Asia and the Emerging Global Economic System

1. Asia and the Emerging Global Economic System Joseph E. Stiglitz Bretton Woods April 10, 2011

2. Changing Global Economic Landscape • Unprecedented growth in Asia • Rapid convergence • China already 2nd largest economy • On the way to being largest economy • Already largest source of savings • “Correcting” a two century long aberration • Economic model markedly different from American style capitalism (especially in East Asia) • Larger role for government • More government controls • Especially in financial markets

3. Asian Economic Model Has Worked • Not only to promote unprecedented growth • But also for stability • Avoided the excesses of the US • And even to manage the instability foisted on them

4. Combination of their success and their economic role (in trade, finance, reserves) implies Asia should/will have a larger role in setting the rules • Differences in interests, economic circumstances, ideology should imply a difference in rules • Before the crisis, Asian countries were put under pressure to adopt “unfettered” financial markets (fully flexible exchange rates—except in East Crisis, when it was recognized that would be destabilizing) • Financial and capital market liberalization • 1997 attempt to change charter of IMF • Sometimes embedded in trade treaties

5. After the Crisis • Recognized that excessive deregulation was responsible for the crisis • And financial and capital market liberalization may have contributed to the rapid spread of crisis around the world • Countries that had maintained regulations (including on cross-border capital flows) fared better • But US Treasury does not seem to have fully learned the lesson

6. New Balance of Global Economic Power • Rules governing global economic system have largely been written by advanced industrial countries, for advanced industrial countries—or for special interests within those countries • Based on “free market” ideology • But justified in terms of “economic principles” • Similarly, for international institutions governing globalization • Marked by flaw governance • Question is: Will emerging markets be able, willing to rewrite these rules? To reflect: • Their countries’ interests • Broader interests within their society • To promote global stability and growth • Including development of the poorest countries

7. A New Global Order—Reflecting Lessons of Past and New Balance of Power • A global reserve system • A global monetary policy • A global regulatory system

8. Global Reserve System • Dependence of global system on the currency of a single country in the multi-polar world of the twenty first century is a historical anachronism • Especially given problems of economic management in the US • Dollar is not a good store of value

9. Dollar Reserve System Is Unstable, Deflationary, and Inequitable • New version of Triffin paradox • Economic circumstances in reserve currency country may differ from those of others—conflicts of interests in “supply” of reserves • Money that is put aside in reserves is money not spent—contributing to lack of global aggregate demand • Developing countries lend money to reserve country (countries) at low interest rates and borrow at high interest rates

10. Reform Good Even for US • Though it has advantage of being able to borrow at low interest rate • Accumulations of reserves mean US is exporting T-bills rather than automobiles (i.e. gives rise to trade deficit) • In past, contractionary effects could be offset by government spending • More difficult now

11. New Global Order • Still, US has resisted change • But with China holding almost $3 trillion in reserves, China’s voice (and that of other holders of reserves) should be more important • China knows that it is earning negative return on dollar holdings • And will experience large capital losses as it revalues

12. Reforms • Long term: Annual emissions of a new global reserve currency • Short term: Annual emissions of SDR’s, combined with reforms in SDR system to make SDR’s more usable

13. Global Monetary System • Financial and capital market integration changes way national monetary policies work • Without regulatory or other barriers, increase in liquidity in one part of world seeks highest return in world—no reason for it to stimulate domestic economy • Especially when credit channel (banking system) is clogged • Except through competitive devaluation • “Portfolio effect” from increase in relative supply of “dollars”

14. Intellectual Incoherence? • QE II was announced as a temporary purchase of long-term government bonds—raising prices and lowering long-term interest rates • But if “adding” demand raises prices (from what they otherwise would have been), then later subtraction of demand will return them to previous level • But anticipating this, buyers will not be willing to pay higher price • Suggesting at most a limited effect

15. Intellectual and Policy Incoherence? • If it is permissible for one Central Bank to add dollars, why should it not be permissible for another Central Bank to subtract dollars • Which is what they have been doing through exchange rate interventions • More generally, other governments attempt to limit potential impacts by imposing constraints on the free flow of capital

16. A New Global Regulatory Regime • Without global regulation, there is a risk of regulatory arbitrage, circumvention • But likelihood of an effective global regime is limited • Each country has a responsibility to protect its citizens and economy • Adopting regulatory regime appropriate for their circumstances • Recognizing the large role that special interests (especially finance) has played in setting national rules in the West and international rules

17. Cross Border Capital Flows • A critical part of the regulatory regime (largely ignored in G20 discussions) concerns cross-border capital flows • Short term flows major source of volatility • Flows often pro-cyclical • Economic theory (taking into account information imperfections and/or life cycle effects) explains why that should be expected • With little (possibly adverse) effect on real growth • A variety of effective capital account management techniques

18. Recent IMF Report Represents Major Policy Shift • Recognizes role of capital flows in creating/enhancing volatility • Evident in the post-crisis period • Recognizes that some nations resorted to capital controls with some success

19. Recent IMF Report Represents Major Policy Shift • But didn’t go far enough • Recommended that they be used only as a last resort, as temporary measures, and that they be non-discriminatory • But capital account management techniques can enhance scope for domestic policy, discourage destabilizing short-term capital flows • There are differences between domestic and foreign flows (based on information asymmetries, preferences, etc.) • Though with globalization, some of these differences diminishing • A global regulatory system (controlling outflows and inflows, reducing scope for regulatory arbitrage, circumvention) would be desirable • Worse, some trade agreements may inhibit ability to adopt appropriate regulatory system

20. Financial Market Liberalization • This too may have contributed to volatility • Without offsetting benefits in terms of economic growth • International financial institutions especially less interested in lending to domestic SME’s • Results not surprising—given information asymmetries • Long-time source of concern—reluctance in US to have national banks • Hamid Rashid, “Credit to Private Sector, Interest Spread and Volatility in Credit-flows: Do Bank Ownership and Deposits Matter?” working paper, 2011 • Detragiache, Tressel and Gupta, 2006, “Foreign Banks in Poor Countries,” IMF Working Paper, WP/06/18

21. Global Imbalances • US tried to shift blame for crisis to Asia—“savings glut” • Real failure was the failure of financial markets to manage risk and allocate capital to address large investment needs • Retrofitting the global economy to face global warming • Development needs (e.g. infrastructure) • Asia should not be encouraged to imitate America’s profligate consumption pattern • Though China needs a change in its “supply driven” economic model • Real challenge is how to recycle savings in a more productive way than has been used in the past • Necessitates creating a risk mitigation facilities

22. Concluding Remarks • New global order provides new opportunity to design a new global financial and monetary system • Old system hasn’t worked well • Problems manifest in crisis • Globalization has made matters worse • Principles underlying it based on flawed theories • Though may have served special interests well • Asia should work to help create this new system

23. Concluding Remarks • But in the meantime, it should resist allure of “financialization” • China attracted by the prestige of having its currency becoming used internationally • Will inevitably happen as China becomes largest trading economy • Does not require full liberalization of financial and capital markets • Internationalization of currency is less important for its economy than developing good financial markets domestically—e.g. to provide credit to SME’s • Notion that once its capital and financial markets have become more developed it should fully liberalize is wrong • Unfettered financial markets have never worked well • And the most recent crisis has provided further evidence