Alarmed by increasing volatility in the stock, commodities, and currency markets of developing countries and emerging economies, UNCTAD´s Trade and Development Report 2006, warns that without quick international action to reduce global trade imbalances, financial crises in the wake of a tumbling dollar will threaten the benign growth performance of the world economy.
Up to now, turbulence has been limited to some peripheral economies with rather high current account deficits. There is no evidence that a major financial crisis --comparable to the Asian or Latin American crises of some ten years ago -- is looming. But the flexibility and pragmatism of US macroeconomic policy that so far has prevented deficiencies in the global trading system from leading to outright deflation and recession -- that has limited the damage "only" to huge trade imbalances -- cannot and will not go on forever.
The report calls for a multilateral effort to redress global imbalances, in part through an expansion in domestic demand in key industrialized countries other than the United States -- countries such as Japan and Germany, which currently have huge surpluses -- so that shocks don´t reverberate through the developing world.
Despite the increasing nervousness of international investors, most emerging-market economies are less vulnerable than during the major shocks of the past two decades. In 2005, South Asian and Southeast Asian countries recorded large surpluses in their current accounts, and Latin America as a whole was also in surplus. After the Asian and Latin American crises, more and more developing countries have followed a similar path: unilaterally stabilizing their exchange rates at rather low levels, running sizeable current account surpluses, and accumulating huge US dollar reserves through interventions in the currency markets.
This undervaluation-plus-intervention strategy is widely considered to be a less-than-optimal method for such countries to expand their economies. But in many respects it is the only feasible way for them to adapt to systemic deficiencies afflicting today´s global economic order -- it is what they can do in the absence of a multilateral financial system which has symmetric obligations for surplus and deficit countries, and which balances the interests of rich and poor nations.
In UNCTAD´s view, it is no accident that the undervaluation-plus-intervention strategy is especially prevalent among developing countries that went through currency crises in the recent past, following previous liberalization of their financial systems and capital accounts. Having learned that reliance on foreign inflows of capital rarely pays off, growing numbers of developing countries have shifted to an alternative strategy that is based on trade surpluses as an engine for investment and growth. This strategy requires them to defend their competitiveness by intervention in currency markets. But this approach also implies that at least one country -- nowadays the United States -- has to accept the corresponding trade and current account deficits.
But UNCTAD economists fear that the United States has become overburdened in its role as the consumer of last resort and as the locomotive of global growth. For a long time, the US Government has been able to ignore its enormous and growing trade imbalance, as no conflict with sustaining full employment and price stability at home has arisen up to this point. But the potential for such a conflict is itself a key risk today, as domestic sources of growth are bound to weaken. UNCTAD considers it unlikely that the personal savings rate in the United States will decline by another 5 percentage points over the next decade, or that the public budget will be allowed to deteriorate by another 6 percentage points. If that is the case, the world economy will have to do without the growth stimuli it has become addicted to over the last 15 years.
A sharp depreciation of the dollar would tend to restore competitiveness and would help re-balance the United States economy, but, given the dependence of global growth on US demand stimuli, a marked slowdown in US demand for imports could spread and amplify around the world just as the positive impulses of growing US demand have done in recent years. Through no fault of the developing countries, this could reduce and even reverse the development progress and poverty reduction recently achieved by such nations.
Despite surpluses in developing countries, the main reason for the US´s perhaps increasingly unmanageable global burden is the fact that other key industrial countries have not only failed to play their corresponding global part, but have actually decisively added to the US´s burden. The huge external surpluses of Japan and Germany and the massive improvement of their competitive positions show that the required competitiveness gains on the US´s part should mainly come at their expense, a process that would be greatly eased if this occurred in the context of buoyant -- rather than stagnant -- domestic demand.
According to the UNCTAD secretariat, China´s part in a benign unwinding of global imbalances differs markedly from these two countries´ roles. Since the beginning of the 1990s, China´s domestic demand and its imports have grown very strongly indeed, and the country has played a vital role in spreading and sustaining growth momentum throughout the developing world -- a process which must not be derailed. Therefore, renminbi revaluation should continue gradually rather than abruptly, taking due account of regional implications. As with China, oil producing countries too have only recently come to play a globally significant part in today´s imbalances. Oil producers should generally use benevolent terms-of-trade developments in favour of investment and diversification of their production structures. Should elevated oil prices persist, their contribution to a benign unwinding of global imbalances could consist of stronger domestic demand growth in line with higher incomes, with extra expenditure being directed to social and physical investments aimed at diversifying their economies.
Crucially, the report says, what is needed for redressing global imbalances is a responsible multilateral effort rather than pressure on parts of the developing world. A well-coordinated international macroeconomic approach would considerably enhance the chances of poorer countries being able to preserve and continue recent improvements in their growth performances. In the absence of such an approach, the report says, developing countries should defend their strategically propitious competitive positions and use the current favourable overall conditions to invest more and to reduce their foreign debts.