[DEBATE] : A new prescription,,C.P. CHANDRASEKHAR

[Riaz K Tayob]

A new prescription

C.P. CHANDRASEKHAR

A Commission of Experts set up by the U.N. makes recommendations that 
promise to address adequately the biggest crisis of capitalism since the 
1930s.

DOUG KANTER/BLOOMBERG NEWS

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.

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 d'Escoto 
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 
d'Escoto different.

That difference, fortunately, is also visible in the tenor and substance 
of the commission's 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 
world's 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.

FLAWED UNDERSTANDING OF MARKETS

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 
commission's 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.

NEED FOR DEMOCRATIC INSTITUTIONS

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.

GLOBAL RESERVE SYSTEM

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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