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Development-led Globalization: Towards Sustainable and Inclusive Development Paths

Report by UNCTAD, 2011

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This report is presented in three parts. The first sets out some of the main features of FDG and suggests that its outcomes have been much more uneven, unstable and unfair than its proponents had claimed or expected. It also shows that there has been a systemic failure to create the economic environment needed to promote productive investment and employment. However, this raises the question of why some countries have been able to grow strongly over the past two or three decades. This section seeks to account for that, and to draw lessons from their success. The second part outlines a rebalancing agenda which aims to deliver lasting and inclusive development gains. It sketches a three-pronged strategy focusing on (a) building developmental states that are able to mobilize domestic resources, strengthen productive capacities and share the gains in an equitable manner; (b) creating more robust multilateral structures capable of forging collective responses to the challenges that countries will face in the years ahead, including those required to tame finance and to promote investment-led responses to climate change; and (c) strengthening regional ties, including through South–South cooperation, in order to enhance stability and open new growth opportunities. The final section will argue that rebalancing is not a narrow technocratic challenge. A true break with the fundamentalist thinking underlying FDG will involve a change of attitudes, morals and values. Accordingly, this report insists on the importance of a normative agenda as an integral part of the broad-based rebalancing involved in the shift towards DLG.




UNCTAD (XIII)/1





Report of the Secretary-General of
UNCTAD to UNCTAD XIII




Development-led globalization: Towards sustainable and
inclusive development paths























United Nations
New York and Geneva, 2011







UNCTAD (XIII)/1


Contents
Page


Preface: The world turned upside down........................................................................................ 3


A. Goodbye finance-driven globalization................................................................................. 4


B. The future is not what it used to be...................................................................................... 6


C. Hello development-led globalization ................................................................................... 7


I. Finance-driven globalization and its limits ................................................................................... 10


A. Introduction.......................................................................................................................... 10


B. Development matters ........................................................................................................... 12


C. The emergence of finance-driven globalization................................................................... 14


1. Financialization ............................................................................................................ 15


2. Debt-driven growth ...................................................................................................... 19


3. Cycles, shocks and crises ............................................................................................. 24


D. Trade, technology and TNCs ............................................................................................... 27


E. Development interrupted ..................................................................................................... 35


F. The ongoing downturn......................................................................................................... 42


G. Future shocks ...................................................................................................................... 43


II. Rebalancing the global economy through sustainable and inclusive development....................... 47


A. Introduction.......................................................................................................................... 47


B. Inclusive development and the investment challenge .......................................................... 48


C. Trade, technology and industrial policy............................................................................... 55


D. Developmental states ........................................................................................................... 59


E. From social protection to inclusive development ................................................................ 63


F. A global New Deal............................................................................................................... 68


1. Taming finance............................................................................................................. 69


2. Turning trade and investment towards development.................................................... 77


3. Managing new threats .................................................................................................. 83


4. Governance matters...................................................................................................... 85


G. New partnerships in the South ............................................................................................. 86


III. The political economy of development ......................................................................................... 92


A. Towards a new development consensus .............................................................................. 93


B. Norms and values................................................................................................................. 95


C. The role of UNCTAD .......................................................................................................... 96




References..................................................................................................................................... 99


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Preface: The world turned upside down


1. In my report to UNCTAD XII (TD/413), I warned that, despite an unprecedented
global boom over the previous five years, significant risks and vulnerabilities threatened
growth prospects and could undermine moves towards a more equitable and effective
global partnership for development. In particular, I argued that “putting liberalized markets
and flexible prices at centre stage has proved to be insufficient in the light of the complex
challenges that the new generation of globalization poses”.


2. At that time, I was swimming against the tide of conventional thinking. Even though
there were clouds on the economic horizon, notably the housing market in the United States
and (closely related) concerns about global imbalances, the consensus forecast was for fair
economic weather sustained by strong market fundamentals. Indeed, at the time that I was
writing, the International Monetary Fund (IMF) was raising its global growth projections.


3. With the benefit of hindsight, my report underestimated the seriousness of the global
imbalances. Sharply rising food prices were an early indication that the world economy was
out of kilter. The danger signs became apparent during the UNCTAD conference in Accra,
when prices for cereals, soybeans and rice were all at historic highs. In the following
months, further rises led to political unrest in several countries. There were also concerns
about the price of oil, which had risen above $100 per barrel, raising inflationary worries
along with the possibility of geopolitical tensions.


4. Financial turbulence hit in August 2007, and the collapse of Northern Rock in
February 2008 and Bear Stearns in March 2008 revealed serious stresses in the financial
markets. Concerns over subprime lending in the United States housing markets intensified
in the middle of 2008. But it was the bankruptcy of Lehman Brothers in September that
triggered a crisis that few had anticipated or even imagined possible, exposing the full
extent of global financial fragility. Credit markets froze and equity prices collapsed.
Leading financial institutions failed, while many others turned to their governments for
support. The speed of contagion was breathtaking, and the sense of panic in the financial
markets and among policymakers was palpable.


5. The first lesson to draw from the crisis is that leaving markets to regulate themselves
is both ineffectual and costly. Bailing out financial institutions has already run into trillions
of dollars, and despite unprecedented fiscal and monetary responses, the global economy
experienced its first contraction since the Great Depression. An estimated 10 per cent of
global output was lost between 2008 and 2010, and tens of millions of jobs were destroyed;
according to estimates by the International Labour Organization (ILO), 200 million people
are currently unemployed worldwide. The impact was felt even in those communities that
had seen few benefits during the boom years: due to the crisis, the number of people living
in extreme poverty jumped by between 50 and 100 million.


6. A second lesson is that when a large number of economies collapse so dramatically,
there must have been underlying weaknesses and fragilities missed or ignored by
policymakers prior to the crisis. No one doubts the creative impulse of market forces, but
the private pursuit of short-term gain can sometimes result in insufficient productive
investment and concentrate the rewards with the favoured few. The risks are particularly
pronounced when financial markets detach themselves from the real economy, tying wealth
creation to the rapid accumulation of debt and rising asset prices rather than to steady
productivity improvements and increasing incomes, and channelling innovation to financial
engineering rather than to technological progress. Such a growth strategy is likely to be
neither stable nor fair.




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7. A third lesson is that when things do fall apart, the state remains the only institution
capable of mobilizing the resources needed to confront large and systemic threats. The idea
that the nation state had somehow outlived its usefulness in a borderless world was never
very serious. Since the state is pivotal to establishing an inclusive social contract and
strengthening participatory politics, it is both imprudent and unrealistic to reduce or bypass
its role in managing economic development and change. The more worrying trend in recent
years has been the growing influence of financial markets in bending public policy and
resources to their own needs and interests – leading a former IMF chief economist to warn
of “a quiet coup” – including in the post-crisis period.


8. Even as a tentative recovery has set in, the imbalances that arose during the previous
boom, particularly in advanced countries, have proved very difficult to overcome. The
private debt overhang remains a drag in many countries, while the combined effect of
financial bailouts and recession has led to rising public deficits, triggering sovereign debt
crises in some countries and stalling the recovery in others. Everywhere, employment
creation has lagged behind, raising the threat of jobless growth and the spectre of
protectionist responses. This provides a fourth lesson from the crisis, namely that in an
interdependent world, countries cannot be expected to tackle destabilizing threats and
imbalances on their own. And yet, to date, effective rebalancing strategies have not
materialized at the multilateral level. The initial reaction to the food and financial crises
was swift, with significant resources committed on both fronts, along with improved policy
coordination; and protectionist responses have so far been kept in check. But the reforms
required to prevent a repetition of the crisis have proved elusive. In the resulting
interregnum, the burden of adjustment has been shifted onto overstretched public and
household finances, with growing threats to the social peace and stability.


9. Neither IMF nor the World Bank, having abandoned their original raison d’être to
the siren calls of unregulated financial markets, have been able to forge a vision of a post-
crisis world economy consistent with changed economic and political realities. This failure
points to a wider hiatus in global governance. The Doha Development Round is fast
approaching its tenth anniversary, and its completion – as initially conceived – is still to
happen. Progress on reducing greenhouse gas emissions has stalled following the failure to
reach a comprehensive deal in Copenhagen. Finally, even before the latest crisis, keeping
the Millennium Development Goals on track was a struggle: their achievement by 2015 is
now only a distant possibility. It is telling that even a small proportion of the resources used
to save financial institutions deemed “too big to fail” could never be found in better
economic times for social and economic development, infrastructure-building and social
welfare, or to address environmental challenges.


A. Goodbye finance-driven globalization


10. It has become commonplace to view these developments as part of the inevitable
stresses and strains of moving to a borderless world economy, and the price to be paid for
the greater efficiency and dynamism of global market forces. Doing so requires a good deal
of faith in the textbook logic of how markets work. In fact, the past 30 years have seen a
persistent slowdown in global growth, weaker investment performance in many countries,
and a sharp rise in income inequality almost everywhere. Moreover, describing the global
economy as a natural system with a logic of its own ignores the policy choices
underpinning it.


11. The extensive deregulation of the financial sector in the advanced countries, the
dismantling of controls on cross-border financial activities, and the ensuing surge in capital
flows marked a radical break with the post-war international policy framework. The rapid
ascent of financial interests has eroded the checks and balances that had previously helped


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channel market forces into the kind of creative and productive activities needed for long-
term growth, and has instead encouraged short-term, and at times destructive, behaviour by
banks, businesses, and households. Ideological support came from the efficient market
hypothesis, which made the case for a hands-off policy approach applicable to all economic
circumstances and challenges.


12. The crisis has put to rest the idea that there is a “one-size-fits-all” policy agenda. It
has also been a considerable shock to the confidence of the developed world, and to the
belief that economic disasters only occur in developing countries because of weak
institutions, corruption and mismanagement. The former head of IMF, Dominique Strauss-
Kahn, was right to conclude that events since 2008 have “devastated the intellectual
foundations of the global economic order of the last twenty-five years” and have shattered
confidence in simple policy fixes to complex development challenges.


13. Since the early 1990s, against the grain of conventional economic wisdom,
UNCTAD has been arguing that the risks from the premature liberalization of trade and
capital flows are significant, that the benefits are not simply there for the taking, and that a
more pragmatic approach to development strategy is essential. In 1993 UNCTAD warned
of an emerging financial crisis in Mexico, in 1995 we flagged the systemic risk from
growing derivatives markets, and in 1997 we were not only alert to the dangers of rapid
financial liberalization in East Asia but also suggested that a combination of repeated
shocks and growing inequalities could produce a backlash against globalization. We have
consistently argued that, in the face of large and unruly capital movements, neither fixed
nor flexible exchange rates can provide the macroeconomic stability needed to secure
strong growth, and that capital controls should be a permanent part of the policy toolkit. We
have warned that an undue emphasis on inflation targeting would likely fuel damaging
boom-and-bust cycles, particularly in developing countries, arguing instead for greater
fiscal space and a more balanced approach to demand management. Throughout the past
decades, we have been warning that the build-up of private and public sector debt was
feeding unsustainable imbalances at the household, national and global level, and that
“bailouts” were neither an effective nor a desirable solution. In 2008, we argued that the
financialization of markets of strategic interest to developing countries had reached
dangerous levels, and that it had become a more significant influence on trade and
development than real economic fundamentals.


14. With all this in mind, I have chosen the term finance-driven globalization (FDG) to
characterize the dominant pattern of international economic relations during the past three
decades. This is intended to convey the idea that financial deregulation, concerted moves to
open up the capital account, and rapidly rising international capital flows have been the
main forces shaping global economic integration since the breakdown of the Bretton
Woods system. Financial markets and institutions have become the masters rather than the
servants of the real economy, distorting trade and investment, heightening levels of
inequality, and posing a systemic threat to economic stability.


15. The latest crisis has served as a further reminder that FDG is a political project and
is, therefore, the subject of legitimate discussion and debate. To date, the response has
largely been one of muddling through, with ad hoc measures to mitigate the damage from
economic shocks, informal partnerships to tackle global imbalances, and impromptu
alliances to push for greater market transparency. There has been progress: the G20 has
added a new and more focused layer of coordination in international economic matters, and
has helped to nudge the multilateral financial institutions towards (marginally) more
representative governance structures and (slightly) less dogmatic advice. However,
divisions have emerged among the advanced economies on how to reform the international
financial system, with alarming signs of a reversion to “business as usual”. Indeed, their
financial sectors have already returned to many of the old practices, even as public finances


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deteriorate and the recovery stalls. Austerity measures are back on the agenda, and
resistance to financial regulation has begun in earnest.


B. The future is not what it used to be


16. Money and finance have dominated policy discussions and grabbed the headlines.
However, there are other important trends shaping development prospects. Soon after
UNCTAD XII in Accra, the United Nations concluded that the planet was now truly urban,
with over half the world’s population living in cities. This figure is expected to rise to over
60 per cent by 2030. Urbanization has long been seen as a progressive trend, closely linked
to a series of cumulative processes raising economic and social well-being. However the
links are not automatic, and considerable challenges lie ahead. Rapid urbanization,
premature deindustrialization and a degraded public sector have led to speculations about a
“hollowing out” of the middle-class, and, more dramatically, a “planet of slums”. Where
these trends have collided with the ambitions of a youthful population, economic
frustrations have spilled over into political unrest, as witnessed recently in North Africa.


17. It would be equally amiss to ignore environmental challenges, and, in particular,
what the United Nations Human Settlements Programme (UN-HABITAT) has dubbed the
“deadly collision” between urbanization and climate change. It is widely acknowledged that
global warming is the unwelcome (and unpriced) result of successful development of
today’s advanced economies. But solving it will require a global policy response that brings
about a new economic trajectory without compromising existing development goals. That
will entail low-carbon, high-growth paths based around new technologies that can deliver
an adequate supply of energy and rising incomes to a growing global population, with
greatly reduced greenhouse gas emissions. A large investment push, with adequate
financing and technology transfer from richer countries, is essential to this rebalancing
challenge, and serves as a reminder of the interrelated nature of the challenges facing the
international community. To date, the requisite economic incentives, degree of political will
and appropriate partnerships have been noticeable by their absence.


18. The rise of new growth poles in the South also heralds a significant shift in the
global economic and political landscape. China has already become the world’s second-
largest economy and its largest exporter. India has now posted two decades of strong
growth and is steadily climbing the export ladder. Growth in other large developing
countries, such as Brazil and Indonesia, picked up in the second half of the last decade.
Since the Accra conference, the share of developing countries in world income has risen by
more than 3 percentage points, to 30 per cent. Trade and investment patterns have shifted
accordingly, and new political alliances and groupings have emerged, suggesting that a new
world order is already taking shape.


19. The resilience to, and rebound from, the crisis in parts of the developing world
certainly marks an important break with the past and has raised hopes of a prolonged period
of convergence ahead. UNCTAD has always looked to an emerging South as being key to a
more balanced global economy. However, a degree of caution is warranted. To date, this
shift has been uneven, with large differences between developing regions and among
individual countries; many of the least developed countries (LDCs) have seen the income
gap between them and other countries widen further during the past two decades,
suggesting that polarization pressures continue to shape global economic relations.
Moreover, many emerging markets remain dependent on the leading economies and
vulnerable to changes in policy and in economic conditions there. The impact of the
Northern debt crisis on developing countries will need to be monitored carefully. The
emerging South is still work in progress, and new forms of cooperation and partnership will
be needed to consolidate recent gains and to meet the challenges ahead.


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C. Hello development-led globalization


20. Against a backdrop of economic imbalances and political tensions in interwar
Europe, John Maynard Keynes called for “new policies and new instruments to adapt and
control the working of economic forces, so that they do not intolerably interfere with
contemporary ideas as to what is fit and proper in the interests of social stability and social
justice”. A new deal did eventually emerge, but only after a push for “business as usual”
had left a trail of currency disorders, wasted resources and shattered communities. Today’s
global economic landscape bears some unnerving similarities to the interwar years; as then,
neither muddling through nor a return to business as usual will get things back on track.
The challenge is to rebalance economies in a way that is timely, sustainable and just.


21. This time around, rebalancing will need a global new deal that can “lifts all boats”,
in developed and developing countries alike. It is a basic truth that people everywhere want
much the same thing: a decent job, a secure home, a safe environment, a better future for
their children and a government that listens and responds to their concerns. UNCTAD has
consistently suggested a battery of policy measures and institutional reforms at the national
and the international level to support rising living standards in developing countries, build
their resilience to external shocks, and help them pursue a balanced integration with the
global economy. The challenge, as I outlined in my report to UNCTAD XII, was less about
“getting prices right” and more about “getting development right”, through a pragmatic,
proactive and socially inclusive approach to macroeconomic, trade and industrial policies.


22. Finding the appropriate mixture of reflation, redistribution and regulatory measures
to achieve these goals is now the urgent task of policymakers, at the international as much
as the national level. I have chosen the term development-led globalization (DLG) to
describe the principles, priorities and policies that need to be pursued to turn tentative
recovery into an inclusive and sustainable future.


23. Reforming the financial system is the place to begin. Even before the crisis, it was
clear that stable and inclusive development was incompatible with speculative market
behaviour, boom-and-bust cycles, and the austerity programmes to which they invariably
lead. It is telling that the emerging success stories from the South have, in large part,
pursued policies that have avoided these dangers. Finance needs to get back to the business
of providing security for people’s savings and mobilizing resources for productive
investment. Reforms are also needed to replace unruly and procyclical capital flows with
predictable and long-term development finance, to regain stability in currency markets and
to support expansionary macroeconomic adjustments. Surveillance and regulation will need
to be strengthened at all levels, and new institutional arrangements may need to be
considered. Regional financial cooperation, despite the current difficulties in the eurozone,
will, in particular, have a much larger role to play in a more balanced international
architecture.


24. Stable monetary and financial arrangements are a precondition for making trade and
investment work for inclusive growth and development. But rebalancing requires that
financial and other resources be channelled towards the right kind of productive activities.
Industrial development remains a priority for many developing countries because of the
opportunities it provides to raise productivity and incomes, and to get the most from
international trade. But a wider sectoral approach, including a focus on the primary sector
in many LDCs, is needed in order to ensure that measures to diversify economic activity are
consistent with job creation, the security of food and energy supplies, and effective
responses to the climate challenge.


25. Talk of “picking winners” has been given an unexpected boost by the exigencies of
the financial crisis, but the real challenge is to make sure that industrial policy, broadly
conceived, is properly aligned with other measures needed to build inclusive development


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paths. Since diversified economies are the building blocks of a dynamic trading system, it is
essential that trade policies and rules – at all levels – support this agenda. Cutting through
the Gordian knot of existing regional trade and investment agreements and building more
productive forms of integration among neighbouring countries offers a way forward for
developing countries. There is also a case for new global rules in areas of particular interest
to developing countries, including for commodity markets and the effective transfer of
technologies.


26. An inclusive development agenda cannot depend on economic policies alone. Under
FDG, the stresses and burdens of unregulated markets have, all too often, been shifted to
individuals and households and, in countries where social welfare systems exist, to
government budgets. In many cases, unprecedented increases in income inequality have
gone hand in hand with underfunded public services and rising levels of household
indebtedness. The resulting cost to economic security and social cohesion has been
enormous. Even when growth has accelerated, as it did in many developing countries
between 2002 and 2008, too many people were left behind. A balanced economy depends
on a strong social compact which, in turn, requires a range of universal and targeted social
policies, tailored to specific circumstances, to ensure that the benefits of growth are widely
enjoyed and its risks are shared fairly.


27. The crisis has confirmed UNCTAD’s long-standing insistence on the importance of
policy space. Its role in building new and more inclusive development paths cannot be
understated. This is needed to allow governments – particularly but not only in developing
countries – to correct market failures, promote collaboration among enterprises in areas of
long-term investment, manage integration with the global economy, and ensure that the
rewards from doing so are evenly shared. In order to do so, states must forge a coherent and
inclusive developmental vision and build a strong compact with different interest groups to
better manage the conflicts and trade-offs that change inevitably brings. Effectiveness also
hinges on a more integrated approach to policymaking which not only links
macroeconomic, sectoral, trade and financial policies in support of growth and
development, but also brings together economic, environmental and social policies, leading
to sustainable and inclusive outcomes. Accordingly, in this report, I will stress the critical
role of the developmental state in building balanced growth paths in an economy where the
mobilization and allocation of resources relies on market forces.


28. This should not be taken to imply that states never fail. Indeed, accountability,
transparency and the rule of law are just as important for making states sufficiently
representative as they are for making markets sufficiently stable. However, when we
compare success stories from North America to Scandinavia to East Asia, we find that
market economies can operate within a wide spectrum of social and political arrangements,
and that, beyond a few core principles, there is no single model of state–market relations for
others to emulate. Each country must be able to experiment and discover what
configuration of institutions and governance works best in its circumstances and in line
with the expectations of its population.


29. Responsibility for the choice of policies to secure a prosperous, fair and stable future
remains to a large extent with national governments, institutions and constituencies.
However, in our interdependent world, a more secure and inclusive global economy
requires strong international leadership and carries collective responsibilities. There are
hard questions to answer about whether current arrangements can help to build socially
inclusive alternatives to FDG, and what governance structures might support DLG.
UNCTAD XIII in Doha provides an opportunity for the international community to discuss
these challenges in a frank, open and constructive manner.


30. This report is presented in three parts. The first sets out some of the main features of
FDG and suggests that its outcomes have been much more uneven, unstable and unfair than


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its proponents had claimed or expected. It also shows that there has been a systemic failure
to create the economic environment needed to promote productive investment and
employment. However, this raises the question of why some countries have been able to
grow strongly over the past two or three decades. This section seeks to account for that, and
to draw lessons from their success.


31. The second part outlines a rebalancing agenda which aims to deliver lasting and
inclusive development gains. It sketches a three-pronged strategy focusing on (a) building
developmental states that are able to mobilize domestic resources, strengthen productive
capacities and share the gains in an equitable manner; (b) creating more robust multilateral
structures capable of forging collective responses to the challenges that countries will face
in the years ahead, including those required to tame finance and to promote investment-led
responses to climate change; and (c) strengthening regional ties, including through South–
South cooperation, in order to enhance stability and open new growth opportunities.


32. The final section will argue that rebalancing is not a narrow technocratic challenge.
A true break with the fundamentalist thinking underlying FDG will involve a change of
attitudes, morals and values. Accordingly, this report insists on the importance of a
normative agenda as an integral part of the broad-based rebalancing involved in the shift
towards DLG.




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I. Finance-driven globalization and its limits


A. Introduction


33. Liberal political economy has long linked the spread of commerce to economic
prosperity, personal liberty and the control of abusive state power. Its neoclassical offspring
has provided a mathematically eloquent account of how unrestricted markets for goods,
assets and factors of production can generate efficiency gains and bring macroeconomic
stability by tying relative prices to global scarcities. Proponents of neo-liberal globalization
have often claimed that these forces, in combination with advances in information and
communication technology, have been propelling the global economy in the direction of a
borderless world, and that policymakers, particularly in developing countries, should not
resist this epochal shift: indeed, conventional economic logic suggests that developing
countries will be the main winners in this “flatter world”.1


34. Expanding trade and advances in information and communication technology have
certainly been important in connecting and shrinking the world over the past thirty years.
However, these were also prominent features of the post-war era of regulated market
capitalism. In contrast, the main drivers of recent economic transformations have been
financial markets and a finance-friendly policy environment. Pressure for financial and
capital account liberalization has been justified by the argument that this would raise
domestic savings, improve resource allocation and spur productive investment, particularly
in capital-scarce developing countries.2 Despite these ambitious promises, the rewards from
FDG for most countries and communities have fallen short of expectations. Global growth
has slowed down in recent decades (fig. 1), become more unbalanced, and been frequently
punctuated by crises. These crises have been particularly prevalent in the developing world
(fig. 2), but they have been growing steadily larger in the advanced economies, culminating
in the deepest economic collapse since the Great Depression.



1 In his keynote speech to the 2005 Labour Party conference, the then British Prime Minister Tony


Blair summed up the conventional view of globalization when he chastised those wishing to debate it:
“You might as well debate whether autumn should follow summer. They are not debating it in China
and India. They are seizing its possibilities in a way that will transform their lives and ours … In the
era of rapid globalization, there is no mystery about what works – an open liberal economy prepared
constantly to remain competitive. The new world rewards those who are open to it.” Full text of
speech available at http://news.bbc.co.uk/2/hi/uk_news/politics/4287370.stm. On a more technical
level, the globalization debate involves the links between economic convergence and openness; see
TDR (1997) and Rodrik (2011b).


See Mishkin (2006) for a standard account. In what follows, domestic financial liberalization includes
the removal of controls on interest rates, the elimination of credit controls and restrictions on foreign
currency deposits, and the liberalization of the stock market to allow foreign investors to buy, earn
income from and sell equities without restriction. Capital account liberalization describes the
unification of the exchange rate and the removal of regulations on capital outflows and offshore
borrowing by financial institutions and non-financial corporations.


2


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Figure 1
The slowdown in global economic growth, 1971–2011
(annual and decadal average, percentages)


-3


-2


-1


0


1


2


3


4


5


6


7
19


71
19


72


19
73


19
74


19
75


19
76


19
77


19
78


19
79


19
80


19
81


19
82


19
83


19
84


19
85


19
86


19
87


19
88


19
89


19
90


19
91


19
92


19
93


19
94


19
95


19
96


19
97


19
98


19
99


20
00


20
01


20
02


20
03


20
04


20
05


20
06


20
07


20
08


20
09


20
10


20
11


3.2%


2.6%
2.4
%


4.1%



Source: UNCTAD secretariat, based on UNCTADStat. For 2011, forecast by UNCTAD.





Figure 2
Number of financial crises, 1950–2009




0


100


200


300


400


500


600


700


1950s 1960s 1970s 1980s 1990s 2000s


Developing and transition countries Developed countries


Source: UNCTAD secretariat. Based on Reinhart and Rogoff (2011).


Note: Financial crises include banking crises, currency crashes, domestic default (or
restructuring), external default (or restructuring), and stock market crashes.




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35. This first part of the report examines the rise of FDG and its two-fold legacy. On the
one hand, it has fostered imbalances, instabilities and inequalities which have damaged
development prospects. These must be systematically tackled at all levels to allow more
inclusive development paths to emerge. On the other hand, new growth poles have emerged
in the South which have proved resilient in the face of the crisis. Paradoxically, that is
because they have been able to resist many of the policies and principles of FDG.


B. Development matters


36. After the Second World War, advanced-country governments concluded that
balanced and coordinated expansionary policies, increased provision of public goods and
services and appropriately designed multilateral arrangements in trade and finance offered
the best way to secure domestic stability and prevent the return of the waste and destruction
of the interwar years (Trade and Development Report (TDR), 2004). The consensus
allowed for a range of instruments to achieve these goals, from indicative planning to
aggregate demand management to steady trade liberalization and relatively strict capital
controls. These tools allowed the authorities to manage government finances counter-
cyclically, to target industrial support, and to direct credit according to domestic policy
goals, while international agreements permitted measured adjustments to balance-of-
payments difficulties and guarded against the build-up of systemic risks. The outcome was
a period of unprecedented growth driven by investment and rapid technological progress,
often linked to strong export demand, and underpinned by full employment and rising
wages.


37. This proved a favourable environment for growth and development in poorer
countries, many of which achieved political independence during these years. However,
developing countries faced additional challenges during this period due to their low
incomes, limited productive capacities, import dependence, technological backwardness
and institutional handicaps – in many cases inherited from the colonial period. These
challenges had been neglected in the original design of the post-war trade and financial
system, and existing international arrangements were unable to close these countries’
widening gaps with the advanced economies. In particular, no global institution was tasked
with the stabilization of primary commodity prices while the promotion of development
cooperation had been added to the objectives of the International Bank for Reconstruction
and Development as an afterthought.3


38. Even so many developing countries were able to adopt “big push” strategies in an
attempt to trigger rapid economic growth and growth accelerated across the developing
world (table 1). In some cases (e.g. the East Asian “tiger” economies) these strategies had a
strong export orientation while, in others (such as in Latin America and in most of the
newly independent African countries) they were linked to import-substitution
industrialization or to Soviet-type planning. Despite differences in their initial conditions,
the common constraints on catch-up growth in developing countries helped focus the early
policy debates on international measures to support faster growth by providing long-term



3 While the original charter for an International Trade Organization contained a more ambitious


mandate linking trade, macroeconomic and financial policy issues, the rules-based system of trade
negotiations to eliminate discriminatory bilateral agreements through the application of unconditional
most favoured treatment was all that survived in the form of the General Agreement on Tariffs and
Trade (GATT). At the same time, the Marshall Plan offered an ambitious approach to development
cooperation. But this did not survive the recovery of Western Europe.


