatment", and the State should be re-equipped to guide the transition, rather than simply dismantled. The complexity of the transition process should be reflected in the volume and conditions of external assistance, as well as in the trade policies of industrialized countries. In conclusion, there is a danger of stagnation and instability in the world economy, notwithstanding the very strong growth of East Asia. This danger would be magnified, not dispelled, by a sudden intensification of financial orthodoxy. What is required, rather, are pragmatic, internationally coordinated measures to increase effective demand in the North and stable financing for the South. In this context, there is need for a new round of SDR allocations, with the bulk channelled to areas suffering from chronic external financial stringency. (* The above is extracted from the speech of the UNCTAD Secretary-General at the Fund/Bank interim committee in Washington last week)