Asia and the Emerging Global Economic System

Joseph E. StiglitzBretton WoodsApril 10, 2011

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

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

• 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

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

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

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

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

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

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

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

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

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”

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

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

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

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

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

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

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

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

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

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