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finance and foreign exchange.4 Looking back from the vantage point of the last three
decades, it is clear that, despite their flaws and limitations, the achievements associated
with these strategies were often impressive.5


Table 1
Average annual per capita growth, by region, 1950–2010 (PPP)


World
Developed
countries


Developing
countries


South
Asia


East
Asia


South-
East
Asia


Latin
America


Middle
East


Sub-
Saharan
Africa


Transition
countries


1951–1959 2.6 3.3 2.7 1.3 4.8 2.5 2.1 2.8 1.7 3.1
1960–1969 3.4 4.7 2.6 2.0 1.5 2.1 2.7 4.4 2.0 4.1
1970–1979 2.4 3.1 3.6 0.7 5.3 4.6 3.6 4.8 0.9 2.7
1980–1989 1.6 2.5 2.2 3.8 6.6 3.1 -0.4 -1.3 -1.2 0.8
1990–1999 1.9 2.0 3.2 3.9 6.0 3.6 1.3 1.6 -0.7 -4.2
2000–2009 2.9 1.1 5.8 5.6 10.2 4.2 2.0 2.8 3.4 6.0


2010 4.1 2.0 6.3 6.0 9.0 5.6 4.4 3.1 2.9 3.8
MEMO
2000–2008 3.3 1.7 6.1 5.7 10.6 4.7 2.6 3.2 3.7 7.5


Source: The Conference Board (2011). Total Economy Database. January. See
http://www.conference-board.org/data/economydatabase/.


39. These experiences have contributed to the emergence of a vast literature contrasting
country experiences and searching for general lessons of growth and development.6 A
series of empirical regularities or “stylized facts” have been identified across countries and
over time, which help to frame the development policy challenge. First, the process of
development draws on underutilized labour and capital to transform the pattern and
composition of economic activity and achieve a rapid rise in productivity, which is a sine
qua non for cumulative improvements in living standards. Sustaining the transformation
requires large-scale coordinated investment to create a more complex and diversified output
matrix, including a steadily more sophisticated range of tradable goods and services.


40. Second, these structural transformations are associated with a shift of the population
from rural to urban areas and a constant reallocation of labour within the urban economy to
higher-productivity activities. Agricultural employment declines as mechanization spreads
into the primary sector, while mutually reinforcing links between output growth and



4 In the discussions of the ITO, the difference was clearly recognized between financing required to


meet imbalances created by long-term development needs, and the provision of liquidity needed to
meet shorter-term cyclical international payments imbalances. The thread was picked up a decade
later around the debate on a Special United Nations Fund for Economic Development (SUNFED), but
a softer lending window was eventually added to the World Bank through the International
Development Association (IDA). However, the first comprehensive agenda was set out by Raúl
Prebisch in his report to UNCTAD I entitled “Towards a new trade policy for development”, in which
it was recognized that trade and finance had to be approached as “interdependent elements” managed
through an integrated policy framework supporting growth and structural change, and backed by
appropriate international cooperation. See Toye and Toye (2004) for a useful discussion of the
intellectual and political origins of the UNCTAD agenda and its evolution.


5 According to UNDESA (2006: 11), in the 1960s and 1970s, 50 of 106 developing countries included
in UNDESA’s analysis experienced sustained expansion, defined as four consecutive five-year
moving average periods with income growth above 2 per cent per capita. See also Maddison (2001)
for a useful comparative assessment of how the different developing regions performed during this
“golden age”.


6 See Ocampo et al. (2009). Kenny and Williams (2001) provide an overview of the growth regression
literature; they note that well over 100 variables have been subjected to millions of regressions with
what they call “disappointing results”.


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UNCTAD (XIII)/1


productivity growth help the manufacturing sector to absorb an expanding labour force
before industrial employment begins to decline at higher income levels. Complementarities
between services and manufacturing ensure a steady rise in employment and output in
transportation, energy, finance and the provision of public goods.


41. Third, the evolving pattern of production is influenced by geographical location,
resource endowments, market size and institutional conditions, with some combinations
being more conducive than others to structural transformation and rising incomes.
Successful countries tend to have high savings rates, a large share of manufacturing output
in gross domestic product (GDP) and a high profit share in manufacturing. These mutually
supporting features point to the importance of the strong profit–investment nexus in
establishing a sustainable development path.


42. Fourth, technological learning and upgrading help to raise productivity and build
dynamic trading advantages. The challenge for most developing countries is to adapt
existing technologies to local conditions as much as making major technological
breakthroughs. Because the market underinvests in knowledge and because the
technological gap between early and late developers tends to widen over time, active public
support is usually needed to strengthen local learning and research capacities, build human
capital, and create a more collaborative environment in support of innovation.


43. Fifth, sustained prosperity depends on rising per capita income and on
improvements in social welfare which, in turn, require appropriate social policies. Since
markets tend to misprice the returns from investment in public goods, for example health
and education, inclusive development requires extensive state intervention and public sector
investment. These policies help to turn a national development strategy into a broader
social consensus. The required policies and institutional support do not exist in the abstract,
but are rooted in local conditions and preferences. Nor are they fixed in time, but must
adapt and evolve in line with changing economic and political circumstances.


44. Putting these elements together requires a coherent strategy which can help
policymakers, at the national and international level, to see development as “a movement
upward of a whole system of interdependent conditions” (Myrdal, 1970) and to strengthen
the linkages required to trigger circular and cumulative growth and development circles.
The importance of institutions and policies necessarily ties the effectiveness of these
development strategies to domestic resource mobilization and capacity-building. However,
the fact that this search must take place against the backdrop of an interdependent world
economy necessarily complicates policy choices. Indeed, correcting the biases and
asymmetries that continue to structure that world remains key to whether or not
policymakers in developing countries can deliver inclusive and sustainable growth and
development.


C. The emergence of finance-driven globalization


45. Weaknesses in the post-war growth model emerged in the late 1960s through
distributional struggles, energy crises, inflationary pressures and balance-of-payments
difficulties that, eventually, triggered policy responses which reinforced a sharp cyclical
downturn in the late 1970s. Efforts to circumvent some of the controls put in place in the
post-war period began with the emergence of a Eurodollar market in the 1960s through the
overseas expansion of United States financial institutions. In 1964, this market had gross
deposits of $19 billion; these reached $86 billion in 1970, and $1.5 trillion by 1980 (Panic,


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UNCTAD (XIII)/1


1996: 65).7 However, it was the collapse of the Bretton Woods system in 1973 that opened
the way to the global dominance of financial markets. From the mid-1970s, the advanced
countries began to deregulate their financial systems and reduce capital controls, in part to
help finance the rising United States current account deficit and, increasingly, believing that
unregulated financial markets would improve the mobilization and allocation of savings,
extinguish inflationary pressures, and stimulate economic growth.8


46. The shocks that hit developed countries during the 1970s had significant
implications for developing economies, including a first boom in private capital flows.9
However, in the late 1970s, restrictive macroeconomic policies in the advanced countries
exposed significant fragilities in developing economies that had failed to address
consistently their problems of domestic resource mobilization and balance-of-payments
sustainability.10 Growth stalled, particularly in Latin America and sub-Saharan Africa, and
several economies collapsed after the lending freeze following Mexico’s default, in August
1982.


47. The collapse of these earlier growth strategies opened the way for a very different
policy agenda, beginning in the advanced countries, that attributed macroeconomic and
balance-of-payments difficulties to price and other market distortions, financial repression,
trade protection, overvalued exchange rates, and “overly generous” social policies. This
diagnosis was worked into ambitious reform packages for developing countries to “roll
back the state” and “liberate” markets by means of privatizations, trade and exchange-rate
liberalization, fiscal discipline, tax cuts, tight monetary policy and labour-market flexibility.


1. Financialization


48. The initial case for unleashing global market forces was strongly tied to the
perceived benefits of trade liberalization and global market competition. In essence, what
was being offered was the realization of a self-regulating market order. The Bretton Woods
institutions were in the forefront of efforts to promote this vision among developing
countries – an approach that was subsequently labelled the “Washington Consensus”.11
However, trade openness was never the strongest basis for advancing this programme, if
only because the advanced countries did not themselves follow the advice consistently.



7 This explosive growth was indicative of the later proliferation, growth and global interpenetration of


private financial institutions, often trading novel assets in new markets. Just as telling of things to
come, already in the late 1960s the United States economy witnessed the first wild ride of hedge
funds, a wave of M&As, a stock market boom, and ballooning credit card and instalment debt. See
Phillips (2008: 33).


8 For a discussion of the economic and political pressures behind financialization in the United States,
see Krippner (2011).


9 This boom was associated with recycled oil surpluses, the first round of financial deregulation, and
booming eurodollar markets. Excess liquidity was recycled in the form of dollar-denominated
syndicated bank credits at variable but, for a time, low or even negative real interest rates. Latin
America was the main recipient of these currency flows. See TDR (1985) for a detailed discussion.


10 On the breakdown, see TDR (2004) and Glyn (2006, chs. 1 and 2).


11 There had been a growing body of research inside the Bretton Woods institutions from the late 1960s
which focused on the market-distorting impact of policy interventions in the areas of agriculture,
trade and finance; this was associated with the work of Schultz, Little, Scitovsky and Scott,
McKinnon and Shaw, Krueger and others. The tenor of this work was to promote the view that
government failures are always a greater obstacle to development than market failures; see Krueger
(1990). The nature and impact of the resulting adjustment packages have been extensively discussed
in the volumes published by UNCTAD and the G-24 in the International Monetary and Financial
Policy Issues for the 1990s collection and in the subsequent G-24 Discussion Papers series.


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Instead, attention quickly turned to financial liberalization and capital account openness.12
These policies spread quickly across the developed countries and, with the strong backing
of the international financial institutions, in the developing world too (fig. 3).


Figure 3
Evolution of de jure capital account openness in developing and developed countries,
1970–2007 (simple average)


-1


-0.5


0


0.5


1


1.5


2


2.5


3


19
70


19
71


19
72


19
73


19
74


19
75


19
76


19
77


19
78


19
79


19
80


19
81


19
82


19
83


19
84


19
85


19
86


19
87


19
88


19
89


19
90


19
91


19
92


19
93


19
94


19
95


19
96


19
97


19
98


19
99


20
00


20
01


20
02


20
03


20
04


20
05


20
06


20
07


Developing countries Developed countries
Source: UNCTAD secretariat. Based on the index proposed by Chinn, Menzie and Ito
(2008) in the paper entitled “A new measure of financial openness”. Journal of
Comparative Policy Analysis. 10 (3): 309–322. September. This measure of de jure capital
account openness is an index ranging from -1.83 to 2.5.


49. The increasing significance of finance in shaping the global economy can be gauged
from a comparison with the evolution of trade flows. In 1970, the average trade openness
(exports plus imports divided by GDP) of the developed economies was around 0.5, and by
2007 it had increased, by 60 per cent, to 0.8 (fig. 4). During the same period, these
countries’ average financial globalization (total foreign assets plus total foreign liabilities
divided by GDP) rose by 800 per cent, from 0.5 to 4.8. In the developing countries, trade
openness and financial globalization also started at similar levels, with indices of
approximately 0.4. During the same period, the index of trade openness rose by 100 per
cent, while financial globalization increased by 250 per cent.13


50. This worldwide policy shift has been accompanied by an explosion in cross-border
financial flows. While in net terms the scale of flows is not unprecedented, the extent of
gross flows has no historical parallels. Daily foreign exchange transactions rose from $80
billion in 1980 to $600 billion in 1989, and to almost $4 trillion in 2010. The ratio of global
capital inflows to global GDP rose from 3 per cent in the early 1980s to over 20 per cent in



12 Many of the more ardent supporters of trade openness have been sceptical about liberalizing finance


in developing countries, calling for a careful “sequencing” of the reform agenda which would
discriminate between good and bad capital flows. However, in terms of textbook logic, “the principles
of international factor movement do not differ in their essentials from those underlying international
trade in goods” (Krugman and Obstfeld, 1997: 159).


13 The same also holds when comparing financial globalization with foreign direct investment, although
the latter rose faster over the first decade of the new millennium.


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UNCTAD (XIII)/1


2007. In 2006, the value of global financial assets was almost three-and-a-half times global
GDP; while advanced countries dominated, the share of emerging markets had more than
doubled since 1995, to 14 per cent. Finally, cross-border mergers and acquisitions (M&As)
rose from $98 billion in 1990 to $1 trillion in 2007, especially in banking, insurance and
other financial services.


Figure 4
Financial globalization and trade openness in developing and developed countries,
1970–2007 (simple average)



Source: UNCTAD secretariat, based on Lane and Milesi-Ferretti (2006) and on the World
Bank’s World Development Indicators.


Note: Financial globalization is the ratio between the stock of foreign assets and liabilities
and each region’s GDP; trade openness is trade flow (exports plus imports) divided by the
region’s GDP.




51. The growing influence of financial markets and institutions has been called
“financialization”. This describes a structural shift in the organization of economic activity
along with changes to economic, political and cultural behaviour, which together have
altered profoundly the way in which wealth is produced and distributed. These include:


(a) The increasing proportion of national income accruing to the financial
sector, including the rapid growth of the remuneration of high-ranking
financiers. In the United States and the United Kingdom, the financial
sector accounts for one third of total activity, compared with one fifth or
less in the late 1970s, with the average for the Organization for Economic
Cooperation and Development (OECD) countries being in the high
twenties.14



14 The OECD classification includes financial intermediation, real estate, renting and business activities;


for a discussion of measures of financialization, see Freeman (2010).


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UNCTAD (XIII)/1


(b) The growth, complexity and increasingly speculative nature of the
activities mediating between savers and investors, accompanied by an
explosive build-up of debt both on a global and personal level. Rising
financial sector leverage has been supported by the proliferation of esoteric
financial products and corresponding markets, and the emergence of
“shadow” financial institutions. By the middle of 2007, the systemically
important European banks had a leverage ratio of 45 to 1, while for United
States banks it was about 34 to 1.15


(c) The channelling of entrepreneurial energies into devising new financial
products and processes to manage the risks accompanying increasing
levels of indebtedness; financial innovation has come to dominate
technological innovation as the way to transform growth prospects by
expanding consumer choice and boosting the efficiency of capital.16


(d) The growing claim that the rights of the owners of financial assets are
beyond social accountability, the imposition of shareholder value as the
principal gauge of corporate performance, and the extension of financial
market calculations into expanding areas of economic and social life,
including pensions, education, healthcare, infrastructure provision and food
supply.


(e) The validation of economic policies by reference to financial market
interests, measured by performance indicators devised, managed and
endorsed by the financial institutions themselves, including the strength of
stock markets, returns from real estate investments, the scale of M&As etc.
As finance has expanded its command over global resources and tightened
its grip upon policymaking, the measures of economic “success” have
become increasingly disconnected from the drawn-out pressures of making
productive investments, raising productivity levels and creating jobs.


52. The uneven impact of these trends on growth and development will be examined in
greater detail below. However, a near-universal feature accompanying FDG has been a
sharp rise in income and wealth inequality. This is important because, in addition to its
moral implications, growing inequality can damage social well-being, threaten economic
stability and undermine political cohesion (Wilkinson and Pickett, 2009). Textbook
economics usually describes a trade-off between growth and equality. In examining this
trade-off, economists have paid a good deal of attention to whether it is trade or technology
that has been the principal link between globalization and rising income inequality, and
whether the general (efficiency) gains outweigh local costs (in terms of income or
employment losses), and if so, how best to compensate the “losers”. The discussion has not
proved conclusive, however, in part because this trade-off is difficult to reconcile with the
wide experience across countries in terms of the timing and scale of these different aspects
of globalization (TDR, 1995; Jaumotte et al., 2008), along with familiar methodological



15 “Another way of looking at these ratios is to say that they represent the amount of the bank’s assets


which have to go bad for the bank to be insolvent. In the United States, on average, if one thirty-fifth
of the bank’s assets went bad, the bank is bust … This is obviously a highly precarious position. It
was also no accident, because those risks were also the reason why the banks had a boom period”
(Lanchester, 2010: 25–26).


16 See Greenspan (1998). For a different assessment of the impact of financialization on
entrepreneurship in the United States, see Kedrosky and Stangler (2011) and Lazonick (2011).


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problems in measuring global inequality.17


53. Understanding the rise of inequality under FDG needs instead to look more carefully
at functional income dynamics, and in particular the divergence between wage and
productivity growth, the imperatives of shareholder value and executive compensation in
shaping corporate behaviour, and the regressive turn in taxation. Unfortunately, consistent
cross-country and time series data are quite difficult to obtain. However, the wage share has
declined in 17 out of 24 countries with data going back to the early 1980s (ILO, 2011), and
in some systemically important countries, the concentration of income and the share of
profits have returned to levels last seen in the 1920s (TDR, 2010; Galbraith, 2011). Across
most countries, the top income strata (in some cases just the top 1 per cent of the
population) have seen the biggest (and in some cases the only) gains from boom conditions,
capturing higher rentier incomes through capital gains and interest payments than would
have been possible under more regulated financial structures, or even conceivable barely a
generation ago (Davies et al., 2006).Capital mobility has made it harder to tax, reducing the
bargaining power of labour and increasing the state’s reliance upon regressive taxes and
bond markets, further amplifying the adverse distributive impact of FDG (Jayadev, 2007).
A growing body of research has begun to tie the scale of the current crisis to these
inequalities, pointing to their skewed impact on the composition of demand, incentives that
promote paper over real investments, and, above all, their links to an increasingly fragile
debt-driven growth model.18 Milanovic (2011: 196) summarizes the destructive logic:


The root cause of the crisis is not to be found in hedge funds and bankers
who simply behaved with the greed to which they are accustomed (and for
which economists used to praise them). The real cause of the crisis lies in
huge inequalities in income distribution that generated much larger investible
funds than could be profitably employed. The political problem of
insufficient economic growth was “solved” by opening the floodgate to cheap
credit. And the opening of the credit floodgate, to placate the middle class,
was needed because in a democratic system an excessively unequal model of
development cannot exist with political stability.


2. Debt-driven growth


54. In countries pursuing strong adjustment policies or otherwise committed to FDG,
inflation has declined, trade and capital inflows have risen, and firms have become more
competitive, giving rise by some accounts to a “great moderation” of steady and sustainable
growth. However, even before the recent crisis hit, this did not adequately describe the
reality of FDG which, over the last thirty years, has given rise to uneven and unstable
growth in both developed and developing economies, around a slowing global trend, severe
macroeconomic imbalances including sluggish investment, periodic consumption booms,
declining savings rates, exchange rate misalignments and current account imbalances.


55. The feature holding these developments together, while adding to the systemic
fragility of FDG, has been mounting levels of debt, especially in the more heavily
financialized advanced economies. Average debt-to-GDP ratios in the leading industrial
economies increased by 50 per cent between 1995 and 2008, to over 300 per cent, with
spectacular rises in such countries as Iceland and Ireland. This trend has been registered



17 It is widely assumed that wealth is even more unevenly distributed than income (WIDER, 2006). The


global pattern of inequality since 1980 is a composite and complex combination of the trend within
countries, the divergence in country mean incomes, and growth and distribution dynamics in the
world’s two most populous countries of China and India. For a discussion of how these factors have
contributed to the global pattern of inequality over the past 30 years, see Milanovic (2011).


18 See, for example, Kumhoff and Ranciere (2010).


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across all sectors, however the build-up has been concentrated in households and financial
institutions, as typified by the figures for the United States (table 2).19 The trend, as
suggested earlier, has been closely linked to rising levels of inequality (and particularly a
falling wage share).


56. The fragility accompanying the accumulation of trillions of dollars in debt has been
compounded by an even larger volume of financial bets through derivatives and other
complex instruments, justified by arguments that these would minimize systemic risk, and
supported by the idea that efficient markets do not make mistakes. On the basis of this
lending activity, not only did the profitability of financial institutions rise sharply but non-
financial firms also became increasingly dependent on financial activities for their revenue
flows, including lending to governments whose own revenue flows were being squeezed, in
many countries, by a combination of slow wage growth and tax cuts.


Table 2
United States: credit market debt outstanding, by sector (billions of dollars)


1974 1984 1994 2004 2010


Domestic financial 258 1 052 3 791 11 936 14 171


Foreign financial 81 233 443 1 439 2 115


Total non-financial business 821 2 315 3 842 7 791 10 876


Total household 680 1 944 4 532 10 576 13 386


Federal government 358 1 364 3 492 4 395 9 386


State and local government 208 514 1 107 1 683 2 465


Total United States financial and non-financial debt 2 406 7 422 17 207 37 820 52 399
Source: United States Federal Reserve (2011). Flow of Funds. D3. 9 June.
57. In this new growth model, the codependence between finance and the real economy
and between the state and the market, which characterized successful post-war models, has
given way to one in which unchecked financial markets and mounting financial leverage
drive the real economy. This shift has led to a change of consumption behaviour, which has
become tied to rising asset prices and access to credit, and, at the firm level, to the
channelling of rising profits towards short-term investments. Indeed, the mushrooming of
mostly short-term cross-border capital flows over the past two decades has done little to
help get worldwide capital formation back to the levels of the 1970s (fig. 5). The
inconsistency of the model is particularly clear with the accumulation of debt in the public
sector, which has often been associated with a sharp slowdown in public investment. Much
of the debt has been contracted to finance current spending and transfer, including interest
payments. The combination of increased public debt and reduced investment suggests that
the debt does not correspond to an equivalent build-up of productive capacity capable of
producing additional revenues for its servicing. At the same time, the distinction between
public and private debt has often been blurred, as states have stepped in to salvage financial
institutions that were judged too big to fail (Reinhart and Rogoff, 2011).



19 Household debt is difficult to measure, and international comparisons suffer from data deficiencies.


However, all advanced countries saw rising debt ratios from the 1990s onwards; the countries that
saw a 50 per cent or more rise between 1995 and 2005 (in terms of percentage of disposable income)
include Ireland, Italy, the Netherlands, Spain and the United Kingdom. See Stockhammer (2008).


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Figure 5
International financial flows and fixed investment (as a percentage of world GDP)



Source: United Nations Department of Economic and Social Affairs (UNDESA). Based on
the National Accounts Main Aggregates database (United Nations Statistics Division) and
International Financial Statistics (International Monetary Fund).


58. The financialization trends that had been building up after the collapse of Bretton
Woods moved up a gear at the start of the current century. In response to the destruction of
trillions of dollars in equity values during the dotcom crisis, the United States and other
advanced countries loosened up their monetary policies, fuelling an unprecedented debt-
driven boom. Consumption expanded, particularly in the United States, on a wave of (more
or less shady) financial trading predicated upon permanently rising houses prices (TDR,
2006). At the same time, several emerging developing countries, especially in East Asia,
which had already experienced the downside of FDG, were gearing up to accumulate
substantial foreign currency reserves to protect themselves against future shocks. Global
growth picked up through this combination of factors, notably in developing countries, but
the underlying macroeconomic imbalances widened rapidly. The resulting leveraging and
maturity mismatches set the global financial system onto the path to unsustainable financial
fragility.


59. By 2005, the value of global financial assets had reached $140 trillion, three times
the size of global output; growth rates – ultimately the basis for servicing the underlying
debt – had failed to keep pace, especially in the more financialized economies. Instead,
increasing leverage, accompanied by a plethora of new financial instruments, encouraged
the acquisition of more debt to cover existing commitments. In several systemically
important countries, the monetary authorities found themselves compelled to support
implausibly high (and continually rising) asset prices in order to maintain household
solvency and financial stability. In the process, central banks lost control of global liquidity


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and the ability to use interest rates to influence either the pace of debt accumulation or the
rhythm of capital formation (Krippner, 2011: ch. 5).


60. An early sign of the problems with this growth model was the rising “global
imbalances” between surplus (largely the United States) and deficit (more dispersed but led
by China, Germany and Japan) countries, which emerged in the mid-1990s and escalated
dramatically in the new millennium. This has been much discussed with an eye to
parcelling out blame, but the rather obvious truth is that in a world where one group of
countries produces more than it can absorb and the other generates global demand and
absorbs more than it produces, then both sides depend on each other (Priewe, 2010). The
global picture was further complicated by the special status of the dollar, which disguised
the recycling of domestic credit creation in the United States through rising imports, the
channelling of international reserves into United States financial markets, and the
perpetuation of asset price bubbles. In Western Europe, distinct national patterns of debt
accumulation were observed, involving variations in domestic demand expansion and
diverse combinations of public and private sector debt. Nevertheless, an equally unbalanced
recycling process revolved around strong productivity, sluggish wages and domestic
demand, and strong export growth, in Germany, together with slower productivity growth
and rising absorption elsewhere (TDR, 2010).


61. The financial arrangements linking uneven demand growth, debt and capital flows
are now weighing heavily on growth prospects in the advanced economies, as the battle
between borrowers and creditors becomes “the defining struggle of the next generation”
(The Economist, 24 June 2010). The threat of a deflationary spiral, in which falling incomes
and asset prices add to the burden of debt while the expectation of further price declines
discourages spending and leads to further economic contraction, continues to haunt
policymakers. There is growing concern that an entire decade may be lost to deflation and
stagnation, much like Japan’s experience in the 1990s.


62. Debt-driven growth in advanced countries shares some similarities with earlier
external debt–led growth episodes in developing countries.20 By contrast, robust output and
export growth in developing countries since 2001 has reduced their debt-to-GDP, debt-to-
export and debt service ratios.21 At the same time, private capital flows to developing
countries have undergone important changes regarding destination, size and composition.
They are now more synchronized across countries than in the past, and the amounts
involved are much higher and include significant resident outflows as well as increased
South–South flows. Finally, the composition of inflows has shifted towards domestic
currency–denominated financial instruments, including government bonds, equities, and
carry trade–style borrowing, lending and investment.22


63. The growing denomination of external liabilities in their own currencies changes the
nature of the risks associated with borrowing from non-residents, and in particular lessens
the danger of currency mismatches in balance sheets, which played a key role in previous
crises. However, these same developments could allow domestic financial markets to
dictate growth patterns in these countries, and increases the risk of exposure to international
contagion, while the use of developing-country current account surpluses to fund
overconsumption in advanced countries can only be detrimental to long-term balanced
growth (fig. 6).



20 UNCTAD first described this growth model in the context of financial liberalization in developing


countries (TDR, 1997), however it became even more prominent in advanced countries following the
dotcom crisis.


21 Developing countries’ external debt levels in terms of share of exports and GDP peaked in the late
1990s. Servicing ratios to exports and output peaked in 1999 and 2002, respectively.


22 For an estimate and discussion of just how far this shift has gone, see Hausmann and Panizza (2011).


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UNCTAD (XIII)/1


Figure 6
Net transfer of financial resources to developing countries, 1995–2010
(as a percentage of GDP)



Sources: UNCTAD secretariat calculations, based on UNCTADStat and on UNDESA data
on net transfers (World Economic Situation and Prospects, various issues).


Note: Net transfers are the sum of net capital flows, income payments, and changes in
official reserves. The term “negative net transfers” means that exports of goods and
services exceed imports, resulting in a transfer of the excess abroad by way of financial
flows (debt servicing, profit remittances, foreign reserve accumulation, capital outflows, or
withdrawal of foreign investors).
64. Financialization has also added new threats and vulnerabilities to growth prospects
in developing countries, at three levels. First, the concentration of the commanding heights
of finance in a few global hubs has magnified the impact of the policy and regulatory
decisions taken in those economies, leaving other countries badly exposed. Second,
countries borrowing to keep reserves, as self-insurance, risk heavy losses through the
widely expected long-term devaluation of the dollar due to the protracted economic
difficulties in the United States and its reliance on aggressively expansionary monetary
policies to try to revive the economy. Third, finance has also penetrated global commodity
and food markets, directly affecting the livelihoods of hundreds of millions of poor citizens
in many developing economies (box 1).


Box 1. The financialization of commodity markets


Trends in commodity prices are a long-standing UNCTAD concern. In recent
years, the focus has shifted away from adverse movements over long periods
of time and towards the damaging consequences of price fluctuations. Long-
term comparisons show that recent price volatility is not unprecedented for
individual commodities; for example, the oil price volatility in 2008, while
remarkable, remained well below its price spike in the early 1970s.
Nevertheless, the speed and amplitude of the recent price swings for a broad
range of commodities clearly distinguishes them from earlier ones. The
magnitude of the most recent price upswing was above historical averages for
food and metals, while the magnitude of the price rebound for oil was similar
to historical averages but occurred at a higher speed.


Although it is difficult to fully assess the financialization of commodity
trading due to the lack of comprehensive data, several indicators suggest that
it is becoming an increasingly important driver of commodity prices. The
value of commodity-related assets under management by financial investors


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rose fivefold between 2005 and 2010, and has increased very rapidly since
mid-2010, reaching a historic high of $410 billion by March 2011. Similarly,
the number of futures and options contracts outstanding on commodity
exchanges started increasing rapidly in 2004, then dipped during the collapse
of commodity prices in the first half of 2008, but then continued to increase
at a rapid pace. By mid-2010, the number of these futures and options
contracts had reached about five times their pre-2004 level.


