1. 1 Study Tour for students from the University of International Business and Economics (Beijing) Geneva, 26 September 2011 TRADE AND DEVELOPMENT REPORT 2011: Post-Crisis Policy Challenges in the World Economy J ö rg Mayer UNCTAD

2. 2 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

3. 3 Global economic recovery is slowing down, with strong downside risks

4. 4 “T wo-speed” recovery pattern continues Note: Linear trends correspond to 2002–2007. Real GDP at market prices, 2002–2011 (Index numbers, 2002 = 100)

5. 5 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

6. 6 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

7. 7 Premature fiscal tightening is 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

8. 8 Developing countries’ post crisis increase in public debt was relatively small Ratio of public debt to GDP, selected income groups, 1970–2010 (Median, in per cent)

9. IMF-sponsored programmes systematically underestimate their negative impact on GDP growth and fiscal balances

10. 10 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

11. 11 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

12. 12 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

13. 13 Commodity prices have recovered amidst high volatility Monthly evolution of selected commodity prices, January 2002–May 2011 (Price indices, 2000 = 100)

14. Many explanations are available for recent commodity price movements C hanges 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)

15. Financial investment continues to rise AUM/global GDP ratio doubled in 2005–07 and rose 4-fold in 2008–10 Commodity investment, assets under management, 2005–2011 ($bn)

16. 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

17. 17 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

18. 18 Exchange rates have become disconnected from macroeconomic fundamentals Real effective exchange rate, selected countries, January 2000–May 2011 (Index numbers, 2005 = 100, CPI based)

19. 19 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

20. Thank you! joerg.mayer@unctad.org (http://www.unctad.org) joerg.mayer@unctad.org