Money makes the world go round, or so the song goes. It can also send it spinning out of control, as witnessed during the 2008 global financial crisis. In response to the soaring economic and social costs that followed, the international community called for a new financial songbook. Gordon Brown, chief conductor of the G20 choir at the time, placed the blame firmly on inadequately regulated financial institutions that had become less “stewards of people’s money” and more “speculators with people’s futures”; what was needed, he insisted, was new global rules underpinned by shared global values. Shortly after, the leaders of the BRIC countries, at their first summit in the Russian Federation, called for more democratic international financial institutions, along with a stable, predictable and more diversified international monetary system.
The United Nations General Assembly added its universal voice with a blueprint for reforming the international financial system, noting, in particular, as an urgent priority, “comprehensive and fast-tracked reform of the IMF”. A number of national legislators joined the chorus with a string of parliamentary hearings and expert commissions, many of which criticized the short-term bias of financial markets, their addiction to toxic and opaque financial instruments, and their failure to adequately service the financial needs of businesses and households. Serious reform, it seemed, was just a matter of time.
Seven years on, and against a backdrop of sluggish global aggregate demand, increasing income inequality and persistent financial fragility, the world economy remains vulnerable to the vagaries of money and finance. It would be wrong to suggest that the reform agenda never got beyond the drawing board; various measures have been adopted, at both the national and international levels, including some with real bite. But so far these have failed to get to grips with the systemic frailties and fragilities of a financialized world. Rather, to date we have, in the words of the Financial Times journalist Martin Wolf, little more than a “chastened version” of the previously unbalanced system.
The persistent short-term and speculative biases of global financial markets, and the inadequate measures to mitigate the risks of future crises, raise important questions about whether the heightened ambition of the international community with respect to a range of new developmental, social and environmental goals can be achieved within the desired time frame. On paper, this new agenda anticipates the biggest investment push in history, but in order to succeed it will require a supportive financial system. Accordingly, this year’s Trade and Development Report examines a series of interconnected challenges facing the international monetary and financial system, from liquidity provision, through banking regulation, to debt restructuring and long-term public financing. Solutions are available, but dedicated action by the international community will be needed if finance is to become the servant of a more dignified, stable and inclusive world.
From global financialization to global financial crisis
Following the collapse of the Bretton Woods system, finance became more prominent, powerful and interconnected; it also grew steadily more distant from the real economy. From the 1980s, most major developed economies rapidly opened up their capital accounts, followed a decade later by many emerging developing economies. As a result, capital began flowing across borders on an unprecedented scale. In 1980, global trade had been at a level relatively close to that of global finance, at around a quarter of world GDP, but by 2008, just prior to the financial crisis, global finance had grown to become nine times greater than global trade; by that time, the global stock of financial assets exceeded $200 trillion. At the same time new financial institutions emerged and more traditional intermediaries increasingly diversified their range of financial products, in both cases with fewer regulations and less oversight. In the process, finance became much more interconnected, with standard measures of financial integration hitting historical highs and global asset prices moving in ever closer tandem.
In a very short period of time, these developments overwhelmed the institutional checks and balances that had ensured a remarkable period of financial stability during the three decades after the end of the Second World War, and which had, in turn, underpinned a steady rise in international trade and an unprecedented drive in capital formation. A new generation of policymakers responded with calls for the rapid dismantling of remaining financial regulations, extolling, instead, the
virtues of self-regulating markets as the best, and on some accounts the only, approach for combining efficiency and stability in a globalizing world.
The resulting financial system became far more generous in creating credit, more innovative in managing risk and more skilled in absorbing small shocks to the system (the so-called Great Moderation). However, it turned out to be much less capable of identifying systemic stresses and weaknesses and anticipating bigger shocks (from the Mexican peso crisis to the Great Recession) or mitigating the resultant damage. The burden of such crises has, instead, fallen squarely on the balance sheet of the public sector, and indeed, on citizens at large.
The scale of the 2008 crisis has left many governments struggling to offset the effects of financial retrenchments in banks, businesses and households as they seek to repair their balance sheets. This is partly because a singular focus on price stability has led policymakers to abandon the art of managing multiple macroeconomic goals; but also because financialization has blunted or removed a range of policy instruments that are needed for effective management of a complex modern economy.
Since the crisis, many developed economies have turned to “unconventional” monetary policy instruments in efforts at recovery. Essentially, key central banks have been buying up the securities held by leading banks in the hope that increased reserves would generate new lending and stimulate new spending in the real economy. The results have been underwhelming: in many developed economies, recovery from the 2008 crisis has been amongst the weakest on record. Job growth
has been slack, real wages have stagnated or fallen, investment has struggled to pick up, and productivity growth has been stuck in second gear. By contrast, stock markets have recovered, property markets have rebounded – in some instances booming again – and profits are up, in many cases beyond the highs reached before the crisis. Meanwhile, debt levels have continued to rise, with an estimated $57 trillion added to global debt since 2007.
More in the report:
Tepid recovery in developed countries
Stagnation: Secular or seasonal?
Financial spillovers to developing and transition economies
Managing capital flows: New vulnerabilities, old challenges
Slowdown and diversity in the developing world
The liquidity conundrum: Too much and too little
Possible steps towards the reform of the international monetary system
International financial regulation: A work in progress
Outstanding issues: Shadow banking and credit rating agencies
Towards a bolder agenda
The recurrent problem of external debt crises
Alternative approaches to sovereign debt restructuring
Restating the case for additional official development assistance
Public-private partnerships
Blending the new with the old: Sovereign wealth funds and development banks
Mukhisa Kituyi, Secretary-General of UNCTAD
More: UNCTAD Trade and Development Report 2015