It is also difficult to assess the impact on prices of the financialization of
commodity trading, because it became influential roughly at the same time as
the demand for commodities from the large emerging economies started
increasing rapidly and when a growing interest in biofuels shifted the demand
for some agricultural commodities from food to fuel. However, recent
analysis shows that variables reflecting financialization remain statistically
significant even after controlling for the influence of changing fundamentals,
refuting the claim that growing demand from the emerging economies was
the only driver of the commodity price hike in 2006–2008.


It is sometimes argued that the price impact of index investments is spurious
because similar hikes could be observed for the prices of commodities that
are not included in the main indexes. However, research shows that the co-
movement between the prices of different commodities increased after 2003–
04, and that for the commodities included in the major indices, this increase
was significantly more pronounced than for those not included.


Information emanating from financial markets can lead to resource
misallocation, because it contaminates the price discovery mechanism in the
commodity markets and generates misleading signals for consumers and
producers. Two arguments are traditionally put forward to defend the
influence of financial markets on commodity price formation: that they help
price discovery and that they provide liquidity. Neither of them is tenable
where herd behaviour is pervasive. In this case, the price found by financial
investors may be unrelated to supply and demand, and it is often the wrong
price in view of the market fundamentals. Similarly, the provision of liquidity
may also be invalid in markets that are subject to herding, that is, where
many and powerful participants share the same information. If the
participants have the same views and dispositions, price swings can be large,
in response to simultaneous changes in the participants’ views. Market
distortions such as these, which are induced by the financialization of
commodity trading, call for active policies to stabilize commodity prices (see
box 14), and for a healthy scepticism about the purported “benefits” of
financialization more generally.


For additional details, see UNCTAD (2011a).




3. Cycles, shocks and crises


65. The potential instability accompanying FDG was already exposed by the first
“modern” financial crisis, which hit the Southern Cone of Latin America (Argentina, Chile
and Uruguay) just a few years after the collapse of the Bretton Woods system. In a story
that would subsequently become familiar, hasty liberalization of finance, trade and the
capital account led to a massive build-up of foreign exchange liabilities by private financial
and non-financial institutions, followed by financial and balance-of-payments collapse. The
ensuing rescue operations involved state bailouts, bank nationalizations and the


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socialization of private external debts. In a perceptive article, Carlos Díaz-Alejandro (1985)
waved goodbye to a world of financial repression and said hello to one of (contagious)
financial crashes, which would include the United States savings and loans crisis; financial
collapses in Scandinavia; the 1987 stock market crash; the Japanese crisis; the emerging
market crises of the 1990s, beginning in Mexico and rolling through East Asia to Latin
America; the dotcom bubble; and the housing and financial bubble which exploded
catastrophically in 2008.23


66. In retrospect, growth in financialized economies has often consisted of episodes of
feverish speculation between crises. This has been fuelled by the combination of tight fiscal
and monetary policies, and trade, financial and capital account liberalization. The ensuing
current account deficits were normally financed with foreign capital inflows (foreign direct
investment, privatizations and portfolio investment). These processes have, in some cases,
been destabilizing, because they perpetuate currency misalignments regardless of the
exchange rate regime, render potentially viable industries uncompetitive, destroy the
established employment patterns, and fuel a succession of domestic credit and asset
bubbles. As it unfolds, the cycle raises the economy’s external vulnerability even as its
“fundamentals” appear to improve. Mounting fragility often quickly turns to disaster
through a sudden shift in capital flows and market expectations, leading to a collapse of the
balance of payments and the exchange rate, followed by the insolvency of domestic banks,
corporate bankruptcies, and rising unemployment. These crises have further worsened the
distributive impact of FDG, since wages and employment drop sharply and poverty levels
rise when crises hit (ILO, 2004). Recoveries under FDG often fail to make up these losses,
especially where policymakers seek to return to business as usual by adopting austerity
measures which reproduce rather than address the imbalances that arose during boom
conditions.


67. The developing world has experienced three full cycles of capital flows and crisis
during the past thirty years, and is currently into the fourth (fig. 7). Each cycle has been
closely tied to policy events in the major reserve-issuing countries, and defined by a
specific type of capital flow which fostered particular vulnerabilities (TDR, 2001; TDR,
2009; and Akyüz, 2011). They illustrate the procyclical bias of the global financial system
and the propensity of unregulated financialized markets to move in tandem, suggesting that
asset prices are driven less by improved prospects of productivity or income gains than by
potentially self-reinforcing expectations of price changes.


68. Cross-market linkages have appeared with a large variety of currencies, stocks and
commodity derivatives, reinforcing herding behaviour across multiple asset classes. Hedge
funds are widely believed to contribute to this process through the sharing of investment
ideas and by using the same macroeconomic indicators to formulate their trades
(Büyükşahin, Haigh and Robe, 2010). When information collected in one market or for the
economy as a whole is used to form expectations about other markets and economies the
danger of contagion adds to other systemic risks. This has been compounded by bank
borrowing abroad to fund the expansion of domestic credit, derivatives trading and carry
trade-style off-balance sheet short-term foreign exchange operations (see TDR, 2010).



23 The privatization of returns and the socialization of the costs of boom-and-bust cycles have been


noted by various commentators; see Lanchester (2010) and Krugman and Wells (2011).


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Figure 7
Real net private capital flows to developing countries (in billions of 2005 dollars and as a
percentage of GDP, 1971–2009)


-50


0


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100


150


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250


300


350


400


19
71


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-1


-0.5


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1.5


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2.5


3


3.5


Real net private capital flows Percentage of GDP (right axis)
Source: UNCTAD secretariat, based on Akyüz (2011).


Note: Real flows are nominal flows adjusted for changes in the United States GDP deflator.
Developing countries does not include Central and Eastern Europe or the Commonwealth
of Independent States.


69. As suggested earlier, rapid swings in asset prices, property values and exchange
rates are likely to increase investment uncertainty, shorten planning horizons and promote
defensive and speculative strategies which can influence adversely the pace and direction of
economic growth and employment creation. This is particularly true in sectors that are
susceptible to herding behaviour, such as residential and commercial real estate investment,
although it can also happen in productive sectors, as was the case in South-East Asia in the
run-up to the 1997 crisis (see TDR, 1996). UNCTAD has consistently argued that FDG
and, specifically, trade and investment agreements, aid dependence and the conditionalities
attached to international lending have increased the vulnerability of developing countries to
shocks, crises and contagion, reduced their ability to respond to these challenges, and
prevented the design and implementation of policies tailored to local needs and
aspirations.24


70. These destabilizing trends have coexisted, albeit uneasily, with more promising
developments driven by the large current account surpluses of the developing countries as a
group. Even those countries running current account deficits have found it easier to attract
capital inflows, although in some cases these have triggered a new form of Dutch disease,
distorting their exchange rates and frustrating efforts to develop manufacturing industry and
diversify domestic production and exports (TDR, 2011). Primarily for these reasons, the
threat of “sudden stops” in capital flows has eased, especially in those developing countries



24 See, for example, TDR (1998), TDR (2006), and LDCR (2009).


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UNCTAD (XIII)/1


that have accumulated large reserves or that have been able to borrow in their own
currencies. Nevertheless, in many countries, underlying structural weaknesses still continue
to limit diversification, restrain productivity growth, restrict gains from trade, and hamper
efforts to alleviate poverty.


D. Trade, technology and TNCs


71. In the early post-war era, trade was considered the most reliable and productive way
of integrating into the global economy. From the point of view of developing countries,
access to world markets could open a “vent for surplus”, permitting the employment of
underutilized land and labour to produce primary and labour-intensive goods for export,
easing their balance-of-payments constraint, and introducing dynamic gains through
specialization and scale economies.. Although these gains from trade can be important,
particularly in the early stages of development, UNCTAD, along with others, has argued
that calls to “free trade” can lock countries in to an established pattern of production that –
even if it makes efficient use of a country’s resource endowments – may not generate the
more dynamic productivity gains that drive catch-up growth. These depend on a variety of
macroeconomic, structural and technological factors that need to be in place for a strong
investment–export nexus to emerge, including in the context of global value chains, and to
support a more diversified economic structure.25


72. A flexible rules-based trading system created under the General Agreement on
Tariffs and Trade (GATT), accompanied by controls on finance and capital flows, helped
secure a stable investment climate and proved conducive to a dynamic trading system. Of
particular importance during the Bretton Woods era was the strong correlation between
trade and output growth. The mutually supporting links between output, investment and
export growth were an important feature of the successful growth model established during
these years. With the creation of a steadily more complex international division of labour,
trade has expanded faster than global output since the end of the Second World War, albeit
unevenly both geographically and over time (fig. 8).26



25 Emphasizing the investment–export nexus is one way around the futile discussion of whether or not


trade is an “engine of growth”, for which there is little historical evidence; see, for example, Bairoch
(1998): 136–38. While economists differ widely on the role of trade policies, there is broad agreement
that investment is critical to trade performance; see TDR (1996), (1999), (2003) and (2006), as well
as Bhagwati (1998), Bhagwati and Srinivasan (1999), Rodrik (1999) and Winters (2004).


26 It was, of course, a key contention of UNCTAD that these links were particularly weak or even
perverse for commodity producers and exporters.


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UNCTAD (XIII)/1


Figure 8
Changes in the volume of world merchandise exports compared to changes in GDP,
1951–2009 (percentage change over the previous year)


-15


-10


-5


0


5


10


15
19


51


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53


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55


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09


Exports GDP


Source: World Trade Organization (WTO). International Trade Statistics. Various issues.


73. For much of this period, the elements that helped to integrate trade into virtuous
growth and development circles found their most supportive environment at a regional
level. For example, the share of intra-European trade in world trade increased from 18.3 per
cent in 1953 to 31.2 per cent in 1973. This expansion was driven by intra-industry trade in
manufactures based on the reduction of quotas and their tariffication, followed by tariff
reductions through a series of trade rounds (Rayment, 1983). The next strong investment–
export nexus emerged in East Asia, beginning in Japan and followed by the first-tier newly
industrialized economies (NIEs) of Hong Kong, the Republic of Korea, Singapore and
Taiwan Province of China. The pace of investment growth in these economies was
unprecedented by historical standards; it allowed these five economies to increase their
share of world trade from just 7 per cent in 1963 to 17 per cent in 1993. However,
beginning in the early 1970s, the investment–export nexus also acquired a distinct
dimension through intraregional flows of foreign direct investment (FDI) (fig. 9).


74. The first-tier NIEs had used TNC involvement strategically to strengthen their
investment–export nexus, including through licensing (Republic of Korea) and
subcontracting (Taiwan Province of China).27 Moreover, FDI inflows became much more
important to a second tier of neighbouring countries in South-East Asia. In terms of the
sequencing of FDI among sectors and countries, a distinct regional pattern emerged
consistent with the “flying geese paradigm” (TDR, 1996): the upgrading of economic
activity from resource-based and labour-intensive industries to more sophisticated
manufactures in leading economies opened up the opportunity for the relocation of
production to less developed neighbours (Malaysia, Thailand, and other economies)
through trade and FDI, and in response to shifts in competitiveness. Thus, while the ratio of
FDI inflows to gross fixed capital formation was between 1 and 3 per cent in the Republic
of Korea and in Taiwan Province of China in 1970s and 1980s, it was between 4 and 25 per
cent in the second-tier NIEs in the 1980s and 1990s (see TDR, 1996: ch. 2; WIR, 2002; and



27 In particular, non-equity modes of operation were important in the Republic of Korea (especially
licensing) and Taiwan Province of China (especially subcontracting).


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UNCTAD (XIII)/1


Petri, 2010). Finally, China began to attract large-scale FDI in the context of regional
networks in the early 1990s (fig. 10), but did so as part of its own strategic shift from a
consumption-led and employment-intensive growth regime to an investment-led and high-
productivity regime, with active policies that ensured that FDI was complementary to
domestic resource mobilization and supported the upgrading of local productive capacities
(see various editions of World Investment Report (WIR); TDR, 2006; and Lo and Zhang,
2010).


Figure 9
Intra-trade of regional groups as a percentage of total trade, 1950–2009



Source: UNCTAD secretariat, from UNCTAD GlobStat.




Figure 10
China: FDI inflows as a percentage of gross fixed capital formation, 1990–2010



Source: UNCTAD secretariat, from UNCTAD FDI/TNC database.
75. Another important feature shared by these dynamic regional trading experiences was
their increasing technological sophistication, reflected in the higher value added of the


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UNCTAD (XIII)/1


tradable goods sector. In the case of Western Europe, this was linked to a backlog of
technologies that had been developed before the Second World War and were then
embodied in a broad range of medium- and high-technology goods that found expanding
markets across the region as incomes began to rise (Fagerberg, 1996). In the case of East
Asia, technological upgrading was acquired from abroad through a mixture of imports and
FDI and was adapted to local conditions by “reverse engineering” and supported by
deliberate policy intervention which enabled these economies to move up the “world
production frontier”.28


76. Beginning in the early 1980s, the links between output growth and trade have
weakened.29 Global trade has been driven more by policies of rapid liberalization (often
introduced through structural adjustment programmes, and as a signal of commitment to
FDG), by the addition of new markets following the collapse of communism and by the
spread of global production networks. This has coincided with a sharp shift in the
composition of developing-country trade towards manufacturing exports (fig. 11), and with
growth rates far exceeding those in the developed countries. This pattern of trade
intensified after the Uruguay Round, which reduced tariff barriers, opened negotiations in
new (trade-related) issues, and imposed a more uniform set of obligations across all WTO
members. The “grand bargain” struck in Marrakesh was that the developing countries
would adopt a single undertaking including significant commitments in such new areas as
intellectual property, while the developed countries would open up in areas of interest to
developing countries such as agriculture, clothing and textiles (TDR, 1995; Ostry, 2000).
Despite the lack of implementation of the developed countries’ side of the bargain,
particularly in agriculture, a new round of negotiations was launched in 2001 in Doha.


Figure 11
Composition of developing countries’ exports, 1973–2009 (as percentages)



Source: UNCTADStat.


Note: SITC-2 data from 1973 to 1994 and SITC-3 data from 1995 onwards.



28 See Allen (2011), who makes it clear that in late-industrializing economies, technological progress,


capital formation and an export orientation are very closely related. See also TDR (2003) on this
point.


29 Indeed, taking average decadal growth rates for trade and output, there was a positive correlation
between 1950 and 1980, however since 1980 the correlation has actually been negative.


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UNCTAD (XIII)/1


77. The broadening of multilateral trade negotiations has coincided with a shift towards
regional and bilateral trade agreements which, increasingly, include intellectual property
provisions with potentially adverse implications for technological learning in developing
countries (fig. 12). These developments have fuelled a debate about whether regional trade
is likely to support or hinder a more open global trading system. Much of this debate
continues to rely on a stylized vision of a borderless world as the ideal environment for
international trade, along with an emphasis on static efficiency gains. Such an approach
fails to register changes in the global economy linked to the rise of international finance –
including the consequences of boom-and-bust cycles, the declining share of wages in
national income, and an overall slowdown in global growth, and the impact of these factors
on international trade.


Figure 12
Regional and bilateral trade agreements (cumulative number)


0


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250


19
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South–South North–South North–North


Source: WTO.


Note: Regional trade agreements notified to GATT/WTO and in force (by date of entry in
force).
78. Changes in wider macroeconomic conditions have coincided with a switch in the
business models of many firms to a focus on “shareholder value”, short-term profitability,
and M&As. Under these conditions, outsourcing (the contracting out of a particular
activity) and offshoring (the relocation of an activity overseas) have become increasingly
important to corporate strategy.


79. The competitive dynamics of global value chains have led to an increasing use of
non-equity modes (NEMs) of operation by transnational corporations (TNCs) (WIR, 2011),
such as international outsourcing of production, licensing of knowledge to host-country
companies, management contracts, and franchising. For example, outsourcing combined
with offshoring has become increasingly important to corporate strategy. Inasmuch as
NEMs require the participation of domestic enterprises with significant productive capacity,


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UNCTAD (XIII)/1


they recall the strategic opportunities successfully used by the first-tier NIEs to make their
relations with TNCs work for development. TNCs initially sliced up the value chain in
specific sectors such as textiles, clothing and electronics, parcelling out steps to different
locations prior to final assembly. By the early 1990s, this model of vertical disintegration
(usually with a leading firm based in an advanced economy) had expanded to other
industries and service activities, engaging suppliers across an increasing number of
developing countries. A well-known example is Nike, which outsources all of its
production of sports goods to subcontractors in China, Indonesia, the Republic of Korea,
Thailand and Viet Nam. Already in 1996, a Nike shoe contained 52 different components
produced by subcontractors in five countries.30 This process has given rise to the idea that
an FDI–export nexus, driven by the liberalization of trade, and drawing on the marketing
skills and technological know-how of TNCs, can allow developing countries to leapfrog
into more sophisticated areas of production, and, in the process, avoid the perceived policy
mistakes associated with the infant industry stages of development. “Getting production
right” by attracting FDI seemed to transform the Washington Consensus mantra of “getting
prices right” into a more complete development strategy, by enabling developing countries
to trade and invest their way out of poverty (Stiglitz, 2002: 67). The idea that FDI did not
carry debt obligations to the host country and was free of speculative and herd mentalities
reinforced its appeal as an instrument for promoting development under FDG.


80. These expectations have been realized only in part. FDI to developing countries has
risen sharply since the early 1990s, in some cases becoming the dominant modality of
capital inflow (fig. 13). Correspondingly, inward FDI stocks grew from 7 per cent of world
GDP in 1980 to around 30 per cent in 2009 (fig. 14). Although rising FDI flows are often
assumed to correspond to a rise in gross fixed capital formation worldwide, this is only the
case if those flows take the form of greenfield investments and expansion of the productive
capacity of existing affiliates.


Figure 13
Composition of net capital flows to developing countries, 1980–2010 (in billions of dollars)


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Direct investment, net Private portfolio flows, net Other private financial flows, net Official flows, net
Source: IMF. World Economic Outlook (various).



30 For a discussion of the organization and the evolution of these production networks, see WIR (2002)


and TDR (2002).


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Figure 14
Distribution of inward FDI stock (as a percentage of world GDP)


0


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Developing economies
Developed economies
South-East Europe and the CIS (Transition economies)



Source: UNCTAD secretariat, from the UNCTAD FDI/TNC database.


81. Still, as a result of the spread of international production networks, global trade has
been boosted, as goods travel across several locations before reaching final consumers. For
example, trade in intermediates has reached 30 per cent of world trade, between 40 and 60
per cent of the merchandise imports of OECD countries, and close to 75 per cent of the
imports of such large developing countries as China (fig. 15 and table 3). Some of the most
successful emerging markets have, in recent years, successfully linked their development
efforts to these international production networks. However, the growth of trade
accompanying the participation in these networks may not always be matched by
comparable increases in value added or in real wages, thereby breaking the links between
exports, productivity growth and rising living standards, which, for example, characterized
the East Asian growth model (TDR, 2002 and 2003). Indeed, the combination of flexible
labour markets and standardized components trade tending to oversupply in highly
competitive markets has raised concerns about the possibility that production networks will
replicate the trade imbalances previously associated with primary commodity exports,
including the possibility of “fallacies of composition”, “enclave economies”, and even
“immiserizing growth” (TDR, 2002; Kaplinsky et al., 2002).31



31 The idea that many developing countries could be trading more but earning less from doing so was


introduced in TDR (2002). Similar findings were reported in a study of 127 developed and developing
countries by Dowrick and Golley (2004), who found that increased trade by developing countries had
supported faster productivity growth between 1960 and 1980 than was the case in the developed
countries, but that that link had weakened in the period from 1980 to 2000, favouring richer countries.


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Figure 15
Trends in the composition of world trade (exports, billions of dollars)



Source: UNCTAD secretariat calculation, based on World Integrated Trade Solution
(WITS) databases.


Table 3
Exports of intermediate products, by income groups and regions (percentages)






Average for
1993 and


1994


Average for
2008 and


2009 2009 Annual growth rate


Income groups
Developed economies 76.6 62.4 61.5 8.7


Developing economies 18.0 29.0 32.0 13.7


Transition economies 4.0 7.0 5.0 15.7


LDCs 2.1 3.5 3.2 14.0


Total 100 100 100 10.2



Developing-country
regions
East and South-East Asia 14.2 23.2 25.2 13.8


Eastern Europe 3.0 6.4 5.4 15.9


Latin America 4.3 4.8 5.2 11.0


Middle East/North Africa 0.3 0.6 0.6 15.8


South Asia 0.7 1.3 1.2 14.5


Sub-Saharan Africa 0.9 1.2 1.1 12.0


Source: UNCTAD staff calculations, based on COMTRADE-WITS.


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E. Development interrupted


82. The institutional, behavioural and policy changes promoted by FDG have failed to
trigger virtuous development circles for most communities. Under FDG, only the relatively
reluctant reformers, including the East Asian NIEs, China and India, have managed to
reduce significantly their income gap with the advanced countries. Most other countries,
including the “strong adjusters” in Latin America and sub-Saharan Africa, have failed to
converge; indeed, despite the broadly shared strong growth performance after 2002, growth
spurts have become much less frequent in developing countries since the early 1980s
(UNDESA, 2006: 11), and many countries are as far behind the richest countries in terms of
per capita income as they were 30 years ago, with only East Asian countries posting strong
and sustained gains (fig. 16).32


Figure 16
Real per capita GDP relative to the United States, 1980–2010



Source: UNCTAD secretariat, based on UNCTADStat.


Note: First-tier NIEs in the right-hand axis; all other economies in the left-hand axis. First-
tier NIEs includes Hong Kong (China), the Republic of Korea, Taiwan Province of China,
and Singapore. Second-tier NIEs includes Indonesia, Malaysia, the Philippines and
Thailand.


83. The first failure of development strategies harnessed to FDG concerns their
weakness in mobilizing sufficient resources to build productive capacities. In most
developing countries, investment rates tumbled in the 1980s, and they have failed to return
to their previous levels (fig. 17). The retrenchment of public sector investment has been
especially pronounced, and in most cases, private (domestic as well as foreign) investment
has failed to fill the gap (TDR, 2003).


84. This failure is partly due to the fact that FDG has had an adverse impact on
household savings at three levels: (a) wage incomes have been squeezed; (b) banks have



32 UNCTAD’s assessment of the performance of the different developing regions can be found in its


Trade and Development Reports, Least Developed Countries Reports, and Economic Development in
Africa Reports.


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UNCTAD (XIII)/1


moved away from the business of protecting household savings and funding long-term
investment projects, and have instead become heavily involved in lending to consumers and
governments; and (c) trade and financial liberalization (together with closely related
cultural and behavioural changes) have raised the propensity to consume, especially luxury
goods, and have fuelled speculative purchases of real estate. However, for reasons
discussed earlier, financialization has also had a damaging impact on the profit–investment
nexus, by channelling retained profits into less productive uses. 33


Figure 17
Gross fixed capital formation, 1970–2009 (as a percentage of GDP, current prices)



Source: UNCTAD secretariat, based on UNCTADStat.




85. A second danger is locking countries in to a narrow pattern of international
specialization with limited growth prospects. UNCTAD research has identified a process of
“premature deindustrialization” in a number of developing countries over the past thirty
years, whereby the share of manufacturing in employment and output starts to decline at a
level of income well below that associated with the trajectory of successful economies –
both developed and developing (fig. 18). In these cases, it becomes increasingly difficult to
produce more sophisticated goods for export and to sustain high levels of domestic demand
and employment creation (TDR, 2003; Least Developed Countries Report (LDCR), 2009).



33 See also Arestis (2004 and 2005). One extensive survey of the impact of financial liberalization has


concluded that there is little evidence to support the idea that financial integration has helped
developing countries increase the resources available to bolster productive investment and support
growth (Prasad et al., 2004: 11).


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UNCTAD (XIII)/1


Figure 18
Manufacturing value added, 1970–2009 (as a percentage of GDP)



Source: UNCTAD secretariat, based on UNCTADStat.




86. Third, and closely related, FDG has often failed to support technological upgrading
(TDR, 2003; LDCR, 2007). In most developing countries, technological progress is more
about adapting and improving existing technologies to achieve higher productivity than
about pushing out the technological frontier. However – and regardless of whether the
technology is imported or developed locally – this still depends on high levels of productive
investment (as most technologies are embodied in capital goods), adequate levels of
spending on research and development (R&D), and a range of appropriate technology
support services. Measuring technological capacity remains a difficult task, particularly as
there is good deal of tacit knowledge and skill involved, however recent trends have tended
to follow much the same pattern as has already been seen in the areas of investment and
industrialization, with several East Asian countries performing strongly, many middle-
income developing countries struggling to keep up, and most LDCs dropping further behind
(table 4). Efforts to correct these weaknesses by attracting FDI have been only partially
successful. While affiliates tend to exhibit higher output and productivity than comparable
local firms, the evidence for technological spillovers from inward FDI is limited,
particularly in LDCs (LDCR, 2007; WIR, 2005).34 This is especially the case where FDI is
focused on assembly activities, or – in cases where more high-tech activities are deployed –
where the absorptive capacity of local companies is insufficient. Failure to address such
weaknesses has given rise to concerns about a “middle-income trap”, since several
countries have moved into the labour-intensive slices of the global value chain but have
found it difficult to further develop the technological infrastructure needed to support the
growth of larger domestic firms, or to sustain upgrading and productivity growth.35



34 For a review of the recent evidence on FDI spillovers, see Harrison and Rodríguez-Clare (2010).
35 For further information on the middle-income trap, see TDR (2002), Ohno (2009), Felipe (2010) and


Wade (2010). Similar concerns are even being expressed in China. In this regard, see: The Economist
(2011). Beware the middle-income trap: China’s roaring growth cannot last indefinitely. 23 June.




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Table 4
Research and development expenditure (as a percentage of GDP)


1996 2000 2004 2007
OECD members 2.2 2.4 2.3 2.3


Middle-income countries 0.6 0.7 0.8 1


East Asia and the Pacific 0.5 0.7 1.1 1.4


South Asia 0.6 0.7 0.7 0.8


Latin America and the Caribbean 0.5 0.6 0.6 0.7


Source: World Bank. World Development Indicators.


87. FDG has not only failed to support catch-up growth and structural transformation. In
many developing countries, it has also been detrimental to the creation of decent jobs
(UNDESA, 2008; TDR, 2010). Given the structural constraints facing many developing
countries, an emphasis on making labour markets “more flexible”, when combined with
restrictive macroeconomic policies, rapid trade and financial liberalization, and boom-and-
bust cycles, has often failed to support the formalization of employment or to promote the
rapid creation of secure jobs. The exception is, once again, East Asia, where development
strategies have differed most significantly from the mainstream policy prescriptions
(Bacchetta, Ernst and Bustamante, 2009; Khan, 2007; and table 5). Since the expansion of
employment can reinforce the impact of productivity growth in establishing virtuous
growth circles, the low employment intensity of growth in most developing countries poses
another obstacle to more inclusive development paths.


Table 5
Vulnerable employment shares, world and regions (percentages)


1998 1999 2000 2005 2006 2007 2008 2009
World 53.7 53.5 53.3 51.9 51.4 51 50.2 50.1
Developed economies and
European Union 11.3 11.1 10.8 10.3 10 9.9 9.7 9.7


Central and South-Eastern
Europe (non-EU) and CIS 24.1 26.7 25.6 22.8 21.9 20.7 20.4 20
East Asia 61.4 60.2 59.1 55.8 55.2 54.5 52.2 50.8
South-East Asia and the Pacific 63.8 66.2 65.5 62.6 62.3 62 62.5 61.8
South Asia 81.9 81.1 82.1 80.5 80.2 79.9 78.9 78.5
Latin America and the Caribbean 35.7 36.1 35.8 33.8 32.7 32.3 31.8 32.2
Middle East 36.8 36 35.7 33.9 33.7 33.3 32.9 32.7
North Africa 43.7 42.1 42.4 42.6 41.1 41.2 40.2 40.4
Sub-Saharan Africa 80.5 79.9 79.5 77.1 76.6 76 75.3 75.8


Source: ILO. Global Employment Trends: 69.


88. Paradoxically, the winners under FDG have been those developing countries that
have resisted rapid financial and capital account liberalization (box 2; and fig. 19) and have
continued to deploy creative and heterodox policy innovations along the lines of those
which, in the 1960s and 1970s, helped Japan, the Republic of Korea, Taiwan Province of
China and other economies to break their constraints on growth. In all these cases, very
high rates of capital formation, economic diversification and technological upgrading have
been mutually reinforcing, while global market forces were used strategically to fill
resource gaps and strengthen local capacities. These economies have, as a result, been able
to manage a successful structural transformation towards higher-productivity sectors. These
successful economies have also built industrial capacity in the context of a strong regional
growth dynamic, including through managed trade and FDI. In all these cases, industrial


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UNCTAD (XIII)/1


policy, rather than purely market processes, has been essential in order to be able to take
full advantage of the scale economies and externalities that external integration can bring.


Box 2. Who benefited from finance-driven globalization?
For developing countries as a whole, there is no positive correlation between
financial globalization and economic growth or investment. The lack of such
a correlation may be due to the fact that econometric exercises do not have
the power to separate countries that benefit from financial globalization from
countries that are harmed by unruly global capital flows. Figure A (below)
uses a sample of 136 developing countries to plot financial globalization
against average real per capita GDP growth over the period 1990–2007. The
figure is then divided into four sub-quadrants. The bottom left corner shows
that there are 52 countries with relatively low levels of financial globalization
(less than 150 per cent, which is close to the cross-country average for this
period) and low growth (below 2 per cent per year, again closer to the cross-
country average in the sample). The bottom right corner shows that there are
24 countries with high financial globalization and low growth. The upper left
corner includes the 41 countries with low financial globalization and high
growth. Finally, the upper right corner shows that there are 19 countries with
high financial globalization and high growth. While figure A cannot provide
a counterfactual and thus does not allow causal statements to be made, it is
interesting that the upper right quadrant is the least populated part of the
figure.


A closer look at the upper right quadrant may shed some light on which
countries can benefit from financial globalization. Out of the 19 countries
included in the high financial globalization high-growth group, 8 are small
island economies, 6 are commodity exporters, and 4 are regional financial
centres. Only one (Malaysia) is a country with a large and successful
manufacturing industry. Figure A does not seem to support the view that
financial globalization is associated with a process of industrialization and
structural transformation.
Figure A
Who benefited from finance-driven globalization


BLR
IRN
IND


BGD


UZB


PAKGTM


DOM


RO


TUR


CHN


BFA
BRA
NPLCOL


MUS


MEX


KOR


TKMALB
SLV


LTUMN


ZWE


POL


KEN
CMR


DZA
MKD


GEO


MDV


HTIUKR


LKA


PRY


BIH


MNGTON


ARM
CRIIDN


GAB


ZAF
ETH


CPV


RWAERI


VNM


MAR


UGA


PERKAZEGY
SVN


BEN


NER


SEN


TJK


TCD


KHM


CAF


ECU


WSM


YEMGIN


THA


FJI
SAU


BLZ


PHLHRVAZE


LI


BTN


GHA


TZA


COM


SVK


MDG


L A
CZE


ARG
N M


BOLVEN
RUS


TUN


KGZ


MWI


SRB


HND


SLB


ISR


MDA


PNG


URY
HUNSWZ


CHL
BWA


DJI


SYC


TTO


TGO


GA
JAM


CIV


MYS


LCA


ABW
BGR


BDI


VCT


SLE


GRD
AGO


GNQ


ATG
JOR


GMBMRT
VUT


DMA


ZMBCOG


KNA


KWTNIC


LBN


ARE


STP


QAT


GNB


PAN
SGP


KIR


-.0
5


0
.0


5
.1


.1
5


tg
ry


0 1 2 3 4 5
tfinglob



Source: UNCTAD secretariat elaboration, based on Lane and Milesi-Ferretti
(2006) and the UNCTADStat database.


39





UNCTAD (XIII)/1


Note: The vertical axis plots average real GDP per capita growth over the
period 1990–2007, and the horizontal axis plots average financial
globalization (defined as gross foreign assets plus gross foreign liabilities
divided by GDP) over the same period. The eight small island economies are:
Antigua and Barbuda, Dominica, Grenada, Saint Kitts and Nevis, Saint
Lucia, Saint Vincent and the Grenadines, Seychelles, and Sao Tome and
Principe. The six commodity producers are: Angola, Botswana, Chile,
Equatorial Guinea, Qatar, and Trinidad and Tobago. The four regional
financial centres are: Lebanon, Panama, Singapore and Uruguay.


It is ironic that the only country in this sample undergoing a successful
structural transformation and benefiting from financial globalization is a
country that, in the recent past, fought hard against the latter. Malaysia started
relaxing restrictions on capital flows in the mid-1970s, and by 1982, it had a
fully open capital account (this is the solid line in figure B). In the early
1990s, the Malaysian authorities started worrying about large inflows of
capital and imposed some restrictions on capital flows. These restrictions
were further tightened in the aftermath of the Asian crisis of 1997–98. By the
year 2000, the Malaysian de jure index of capital account liberalization was
back at its 1970 level. Rather than resulting in a collapse of de facto financial
globalization (the dashed line in figure B), these changes in capital account
regulations were successful in slowing down the process of financial
integration and in decoupling Malaysia from the rapid increase in global
financial integration (the dotted line in figure B). While IMF and several
observers criticized Malaysia for retreating from the rapid process of
financial integration (Johnson et al., 2007), there is evidence that Malaysia’s
more careful attitude towards foreign finance paid off, and helped the country
to recover from the effects of the Asian financial crisis of 1997–98 (see also
box 4 on capital controls).


Figure B
Financial globalization: Malaysia versus the world average


-0.5


0


0.5


1


1.5


2


2.5


3


3.5


4


4.5


19
70


19
71


19
72


19
73


19
74


19
75


19
76


19
77


19
78


19
79


19
80


19
81


19
82


19
83


19
84


19
85


19
86


19
87


19
88


19
89


19
90


19
91


19
92


19
93


19
94


19
95


19
96


19
97


19
98


19
99


20
00


20
01


20
02


20
03


20
04


20
05


20
06


20
07


De facto financial globalization index (Malaysia) De facto financial globalization index (World) De jure financial globalization index (Malaysia)


Source: UNCTAD secretariat elaboration, based on Lane and Milesi-Ferretti
(2006) and the UNCTADStat database.


40





UNCTAD (XIII)/1


89. These experiences suggest that, in order to establish a successful development path,
it is essential to ensure the space to introduce a range of policies for building domestic
productive capacities and local technologies, and to establish the institutions and support
measures to spread the resulting gains. However, for many developing countries, policy
space has been reduced under FDG and through a variety of channels. Firstly, capital
account liberalization can make independent monetary policy impossible, regardless of the
exchange-rate regime (developing countries often cannot bear the balance-of-payments
pressures under a fixed exchange-rate regime, or the costs of exchange-rate volatility under
floating exchange rates; see TDR, 2002 and 2011). Secondly, while a commitment to
arbitrarily low inflation targets and tight public sector spending is more a signalling device
to demonstrate commitment to FDG than an effective anti-inflation policy (TDR, 2010),
these measures do restrict the potential of macroeconomic policy to achieve wider
developmental goals (Bradford, 2005). Thirdly, since FDG increases the elasticity of the
supply of capital, it reduces the ability of countries to set their preferred tax schedule,
induces a shift towards taxes on labour, and encourages a race to the bottom in which
several countries try to attract capital by lowering taxation, and, eventually, end up with
lower tax revenues and no change in their capital stock. Fourthly, since most developing
countries are unable to borrow abroad in domestic currency (the “original sin”; see
Eichengreen et al., 2003), during recessions the real value of their currency tends to decline,
raising the cost of servicing foreign debt exactly when the capacity to pay is diminished.
This increases the risk attached to lending to poorer countries, reduces the space for
countercyclical policies, and induces monetary policy to target exchange-rate rather than
output stability (Hausmann and Panizza, 2011). Finally, FDG has eroded policy space
through the changes it has triggered in the political process, particularly in the advanced
economies. The lobbying power of the United States financial industry has increased
enormously (Johnson, 2009), and its political clout has been used to push for further
liberalization in the United States and abroad. Three manifestations of this strategy were the
sharp financial liberalization demanded of the East Asian countries after the crisis of the
mid-1990s, the requirement that countries signing free trade agreements and bilateral
investment treaties with the United States should renounce some forms of capital account
management, and the concerted push for the deregulation of financial services at the
multilateral level (Igan et al., 2011)..


Figure 19
Decomposition of productivity growth by country group, 1990–2005


-2 -1 0 1 2 3 4


Latin America


Africa


Asia


High-income


Sectoral productivity growth Structural change


Source: McMillan and Rodrik (2011).


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UNCTAD (XIII)/1


Note: Sectoral productivity growth refers to contributions to labour productivity growth
from within sectors; structural change refers to productivity growth resulting from the
movement of labour across sectors.


F. The ongoing downturn


90. The full extent of excessive indebtedness, unregulated capital flows and financial
speculation became apparent in the wake of the collapse of Lehman Brothers in September
2008. The cost of the subsequent crisis, in terms of declining asset values and government
bailouts of collapsed financial institutions, has already run into the trillions of dollars. The
crisis has wrought widespread damage via growth collapses, job losses, corporate
bankruptcies, and the prospect of prolonged stagnation in several advanced economies.
Developing countries, which bore no responsibility for the crisis, were hit by declining
export prices and volumes, contracting markets, frozen credit lines, reduced FDI, capital
flight, and lost migrant remittances. No country has avoided the impact of the crisis
completely, and the percentage point drop in GDP growth was even larger in many LDCs
than in some advanced countries (LDCR, 2010).


91. The myth of the self-regulating market has proved itself to be damaging, precisely
when it had been given maximum latitude to deliver its promised benefits. Those
economists who saw the warning signs were not listened to, as their voices were drowned
out by the chorus of praise for a system offering increasing rewards to the few and
transferring the risks to those least able to understand them. At least since Adam Smith,
serious thinkers have understood that the destructive features of markets need to be
moderated through an array of rules and institutions. Moreover, the idea that dismantling
the checks and balances on financial markets would help unleash a new wave of productive
entrepreneurship and technological progress goes against history, which shows that these
markets are prone to generating wrong information, excessive risk-taking and herding
behaviour, and regularly culminate in large-scale panics, crashes and protracted crises.36 As
Keynes famously noted, the casino is no place for promoting productive entrepreneurship.
But the irrationality (exuberant or otherwise) of markets is only part of the problem. The
United States economist Hyman Minsky has demonstrated that moral hazard and fragility is
hard-wired into the structure of deregulated financial systems. When it is combined with
the tendency of markets to concentrate economic power, financial deregulation becomes a
potential source of not-so-innocent economic fraud (Galbraith, 2004) and a danger to social
stability (Soros, 2008).


92. Rolling back the “rule of rentiers” (Krugman, 2011) is certainly an essential step to
rebalancing the global economy, and to the prospect of sustained and inclusive growth for
developed and developing countries alike. To date, attention has, instead, largely focused
on saving large financial institutions through direct government support and the provision
of cheap money. This was no doubt necessary to prevent a repetition of the Great
Depression. However, the response of the financial sector has been to speculate globally,
even as it denies loans to the productive sector. At the moment, finance is a macroeconomic
dead weight, bearing heavily on global recovery efforts. If “business as usual” persists,
growth will remain patchy, investment will remain subdued, unemployment will remain
high, and inequality will increase further, as states seek to balance budgets through
additional cuts in investment, salaries and social security transfers. Indeed, if history is any
guide, the likelihood of mounting social tensions spilling over into political instability is a
very real one (Voth and Ponticelli, 2011). Moreover, the longer the crisis drags on, the



36 The periodic tendency of unregulated financial markets to “go crazy”, in the words of the Financial


Times journalist Martin Wolf, is described by Kindleberger (1984).


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UNCTAD (XIII)/1


greater the temptation is for economies to resort to a more inward-looking agenda.
Meanwhile, speculation in the food and energy markets is again contributing to increased
food and energy insecurity, with the price of oil again climbing sharply and some food
staples hitting new highs (fig. 20).


93. In this context, it would be optimistic to expect large emerging economies to lead
the global recovery, especially if this is accompanied by calls for them to open up the next
frontier for financial accumulation. The proposition sounds encouraging but is in fact
deeply misleading. Even in the best possible circumstances, the emerging economies are
constrained by their relatively low absorptive capacity and inability to issue international
currencies. Moreover, there is a growing recognition of the need for countries that have
built growth around a strong investment–export nexus to start relying more on domestic
sources of growth. This will involve difficult adjustments and trade-offs, along with
strategic policy action. Without far-sighted and effective measures at national, regional and
international levels, new imbalances will build up in these economies, with the threat of
repeated shocks and crises increasing while the advanced economies have already
exhausted much of their capacity to prop up the financial sector.


Figure 20
Commodity prices, January 2000–May 2011 (2000=100)


0


50


100


150


200


250


300


350


400


450


500


Ja
n2


00
0


M
ay


20
00


Se
p2


00
0


Ja
n2


00
1


M
ay


20
01


Se
p2


00
1


Ja
n2


00
2


M
ay


20
02


Se
p2


00
2


Ja
n2


00
3


M
ay


20
03


Se
p2


00
3


Ja
n2


00
4


M
ay


20
04


Se
p2


00
4


Ja
n2


00
5


M
ay


20
05


Se
p2


00
5


Ja
n2


00
6


M
ay


20
06


Se
p2


00
6


Ja
n2


00
7


M
ay


20
07


Se
p2


00
7


Ja
n2


00
8


M
ay


20
08


Se
p2


00
8


Ja
n2


00
9


M
ay


20
09


Se
p2


00
9


Ja
n2


01
0


M
ay


20
10


Se
p2


01
0


Ja
n2


01
1


M
ay


20
11


All groups Food Agricultural raw materials Minerals, ores and metals Crude petroleum
Source: UNCTAD GlobStat.


G. Future shocks


94. FDG promised to eliminate chronic resource misallocation and balance of payments
instability and, “for all practical purposes”, the business cycle itself (Lucas, 2003). In
reality, rising debt levels and increased leverage and speculative behaviour have created a
world of systemic financial fragility and new types of business cycles. These have brought
episodes of prosperity, but they have often collapsed through currency, banking or balance-
of-payments crises, and been followed by long periods of sluggish growth and weak job
creation. Hopes of a more inclusive growth model were dashed by growing inequality and a
shift in the risks and stresses generated by unregulated markets onto individuals and
households.


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UNCTAD (XIII)/1


95. The ongoing global crisis has already caused untold damage to livelihoods and to
prospects of employment and prosperity in many countries. However, this crisis is
accompanied by the slowly unfolding environmental crisis – in particular, by rising global
temperatures, which pose even more fundamental challenges to sustainable development.
There is a growing recognition that so long as environmental risks and imbalances are
linked to long-run economic (and demographic) pressures, it will be difficult to correct
these separately from the financial and social imbalances that have emerged over the past
two or three decades. This makes attempts to return to “business as usual” even more
misguided. The recomposition of FDG is not only undesirable for economic and social
reasons; it would also impose intolerable stresses on the planet’s ecological balance.


96. It is widely recognized that the development path adopted by today’s advanced
countries has not properly accounted for its (ab)use of “natural capital” or damage to
ecosystems, and that, given current technologies (or those on the horizon), the Earth’s
ecological limits do not permit the replication around the world of the patterns of
production and consumption of the advanced countries. Industrialization based on fossil
fuels has, over the past two centuries, helped those countries achieve unprecedented
increases in living standards, but at the cost of a build-up of carbon emissions that has
overrun the absorptive capacity of the atmosphere and brought about dangerous and
potentially irreversible changes in the earth’s climate.


97. Despite a growing awareness of those limits, the world remains far from finding
ways of correcting the mounting environmental imbalances or the catastrophic outcomes
that the scientific community predicts for the planet. Recent evidence that carbon emissions
have continued to rise even during the recession adds to concerns that the planet is heading
towards dangerous tipping points beyond which it may become impossible to recover a
recognizable form of ecological balance.


98. For many developing countries, these environmental threats are already adding to
the vicious circle that traps them at a low level of income, degrades their resource base, and
constrains their ability to build resilience to withstand future shocks. Recent estimates
suggest that 300,000 people die each year because of global warming, while 300 million
lives are seriously threatened by the ongoing environmental transition (Global
Humanitarian Forum, 2009). Unfortunately, an environmentally sustainable growth path for
the global economy has proved an elusive goal, in part because of the reluctance of the
most advanced countries to recognize the closely interrelated nature of development and
environmental challenges (box 3).


Box 3. The climate–development nexus


A temperature increase of 2oC above pre-industrial levels is the maximum
target established by the scientific community for stabilizing carbon
concentrations at a level that would prevent dangerous imbalances in the
climate system, and for adapting to the changes that such a rise would still
bring. This corresponds to a target greenhouse gas concentration (in terms of
carbon dioxide equivalents (CO2e)) of between 350 and 450 parts per million
(ppm), and to a global emission reduction of around 50–80 per cent over
1990 levels by 2050.


These targets will require aggressive action by the advanced countries and the
active participation of the developing countries, which can occur only if
economic growth and development are allowed to proceed in a sustainable
manner. In accordance with the principle of common but differentiated
responsibilities, distinct climate policies will be required in developed and
developing countries.


Energy is the pivotal issue at the interface of climate and development. In


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UNCTAD (XIII)/1


most of the developing world, access to energy services is far below what is
needed to achieve human development goals; indeed, around 2 billion people
are without access to modern energy services. Globally, approximately 31
million tons of oil equivalent are consumed in the form of primary energy
every day, which is equivalent to 55 kilowatt-hours (kWh) per person per
day, with rich countries on average consuming more than twice that figure.
Most African countries and all countries in South Asia consume well under
20kWh per capita per day. China is still well below the global average, and
even most emerging markets consume less than a third of the advanced
economies’ per capita average. It goes without saying that rising income
levels in poorer countries will tend to close these energy gaps.


100kWh per capita per day can be used as a reasonable target for energy
security. Up to this level, there is a very strong correlation between increased
energy consumption and development outcomes. However, these levels of
energy consumption will be out of the reach of most poor countries unless the
price of energy services declines significantly. For example, if energy costs
10 cents per kWh, then $10 per day would be needed to consume the
requisite levels of energy services. This is not just a problem for the bottom
billion; spending $10 per day on energy services would also exhaust the per
capita income of countries such as Angola or Ecuador.


The bulk of energy infrastructure in developing countries is yet to be built,
leaving energy services undersupplied and expensive; meanwhile, many
people still rely primarily on traditional biomass fuels for their energy needs,
especially wood, crop wastes and animal dung. Under these circumstances, it
may be cheaper and easier to switch to a renewable pathway than to retool
existing infrastructure. Cost and technical improvements across a wide range
of small-scale, decentralized technologies based on renewable energy already
offer, in many situations, a cost-effective and sustainable approach to rural
electrification.


Most market-based solutions under discussion in climate circles, such as cap
and trade and carbon taxes, could work against development because they
aim to raise the price of renewables in order to make them attractive to
private investors. What is needed, instead, is a strategy leading to a
significant and rapid reduction in the cost of renewable energy. The most
promising option is a massive public investment push, coupled in the short
term with appropriate subsidies to offset high initial technological and scale
hurdles. If targeted at the most promising technology options, especially solar
and wind, such a strategy would give the private sector clear and credible
signals and encourage productivity gains and energy efficiency.


For further information, see TDR (2009) and UNCTAD (2011c).



99. It would be economically unrealistic and morally unacceptable to demand that, as
part of their contribution to addressing the climate challenge, the developing countries
should compromise their economic growth ambitions in order to protect much higher living
standards elsewhere. Rather, new partnerships will have to be formed around the
development and diffusion of green technologies, large-scale retrofitting programmes, the
coordinated replacement of energy-intensive patterns of production by alternatives fuelled
by renewable sources, and changes in trade patterns supporting the transition of the global
productive matrix towards environmental sustainability (TDR, 2009; UNDESA, 2009). The
only way to close income gaps, within and across countries, while building a low-carbon
high-growth global economy is through a shift to a new modality of global development


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encompassing economic, social and environmental dimensions, which this report refers to
as development-led globalization (DLG).


100. This first part of the report has argued that “business as usual” is the wrong
response, both for short-term macroeconomic and for long-term structural, social and
environmental reasons. The interconnected challenges of rebalancing financial systems and
real economies, repairing domestic social contracts, and tackling environmental,
demographic and food challenges cannot be dealt with through the incremental and discrete
actions which are typical of the interplay of market forces. It will be difficult to face these
challenges and kick-start global recovery while Northern consumers, businesses and
governments seek to repair their balance sheets, and with the financial system entangled in
a wholly speculative web of debts entirely of its own making. Greater austerity is certainly
not the way to lift all boats. Moreover, under these conditions, attempts by most countries
to push down hard on the export pedal would be ineffective, while also generating
dangerous frictions in the global trading system. It is nothing short of disastrous that an
effective investment-led and environmentally sound response to the current global
predicament continues to elude the international community. Identifying some of the
elements of a new DLG is the aim of the next part of this report.


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II. Rebalancing the global economy through sustainable and
inclusive development


A. Introduction


101. Part I of this report argued that FDG has failed to harness the creative forces of
markets in support of broad-based growth, while giving greater sway to their more
destabilizing and destructive tendencies. Despite this, several success stories in the
developing world have delivered sustained growth for several decades, and have proved
resilient in the face of the crisis. These achievements have spurred speculation about new
“global growth generators” and a “great convergence” in incomes. These are certainly
encouraging trends. However, it would be misleading to ignore the fact that, for long
periods of FDG, most developing countries posted lower per capita growth than advanced
countries (fig. 21). Moreover, these trends give little support to calls to stick to business as
usual, since one of the paradoxes of FDG is that emerging success stories have adopted
proactive development strategies which are, in many respects, at odds with the dominant
strand of economic thinking. Hanging the future of catch-up growth on the recent debt-
fuelled boom would seem particularly risky, given what has happened since 2008, given
that the imbalances that have accompanied FDG continue to impair sustainable and
inclusive development in most countries, and given the real concerns that, in the absence of
lasting reforms to the international architecture, another financial crisis could have
damaging consequences even for successful developing countries. All the while,
demographic and environmental pressures have been mounting, but lasting solutions have
been elusive.


Figure 21
Real per capita GDP growth rates, five-year average


0


2


4


6


8


10


12


19
80


19
81


19
82


19
83


19
84


19
85


19
86


19
87


19
88


19
89


19
90


19
91


19
92


19
93


19
94


19
95


19
96


19
97


19
98


19
99


20
00


20
01


20
02


20
03


20
04


20
05


20
06


20
07


20
08


Developed countries China Developing excluding China and India India


Source: UNCTAD secretariat, based on the World Bank’s World Development Indicators
(2010).


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102. The challenge for policymakers is to put inclusive development firmly at the
forefront of the policy agenda. The interrelated nature of the components of inclusive
development will add significantly to the burdens of this task. Still, it remains possible to
set out policy measures at the national, regional and global level to rebalance the world
economy, transcend FDG, turn recent growth spurts into sustainable development paths,
and ensure that the gains are enjoyed by all sections of society, particularly the poorest and
most vulnerable. This, in essence, is the challenge of DLG.


B. Inclusive development and the investment challenge


103. There is a strong correlation between per capita income and social welfare. This is
hardly surprising, but it does not imply that development is synonymous with economic
growth. Even growth spurts that continue for some years need not lead to widely shared
gains, and where spurts are followed by collapses there is a likelihood that social welfare
will suffer. This appears to have been the case with the boom-and-bust cycles generated
under FDG. Moreover, at any income level, there is considerable variation across countries
in terms of their social indicators: policy choices matter to the kind of development path
that countries follow.


104. The key to inclusive development lies in the institutional and policy links which
ensure that growth promotes social development, while social development supports
economic growth. The Millennium Development Goals (MDGs) have added poverty,
employment and social objectives to the international policy agenda, and have indicated the
need for a significant scaling-up of resources to finance new investments in social
infrastructure and safety nets, along with the formation of new partnerships to accelerate
progress on human development. These have been welcome developments. However, and
even before the crisis hit, the MDGs had been hampered by the uneven growth and global
imbalances accompanying FDG and by inconsistent economic policy advice.


105. A clear picture that emerges from developments over the last decade is the very
strong correlation between high levels of inequality and limited progress on the MDGs.
Figure 22 plots the average Gini index over the period 2000–2008 against the average
headcount poverty rate for the same time interval; it suggests a weak but positive
association between inequality and the share of population earning less than $2 per day.
The picture is enriched once we assess directly the impact of inequality on the mapping
between growth and human development. Figure 23 shows the differential impact of
growth on poverty, by splitting the sample between equal and unequal countries. Those
countries with a relatively low inequality (e.g. a Gini index below the sample average)
display a much stronger correlation between growth and poverty reduction vis-à-vis the
unequal economies for which the impact of growth is close to zero. The importance of
addressing inequality becomes even clearer when we consider other measures of human
development such as the under-five mortality rate (MDG-4) and the primary school
enrolment rate (MDG-2). While the association with growth is positive for the more equal
countries, it turns negative when we look at unequal societies. Economic growth, in other
words, can worsen the living conditions of vulnerable people where the distribution of
income is unequal (UNCTAD, 2010a).


106. Economic and social imbalances are not the only threat to inclusive and sustainable
development. Growing environmental fragility poses a profound threat to sustainable
development, and this, in turn, is closely linked to demographic pressures and particularly
those associated with a rapidly urbanizing planet. This demographic shift, in turn, is placing
increasing pressure on labour markets and social services in many developing countries,
while also adding to the demands on agricultural systems, which have, in many developing


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UNCTAD (XIII)/1


countries, suffered in recent years from underinvestment even as climatic changes impact
on their yields.


Figure 22
Poverty and inequality


0
20


40
60


%
P


op
ul


at
io


n
un


de
r 2


$
P


ov
er


ty
L


in
e


20 30 40 50 60
Gini Index, average 2000-2008


Fitted values HPI



Source: UNCTAD secretariat, based on the World Bank’s World Development Indicators
(2010).
Note: HPI is the Human Poverty Index.


Figure 23
Poverty, inequality and growth


-2
0


0
20


40
60


%
o


f P
op


ul
at


io
n


un
de


r 2
$


P
ov


er
ty


L
in


e


-5 0 5 10 15 20
Average Growth 2000-2008


Fitted values Equal
Fitted values Unequal



Source: UNCTAD secretariat, based on the World Bank’s World Development Indicators
(2010).


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UNCTAD (XIII)/1


107. Rebalancing the global economy along these interconnected fronts will be unlikely
in the context of slow or unstable growth. Most developing countries need to sustain annual
growth rates in excess of 6 per cent per annum to address their economic and social deficits
and close the income gap on those higher up the development ladder. The central economic
policy challenge remains that of absorbing underutilized domestic resources and adding
new ones by building stronger links between productive sectors and expanding markets, at
home and abroad. The nature of that challenge varies over time, and across countries at
different levels of development. However, in all cases, it is essential that resources are not
wasted or siphoned off by a small minority, that support is given to sectors with strong
employment multipliers, and that infrastructure investment, including in social sectors,
receives strong government support. This will often require investment rates in excess of 25
per cent of GDP.37 There are complex relationships between investment, growth and
development, with multiple lines of causation running across changes in technology and
productivity, scale economies, complementarities between demand and supply, and shifting
patterns of employment and trade.


108. Very few countries have achieved the required investment and growth rates under
FDG, and in those that have, market forces have not been left alone to generate the required
financial resources or to direct them in the most productive manner. A significant body of
evidence suggests that, after the initial stages of industrialization, when agricultural and
commercial incomes provide the main sources of finance, a large part of capital
accumulation is financed from retained profits, often in a symbiotic relationship with long-
term bank lending which, in turn, is frequently state-led.38 For many developing countries,
a persistent obstacle to building this profit–investment nexus is the absence of local
enterprises with the ability to generate sufficient profits to manage a big investment push
and the large projects that are needed for industrial and technological upgrading. Given the
well-documented rise in the minimum scale of investment needed to maintain a process of
structural transformation, more attention needs to be given to the challenge of building and
regulating large enterprises in developing countries.39 Where local capacity to undertake
large projects is weak, FDI can make a contribution to industrial upgrading and the
progressive establishment of such local capacity, provided appropriate strategies and
regulations are in place.


109. Beginning the discussion of DLG with productive investment is important, because
it provides an initial link between inclusiveness and a more traditional development agenda.
As was discussed earlier, FDG has encouraged the rich to get much richer, on the grounds
that they save and invest more than other sectors of society. This trickle-down logic has not
worked. For example, economists have long understood that savings may be low because
investments are low, rather than vice versa. Moreover, the extent to which the rich save and



37 Among the many variables fed into growth equations, investment still emerges as one of the few with


a consistently robust and independent impact on economic growth. See TDR (2003): 61–64.
38 On this profit–investment nexus, see TDR (1994, 1997, 2003), Singh (1999), Ros (2000) and van


Treeck (2008). An examination of this nexus from an historical perspective will inevitably have to
address the role of entrepreneurship in the development process. Such an examination will need to
avoid seeing it as an exogenous variable. In analysing the steady loss of England’s economic lead to
the United States starting from the late nineteenth century, Habbakuk (1962: 213) concluded that “the
abundance of entrepreneurial talent in the United States of America was the consequence rather than
the cause of a high rate of growth, and it was the slow expansion of English industry which accounted
for the performance of English entrepreneurs…not the reverse.”


39 It is a paradox of FDG that while the growing economic influence of large corporations, both
financial and non-financial, has been a visible trend in advanced countries, the accompanying
development agenda has devoted most of its attention to small enterprises and microfinance. Again,
the issue is one of finding the right balance; on the links between firm size and economic growth, see
Tybout (2000).


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invest their incomes in productive assets can vary considerably among countries, depending
on how profits are generated and the extent to which they are consumed. Moreover, if
profits are siphoned off into luxury consumption or financial assets, as has happened under
FDG, the investment linkages required for inclusive development will be weak or
missing.40 Depending on circumstances, different combinations of fiscal, monetary and
exchange-rate policies, including capital controls (box 4), can support the achievement of
high rates of productive investment and growth.


Box 4. The case for capital controls


Foreign capital can make a positive contribution to economic development.
However, experience shows that some types of international short-term
capital flows can inflict devastating effects on an economy when policies
falter in managing those flows (Bernanke, 2011: 24). Even IMF is breaking
away from its traditional reluctance to endorse capital controls, despite the
fact that these have always been permitted by its Articles of Agreement (see,
for example, Articles VI and VII). There is a growing global consensus
around the proposition that capital controls may be legitimate policy tools to
address macroeconomic and prudential imperatives. However, while IMF
economists recognize that “controls seem to be quite effective in countries
that maintain extensive systems of restrictions on most categories of flows”,41
the Fund still seems to see these as a last resort and to be applied only on a
prudential and temporary basis.


A regulatory framework appropriately extended to transactions involving
foreign assets and liabilities can help to contain destabilizing capital flows by
addressing maturity and currency mismatches and exchange rate–related
credit risks. Such controls have recently been introduced by a number of
emerging economies, including market-friendly taxes on selected inward
capital (Brazil), on foreigners’ government bond purchases and banks’
foreign exchange borrowing (Republic of Korea), and on interest income and
capital gains earned by foreigners (Thailand and Republic of Korea). Their
outcomes have been contested, with suggestions that some of these measures
were too marginal to be effective.


It is also not clear that this approach would provide sufficient protection
against the risks posed by the kind of unstable capital flows witnessed in
recent years. Thus, a broad array of measures to control the entry of non-
residents might be needed.


UNCTAD research suggests that controls over short-term capital inflows and
outflows should be part of the arsenal of public policy, to be used as and
when necessary to regulate currency movements, secure sufficient reserves of
hard currency, and maintain the exchange rate within reasonable levels,
rather than being introduced as ad hoc temporary measures. The instruments
available are well known. Many of them were widely and successfully used
during the 1960s and 1970s in the advanced economies, and more recently by
many developing countries (TDR, 1998). Over time, and across different
countries, they have included:



40 In this sense, productive investment acts like a social tax restricting the use of profits for the personal


consumption of the owners of capital, thereby making for less personal inequality and also bestowing
a degree of legitimacy on the broader pattern of income distribution. For further discussion of these
links, see TDR (1997).


41 http://www.imf.org/external/pubs/ft/spn/2010/spn1004.pdf


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(a) Licensing, ceilings on foreign participation, and differential rules
on the establishment and operation of foreign financial institutions;


(b) Taxes, administrative limitations and compulsory deposits – on
foreign currency bank accounts, on currency transfers, on
foreigners’ purchases of government bonds, on bank borrowing in
foreign currency, and on interest income and capital gains earned
by foreigners;


(c) Controls on domestic borrowing linked to foreign currency
transactions, through the imposition of variable bank reserve
requirements and ceilings on foreign holdings of debt issued by the
domestic private and public sectors;


(d) Limitation of offshore trading in the domestic currency, to prevent
speculation and foster the repatriation of domestic assets.


These measures carry costs as well as benefits, and the choice to use them
should reside with domestic policymakers after careful consideration of
circumstances and depending on local needs.


At a global level, a financial transactions tax has been proposed as a way both
to limit unruly flows and to provide funding for global public goods. This
was originally suggested by Keynes, and it was made famous by James Tobin
who proposed a small ad valorem tax on all spot transactions in foreign
exchange, including on forward and swap transactions. The impact of the tax
on volatility and revenue would depend on its size and incidence. However,
most proposals currently on offer would have only a modest impact on both
fronts. Despite this limitation, the political obstacles to such a proposal
remain deep.


See the following materials for additional details: TDR (1998); Epstein G,
Grabel I and Jomo KS (2004). Capital Management Techniques in
Developing Countries: An Assessment of Experiences from the 1990s and
Lessons for the Future. G-24 discussion paper no. 27. UNCTAD. Geneva;
IMF (2011). Recent Experiences in Managing Capital Inflows: Cross-Cutting
Themes and Possible Policy Framework.



110. Access to credit can complement the use of retained profits in financing productive
investment. However, left to themselves, private financial institutions often fail to provide
credit on a sufficient scale or on appropriate terms. In particular, sectors that have large
sunk costs or long gestation lags or high risks (such as infrastructure) are often starved of
finance even where it is understood that they are required to support growth elsewhere in
the economy. As a result, financial deepening needs to be properly managed by
policymakers, for example through selective equity stakes and directed credits, and in a
manner that supports building productive capacities (Chandrasekhar, 2008). The need for
appropriate regulation of the financial sector is relevant regardless of the ownership
structure of the financial institutions, e.g. whether they are state-owned or privately owned,
and in the latter case, whether the dominant interests are domestic or foreign. Development
banks have a potentially prominent role in supporting the profit–investment nexus in
developing countries by filling financing gaps, whether at near-commercial rates on a
general basis and on more favourable terms to selective sectors, and/or by providing other
investment support services (box 5).






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Box 5. Back to the future: The role of development banks


A key problem for developing-country governments is how to achieve policy
coherence and mobilize domestic resources in support of virtuous circles of
investment, productivity growth, and rising incomes. Commercial financial
institutions are part of the required institutional environment, but their
procyclical lending patterns, their focus on short-term profitability and the
widespread market failures in developing countries set limits on their
potential contribution. One possible alternative is national development
banks (NDBs), partially or wholly owned by the state. These are understood
as “financial institutions set up to foster economic development… taking into
account objectives of social development and regional integration, mainly by
providing long-term financing to, or facilitating the financing of, projects
generating positive externalities” (UNDESA, 2005: 9).


NDBs are far from unusual. Since the Industrial Revolution, but more often
since the Second World War, governments have intervened extensively in
financial markets to support capital accumulation through the mobilization
and (re)direction of financial flows towards priority sectors, regions or firms.
These experiences have been widely diverse in terms both of their forms and
their outcomes. However, in the wake of the balance-of-payments and other
crises taking place across the developing countries since the early 1980s, and
the ensuing structural adjustment programmes, there has been strong and
continuous pressure to privatize and liberalize the financial system and
transfer government control of resource allocation to private (often foreign-
owned) financial institutions. This has included winding down or privatizing
many NDBs.


A basic rationale for NDBs is that they can take externalities (i.e.
discrepancies between social and private returns) into account in their lending
decisions, and can lend in order to promote social inclusion and to maximize
long-term social welfare rather than short-term private profits. This can give
NDBs a pivotal role in catalysing catch-up growth through long-term and
large-scale strategic projects. These include infrastructure (energy, transport,
sanitation, housing and so on), agriculture, heavy industry, R&D (where
externalities are especially pervasive), the internalization of significant
production chains, national integration, regional development, import
substitution and export diversification. In sum, NDBs “can play a role in both
the creation of markets for long-term financing and in guaranteeing access to
financial services by the poor” (UNDESA, 2005). In contrast to private
commercial banks, development banks can also help to stabilize domestic
financial markets because they do not engage in speculative operations,
which can support the government during financial or balance-of-payments
crises.


NDBs are likely to be capitalized through tax revenues, however diversifying
the sources of funding (subsidized foreign loans or aid) will increase the
financial autonomy of the NDBs, avoid competition with other potential uses
of tax revenues and with the sources of regular bank funding (e.g. public
deposits and short-term papers), and reduce the maturity mismatches which
limit the capacity of commercial banks to finance development projects.


Once in operation, NDBs tend to engage in several types of operations,
including (a) project appraisal, taking into account social rather than private
rates of return; (b) provision of long-term loans, which is essential for
infrastructure projects, either to domestic investors or to a combination of


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domestic and foreign enterprises; (c) purchase of equity positions (shares or
options) to signal state support and commitment; (d) provision of expertise
and technical assistance to key sectors and strategic projects; (e) signalling
government support for specific projects, and catalysing private sector credit
into supporting ventures; (f) provision of countercyclical credit in order to
moderate economic fluctuations; (g) pooling of small private- or public-
sector (e.g. municipality) loans into negotiable packages; and (h) creation of
new mechanisms and markets for long-term lending.


The ownership structure and operations of NDBs can take very different
forms, which invariably change over time. For example, state-owned banks
have been pervasive in some advanced countries; in Germany and Japan they
account for credits equivalent – respectively – to 45 and 20 per cent of the
domestic market (in 2005). In Brazil, state-owned banks provide credit
directly to strategic firms, while in India they more usually take the form of
universal banks. In China, household retail deposits support the lending
programmes of the four main (state-owned) commercial banks. In most
countries, NDBs offer support to strategic sectors, such as the Banque
Nationale de Développement Agricole in Mali (agriculture) or the Banco
Nacional de Desenvolvimento Econômico e Social in Brazil (infrastructure,
heavy industry and the emergence of “national champions”). Other priority
sectors can include education, fisheries, health, manufacturing, mining,
tourism, and export-import activities. Experience shows no contradiction
between a developed and internationally integrated financial system and
extensive public sector intervention in the provision and direction of credit
flows.



111. Private firms are most likely to take the lead role in animating the profit–investment
nexus. However, this does not exclude a potentially significant role for public investment.
Rather, an important policy challenge for countries at all levels of development is to strike
an appropriate balance between the two. Reversing the declining share of public investment
that has occurred under FDG is likely to be a priority in many developing countries,
including the least developed (UNCTAD, 2010b; TDR, 2011). As will be discussed further
below, retooling macroeconomic policy to strengthen its capacity to mobilize financing for
long-term public investment and social development will require enlarging the fiscal policy
space by steadily broadening the tax base, where possible, making the tax structure more
progressive.


112. Finally, FDI can help catalyse and bolster the profit–investment nexus. To do so,
and as with large domestic firms, policymakers will need to monitor whether and to what
extent TNCs bolster the capabilities of domestic firms through, for instance, access to
finance and technological and other spillovers. At the same time, it is also important to
monitor potential negative consequences, such as net balance-of-payments impacts, or the
attrition of local companies in the face of competition with TNCs.42 A range of policies is
available to more assertive governments to make sure that the interests of TNCs, as much
as possible, coincide with national development objectives. Countries that have adopted
clear policies to guide FDI as part of their national development strategy do not appear to
have had much difficulty in attracting it: coherent national policies and good prospects for



42 On the balance-of-payment effects of FDI flows, see WIR (2006) and TDR (1999).


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growth remain the key attraction for TNCs, and at the same time increase the chances that
host countries will take advantage of TNCs’ presence.43


C. Trade, technology and industrial policy


113. As discussed earlier, strong links between investment and exports provide another
key link in building virtuous growth and development circles. The kind of investment–
export nexus compatible with sustainable growth and development is unlikely to emerge
automatically, even in the case of commodity exporters and labour-intensive manufacturers
where many developing countries have their greatest resource and cost advantages.
However, when it comes to building more inclusive and sustainable development paths, it is
not just the volume of trade that matters. Most countries appear to have diversified their
economies as they successfully move up the income ladder, before becoming less
diversified as they shift to a more service-driven economy at high levels of development
(see Imbs and Wacziarg (2003), and fig. 24). Such diversification appears to be closely
linked to improving employment conditions and bolstering economic resilience to external
shocks. The policy challenges will increase considerably as the production process becomes
more scale- and knowledge-intensive, since the technological and organizational
capabilities required to compete internationally are becoming more costly to acquire and
more difficult to master, and the investment climate is becoming more challenging.


Figure 24
Diversification and economic development



Source: UNCTAD secretariat, based on the World Bank’s World Development Indicators
(2010).


Note: Diversification is 1/Herfindahl-Hirschman Index.



43 For further discussion of the kinds of policies needed to ensure that FDI brings about wider


development gains, see various editions of WIR, as well as TDR (1996) and the Economic
Development in Africa Report (EDAR) (2005).


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114. The middle-income trap, as discussed earlier, has become a reality for a number of
countries under FDG, particularly where trade in manufactures (and services) is tightly
organized around international production networks. The danger is that countries are stuck
with a narrow structure of production which is difficult to broaden and deepen. A vibrant
industrial base, robust local markets and a dynamic enterprise sector are essential if FDI is
to contribute to a continuous process of economic and technological upgrading. Countries
where an inflow of FDI has been accompanied by significant investments in building
domestic capabilities (e.g. China, Ireland and Singapore) have been the most successful in
leveraging the potential benefits of FDI (Harrison and Rodríguez-Clare, 2010).


115. Accordingly, there is a need for policymakers to continuously promote investment in
activities with potential for raising productivity growth and with strong backward and
forward linkages both within and across borders. Macroeconomic policies, including
exchange rate and interest rate policies, can certainly have a strong bearing on the pace and
direction of structural change (Rodrik, 2010), although their impact tends to be “horizontal”
(or cross-sector). By contrast, industrial policy is “vertical”, aiming to produce
differentiated outcomes in order to promote expansion of the sectors and activities with the
greatest potential for generating economies of scale, upgrading skills and raising
productivity. However, a continuous process of structural transformation and upgrading
will almost certainly require the constant interaction of these policies; aggregate investment
can be boosted through the expansion of sectors with strong backward and forward linkages
to the rest of the economy, while industrial policies can help to strengthen the profit–
investment nexus, boost the fiscal base, and ease the balance-of-payments constraint.


116. As discussed earlier, FDG has often failed to generate the required productive
linkages in developing countries. This is not so much because FDG has shunned industrial
policies, but (as with macroeconomic policy) because its preferred measures – privatizing
state assets, attracting FDI, promoting SMEs etc. – were subordinate to the task of getting
prices right. This approach lacks the strategic focus needed for establishing a more dynamic
development path, does not actively extend support for the absorption, diffusion and
upgrading of technologies, and does not alleviate the balance-of-payments constraint.


117. In most developing countries, a much more expansive and active industrial policy is
required to support, direct and coordinate the processes of capital accumulation and
structural transformation. This is not synonymous with public ownership or picking
winners, although these are not precluded; rather, it is part of a process of coordinated
search and discovery, whereby firms and governments uncover market failures, learn about
the underlying costs and profit opportunities associated with new activities and
technologies, evaluate the possible externalities associated with particular projects, and use
the acquired information and skills to push towards a more diversified and higher-value-
added economy.


118. Successful industrial policies have often targeted the expansion of capital- and
knowledge-intensive sectors with high technological sophistication, supported strategic
forward and backward linkages and aggregate demand growth, and relaxed the balance-of-
payments constraint through the creation of new competitive advantages. These strategic
sectors tend to be concentrated in manufacturing.44 However, as these features are present
in other sectors of the economy in many developing countries, and particularly LDCs, these
policies will more likely depart from priority areas in agriculture, because of their economic
significance, potential linkages to other sectors, importance for the balance of payments,
and the fact that large numbers of poor people still live in rural areas (LDCR, 2009).



44 The capital goods sector remains, in this respect, key to diversification in many middle-income


countries. See Lo and Zhang (2010) for a discussion of the importance of this sector to the recent
Chinese growth story.


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119. Specific constraints that must be addressed in order to raise growth prospects in the
rural economy include poor soil fertility, limited access to seeds at affordable prices,
limited availability of water, lack of appropriate crop technologies, and gender-biased
property rights. There are no quick or general solutions, but macroeconomic and exchange
rate policies can be used to reduce income instability and raise the relative profitability of
different activities. Beyond these horizontal measures, effective policy intervention might,
depending on circumstances, require reforms to the land tenure systems, the provision of
extension services, tailored financial institutions to provide credit, and significant
investments in physical and social infrastructure, including irrigation, rural roads, and
storage and transportation facilities. Still, it remains the case that even in predominantly
rural economies, there tends to be a strong positive correlation between the growth of
manufacturing output and the growth of productivity in manufacturing as well as non-
manufacturing activities. In countries that have experienced “premature
deindustrialization”, as has been the case in sub-Saharan Africa, simply recovering lost
ground in manufacturing is likely to bring rapid productivity gains.45


120. A comprehensive industrial policy framework should consider the following
elements (TDR, 1996 and 2006):


(a) A managed financial sector, including both private and state-owned
institutions, to help mobilize and protect savings, and to bolster profits for
productive investments particularly in priority areas (e.g. using preferential
credit conditions and measures to help socialize risks on long-term
projects).


(b) Subsidizing the early stages of new products or technologies, including
through favourable fiscal measures, public R&D funds, training schemes
and other measures to bolster human capital development.


(c) Sectoral dialogues between businesses and the government, to identify
investment opportunities that might be vulnerable to coordination failures
or to other kinds of market failure.


(d) General and strategic trade measures, including export incentives, targeted
import restrictions, support in meeting international product standards, a
competitive exchange rate etc. to help firms take advantage of foreign
market opportunities.


(e) The use of public spending to support strategic sectors, including through
government procurement (such as tendering and reverse auctions), and the
use of public investment to remove general growth bottlenecks, especially
in infrastructure.


(f) Competition rules and targeted policies to regulate market power, manage
entry into key growth sectors, address coordination failures, and promote
knowledge development, including in intellectual property, with the aim of
maximizing learning spillovers.


(g) Targeted regional measures to address geographical inequalities –
including tax incentives and regional funds, as well as support for local
skills development to attract investment.



45 Moreover, it is essential to begin absorbing the rapidly expanding urban population into the formal


economy. For a more detailed discussion of the specific industrial policy challenges in LDCs and
Africa, see TDR (1998), LDCR (2009) and EDAR (2011).


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121. There has, in recent years, been a tendency to restrict industrial policy measures
through multilateral, regional or bilateral agreements (TDR, 2006; Rodrik, 2007). However,
some countries have carefully crafted their international commitments (see, for example,
WIR (2011), chapter 3), and there still remains scope for many of these policies, especially
if countries do not give up policy space any further. Just as importantly, because these
policies work by creating, directing and withdrawing rents to the private sector, there are a
number of institutional factors which appear to be important for their success and whose
absence can help to explain the failure of past efforts in developing countries. First, the
rents created by these measures should be provided only to productive activities that
support the broader national economic strategy and on a temporary basis. Second, these
rents should be made available only as a condition of enhanced performance, especially
with respect to exports and technological upgrading. Third, an appropriate structure of
public institutions and, not least, a dedicated and competent public bureaucracy is required
to manage these rents (see below). Fourth, strong counterparts in the private sector are
needed to coordinate with the government, facilitate information exchanges, and resist
short-term pressures which could undermine these development policies. Large, diversified
business enterprises that have close, interlocking ownership relationships with banks
provide one such model.


122. Development strategies should also, albeit with appropriate limits, look to constantly
push the technology frontier by incorporating selected high-productivity projects with a
more advanced technological and skill profile and with higher levels of R&D. Doing so can
be linked to investments in tertiary education, science parks, or efforts to attract a skilled
diaspora abroad with the hope that there will be transfers of expertise elsewhere through
changing jobs or opening small businesses. UNCTAD has argued that a national innovation
strategy can help coordinate the various activities and policies, in both the private and
public sectors, in support of the stronger knowledge and learning capacities that are needed
to close technological gaps (LDCR, 2007).


123. At all levels of development, strengthening non-tradable sectors will also have a role
to play in ensuring inclusive growth. These include infrastructure (roads, ports and airports,
electricity generation and transmission lines, housing, water and sewerage provision),
which might benefit from large-scale public works programmes, as well as lower-
productivity sectors including construction, repair workshops and non-durable consumer
goods industries, which have a significant employment-generating potential and train
entrants to the labour markets. It should be clear that in these sectors there are potential
trade-offs between boosting productivity and expanding employment. How best to manage
those trade-offs cannot be determined outside particular circumstances.


124. What seems abundantly clear from an examination of success stories is that the
investment and industrial policy challenges have been approached in an integrated fashion
as part of a broader development vision of progressive structural changes and rising living
standards. This requires the presence of institutions that can fashion a vision of the national
interest that is not limited to those with privileges and vested positions in the status quo.
Political leadership and effective governance structures to build and sustain support for
inclusive development paths is, as a consequence, a crucial ingredient for the prospects of
their success.


125. The challenge of industrial policy is likely to take on even more importance as
efforts step up to create a low-carbon future and for which policies focused on specific
sectors – particularly energy, transport, and extractive industries – will be critical.
Currently, many countries still have policies favouring high-emissions sectors. A logical,
though not easy, first step would be to reorient support from these sectors towards
renewable and/or cleaner energy sources. The lead will need to come from advanced
countries, whose emissions have contributed most to the problem of warming temperatures.


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But in all cases, taking that step will involve the kind of integrated approach to
macroeconomic and industrial policy outlined in this section.46


D. Developmental states


126. Active macroeconomic and industrial policies are often seen with scepticism
because of concerns that the state, especially in poor countries, is “too inefficient” or that
civil servants are “too corrupt” to implement discretionary policies successfully. There are
undoubtedly failed policy experiments to point to, but concentrating on these is often driven
by an ideology which either ignores or deliberately aims to obscure the policy successes in
countries, at all income levels, in nudging and bending as well as supplanting market forces
in order to achieve their economic goals.


127. Despite any number of shortcomings, the state remains the only institution that can
manage large-scale economic and social change, that can influence the aggregate level of
employment, the production and allocation of goods and services and the distribution of
income and assets, that can limit the power of sectional interests, and that is (or at least is
potentially) accountable for its decisions. Institutional weaknesses and governance deficits
must be confronted at every level of development; the history of today’s advanced countries
is one of constantly reforming corrupt bureaucracies, inefficient markets and weak state
institutions while building up effective public services.47 Regardless of its preferred policy
goals and instruments, any successful state must be able to strengthen its own capacities to
promote learning and cooperation and to deepen the institutional networks that are needed
by non-government actors to support long-term growth and innovation, especially where
market failures are rife.48


128. Developmental states have not been unduly concerned with ownership or direct
control of large parts of the economy, but with the design of policies and incentives in
support of rapid and broadly shared growth.49 The key features that discriminate between
the institutions that have promoted sustained catch-up growth and those that have not,
including in the era of FDG, are related to the state’s capacity to coordinate different
interest groups, generate confidence in its actions and behaviour, and establish national
development as an urgent overarching project. Successful states have enhanced their
competencies through the development of structures of accountability; through continuous
improvements to staff recruitment, promotion, compensation and training; and through the
introduction of (semi-)public institutions and other types of partnerships, particularly with
industry associations, but also with trade unions, universities and research bodies. They
have also created regulatory and supervisory bodies, often with significant degrees of
independence from the political process, to provide the rules and surveillance that help
markets to operate, while seeking to minimize possible microeconomic and macroeconomic
distortions.



46 For further discussion of the role of industrial policy in promoting low-carbon economies, including


the advanced role of a number of developing countries, see UNDESA (2009), TDR (2009), WIR
(2010) and UNCTAD (2011c).


47 On Britain and France in the nineteenth century, see Wraith and Simpkins (1963); on the United
States in the early twentieth century, see Glaeser and Goldin (2006); on Japan, see Johnson (1982);
and on the small European economies, see Vartianen (1995).


48 For a useful comparative assessment of different developmental state arrangements, see Akyüz, ed.
(1999), Kohli (2004) and Omano (2010). Douglas North (2004) has used the term “adaptive
efficiency” to refer to political arrangements that encourage change through a process of participation
and cooperation. Accordingly, North places a strong emphasis on institutional arrangements that are
predisposed to learning and experimentation as a condition for long-term growth and development.


49 Government spending is not, therefore, a good measure of state intervention.


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129. Building upon this idea of continuous adaptation to shifting economic
circumstances, the notion of the developmental state grew in relevance through its
perceived role in the industrialization of several East Asian economies, with Japan as the
classic precursor, followed by the four “tigers” (Republic of Korea, Taiwan Province of
China, Singapore and Hong Kong) in the 1960s and 1970s (TDR, 1994). These were
followed, in turn, by Malaysia, Thailand, Indonesia, China, Viet Nam, and others. In all
these cases, the state created a predictable economic environment with reasonably secure
property rights, a prominent role for market competition based on technological advantages,
and a broadly pro-investment stance. These states also invested heavily in human capital.
This has been referred to as “market-enhancing governance” (Khan, 2009).50 However,
albeit with varying degrees of success across these countries, the basic bargain between the
state and business went well beyond providing these conditions; it also increased the supply
of investible resources, socialized long-term investment risks, and provided support
services in such areas as technology, training and exporting. State-sponsored accumulation
and technological progress involved, variously, the transfer of assets from less to more
productive sectors, control of the financial system, obtaining foreign technologies and
adapting them to local conditions, a pro-investment macroeconomic policy, and direct
public investments in some activities along with selected priority investments to encourage
diversification and upgrading. These have been pursued within an integrated strategy based
on a shared vision of the country’s development, and have generally enjoyed broad, though
not unanimous, social consent, supported by institutional arrangements for continuous
dialogue and coordination with key stakeholders.


130. Successful developmental states exhibit a number of other important qualities other
than being open to dialogue. Particularly importantly, they have also been willing and able
to discipline the beneficiaries of state support. This has meant attaching clear performance
criteria – whether in the form of export targets, the replacement of imports, increasing local
content, or closing the gap between domestic and world prices – to that support, and
withdrawing it when firms eventually become competitive in international markets or if
they consistently fail to perform according to expectations. The weakness or absence of
such criteria, or their inconsistent application, appears to be one of the reasons why
industrial upgrading in Asia’s second-tier NIEs has advanced more slowly than in its first-
tier NIEs.51


131. Developmental states have also been willing and able to experiment with policy
choices. This reflects the realities of operating in an uncertain world where knowledge of
the best ways to promote economic growth and development is both limited and heavily
contextual. Experimentation, together with rules and norms to ensure that failed
experiments are dropped rather than continued, is thus crucial for raising the probability of
success for an adopted development strategy.



50 This is what many commentators refer to as “good” governance. As Khan (2009) shows in his


examination of cross-country correlations, there is a positive (albeit weak) relationship between good
governance and subsequent growth performance. However, this is explained by the performance of
advanced countries. Market-enhancing governance does not correlate positively with growth among
developing countries. This does not mean that it is not important – any country in which the market
plays a prominent role should be concerned with improving its efficiency through market-enhancing
governance – but rather that it is not sufficient for achieving catch-up growth.


51 For further discussion on the disciplining role of the state, and why some states appear to be better
than others in this respect, see Amsden (2001) and Wade (2010). The ability of the state to carry out
this function is likely to be made more difficult where TNCs have a particularly dominant role in the
economy. On the differences between the role of the developmental state in the first- and second-tier
NIEs, see the papers in Akyüz (ed.) (1999).


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132. Given the pressing need to build more inclusive development paths, as well as the
successes achieved in several countries over time, the notion that the poorest countries in
the world should wait until their state institutions are judged by others to be “good enough”
before they can exercise their national developmental prerogatives is both unrealistic and
destructive of the prospects for development (LDCR, 2011). There is no reason to suppose
that the stock of successful development strategies has already been exhausted, and
countries are likely to thrive in the future by discovering unique development paths
responding to their specific challenges (box 6).


Box 6. Inclusive growth in sub-Saharan Africa: An alternative agenda
At the beginning of the millennium, there was little doubt that the promises
of structural adjustment programmes had failed to materialize in sub-Saharan
Africa (SSA). The combination of macroeconomic austerity, rapid
liberalization, privatization and deregulation not only failed to produce a
supply-side revolution but, instead, set the region back economically;
productivity growth stalled in most sectors, and the informal economy had
grown rapidly since the onset of the international debt crisis in the early
1980s.


Since then, there has been much discussion of an African “economic
renaissance”. GDP growth between 2001 and 2008 averaged 6 per cent per
annum across the region, which translated into real per capita growth of about
3 per cent. Growth was also relatively widespread, and only a few economies
contracted during this period. There was a sharp downward swing in 2009 as
a result of the financial and economic crisis, but generally growth rates
remained positive, and there has been a rebound in many countries.


In light of these changes, IMF has talked of a “great SSA growth take-off”
attributed to the earlier structural and institutional reforms “that reduced state
controls and liberalized trade and domestic financial markets”. It has also
speculated that SSA could be the new financial frontier, with calls to
intensify financial liberalization and integration. Ignoring its own research on
the lack of empirical evidence linking financial liberalization to growth, the
Fund has also claimed that “there is general agreement that the kinds of
reform needed to curtail the power of entrenched economic interests and
liberate the productive potential of developing economies are also helpful in
attracting private capital flows and making these flows more productive”
(IMF, 2010).


While the growth spurt in SSA is a welcome development, the term “take-
off” is too strong to describe what has been happening across the region.
First, there has been wide variation in economic performance across the
region, with very rapid growth rates in some oil and mineral exporters, which
distorts the picture for the majority of non-booming-export countries.
Second, even during IMF’s chosen period (1995–2007), the number of fast-
growing countries (17) is matched by the number of slow growers (14).
Third, even under these exceptional circumstances, the average performance
for the region still lags behind that in East and South Asia for this period, and
the income gap with other developing countries has continued to widen – for
some countries sharply. SSA is still a long way from repeating the East Asian
take-off, and business as usual will not bring it about.


An alternative and pragmatic development agenda for SSA is needed to bring
about more inclusive and sustained growth across the region. Such an agenda
will need to be both more comprehensive and more integrated than was the


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case previously. It will, on the one hand, have to better connect
macroeconomic policies with the sectoral measures needed to effect
structural transformation, and on the other hand, construct a social agenda
beyond simply meeting the MDGs. This will require building a policy
framework around a strong growth–investment–employment nexus. It will
mean more active fiscal measures, including countercyclical measures and a
commitment to public investment. Monetary policy will also have an
important role to play, ensuring that interest rates remain low and exchange
rates remain stable and competitive. These policy instruments can help to
strengthen investment prospects, including in the agricultural sector, but they
will require support from development banks to ensure that credit is
effectively channelled, and capital controls to support an effective and stable
exchange rate regime.


Structural transformation will also require effective industrial policy.
Traditional aspects of this agenda, including dealing with market failures and
picking winners, need to be addressed, together with the creation and
management of rents. However, the absence of firms of an adequate size
remains an obstacle, not only to building a strong profit–investment nexus in
many African countries, but also to taking advantage of increased FDI flows
in some key sectors.


A key institutional challenge will be creating (or in some cases recreating)
developmental states in SSA. In doing so, it will be important to take lessons
from other experiences, even while recognizing that local conditions and
constraints are paramount in defining the context for rethinking the role of
the state. Success cases from the region, including Botswana and Mauritius,
provide useful lessons in this respect. However, as is the case in SSA,
external constraints remain tighter than in other regions. Emerging African
developmental states must also be ready to position themselves in the wider
regional context and beyond, including the establishment of South–South
links outside the region. Given the adjustments currently under way in many
advanced countries, this South–South agenda has arguably become much
more important than in earlier periods. It will necessarily involve both
augmenting strategic economic ties through trade, FDI, finance and
technology, and greater cooperation through the sharing of information and
policy lessons.


For further discussions, see TDR (1998) and the annual Economic
Development in Africa Report.



133. Still, securing the means to “govern the market” in support of inclusive development
will require the (re)construction of state policymaking and managerial capacity in many
developing countries, including reforms to administrative processes and policymaking.
Restoring an effective role for the state will, in many cases, require a break with the
adjustment programmes that accompanied FDG. Although the intention was often
otherwise, these programmes have in many cases led to a softening of state authority and its
capture by privileged insiders (Mkandawire, 2001). Honest, impartial and competent
administrative, fiscal and judicial systems are crucial, not only for upholding the rule of law
and limiting corruption, but also for building an atmosphere of trust in public institutions
without which any state is likely to prove highly fragile.


134. All this should not be taken to imply that states – developmental or otherwise – are
infallible, or even necessarily benevolent, but it recognizes that market economies can
operate efficiently within a wide spectrum of political and social arrangements, and that


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successful development strategies are moulded to local conditions and constraints.
Moreover, when market economies are compared over time, we see considerable shifts in
their political and social arrangements, suggesting that what works in one period may fail in
another, and that successful economies are those that have developed the capacity to adapt
their institutions and conventions to changing circumstances. This implies that, beyond a
few core elements, there is no homogeneous model of state–market relations. Each country
must experiment and find the configuration of institutions and conventions that will work
best in its national conditions, and meet the shifting expectations of its population at each
point in time.


E. From social protection to inclusive development


135. Successful developmental states have been able to rise to the investment and
industrialization challenges. However, doing so is not necessarily sufficient to establish an
inclusive development path. Experience shows that abject poverty has persisted despite
rapid growth in several economies; in contrast, some poorer and slower-growing economies
have been remarkably successful in alleviating extreme poverty and social deprivation
(Dagdeviren et al., 2002). The relatively equal distribution of income and wealth in several
Asian “tiger” economies and, before them, in the Scandinavian countries, demonstrates that
equality is compatible with strong economic performance.52 By contrast, high levels of
inequality in many Latin American economies have coincided with weak and uneven
economic performance. These lessons suggest that growth and social inclusion can be
pursued together with the aim of building a resilient social contract that can support
structural changes but also mitigate the social costs that often accompany the development
process (UNDESA, 2008; United Nations Research Institute for Social Development
(UNRISD), 2010).


136. The channels linking inequality and growth are many and complex. However, three
crucial variables for building greater inclusiveness into any policy strategy, and at all levels
of development, are the distribution of income, the employment content of growth, and its
gender dimensions. In light of the earlier discussion, measures to reregulate finance are
likely to have a direct and positive impact on stimulating a more inclusive pattern of
growth, including by impacting on all these variables, but also by freeing up policy space to
address them more effectively. This is particularly important in strengthening the
employment content of growth. In many developing countries, where the labour force is
expanding quickly, particularly in urban areas, job creation remains the only assured way of
tackling poverty on a sustained basis. However, for inclusive development, jobs must also
bring steadily rising household incomes and expanding local markets. In this respect, as
discussed earlier, the tendency under FDG for wages to lag behind productivity growth can
pose a major obstacle to inclusive development. In part, this reflects the recent additions to
the global labour force along with heightened mobility of capital, leading, under some
circumstances, to a race to the bottom. However, policy choices also matter; under FDG,
low levels of inflation and labour market flexibility have been given priority over job
creation and decent work conditions. More appropriate macroeconomic policies, along with
active labour market policies, can help to manage the cyclical threats to employment, and
also boost skills and capacities to ensure that workers can adapt to longer-term structural
changes. There is, in addition, an array of measures, from transfer payments and
microfinance schemes to public work programmes, that can be used to improve the
effectiveness of labour markets even in the poorest countries (UNDESA, 2008; ILO, 2011).



52 For a comparison of the East Asian and Scandinavian experiences, see Chang and Kozul-Wright


(1994), Yu (1999) and Moene and Wallerstein (2006).


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137. There is a close relationship between socio-economic development and women’s
empowerment. Economic policies, particularly those aimed at fostering market integration,
tend to impact on men and women differently, and development strategies should aim to
promote gender and other forms of equality, in order not only to increase social welfare and
facilitate the realization of human potential but also to improve the underlying performance
of the economy. It is often claimed that international trade offers opportunities for women’s
empowerment through employment in the export sectors, the production of cash crops, and
the creation of new businesses by women entrepreneurs. This is certainly true. However,
trade can also have a negative impact on women, if it disrupts economic sectors and
markets where they were active, or if it creates mainly temporary or seasonal low-paid jobs
with few opportunities for training and promotion and limited or no social security
provision. Indeed, on some assessments, gender inequality has been an important factor in
the unfavourable movement in the terms of trade between developed and developing
countries (Osterreich, 2007). The opening to international markets requires adaptation at
several levels, but women are often less able to adapt than men, due to gender biases in
education and training, gender inequalities in the distribution of income and command over
resources, and entrenched inequalities in the distribution of household tasks, which translate
into gender differences in occupational distribution and earning potential (box 7).


138. These variables are as important for building new and inclusive growth paths in
developed and developing countries alike. However, three particular issues for
policymakers in developing countries are likely to come to the fore. First, over half of the
labour force in many developing countries works in agriculture, often mixing paid
employment with work on their own small plots, with insecure conditions and poor
rewards. Experiences in Asia and Latin America (though less so in Africa) show that the
expansion of non-farm rural employment and improvements in job conditions for these
workers can have a large and immediate impact on household security.53 In the case of
China, for example, it has been found that growth in agriculture is 3.5 times more
successful in reducing poverty than growth in the non-agricultural sector, and the figure is
even higher in South Asia (United Nations Economic and Social Commission for Asia and
the Pacific (UNESCAP), 2008: 127). Public spending in support of this sector is therefore
key to the inclusive development agenda in many countries. However, particularly where
agriculture comprises mainly smallholders, the state will need to partner with producer
associations and other non-state actors to deliver support services.54


Box 7. Trade and gender


Millions of women in developing countries work in sectors such as
agriculture, textiles and clothing, which are not only important for export
performance but are also highly vulnerable to the impact of premature trade
liberalization. For example, between 50 and 90 per cent of workers employed
in the export sector of middle-income countries are female (OECD, 2005).
Women also play a significant role in informal cross-border trade. While
many of them pay taxes and duties, they are disproportionately exposed to
bribery, harassment and physical attacks at border points (UNIFEM, 2010;
World Bank, 2011). Additionally, women are more vulnerable than men to
shocks emanating from the trade sector, and empirical evidence shows that
trade liberalization can generate a greater adjustment burden for women.


Recognition of women’s contribution to trade and their exceptional
vulnerability have led to a growing interest in the relationship between trade



53 See Demeke, Guta and Ferede (2003), Gordon and Craig (2001), and Mugrai and Ravallion (2005).
54 UNCTAD has extensively researched the potential of organic farming, both for its economic and its


ecological potential. See, for example, UNCTAD (2006).


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and gender. A key issue is how to better integrate gender analysis (which
tends to focus on the household level, including women’s unpaid labour and
the gender wage gap) with a detailed analysis of the adjustment burden
associated with trade liberalization, and the implications for women’s
empowerment.


Initial concerns about gender being a “new” issue or another potential source
of conditionality are easing, as more governments realize the importance of
adopting a proactive stance to engendering trade. The reasons are twofold.
Firstly, there is recognition that gender equality is a commitment emanating
from international negotiations, including the Committee on the Elimination
of Discrimination against Women, the Beijing Platform for Action, and
various regional initiatives. Most governments are also committed to social
equity and social development objectives, including the MDGs. Secondly,
there is growing empirical evidence about the relationship between gender
and trade competitiveness, leading several governments to take action to
mitigate the adverse impact of technological disparities, market distortions,
information bias and asymmetries in resource mobility on women’s
productivity, livelihoods and empowerment. Government initiatives
promoting gender equality and women’s empowerment in the field of trade
include:


(a) The gender-sensitization of Uganda’s export strategy in
2007;


(b) The implementation of the East African Subregional
Support Initiative for the Advancement of Women
(EASSI) at five border points including Kenya, Rwanda,
South Sudan and the United Republic of Tanzania, as part
of its joint gender and trade project; and


(c) The Government of India has conducted a study on
gender and trade and is currently examining the scope for
a gender-based foreign trade policy.


Gender-related commitments need to be tailored to the economic and
political context of the countries involved. Gender and trade impact-
assessment tools could provide useful information on sensitive sectors where
trade liberalization should be expedited, delayed or avoided, with a view to
protecting or promoting women’s employment and women-owned
enterprises. In these sectors, training and educational policies and other
measures should be put in place to upgrade women’s skills, tailor their
market integration, and provide financing and technology to enable them to
move to higher value-added sectors.


Explicit references to gender equality in the trade agreements could also help
to increase the political commitment of key stakeholders, and may increase
the funding available for gender-related programmes of technical
cooperation, including the Aid for Trade framework. Such financing is
critical for the establishment of research capacity in the developing countries
to conduct gender impact assessments of trade agreements, to foster the
construction of gender-disaggregated databases, and to further encourage
developing-country governments to take ownership of gender-related policy
options, while enhancing the coverage of gender-related trade assessments.




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139. Second, in many developing countries, rapid liberalization and tight macroeconomic
policies have added to the informal labour market and contributed to downward pressure on
wages in the formal economy. Improvement of employment conditions depends on
increasing investment and accelerating economic growth. However, well-designed labour
market and workplace regulations can prevent a race to the bottom by restricting the ability
of firms to gain competitive advantages through the erosion of wages and benefits or
standards of safety and security in the workplace. Inclusive growth can be promoted
through steadily rising minimum wages (appropriately tied to productivity and inflation
rates), coupled with incentives for improving the incomes of small-scale producers (such as
credit subsidies), improved health and safety regulations (and the means to enforce them),
and the reduction of wage dispersion. The introduction and design of such measures will be
country-specific, but will in all cases require the developmental state to engage in an open
and continuous extended dialogue with relevant interest groups, including organized labour,
much as it has done with business interests. Under some circumstances, and where the
institutional conditions are in place, an incomes policy can serve as a useful framework for
combining fast growth, employment creation and rising living standards (TDR, 2010).


140. Third, the state can create markets, including through government procurement and
public sector investment in education, training and health programmes, and can boost
aggregate demand and crowd in private investment. How these are managed will impact on
developmental and poverty reduction goals, especially in economies operating below
potential (UNCTAD, 2010b). In particular, universal development-oriented social
programmes, unlike targeted programmes and safety nets, can have a significant impact
against different modalities of poverty and exclusion. Programmes including environmental
preservation, and the provision of public education and training, health, water and
sanitation, housing, transportation, parks and public amenities, food security and affordable
clothing can have relatively low managerial costs and improve the standard of living of the
poor (EDAR, 2002). Cash transfers can also support vulnerable groups, including single
parents, children, senior citizens, and those suffering from chronic illnesses or disabilities,
who may have few alternative sources of income. These transfers have also been shown to
support regional development through the generation of employment in deprived areas and
the expansion of markets for local produce (UNDESA, 2008).


141. In countries that have already built state capacities in support of development, the
administrative infrastructure required to manage universal social programmes is also likely
to be in place, or can be created relatively quickly. In other cases, this will be part of a
wider effort to establish a developmental state. Public goods and social wage programmes
can be rolled out gradually, for example one product or service at a time, or in selected
regions, making them relatively simple and cost-effective. Despite their universal coverage,
they can incorporate several advantages of narrowly targeted programmes, which may be
called “smart targeting”: they are universal because they are available to all, and they are
targeted because distinct social groups are affected differently by each project or initiative.
These welfare programmes are not optional extras; they are essential components of an
inclusive development strategy, because they support productivity growth, skills
development, and the growth and stabilization of demand as the economy is transformed
through rapid economic development.


142. Universal social programmes have been criticized for creating incentives leading to
overconsumption (e.g. free health services could lead to unnecessary consultations) or to
manipulation by unscrupulous politicians. This is possible, but it can be minimized by
“smart targeting” and the introduction of democratic mechanisms of accountability for


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public policy.55 Private (including foreign) providers can in some cases supplement state
efforts in this area. However, the commercialization of health or education services through
certain types of public–private partnerships or outright privatization can, particularly in the
absence of appropriate bureaucratic capacity, be costly for the state, unreliable in terms of
impact, and unaccountable to the citizens (Akitoby et al., 2011).


143. The influence of market forces on the provision of public goods can become
especially destabilizing if the goods are financialized, that is, if provision is mediated by
financial transactions or financial markets.56 For example, privatization can dilute the social
priorities of utility companies through the imposition of fees (e.g. for sanitation) or other
restrictions on use (e.g. healthcare services or water), or it can subject the providers to the
vagaries of the stock market and the threat of takeover, with the attendant pressures for
subcontracting, downsizing, break-up, investment cutbacks, or deterioration of standards of
service in order to beef up short-term profitability.


144. The financing of public investment and social programmes is bound to be
challenging in most developing countries. Unlike the measures to support productive
investment and structural transformation, such programmes involve the state in the
mobilization of a much larger share of national resources. While there are some broadly
regular features linking state expenditure and development, trust and credibility are key to
the effective delivery and management of public services.57 Building that trust, in many
countries, is likely to require the modernization of the tax system, the expansion of the tax
base, and the development of financial markets to finance the public sector debt on a
sustainable basis. It is impossible to sustain ambitious public sector initiatives with tax rates
much lower than 20 per cent of GDP, as is often the case in poor countries. Tax revenues
play a fundamental role in the mobilization of resources for the allocative, distributive,
growth and stabilization functions of the state, especially in the light of the weakness of the
financial systems in poor countries and the persistent volatility of commodity prices and
international aid flows. Research shows that there is scope for raising tax revenues in poor
countries and, simultaneously, expanding fiscal space and shifting the tax systems in a more
progressive direction (TDR, 2011). This will require the enforcement of tax laws and a
reduction or elimination of the scope for capital flight and the deductions, exemptions and
loopholes favouring the well-off, financial-sector interests, and TNCs. For many poorer
developing countries, it is also important to recognize that trade taxes remain an important
component of revenue generation, and that the efficiency gains from liberalization can be
offset by revenue losses.


145. In sum, inclusive development will depend on the integration of growth-promoting
macroeconomic policies with developmental industrial policies and redistributive measures.
These elements must be combined with a social protection framework aiming at the
elimination of the causes of poverty and exclusion: dispossession from the land; lack of
decent employment, and poor housing, education and health provision. These are ambitious
targets, but they have been achieved in several countries. In contrast, in developing



55 In the case of East Asian developmental states, selective welfare developmentalism involved a


combination of state, market and family institutions to advance social policy, often to secure political
stability and support. See Kwon (1999).


56 The term public–private partnerships (PPPs) has become increasingly popular among the donor
community. However, this covers a very broad range of approaches, and if the record of advanced
countries is any indication, an equally wide array of outcomes. An independent assessment of PPPs in
the development context would be a useful exercise in mapping out what might work and under what
conditions.


57 There is, for example, a strong positive correlation between per capita income and government
spending (Wagner’s Law), as well as between trade openness and the size of government. There is
also an inverse relation between government revenue and the size of the agricultural sector.


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countries lacking a vision of a more inclusive future, the resources needed to extend social
protection have often been wasted, or they have lagged far behind policy pronouncements,
leaving gaps in coverage and quality, as well as dashing expectations and fuelling
discontent.


F. A global New Deal


146. Since the international debt crisis of the early 1980s, most developing countries have
increased their integration with the global economy. Their commitments have included
trade and capital account liberalization, adherence to WTO and WTO-plus trade
agreements, incentives to attract FDI, tighter intellectual property laws and so on. They
have done this against a backdrop of slowing global growth, an increased incidence of
economic crisis, and widening gaps within and across countries – all of which can be
traced, in varying degrees, to FDG.


147. Suggestions for a more measured pace of integration have often been resisted,
particularly at the international level, and portrayed as a sign of reluctance to implement the
reforms required to compete globally. However, and as argued previously, the countries
that have made the strongest gains under FDG have pursued a discretionary and strategic
integration with the global economy rather than adopting wholesale policies of
liberalization and financialization, have placed considerable emphasis on industrial
development, and have, in many cases, looked to strengthen their economic ties with
neighbouring countries. In doing so, they have often gone against conventional wisdom.


148. For many other developing countries, the international trade and finance system that
evolved after the debt crisis has not only broken with the flexibilities of the post-war
system, it has failed to provide sufficient financial and technological resources to enable
them to achieve rapid and inclusive growth. Indeed, under present arrangements, most
countries almost invariably find themselves obliged to adjust to the shocks associated with
FDG through domestic retrenchment. IMF has abandoned the objective of stable exchange
rates in an orderly international financial system, or rather, has entrusted that stability to
market forces, and while its surveillance activities have been increasingly tied to financial
crisis management and lending, it has a patchy record in detecting mounting fragility and
issuing timely warnings. The World Bank has also retreated from its principal aim of long-
term infrastructure lending in favour of adjustment lending and poverty reduction. Much
like IMF, its surveillance activities have shifted as a result, away from project
implementation and the creditworthiness of borrowers, and more to adherence to detailed
policy programmes in line with market-friendly development strategies (Ahluwalia, 1999:
3–5).


149. Developing countries have, in response, consistently called for more predictable
multilateral resources to support their integration efforts, for more flexibility to tailor
policies to local needs and conditions, and for greater coherence across the overlapping
international trade, financial and production systems. Building these aims into the
multilateral architecture will be essential to achieving DLG. This does not, however, mean
simply returning to the earlier Bretton Woods system, even if this were possible. The post-
war global deal was never completed in areas of particular interest to developing countries,
and the flexibilities allowed to countries were often established on an ad hoc basis rather
than as a formal part of the rules themselves. Indeed, given the much more variable
geometry of today’s global economy, combining effective multilateral rules and disciplines
with appropriate policy space is a major challenge facing the international community.


150. The need for reform is not only in the interest of developing countries. The crisis has
made it clear that the advanced countries also need policy space to manage changing
circumstances, and that they can no longer guarantee a stable global economy or deal with


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new and interrelated threats to future prosperity by themselves. Moreover, if they are to
avoid damaging deflationary adjustments, return quickly to robust growth, and ensure that
the international trading system remains open, they also have a direct interest in
strengthening international coordination and support, and in an inclusive manner.


151. Just as much as at the domestic level, these overlapping interests cannot be
effectively united by muddling through or a return to business as usual. The rebalancing
challenges at the heart of DLG will need a global new deal involving a large and diverse
group of economies, and must reflect the ongoing shifts in the distribution of economic
power and political influence among countries. Unfortunately, the degree of trust among
countries that is needed in order to manage appropriate collective responses and actions and
deliver reliable development cooperation for the most disadvantaged members of the
international community has been gradually eroded during FDG and has been hit even
harder as a result of the financial crisis, and is in urgent need of repair.


152. The idea of a global New Deal alludes to the rebalancing efforts that a number of
countries undertook during the 1930s in response to a deeply destructive financial crisis.58
In the case of the United States, a series of interconnected public investments in energy,
agriculture, and social infrastructure, along with strong regulation of financial and labour
markets and expansionary macroeconomic policy, laid the foundation not only for a return
to full employment but for a strong industrial take-off in some of the most underdeveloped
parts of the country, crowding in substantial private investment and building local markets
through a virtuous growth circle.


153. Today’s global New Deal should also look to lift all boats, through support for
productive investment, economic diversification and expanding markets. However, it goes
without saying that coordination at the international level is very different from national-
level programmes, given that representative governments are being asked to surrender some
measure of their sovereignty in support of collective actions and goals. It is imperative,
therefore, for international measures to be designed in such a way that they complement or
strengthen state capacities to deliver on national objectives and meet the needs of their
constituencies. If reforms to the existing multilateral architecture are to be credible and
effective, they must provide for much greater collective influence from developing
countries and embody a much stronger sense of cooperation among all countries. This will
require rethinking the global agenda, and, in particular, a willingness to examine
rebalancing challenges from a much more integrated perspective. It will also require careful
examination of the structure of representation in the existing multilateral trade and financial
institutions and their decision-making practices.


1. Taming finance


154. Taming finance is the place to begin rebalancing the global economy. It is now
generally recognized that financial liberalization was pushed too hard in the 1990s, that
global surveillance failed to pick up the emerging imbalances that built up under FDG, and
that multilateral arrangements lacked the resources, authority and ideological orientation to
prevent the build-up of financial fragility (IMF Independent Evaluation Office, 2011). We
have been here before. After the Asian financial crisis in the late 1990s, a series of
proposals were put forward to reform the international financial system (TDR, 1998;
Rogoff, 1999). These were resisted (particularly by developed countries and international
financial institutions) and subsequently stalled, and were then largely forgotten as the next



58 The New Deal was, strictly speaking, a term coined to refer to a series of initiatives of the Roosevelt


administration in the United States. However, similar initiatives which shaped an alternative
development model can be found across a number of countries starting from the early 1930s, even
though they only took off after the end of the Second World War.


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boom in capital flows took hold. Instead, a series of ad hoc arrangements was adopted. This
included self-insurance through reserve accumulation, along with various codes and
standards to help strengthen domestic financial systems in debtor countries, enhance these
countries’ macroeconomic and financial policy formulation, and improve the collection and
disclosure of information. While such measures can be beneficial, they have not been
sufficient to address macroeconomic imbalances or recover financial stability, and in many
cases have involved substantial costs (TDR, 2001: 79–107; and TDR, 2011).


155. A much more ambitious reform agenda for the international financial system is
clearly necessary if it is to bring about lasting stability and support the shift to a truly
development-led globalization. This should include the following elements:


(a) Measures to align and stabilize exchange rates, particularly among the G-3
currencies, are urgently needed. This will likely involve moving away from
a dollar-based payments system, stronger surveillance of the
macroeconomic policies of reserve currency countries, the promotion of
capital controls, and the possible use of exchange rate target zones (TDR,
2001 and 2011). However, to the extent that some of these reforms will
take time to implement, regional monetary arrangements might provide a
useful option for developing countries (see below).


(b) A more balanced approach to sovereign debt restructuring is needed,
including arrangements spreading the burden of adjustment more equitably
between borrowers and private sector creditors (box 8). The use of
“bailouts” to deal with financial crises has proved very costly and has
created moral hazard. Furthermore, the funds required have been getting
larger and more difficult to raise.


(c) The expansion of multilateral financial resources in line with the growth of
cross-border transactions, bringing them to a level sufficient to undertake
effective countercyclical financing and to deal with payment difficulties
that emerge on the capital account. The recent tripling of IMF funding
marks progress in this direction, but it is also necessary to move towards
more reliable and less politicized ways of creating international liquidity
(box 9).


(d) A pruning back of the policy conditionalities that have mushroomed
around adjustment and crisis lending. These have imposed a deflationary
bias on borrowing countries and reduced the policy space to manage crises
and launch sustainable recoveries. The international financial institutions
should, instead, help developing-country policymakers to identify trade-
offs, examine the policy options, and draw upon the experiences of other
countries. 


Box 8. Dealing with debt


The ongoing global turbulence has highlighted the need for new approaches
to external debt management and debt crisis prevention. Although attention
should continue to be paid to debt sustainability indicators, including fiscal
balance, these do not seem to be sufficient. There was unprecedented risk-
taking by lenders and borrowers during the boom years before the crisis, with
responsibility and accountability missing on both sides. Global financial
interconnectedness has made contagion swifter, more severe, and larger in
scale. The interlinkages between the financial sector and state budgets have
made the assessment of contingent liabilities especially challenging. The
change in debt composition, from predominantly syndicated bank lending to


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bond financing, has increased financial instability during crises, as
marketable securities can change hands much faster, making herd behaviour
both more prevalent and more damaging.


Worse still, there is currently no early warning system for public or private
debt-servicing difficulties, even in cases where default could have systemic
implications. The rating agencies are supposed to be whistle-blowers, but all
of them failed in the run-up to the current crisis. Indeed, as these agencies
have no liability in case the market proves them wrong, they have an
incentive to bias credit ratings upwards in order to satisfy their customers.
This is most clearly seen in the case of private instruments, but a similar
effect could, arguably, be observed in the overrating of the sovereign debt
instruments issued by financially fragile states before the crisis. UNCTAD
(2008) has proposed subjecting these agencies to regulatory oversight, and
regularly publishing their rating performance.


In 2009, UNCTAD started an initiative to establish principles of responsible
sovereign lending and borrowing, in order to reduce the frequency and
severity of debt crises. This process has been inclusive and transparent, with
the participation of a range of stakeholders – including experts in economics
and law, senior representatives of the private sector, non-governmental
organizations, and observers from the multilateral financial institutions. In
May 2011, a set of draft principles was released by UNCTAD specifying the
key responsibilities of lenders and borrowers, including due diligence,
fiduciary duty, proper approval, transparency and disclosure, and alternatives
for debt restructuring. In view of the heterogeneity of national conditions,
these principles do not include specific thresholds or quantitative targets.
However, they offer economic, legal and moral guidelines for lending and
borrowing, and their adoption has been encouraged by the United Nations
General Assembly (resolution 65/144). As with any set of voluntary
standards, free riding and enforcement will pose significant challenges, but in
the absence of effective global action, the burden of coping with international
financial instability will continue to fall mainly on developing-country
governments.


UNCTAD has also been a long-standing advocate of orderly debt workout
procedures drawing on national bankruptcy laws, notably chapters 9 and 11
of the United States bankruptcy code. These procedures should meet two
objectives. On the one hand, they should help prevent financial meltdown in
countries facing difficulties servicing their external obligations, which often
results in a loss of market confidence, currency collapse and drastic interest
rates hikes, inflicting serious damage on public and private balance sheets
and leading to large losses in output and employment and a sharp increase in
poverty. On the other hand, they should provide mechanisms to facilitate an
equitable restructuring of debt that can no longer be serviced according to the
original contract. These goals need not require fully fledged international
bankruptcy procedures, but simply the application of a few principles:


(a) A temporary standstill, whether debt is public or private, and
regardless of whether the servicing difficulties are due to
solvency or liquidity problems (a distinction which is not
always clear-cut). In order to avoid conflicts of interest, the
standstill should be decided unilaterally by the debtor country
and sanctioned by an independent panel, rather than by IMF,
since the countries affected are among the shareholders of the


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Fund, which is itself also a creditor. Sanction should provide an
automatic stay on creditor litigation.


(b) Standstills should be accompanied by exchange controls,
including the suspension of convertibility for foreign currency
deposits and other assets held by residents as well as non-
residents.


(c) Provision of debtor-in-possession financing, automatically
granting seniority status to debt contracted after the imposition
of the standstill. IMF should lend into arrears for financing
imports and other vital current account transactions.


(d) Debt restructuring including rollovers and write-offs, based on
negotiations between the debtor and creditors, and facilitated
by the introduction of automatic rollover and collective action
clauses in debt contracts. IMF should not be involved in the
negotiations between sovereign debtors and private creditors.


Although these principles leave open several details, they could serve as the
basis for a coherent and comprehensive approach to crisis intervention and
resolution in the early twenty-first century.



Box 9. Special drawing rights


International monetary cooperation, orderly exchange rate arrangements and
confidence in the availability of liquidity are necessary for the continuing
growth of international trade, and to ensure that balance-of-payments
adjustments are achieved “without resorting to measures destructive of
national or international prosperity” (IMF Article I (v)).


One of the principal goals of the architects of the Bretton Woods system was
to ensure the provision of international liquidity. It is common knowledge
that an international reserve system based on a national currency (or on a
basket of national currencies) cannot provide for an orderly global monetary
environment, because national central banks are primarily committed to
national targets. However, the decisions taken by those central banks issuing
international reserve currencies strongly affect all other countries; for
example, international liquidity can fluctuate because of domestic
imperatives, regardless of global needs. FDG has failed to address this
problem. Instead, it has introduced a deflationary bias in the world economy
and forced many countries to take out expensive “self-insurance” through
reserve accumulation, whereby resources that might support socially
desirable goals are transferred by the developing countries, at low interest
rates, to the developed countries which issue reserve currencies simply to lie
dormant in case of future need.


There has been considerable discussion about establishing a global reserve
currency in parallel with national currencies. This could be arranged in
different ways, but the most practical way is to build on existing mechanisms
to support an expanded role for special drawing rights (SDRs), or expanded
SDRs. Under present arrangements, SDRs are allocated to member countries
in proportion to their IMF quotas. Members obtain or use SDRs through
voluntary exchanges, or by the Fund designating members with strong
external positions to purchase SDRs from those wishing to use their allocated
SDRs. When members’ holdings rise above or fall below their allocation,


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they either earn or pay interest, with the interest rate being determined as the
weighted average of the money market interest rates in the currencies
constituting the SDRs. Any increase in the supply of SDRs should obey some
basic principles: it should accommodate global growth, so as to meet global
demand for reserves; it should be flexible enough to operate in a
countercyclical manner; it should include both liquidity finance and
incentives for surplus countries to share the burden of adjustment; and it
should include what UNCTAD has called a “development link”, or incentives
for the use of reserves to finance expenditures related to development and
climate change.


The low cost and other advantages of SDRs have given rise to calls for their
regular distribution to poor countries to ease the burden of holding reserves.
Regular allocations of SDRs are certainly the most straightforward way to
raise developing countries’ share in reserve assets and help address the
inequities in the current system. Allocations should be on a predetermined
basis, and should be linked to growth in world income and/or trade. They
could also be adjusted countercyclically – for example, accelerated at times
of global slowdown. Using current quotas as the basis for allocation among
countries would not raise the share of SDRs in reserve assets, since a large
proportion would go to countries that do not need or use them. Given their
external vulnerability, developing countries have much greater need and
demand for reserves, and this should be taken into consideration in reaching a
formula for the allocation of SDRs (under some proposals, all allocations
could be given to developing countries). Another possible way forward is to
make IMF an SDRs-based organization; that is, to have SDRs replace quotas
and the General Arrangements to Borrow and New Arrangements to Borrow
as the single source of funding for IMF.


The Fund could be permitted to issue SDRs to itself on a regular basis, to be
used in lending operations. Again, this could be linked to growth in world
income and/or trade. Such an arrangement could bring a considerable
improvement to the governance of IMF, allowing it to stay at equal distance
to all its members and helping the Fund to perform policy surveillance even-
handedly. It is also possible to supplement this proposal with a mechanism to
remove the dollar overhang by allowing countries to replace their existing
stocks of dollar reserves with SDRs without disrupting the currency markets.


SDRs would allow the expansion of international liquidity without requiring
the United States to run ever-growing deficits – a major source of global
imbalances. However, a simple shift from dollars towards SDRs cannot
address the deflationary bias in the global economy because of the lack of
effective arrangements for adjustment in the surplus countries. This bias may
even be aggravated because the United States can no longer run growing
deficits in times of worldwide need. Consequently, any initiative to move
away from the dollar as the dominant reserve currency should be
accompanied by arrangements to ensure adjustment in surplus countries as
well as changes in the governance of the Fund itself.


For further discussion, see UNCTAD (2001) and UNCTAD (2009).







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156. These measures are hardly new or particularly radical, and the obstacles are, in all
cases, political rather than technical. It is, in this context, worth recalling the remarks of
Kenneth Rogoff following the Asian financial crisis, but which seem just as germane to the
discussion of DLG in light of what has happened since:


It is easy to fall into the trap of thinking that big institutional changes are
unrealistic or infeasible, especially in the United States where
macroeconomic policy institutions have generally evolved only slowly for
the past few decades. Not so long ago, the prospects for a single European
currency seemed no more likely than those for the break-up of the Soviet
empire or the reunification of Germany. Perhaps large institutional changes
only seem impossible until they happen – at which point they seem
foreordained. Even if none of the large-scale plans is feasible in the present
world political environment, after another crisis or two, the impossible may
start seeming realistic (Rogoff, 1999: 28).


157. Stable, affordable and long-term finance remains a constraint on sustainable and
inclusive growth in many developing countries, particularly LDCs. At the time of the
International Conference on Financing for Development, held in Monterrey in 2002,
UNCTAD estimated that a doubling of official financial flows would be needed to close the
resource gap facing recipient countries. Following declines in the 1990s, aid flows have
recovered sharply, albeit still short of the levels promised by the international community,
and at times strongly oriented to countries emerging from conflict (fig. 25).59 There has
also been a good deal of constructive discussion about aid effectiveness, with a growing
consensus around the need to reduce the unpredictability of aid flows, to deal with the
fragmentation of flows among sources and destinations, and to transfer ownership of aid
programmes to recipient countries. These have been long-standing UNCTAD demands.
However, this is only the start of a reform process to get development cooperation back on
track (box 10). In recent years, aid programmes have focused increasingly on social
outcomes, often at the expense of support for developing domestic resource mobilization
and the creation of new productive capacities. This has taken attention away from what
should be the principal preoccupation of development cooperation, which is to move its
recipients as quickly as possible to a position where they can mobilize their own resources
for development (EDAR, 2006). As such, the delivery of aid should be carefully and
constructively tied to the ambitions of recipient developmental states. This would make
budget support, including through a large grant component, a desirable form of
cooperation.60 Moving development cooperation in that direction is central to UNCTAD’s
efforts to promote a New International Development Architecture for the LDCs (LDCR,
2010).



59 UNCTAD was closely involved in establishing the 0.7 per cent aid goal, which was formally


recognized by the United Nations General Assembly as a best endeavour of donor governments but
was never officially endorsed as a binding target. On UNCTAD’s contribution, see Clemens and
Moss (2005).


60 Donors have a precedent for this approach in their own experience with the Marshall Plan. See EDAR
(2006).


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Figure 25
Net official development assistance and official aid flows to sub-Saharan Africa
(constant 2008 dollars, per capita)


0


20


40


60


80


100


120


19
80


19
82


19
84


19
86


19
88


19
90


19
92


19
94


19
96


19
98


20
00


20
02


20
04


20
06


20
08


Post-conflict countries Sub-Saharan Africa


Source: World Development Indicators 2011.


Note: The post-conflict countries are the Democratic Republic of the Congo, Eritrea,
Liberia, Mozambique, Rwanda, Senegal and Sierra Leone. Sub-Saharan Africa excludes
Nigeria.


Box 10. Making aid work for inclusive development


Over the years, aid has been provided to address a variety of problems. There
are grounds for both satisfaction and disappointment, though generally aid
skeptics have failed to prove their case. Still, there is a need for a new
international architecture for aid that ensures that official development
assistance (ODA) better complements national resource mobilization efforts,
helping to fill the gap between domestic saving and the volume of investment
required to meet national development goals, including the MDGs. There is a
growing recognition that aid should be channelled through the state budget,
and that it should be part of a comprehensive fiscal and financing package
supporting the implementation of national programmes and priorities. This
shift would reinforce the ownership of national policies and programmes and
improve the accountability of governments to their national constituencies.
At the same time, several relatively new aid organizations, such as the
Investment Climate Facility for Africa, the Global Fund, and the Millennium
Challenge Account need to be accommodated in any discussion of a future
aid architecture. These tend to focus on global public goods and do not
necessarily deliver aid in accordance with the development priorities of the
recipient countries.


The experience of the European Union (EU) with regional funds offers one
model for reforming the aid architecture. These funds have a clear focus on
strengthening investment, are packaged in the form of multi-year
programmes, have strong local ownership, and seek to deal with fungibility
problems through matching funds and additionality principles. They also
contain clearly stated aims to strengthen state capacity at the local and central
level. UNCTAD has also argued that greater multilateralization of aid, along
similar lines to the EU model, can help to correct the unpredictability of aid


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flows, reducing unnecessary and costly competition among donors as well as
the administrative burden of aid. It can also provide a buttress against the
politicization of aid, which has been so damaging in the past. Well-designed,
grant-based regional development funds under more inclusive multilateral
arrangements could provide one possible way forward. Such funds would be
explicitly focused on economic development, with a major responsibility for
strengthening the investment–growth nexus. In part, these would build on
MDG-8, but there would be a wider mandate to include investment in
physical infrastructure, support for sectoral strategies, technological
upgrading, and urban development.


While the use of aid to strengthen productive capacities has diminished in
recent years, UNCTAD has for more than 40 years tried to bring out the
potential complementarities between aid and trade, insisting on a more
integrated approach to managing these flows in support of lasting
development gains. The notion of “Aid for Trade” (AfT) has gained
prominence in the international aid discourse since it was introduced at the
Sixth WTO Ministerial Conference held in Hong Kong (China) in 2005. This
recognizes that developing countries, and especially LDCs, need targeted
financial support to help them adjust to the stresses that accompany increased
openness, and to build a strong investment–export nexus around a more
diversified economy that can ensure significant future gains from trade.
These objectives will be more easily reached if AfT gains an appropriate
scale, includes genuinely new funding in excess of current aid commitments,
is accompanied by appropriate trade and industrial policies, and is managed
within the United Nations system in order to ensure that the gains from trade
support inclusive development strategies.


Finally, there is currently no permanent multilateral forum addressing aid
effectiveness from the perspective of the recipients. The OECD Development
Assistance Committee is an important venue for these debates, but it focuses
largely on donor issues. This is one of the reasons why proponents of South–
South cooperation have been reluctant to join the traditional aid architecture.
Given these concerns, it may be worth exploring alternative ways to combine
the experience of different international agencies and the wider development
community, working on the consensus-building principle, and offering an
open forum for frank, well-informed and constructive debate on aid and
development issues.



158. The multilateral development banks also have an essential role to play supporting
DLG. These institutions have traditionally offered a range of services and a mixture of hard
and soft lending channels (UNDESA, 2005). There are a number of important unresolved
issues, in particular the extent to which their financing takes the form of grants or lending
(and whether at commercial or compensatory rates), and whether poverty reduction or
broader development goals should define their mandates. Moreover, given that the flow of
finance, particularly to middle-income countries, has been inadequate in recent years, their
ability to leverage more innovative sources of financing deserves closer attention and
consideration.


159. To revitalize their role and refocus their activities in support of inclusive
development, they will need to retreat from policy-based lending and concentrate more on
funding those public goods, including infrastructure, that are likely to strengthen the
productive capacities of borrowing countries. These institutions should also be in a position
to provide trade finance, particularly during crises, to play a constructive role in the


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development of local bond markets, and to devise more innovative mechanisms to combine
public and private resources in support of developmental and socially inclusive goals
(Griffith-Jones, 2008). Existing institutions with a strong regional focus might be
complemented by more functional financing agencies in areas such as agriculture
development or climate financing (box 14). But in all cases, there is a pressing need to
reform the governance structures of these institutions to make them more representative and
socially accountable.


2. Turning trade and investment towards development


160. Since the early 1980s, the governance of international trade has moved towards a
single-tier system of rights and obligations, with exceptions granted only for the LDCs. At
its best, this has brought a degree of predictability to trade relations and controlled the
arbitrary action of powerful countries.61 On the other hand, it has lent itself to prolonged
negotiations which, in part, have contributed to the proliferation of bilateral and regional
agreements covering a range of trade and trade-related issues. Moreover, at all levels of
rule-making, priority has been given to liberalization (and deregulation), which has
crowded out a range of issues including movements in the terms of trade, technology
transfer, non-tariff barriers, and restrictive business practices – all of which has had a strong
bearing on trade performance in developing countries, and in instances where effective
norms and regulations could be usefully discussed at the international level. The absence of
rules in some areas contrasts with the proliferation of demands in others, through the
different layers of the trading system. Given the diminishing capacities of the state in many
developing countries, it has become difficult for many states to take full advantage of their
rights, defend their interests and even meet their obligations.


161. In order to maximize the potential gains from trade and to direct them towards
inclusive development, developing countries require not just a rules-based global trading
system, but also the support and the space to use policy instruments to promote capital
formation and economic diversification and to manage the adjustment costs that such
changes imply. There must be an effort to ensure that existing agreements maximize policy
space, and where appropriate, expand it in sectoral areas of interest to developing countries
through the formalizing and strengthening of special and differential treatment.62 At the
same time, developing countries are aware that the absence of rules and effective
surveillance in areas of particular interest to them continue to hamper efforts to build a
more balanced international division of labour.


162. The balance between global trade rules and sufficient policy space is proving
increasingly challenging as new issues emerge (e.g. the environment and food security) and
become interlinked with the workings of the trading system. These issues are also likely to
have differential impacts on countries due to their diverse economic and institutional
capacities. Some of these issues (such as climate change and resource depletion) involve
managing truly global externalities, but others have a stronger regional dimension (such as
many health and conflict issues), and others are more in the nature of “semi-public”
goods.63 Given that these issues have already produced tensions in the trading system, and



61 It is still the case, however, that a range of commercial policies – including tariff escalation, non-tariff


barriers, subsidies, anti-dumping procedures and product standards – continue to favour products and
markets in which more advanced countries have either a very weak or a dominant market position.


62 For a discussion of where things currently stand on special and differential treatment, see Faizel
(2007).


63 The idea of global public goods is often used to describe international policy challenges, although the
two defining features of a public good, non-excludability and non-rivalry, often do not strictly apply
at the international level, hence the use of the term “semi-private”. There is a case for further
clarification of this terminology.


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that these are likely to intensify in the future, WTO, as custodian of the rule-making process
linked to trade, might usefully examine, through an independent blue-ribbon commission,
the question of whether or not the right balance is being struck. Such a commission could
explore the technical and legal implications of such issues as moving to a plurilateral
approach to negotiating trade rules, the appropriate scheduling and implementing
procedures, the use of a supermajority or other means to ensure arrival at a timely
consensus, the formalization of rules on policy space etc. In those areas where the goal of
an open trading system overlaps with the delivery of other public goods (such as a healthy
and stable environment), or carries strong development implications (such as those relating
to international production or food security), the appropriate United Nations bodies should
be invited on an equal footing to any deliberations on the design of appropriate rules and
standards. In addition, and in much the same way as IMF has an independent evaluation
office to “enhance the learning culture within the Fund, help build the Fund’s external
credibility, and promote a greater understanding of the work of the Fund”, something
similar could be considered for the trading system.


163. In the case of international production, where trade and investment issues have
become increasingly intertwined, the issues range from restrictive business practices to
transfer pricing and non-tariff barriers. The case for a common set of global rules on FDI
has been rejected by developing countries, in large part because the tenor of such
discussions has been unduly focused on liberalization measures and the rights of
corporations. However, there may be room to develop a developmental approach to these
challenges through a different kind of forum. For example, the implementation and
surveillance of responsible investment procedures could help reduce abusive or
distortionary practices in areas that are sensitive to developing countries (box 11).


Box 11. Principles for Responsible Agricultural Investment (PRAI)


Responsible international investors are companies, funds or individuals
which, in the course of their operations, act within the law, behave as good
citizens, and do not generate extraordinary social, economic or environmental
costs on host countries and communities. And yet, there are ample examples
of TNCs and other investors creating or profiting from market and other
distortions in developing countries through the payment of bribes, using their
political influence to shut out potential competitors, causing inordinate
environmental damage, or ignoring the rights of local communities. Such
concerns underlie the development of the Principles for Responsible
Agricultural Investment that Respects Rights, Livelihoods and Resources.


In the 2000s, international organizations began to take note that foreign
commercial interest in agriculture was rising in the developing world because
of increasing prices and profits in food and other agricultural products.
Alarming press reports were partially validated by major incidents taking
place in Madagascar and elsewhere. These led four international agencies
(UNCTAD, the Food and Agriculture Organization of the United Nations, the
World Bank, and the International Fund for Agricultural Development) to
initiate a joint project addressing these challenges. The issue of responsible
investment in agriculture, including large-scale land acquisitions, was
debated at the United Nations General Assembly during its sixty-fourth
session, at which UNCTAD gave submissions based on the World Investment
Report 2009. The General Assembly took note of “the initiative on promoting
responsible international investment in agriculture, which aims to develop
relevant principles and an international framework”, and stressed “the
importance of promoting responsible international investment in agriculture,
and in this regard invites the United Nations Conference on Trade and


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Development, in cooperation with other relevant international organizations,
to continue its research and analysis on this issue” (General Assembly
resolution 64/192).


The PRAI are based on detailed research on the nature, extent and impact of
foreign investment and on best practices in law and policy, and they provide
a framework for national regulations, international investment agreements,
global corporate social responsibility initiatives, and individual investment
contracts. The principles are:


Principle 1: Existing rights to land and associated natural
resources are recognized and respected.


Principle 2: Investments do not jeopardize food security but
rather strengthen it.


Principle 3: Processes relating to investment in agriculture are
transparent, monitored, and ensure accountability by all
stakeholders, within a proper business, legal, and regulatory
environment.


Principle 4: All those materially affected are consulted, and
agreements from consultations are recorded and enforced.


Principle 5: Investors ensure that projects respect the rule of
law, reflect industry best practice, are viable economically, and
result in durable shared value.


Principle 6: Investments generate desirable social and
distributional impacts and do not increase vulnerability.


Principle 7: Environmental impacts of a project are quantified
and measures taken to encourage sustainable resource use, while
minimizing the risk/magnitude of negative impacts and
mitigating them.


The PRAI should reduce the scope for negative externalities and raise the
likelihood of positive outcomes from foreign investment in agriculture. To
further the application and implementation of the PRAI, UNCTAD and its
partner agencies have several projects under way, including capacity-
building, calibrating private-sector compliance with the PRAI, and engaging
investor commitment to the PRAI.


Source: World Investment Report (2009).



164. The absence of clear international norms and rules on technology transfer has also
been damaging to the interests of developing countries. Technology is a critical lever for
raising economic growth but at the same time it is a potential source of rising inequality.
Under FDG, the latter has trumped the former. In part, that is because technology is a major
source of rents, and their protection has become a priority for countries and corporations at
the top of the technological ladder, especially through tighter intellectual property rules. A
more balanced set of arrangements is urgently needed to ensure that access to technology
becomes part of a more inclusive DLG. UNCTAD has already proposed several
international measures (in LDCR, 2009) in support of technological development in the
LDCs, many of which have wider relevance across the developing world (box 12). Such
arrangements are becoming all the more important in the context of moving towards a low-
carbon future, for which technological learning and capacity-building will require
international collaboration if the appropriate technologies are to be developed and


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disseminated in a timely manner. A much bolder and more flexible approach to green
technologies will be needed than is currently the case, including with respect to intellectual
property rights (IPRs), subsidies for new technologies, multilateral R&D funding etc. (see
UNDESA, 2009; and UNCTAD, 2011c).


Box 12. Rebalancing the international environment for technology transfer


The global IPR regime has tended to skew research and development towards
technologies offering high market returns, rather than towards those offering
the greatest social benefits or addressing the needs of developing countries.
The idea that gains from innovation would trickle down the development
ladder has found little empirical support. It has also been difficult to find
evidence of significant indirect benefits from tighter intellectual property
protection in the form of technology spillovers from FDI inflows, or evidence
of greater innovative activity as a result of access to patent disclosures and
technologies. Instead, IPR debates have tended to emphasize the safeguards
and flexibilities contained in the global intellectual property regime, notably
through parallel import arrangements and compulsory licensing. However,
many countries have forgone these flexibilities through bilateral “TRIPS-plus”
agreements with the major technology exporters.


These difficulties are beginning to be recognized, along with the realization
that the global IPR regime should be reoriented towards the technology and
knowledge needs of developing countries. In order to be effective, such
mechanisms should address issues of technology policy space and promote
local technological learning. Some avenues that might be considered for these
purposes are examined below.


Technology-sharing consortia: These are based on the voluntary exchange of
technology among firms involved in similar activities. Such collaboration can
lead to faster rates of adoption of superior technologies than licensing
arrangements, and can encourage greater R&D spending by internalizing the
externalities of innovation. In order to cooperate effectively, a firm must have
sufficient internal capacities and technological information of its own to offer
in exchange, and there must be a strong culture of transparency among
consortium members to reduce the threat of free riding. Various financial
incentives and support could be provided to consortia through development
cooperation, including triangular cooperation.


Global and regional research funds: Several areas of interest to developing
countries, including health, agriculture, energy, and climate change, have
lacked funding for technology development. Public expenditures in these areas
have been stagnant or falling, even in the advanced economies. Dedicated
research funds could become focal points for the coordination of research at
national and international levels, and among private, public and non-profit
organizations, while ensuring open access to all available research in line with
the urgency of these challenges. Scaled-up technical cooperation and training
programmes could complement these funds, including incentives for the short-
term mobility of skilled workers from advanced and emerging economies.
Some initiatives are already under way, including through South–South and
triangular cooperation, in the areas of medical and agricultural research.
Regional R&D facilities could be further supported by the international
community, through South–South collaboration, or even across developing
countries and LDCs (offering and receiving technical know-how and training)
and developed countries (offering financial support).


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A technology licensing initiative: Developing-country firms often find it
difficult to search for appropriate technologies, and they tend to lack the
negotiating skills to acquire licences at cost-effective rates. A technology
licensing initiative funded by developing-country governments or through
donor agencies could help to address these issues by acting as a licensing pool
offering technologies at subsidized rates for developing-country firms,
particularly those from LDCs. A licensing initiative would also provide a
database of similar technologies and their relative merits and licensing costs.
By acting as a clearing house for the licensed technologies, it could also reduce
bargaining asymmetries between firms based in developed and developing
countries. As incentives for firms in the advanced countries to participate in
these initiatives, licensing fees could be waived, while internationally agreed
standards of IPR protection would be maintained. Advanced-country firms
could also receive a label that they are “pro-development” (similar to eco-
labelling). Developing-country firms wishing to participate in this initiative
might be subsidized according to their country of origin and/or ability to pay.



165. There is, finally, an urgent need for greater coherence between the international
trading, production and financial systems. Rather than being governed by comparative
advantages, trade flows are frequently distorted by unstable and misaligned exchange rates
with little relation to underlying economic fundamentals, the effects often being analogous
to those of changes in tariffs. This problem is ignored in current global arrangements,
which are based on a false dichotomy between trade and finance. The dangers of that
dichotomy have been further exposed by policy incoherence across the various parts of the
multilateral system in response to the financial crisis, on such issues as the use of
instruments to manage capital flows (TDR, 2011). The financialization of markets has also
distorted trade in areas of pressing concern to many developing countries. In particular, the
mechanisms for dealing with commodity price volatility are piecemeal and in many cases
are an obstacle to the smooth functioning of the trading system. These problems can be
addressed in a more systematic way by the international community to mitigate the
potentially adverse impacts of speculative trading upon the security and livelihoods of the
most vulnerable communities and the poorest countries (box 13).


Box 13. Stabilizing commodity prices


The impact of price volatility depends on the commodity and on the
economy’s structure, but typically, it affects the balance of payments and the
external debt, hampers fiscal planning, exacerbates social inequalities and
impedes inclusive development. These effects tend to be stronger in
developing than in developed countries, and to pose particular problems for
the least developed countries.


Global price volatility is partly due to the increased participation of financial
players in commodity markets, which has changed the nature and use of
information driving price formation (see box 1). Market participants no
longer base their trading decisions purely on the fundamentals of supply and
demand; they also consider other markets as part of their strategies of
portfolio diversification which, in turn, introduces spurious signals into
commodity price formation. Therefore, in addition to emergency measures
designed to assist the most vulnerable, and longer-term measures designed to
increase and stabilize commodity supplies, it is necessary to consider how
commodity markets can be reformed so as to provide more reliable price
signals to producers and consumers, avoid herding, and prevent market
players from systematically sending misleading signals to countries and


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firms.


Significantly, the developed countries and the international financial
institutions currently reject international commodity agreements or
compensatory facilities to offset shortfalls of commodity export earnings,
such as IMF’s Compensatory and Contingency Financing Facility and the
European Commission’s STABEX, aimed at the stabilization of African,
Caribbean and Pacific countries’ export earnings. Instead, they have pushed
for market mechanisms for managing commodity price risks and the
accompanying income shocks, and have encouraged primary commodity
producers to contribute to the financialization of commodity markets through
their engagement with market-based hedging instruments in futures and
derivatives markets. So far, these initiatives have not been very successful.
Given the limitations of the mainstream policies, and in order to restore the
proper functioning of commodity markets, swift political action is required
on a global scale. It should focus on the following measures:


First, a global countercyclical financial facility to support demand
management in commodity-dependent countries, particularly in LDCs where
the opportunity cost of holding savings abroad is high in the light of
immediate needs to accelerate economic development and reduce poverty.
This should allow for fast disbursement of funds with low policy
conditionality and high concessionary elements at times of commodity price
shocks.


Second, greater transparency in physical markets, where this is appropriate,
in order to assist producers and traders’ estimates of stocks and spare
productive capacity, areas under plantation, harvests, and likely demand
shifts.


Third, better access to information in commodity derivatives markets,
especially regarding position-taking by different categories of participants.
Ensuring that the reporting requirements for trading on European exchanges
more closely follow those enforced in the United States would considerably
improve transparency of trading and discourage regulatory migration.


Fourth, tighter regulation of financial market participants, in order to contain
financial investors’ impacts on commodity markets. Measures could include
position limits, or the prohibition of proprietary trading by financial
institutions involved in hedging transactions on behalf of clients because of
potential conflicts of interest. Moreover, introducing a transaction tax system,
which could generally slow down financial market activities.


Fifth, market surveillance authorities could be mandated to intervene directly
in exchange trading on an occasional basis by buying or selling derivatives
contracts with a view to deflating price bubbles. It is commonly believed that
mechanisms that try to stabilize commodity prices with internationally held
buffer stocks and/or supply controls are not successful in reducing price
volatility and tend to be more effective in moderating downward price
movements than price surges. However, such intervention could be
reconsidered if reforms aimed at achieving greater market transparency and
tighter market regulation either were not in place or proved ineffective. While
most of the trigger mechanisms could be rules-based, and therefore
predictable, such intervention would necessarily have some judgmental
components. Unlike the other market participants, such an intervening
authority would have no incentive to engage in any form of herd behaviour.


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Rather, it could break the informational cascades that underlie herd
behaviour, by announcing when, in its view, prices are far out of line with
fundamentals.


For further discussion, see LDCR (2010) and UNCTAD (2011a).




3. Managing new threats


166. The search for sustainable and inclusive alternatives must address the growing
threats and insecurity linked to the interrelated crises in food, energy and water, and their
links to climate change. In all these cases, any balanced solution will require massive
investments (from the public and private sectors) in new infrastructure, new technologies
and new institutions.


167. A global New Deal should seek to establish a comprehensive public policy agenda
that aims to protect the planet’s natural resources by promoting conservation and more
efficient resource use, but that also supports alternative investment strategies that can
ensure that future resource use is consistent with catch-up growth and job creation in
developing countries. New rules and regulations to help establish effective carbon markets
will certainly have a role to play in this process. However, in order to combine the
responsible use of resources with these development goals, nothing less than a fundamental
transformation as regards financial and technological support to developing countries is
needed. Such a transformation would involve moving beyond the long-standing promises of
such support from developed countries, to a full-blown strategy of how the investments that
developing countries would have to undertake in order to meet their side of the bargain will
be generated. Establishing such an agenda will require a much greater degree of
collaboration between rich and poor countries.


168. This is particularly true in the case of climate change, where estimates can –
depending on the assessed scale of the threats and the chosen time frame – reach 2 per cent
of world output per year to meet this challenge. The amounts currently available to deal
with mitigation and adaptation challenges remain woefully inadequate. Private investment
should fill this gap in the long run, but given the uncertainties and externalities surrounding
areas such as transportation and energy supply, the required incentives will only come from
large upfront investments by the public sector. Consequently, national and international
resources will need to be mobilized much more vigorously than in the past, in order to
launch low-emission, high-growth paths. The institutional framework to support this push
should include a development compact addressing the issues of equitable adjustments, and
an inclusive governance structure where all voices can be heard, as well as transparent
financing mechanisms that avoid past biases in multilateral arrangements (box 14).


Box 14. Financing sustainable development
In the coming decades, as in the recent past, few issues are likely to be as
challenging to established patterns of international collaboration as the need
to mobilize adequate financial investment to constrain global temperature
increases within internationally agreed limits. Estimates of the scale of
sustained public and private investment required per year between 2020 and
2050 range from about 1 per cent of world GDP to more than 2 per cent of
world GDP. Much of this investment will be required to take place in
developing countries.


There are, accordingly, two essential aspects of the problem to be solved.
First, on any reasonable level of ambition or optimism, the pace and scope of
the transformation required in both production and consumption patterns is


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unprecedented. Unlike in the past, the technological revolutions and the
necessary changes in basic patterns of consumption and production cannot
follow the slow and highly uneven patterns of global diffusion of previous
global technological transitions. Eighty per cent of the transformation
required will be in the energy sector – with decarbonization of the energy
supply by 2050 and massive reductions in global per capita emissions and
energy consumption being the twin requirements for success (see box 3).
Achieving these objectives will require sustained, consistent and intensive
efforts by both developed and developing countries across a wide range of
technologies and activities, and will also require far more efficient and
equitable means of coordination than have yet been devised.


The second aspect of the problem, which has received significant and
necessary attention since the Copenhagen meeting of the Conference of the
Parties to the United Nations Framework Convention on Climate Change
(UNFCCC), is the challenge of mobilizing and prioritizing financial
resources for the required developing-country investments in ways that
equitably balance the still large development needs of developing and
emerging countries with the requirements of planetary sustainability.
Ensuring that achievement of fundamental development goals is not hindered
by higher costs of energy production and consumption, or by an unreasonable
shifting of the burdens of adjustment onto developing countries, is not simply
a question of the availability of international financing, however.
Development in its fullest sense is not primarily about assuring access to
international finance or technology on reasonable terms; instead, it is about
substantially strengthening national capabilities for self-sustaining
innovation, and about competitiveness and convergence.


Historical experience suggests that although there are many potential
pathways to development, financial self-reliance and sustained attention to
developing home-grown industrial capabilities have been decisive factors in
most successful cases of “late” industrial development or “catch-up”. It is
vital, accordingly, for developing countries to place the question of
international finance in the context of how different approaches to global
finance strengthen or weaken their national capacities for industrial
development, and especially their prospects for co-ownership and co-
development of the core industrial and consumer technologies of the twenty-
first century.


Today, any discussion of prospects for mobilizing large-scale financial
resources for investment to contain global climate change must begin with
the Report of the United Nations Secretary-General’s High-Level Advisory
Group on Climate Change Financing (AGF). The terms of reference for the
AGF posed the challenge narrowly, asking the panel to develop “practical
proposals on how to significantly scale up long-term financing for mitigation
and adaptation strategies in developing countries from various public as well
as private sources, and how best to deliver it.” While AGF members were
also enjoined to “provide views and suggestions, based on the best possible
analysis, that are in support of development”, the analysis conducted did not
attempt to link financial instruments and mechanisms to developing-country
uses or needs.


The AGF report finds that mobilizing $100 billion in annual flows is
“challenging but feasible” – but does so on strong assumptions concerning
the optimum path to global climate financing and, less plausibly, the


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willingness of the international community as whole to adopt that path. The
report argues that carbon pricing is the most efficient pathway to
simultaneously raise revenues on this scale, a small share of which can be
diverted to international transfers from developed to developing countries,
and provide adequate stimulus for non-incremental private investment
response. Establishing a clear link between new revenue measures and
“moderate” carbon pricing of $20–25 CO2te, the AGF analysis also suggests,
is the key to both revenue efficiency and political acceptability. Moreover,
imposing a global carbon pricing regime may unlock a new “business logic”
for new and dynamic forms of private international business collaboration –
as much between developing as between developed countries.


Developing countries have expressed at least three concerns with the AGF
conclusions. First, they rely upon a mechanism – carbon pricing – that is far
from enjoying the broad political support required for effective
implementation, even among developed countries whose capacity to scale up
falls a long way short of what many countries believe is required to ensure
that the burden of adjustment to a low-carbon future will not be carried by
those who contributed least to the problem. The second concern is whether
such a global regime could “solve” the climate and sustainability problem
merely by reproducing, and perhaps intensifying, the problem of (uneven)
development. Since one of the most important consequences of carbon
pricing is to create significant new markets for products that are low-carbon-
emitting or highly energy-efficient, developing countries will need to be
assured that their own industries and labour will stand to benefit
proportionally from the political and financial investments they make in
global market development by participating in a global carbon pricing
regime. Third, given that private financing is unlikely to provide the needed
upfront investment because the returns from such investment are nearly
impossible to capture, public investment by developing countries that only
builds industries in developed countries will enjoy little if any public support.


Within a strong global regime for carbon pricing, it is likely, as the AGF
report concludes, that large-scale international public and private resource
flows will become both feasible and attractive. Yet there are not only serious
doubts about whether the scale will be sufficient to meet the challenge; there
are also important reasons for developing countries to wish to limit their
reliance on large-scale international financial flows. First, long and hard
experience has taught that large-scale financial flows can be, and eventually
almost always are, destabilizing. Second, to the extent that financial flows are
used to purchase goods and services that can be more beneficially or
efficiently produced at home, they are inefficient – especially where non-
financial flows of licensing rights and claims on future revenue streams can
be accomplished with far less transfer of real resources.


This means that new vehicles might ultimately have to be designed to avoid
these problems. In this respect, leveraging scale and financial commitment
through regional financial collaboration presents an important alternative to
traditional multilateral financing mechanisms.




4. Governance matters


169. The effectiveness of the international economic system to deliver sustainable and
inclusive outcomes is very closely tied to whether the various members recognize its


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legitimacy and act accordingly. There is nothing more corrosive to an effective rules-based
system than the belief that there is one set of rules for some and another set of rules for
others, or that rules can be circumvented because of asymmetric power relations.


170. The current system continues to be dominated by a small number of economic
powers, which are home to the world’s largest corporations and financial institutions, and
which exercise a controlling influence in IMF and the World Bank. The weighted voting
systems of these institutions more closely resemble the Prussian electoral rules of 1848 than
the constitutional principles of today’s advanced countries. In contrast, at WTO, countries
have equal voting rights, but decisions are taken by a consensus which emerges through
consultations held by the Chairs of the three principal WTO bodies. This process has
allowed countries with superior resources for negotiation to drive the agenda. The deadlock
in the Doha Round suggests, however, that this dominance is no longer assured. Similar
impasses have emerged around other issues taken up by the international community, such
as climate change, as was dramatically illustrated in Copenhagen in 2009.


171. In recent years, measures have been introduced to improve representation and
accountability in the Bretton Woods institutions, but these have been tentative (Helleiner,
2009). The G-20 process has also helped to broaden participation in global decision-
making. However, the voice of most developing countries remains either weak or entirely
absent. A global New Deal will need to accelerate the reform process if more effective
approaches to global problems are to materialize. There have been intermittent calls for
modernizing the structures established at the end of the Second World War, including
pruning back overlapping mandates and finding better ways to coordinate their actions and
policy advice. But despite the recognition that the growth in global interdependence poses
greater problems today, the mechanisms and institutions put in place over the past three
decades have not been up to the challenge regarding the coherence, complementarity and
coordination of global economic policymaking. Proposals in the current context of
globalization should start with an attempt to address these problems, inter alia through the
appropriate parts of the United Nations system.


172. While United Nations Member States have repeatedly reaffirmed the role of the
Economic and Social Council (ECOSOC) in promoting overall coherence, coordination and
cooperation in economic, social and related fields, the Council continues to face difficulties
in effectively fulfilling this role. A revived and strengthened ECOSOC could address global
economic issues in a manner that parallels what its counterpart does in the security sphere.
Such a reform of international governance should be supported by all countries sharing the
conviction that democratic accountability is a prerequisite for sustainable and inclusive
development.


G. New partnerships in the South


173. An effective global regulatory regime supporting inclusive development needs to
address the imbalances and vulnerabilities which currently structure the world economy.
Multilateral governance will need to strengthen collective rules and actions in some areas,
particularly finance, even as it looks to expand national policy space in others. Progress
towards a new regulatory regime can be facilitated by well-designed regional anchors. After
several disappointments and false starts, there are signs that regional integration is gaining
renewed support across the developing world. The initiatives include attempts to forge
greater consistency around trade and investment policies in Africa and Latin America, the
creation of regional production networks in Asia, and the renewed efforts to strengthen
South–South cooperation.


174. Much of the alarmism about regional arrangements and regional blocs is misplaced,
and most actions enhancing regional cooperation need not discriminate against outsiders or


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undermine global trade rules. As discussed earlier, the expansion of regional intra-industry
trade is driven by dynamic economies of scale and specialization, and it tends to be more
intense among countries at similar levels of development. It is also likely to lead to
demands for further integration in order to lower intraregional trade barriers including
conflicting rules and administrative procedures, and to demands for better transport and
communications infrastructure, and for institutions to manage regional cooperation, as was
the case in Western Europe. At first, such cooperation tends to focus on technical issues
(standards, trade barriers and the like), but as regional production systems become more
integrated, the regional policy framework is likely to include financial and structural
challenges. Such shared challenges can often be better handled through a dialogue between
neighbouring countries whose priorities are similar and where trust and a sense of common
purpose can be more readily forged.


175. Despite the potential gains, including the incentives and support which larger
countries can offer to their smaller partners, it has not been easy to reach agreement around
proposals for a regional division of labour combining countries at different levels of
development. Such arrangements can favour the concentration of economic activity in
particular firms and locations, producing uneven and divergent tendencies which will
disrupt efforts at greater cooperation. In part, the problem has stemmed from a one-sided
emphasis on liberalization measures and efficiency gains at the expense of a discussion of
institutional arrangements that support a broader cooperation agenda and structural
transformation. An emphasis on the latter should help to ensure a stronger focus on the
challenges of building productive capacities. This can be best achieved with the support of
strategic industrial policies as well as active financial, labour-market, trade and
macroeconomic policies, in order to expand and diversify trade among developing
countries. This latter goal can also be pursued by combining measures to accelerate
industrialization while cutting trade barriers. Consequently, policy coordination at the
regional level is likely to take on much greater importance than it has today (box 15).


176. One possible model, involving a mixture of market and non-market forces, is the
“flying geese” paradigm associated with East Asian development. As discussed earlier,
while strong trade and investment ties have forged an economic hierarchy around recycling
comparative advantage, government policies have played a critical role in fostering this
pattern of regional integration. The emergence of similar models elsewhere cannot,
however, be taken for granted, nor can it be assumed that their developmental impact will
replicate East Asia’s. Still, this experience does suggest that, with proper policies, South–
South cooperation can play a decisive role in fostering inclusive development through
closer trade and investment links.


177. In light both of the expansion of these networks and their ongoing dependence on
markets in advanced countries, there is a need to explore whether and how they can be
harnessed to supply markets in the South. Arthur Lewis (1979) recognized this potential
some time ago, but it has arguably become all the more important given the deflationary
adjustments currently under way in the advanced economies and their weak medium-term
growth prospects. The long-standing effort among developing countries through the trade
negotiations around the Generalized System of Trade Preferences (GSTP) could be scaled
up in support of such an orientation, but the agenda must move beyond tariff-cutting among
members to include arrangements for trade financing as well as adjustment support
(particularly in LDC members) and measures to bolster industrial cooperation.


Box 15. Rethinking the regional trade agenda


The proliferation of regional trade agreements (RTAs) has generated calls to
clean up the existing “spaghetti bowl” of agreements. This is certainly
needed, but the traditional “building block versus stumbling block” paradigm
no longer offers an appropriate basis to assess RTAs. Rather, the key


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challenge is how to ensure that RTAs bolster trade through productive
integration, and support economic diversification among countries at
different levels of development.


One reason why such agreements have proliferated is the international
fragmentation of production. Fragmentation is not a new phenomenon, but in
recent years it has been extended greatly, generating new challenges for
global policy cooperation. Correspondingly, FDI has strengthened the
investment–export nexus at the regional level, but it has also thrown up new
challenges calling for improved regional coordination and monitoring,
particularly in those dynamic sectors where there is a significant danger of
overinvestment. In contrast, uncoordinated policies aimed at attracting FDI
can result in a race to the bottom, as governments cut regulations and offer
tax incentives in a wasteful bidding war to attract TNCs, rather than striking a
more sensible balance between the costs and benefits of foreign investment.
Regional arrangements can help to establish common bargaining positions on
such areas as the harmonization of corporate codes, contract enforcement, tax
incentives, and avoidance of transfer pricing.


An integrated approach addressing the challenges of building productive
capacities, including strategic trade and industrial policies as well as
financial, labour market and macroeconomic policies was adopted in the
early discussion of the GSTP, which aimed at expanding and diversifying
trade among developing countries by combining measures to cut trade
barriers with efforts to accelerate industrialization. A similar approach
underpinned the European experience, although it was conceived and
implemented under very different historical, economic and political
circumstances. These types of regional arrangements can help to:


(a) Lower technical and bureaucratic barriers to trade,
harmonizing customs regulations and ensuring the
dissemination of information about trading opportunities and
institutional sources of support for exports, helping to match
potential suppliers with foreign buyers. These barriers and
market distortions currently impede the involvement of many
small and medium-sized enterprises in foreign trade;


(b) Build cooperation on such trade-related services as insurance,
export credits and trade facilitation;


(c) Harmonize rules and regulations on a regional basis, and pool
resources to ensure the more effective allocation of resources
in light of local needs and circumstances;


(d) Provide physical infrastructure, particularly transport and
communications networks, energy supply, and management
capacity;


(e) Address constraints to growth, including those associated with
technological development.


Achieving these outcomes will require reforms to the multilateral trading
system. Consideration could be given to experimenting with innovative forms
of commitment, including those without a linkage to WTO-type dispute
settlements, and allowing some space for (temporary) rollbacks. It will also
be necessary to strengthen the monitoring of the RTAs. A basic rationale for
international cooperation is that the cost of complying with different


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standards and rules of origin across RTAs may be high. Economies of scale
(across countries) and scope (across issues) are likely to exist in rule-making.
Whether or not this can help to bring some of the areas currently being
negotiated in RTAs into the multilateral system, it could help to shift the
RTAs in a more developmental direction.


The multilateralization of RTAs could be facilitated by the establishment of
large-scale RTAs such as the GSTP, which is the largest South–South trade
cooperation initiative in existence, and where the big country/small country
division might be better addressed. Integration between member countries
beyond trade liberalization, including around administrative procedures,
should also be promoted in order to improve coherence across the multilateral
trading system and the RTAs.



178. The expansion of regional trade has added impetus to discussions on regional
monetary and financial cooperation. Though policy shifts at IMF and the expanded role of
the G-20 have opened up the possibility for reforms at the multilateral level, the pace of
reform may prove too slow or indecisive to address developing-country concerns over the
impact of financial shocks and global crises. Gaps in the multilateral framework have
created incentives for several developing countries, starting in post-1997 East Asia, to
accumulate foreign reserves as an insurance policy against future shocks and contagion.
However, as noted earlier, they are costly, their accumulation has contributed to the
overvaluation of domestic currencies, and they have often not supported growth-oriented
policies.


179. Regional monetary and financial cooperation covers a wide spectrum, ranging from
relatively simple trade-related payment initiatives to more complex measures related to
liquidity and development finance, and from macroeconomic dialogue between
policymakers to mechanisms of surveillance and policy coordination, ultimately leading to
a monetary union (TDR, 2001, 2007 and 2011). Such cooperation is often considered a
second-best option, but this is misleading. The combination of knowledge and voice which
can accompany regional arrangements may allow for better focus, greater timeliness, and
softer conditionalities than those currently emerging from multilateral discussions (Griffith-
Jones, 2008; Ocampo, 2006). Nevertheless, there is no recipe, mandatory sequence or ideal
timing when it comes to regional financial arrangements, and distinct initiatives may be
combined according to the degree of integration and the political economy of each region
(TDR, 2007; LDCR, 2011).


180. Given the recent events in Western Europe, there may be growing resistance against
regional monetary and financial cooperation. However, the European experience has
achieved significant successes over several decades, including the European Payments
Union and the European Investment Bank, as well as the wider process of economic and
social integration. Moreover, regional cooperation does not necessitate the liberalization of
capital flows or uniform macroeconomic regulations along the lines of the Stability and
Growth Pact, neither does it necessarily lead to monetary union or prevent countries from
controlling their exchange rates. In other words, monetary and financial cooperation need
not restrict policy space. Rather, it can offer a constructive response to the loss of
sovereignty under FDG, supporting the emergence of stronger countercyclical, inclusive
and developmental macroeconomic policies and providing the financial support for a
common industrial strategy (box 16).


181. Beyond these regional arrangements, the emergence of new growth poles in the
South can be leveraged in support of more widespread developmental gains through South–
South integration and cooperation that targets in particular the LDCs. Indeed, following a
two-decade hiatus, new institutional arrangements have emerged among developing


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countries to discuss mutual needs and challenges and to extend cooperation and support
(EDAR, 2010). In contrast with traditional North–South cooperation, South–South
initiatives involve countries with shared development challenges and suggest more equal
relationships between donor and recipient countries. However, growing divergencies
between emerging countries and LDCs suggest that capacity-building in support of
developmental states should become an important component of South–South cooperation,
as it has distinct advantages over traditional forms of development cooperation (LDCR,
2011).


Box 16. Regional monetary arrangements
The idea that developing countries can benefit from closer trade integration
with each other and, especially, with neighbouring countries, is one of the
cornerstones of UNCTAD’s tradition. Trade among neighbouring developing
countries is much more concentrated on industrial and more sophisticated
goods than their exports to developed countries (TDR, 2007). This can be
particularly important in promoting the structural changes associated with
development. In recent years, successful regionalization experiences have
been built on closer trade and investment ties.


Maintaining stable and properly aligned currencies is essential for this
process to be driven by underlying economic fundamentals, and for
preventing financial instability and trade tensions within the region. It is
unlikely that these objectives could be achieved with each country acting
alone, reinforcing the idea that closer monetary and financial cooperation
could help underpin the efforts towards regional economic integration
(UNCTAD, 2011b).


The main benefit of regional monetary integration comes from greater
currency, payments, and financial stability, but this depends on the design of
the integration process, including its supporting institutions and mechanisms
– for example, the provision of trade finance, liquidity to cushion against
external shocks, and long-term development finance to support private and
public investment. These can be at least partially supplied by regional
payments systems, monetary funds, and development banks.


Regional payments systems save foreign reserves and reduce the transaction
costs associated with their use. They can also provide short-term credit to
deficit countries, include regulations ensuring that surplus and deficit
countries have to contribute to a more balanced position, and create
incentives for exchange rate coordination. In case of a shortage of
international currency, regional payments systems can reduce the adverse
impact of that shortage on regional trade, as the Agreement on Reciprocal
Payments and Credits did in Latin America. While Argentina and Brazil have
recently created the System of Payments in Local Currency, targeting only
the reduction of transactions costs, the Unified Regional Payment Clearing
System (SUCRE) – an initiative of the Bolivarian Alliance for the Peoples of
Our America (ALBA) – means to build upon the much more complete
experience of the European Payments Union in the 1950s.


Regional monetary funds can pool reserves and organize swap arrangements
among central banks, leveraging the available resources and helping to avoid
uncontrolled devaluations that may compromise the integration process. As
external shocks often strike first and most intensely at one or two countries in
a region, a timely response from a regional fund can help to prevent
contagion. The Latin American Reserve Fund (FLAR) and the Chiang Mai


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Initiative provide examples to be emulated and improved upon. Again in
Latin America, the creation of a wider Common Reserve Fund has been
proposed, since FLAR includes only some countries in the region.


Regional development banks can be particularly suitable for financing
regional public goods, especially when these require large investments and
regional coordination, such as cross-border infrastructure. Together with
regional monetary funds, development banks can contribute to the reduction
of the financial fragility derived from currency mismatches, issuing bonds
and making loans in local currencies or helping to introduce new financial
assets. The Andean Development Corporation, often singled out for its
efficiency and for being (until recently) entirely funded by countries in the
region, has been the main source of multilateral finance for the Andean
countries. In 2007, seven countries in South America decided to create a new
regional development bank, the Banco del Sur.


There is also scope for initiatives involving larger groups of countries. First,
the assets of developing countries’ sovereign wealth funds have reached $3.5
trillion. Even 1 per cent of these funds, if used to finance development
projects in LDCs through regional development banks, might generate a far
higher volume of loans than those provided by the World Bank and its
existing network of regional development banks. Second, ODA can be
channelled into regional programmes in order to meet development goals,
which could also be funded through more innovative forms of financing
mechanisms at the regional level. Third, the Commission of Experts of the
President of the United Nations General Assembly on Reforms of the
International Monetary and Financial System has proposed the establishment
of a new global credit facility with a modular governance structure operated
through regional financial institutions, which could be partly funded by
countries’ reserves. Finally, the United Nations has recommended that
regional financial institutions should be given a central role in the provision
of interim finance, when the system for sovereign debtors is reformed.


For additional details, see UNCTAD (2011b) and LDCR (2011).



182. A related area where South–South policy initiatives could make an important
contribution is in curtailing “races to the bottom” as part of wasteful bidding by countries
hoping to attract TNCs. Developing countries could increase their bargaining strength vis-
à-vis TNCs, and improve their chances of following a growth path consistent with their
own strategic priorities through a greater harmonization of their codes and policies towards
contract enforcement, tax, and other incentives to FDI.


183. Beyond development cooperation, many of the new threats to inclusive growth and
development can be approached through stronger South–South links. They include food
security, where scaling up agricultural extension and support services, improved water
management and strengthened R&D can benefit from shared circumstances among
developing countries (UNCTAD, 2009 and 2010c). Other areas where South–South
cooperation opens up new possibilities include climate adaptation and improved response to
natural disasters (UNDESA, 2008). In such cases, new partnerships, such as those
involving triangular cooperation, can be used to support more effective action. This has
already been noted in the cases of agriculture and renewable energy. However, because
these new challenges require large-scale investment and new technologies, effective actions
will still have to be managed and financed at the multilateral level.


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III. The political economy of development


184. The architects of FDG have insisted that, left to themselves, market forces would
unleash a wellspring of entrepreneurial energy, ensure a fair distribution of the resulting
increase in prosperity, and guarantee a more secure and stable future for all. This reflected a
willingness to stick to textbook assumptions of how markets work, even in the face of
overwhelming evidence that the promised results were not materializing. In the wake of the
crisis, Alan Greenspan, former Chair of the United States Federal Reserve, acknowledged
that “a misplaced faith in market forces” had brought the economy to the edge of an
economic abyss. This is a particularly telling phrase. Fundamentalists, whether religious or
secular, are usually distinguished by a limpet-like attachment to a basic set of beliefs and to
linear models of causation. This, in turn, encourages a retreat from complexity and a search
for simple and apparently irrefutable solutions. A good deal of economic thinking in recent
years has reflected this pattern, and has encouraged a disdain for alternative viewpoints and
policy options.


185. Such thinking has dangerous historical precedents. During the interwar years, the
upholders of conventional economic thinking were preoccupied with a “return to normalcy”
through the natural workings of the gold standard; the restraining of any interference with
market forces required budgets to be balanced, central bankers to be given independence,
the rights of creditors to be upheld at all costs, labour markets to be flexible, and the rapid
liberalization of trade and finance. In the absence of effective governance structures to
manage the resulting imbalances and contradictions that followed, normalcy eventually
turned to nightmare.64


186. Contemporary economists are perhaps more aware than their predecessors that
markets can fail, that economic reality is characterized by persistent disequilibria, irregular
fluctuations, cumulative development and unforeseen shocks, and that in such a world, both
power and history are likely to have a bearing on economic performance. Still, these are not
things they feel comfortable talking about, and the tendency remains to suggest that the job
of the economist is to present “technocratic” solutions to particular problems while the job
of the politician is make value judgments as to their feasibility and popularity. The current
crisis has done much to expose this false dichotomy. In fact, the language of conventional
economics shapes how it sees the world, and in ways which are often strongly supportive of
the most fortunate, articulate, and politically influential in the larger community (Galbraith,
2004).


187. As a result, the crisis has not only served as a reminder that markets can fail, and in
quite spectacular and damaging ways; it has also exposed the flawed values and
assumptions behind the idea of a self-regulating market economy. Indeed, in many respects,
the greatest damage from the crisis is to the underlying trust, confidence, cohesion and
sense of justice and responsibility that are essential to a balanced economic and social
system, at the national as well as the international level. These are proving difficult to
repair.


188. The latest crisis, which began in the financial markets of the most advanced
economies, has provoked some soul-searching by policymakers and politicians who had
previously embraced this faith. The former Prime Minister of the United Kingdom, Gordon
Brown, for example, has concluded that markets need morals as much as money men and to
be fair as much as laissez-faire, and that bankers need to see themselves more as public
servants than as masters of the universe. French President Nicolas Sarkozy has talked about
the “intellectual, moral and political battle” that must be fought to correct the “injustices,



64 See Boyce (2009) for a detailed account of how the economic and political forces behind this return


to normalcy played out to disastrous consequences during the interwar period.


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improprieties and acts of folly that in the future will no longer be tolerable and will not be
tolerated”. And at the 2009 G-20 summit in London, both were joined by other world
leaders in calling for a “new global consensus on the key values and principles that will
promote sustainable economic activity”. This remains work in progress.


A. Towards a new development consensus


189. In this report, we have argued that any new consensus must also be inclusive if the
measures adopted at the national as well as the international level are to bring about a more
balanced and prosperous future for all. The following points are intended as a starting point
for a discussion on the alternative principles around which a new consensus might be
forged:


(a) Development is about ends, not means: Most people in most countries want
similar things: a decent job, a secure home, a safe environment, a better future for their
children, and the right to voice their opinion on how the larger community goes about
achieving these goals. There is no universal blueprint for achieving these ends, and the
institutions and policies that are required can only be fashioned around the matrix of local
capacities, conditions and needs.


(b) Growth is an important means to achieving these ends: Developing
countries must create the conditions for mobilizing domestic resources and build productive
capacity, including local enterprises with a high propensity to invest and strong incentives
to learn and innovate. Markets and property rights can all help to achieve robust growth and
development, but they require complementary legal and financial institutions, shared values
and agreed modes of behaviour. Moreover, a wide range of policy instruments, including
discretionary macroeconomic and industrial policies, are essential tools for addressing the
structural threats and weaknesses that constrain the development of more diversified and
dynamic economies.


(c) Technological progress is key to sustained growth: Technological change
is key to building virtuous circles of productivity growth, structural transformation, rising
living standards, and increased investment in knowledge production. It has also been a
source of global economic divisions as technological innovators have forged ahead; for
developing countries, closing the technological divide requires importing technologies from
abroad and adapting them to their economic circumstances, and this is only possible with
much greater volumes of investment, including FDI, and integrated policies and institutions
that promote learning, innovation and experimentation. This is just as big a challenge at the
global as at the national level, and perhaps more so, as new threats require global
technological responses.


(d) Sustainable growth has a social dimension: Faster growth, without the
gains being broadly shared across all households and communities, is neither desirable nor
viable. Inequality is an obstacle to economic and political stability and to sustained growth.
Consequently, building a more inclusive future requires paying as much attention to
employment, distribution and social protection as to inflation, efficiency and the protection
of property rights. An integrated policy framework is needed to ensure that social and
economic goals are mutually supportive.


(e) Developmental states are central to balanced growth and development:
Inclusive development is a continuing process of transformation in which economic,
political and social factors are closely interrelated. Institutions for consultation, discussion
and participation are essential to generate the popular assent that is needed to ensure
development is inclusive and stable. This will require a developmental state to build a
robust social contract and provide a coherent vision of the future. Such a state is required


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not only to help mobilize and channel resources productively but also to manage the
conflicts and trade-offs that change brings. Outside pressure and advice for economic and
institutional reform can play a role in strengthening developmental states, but in doing so,
this should recognize that there are no easy solutions or quick fixes to development
problems, that questions about the nature and direction of development policy are properly
the responsibility of local institutions and their representatives, and that room for policy
experimentation will be key to establishing an effective combination of economic and
social forces in support of inclusive outcomes.


(f) A balanced global economy requires strong national economies:
International competition can help to strengthen the creative impulse of market forces.
However, in the presence of scale economies, technological asymmetries and dominant
market positions, it cannot be presumed that trade and financial liberalization will
automatically benefit all countries in the global economy. Rather, whether global firms and
markets help establish a virtuous development circle where domestic growth and external
integration reinforce one another will depend on initial productive capacities and
institutional capabilities at the time of exposure and the effective design of policies to
manage the integration process. A balanced global economy will not emerge if countries
lack the policy space to leverage the potential benefits and mitigate the costs of closer
integration.


(g) Strong national economies require robust international cooperation:
Building the institutional structures and flexibilities in support of inclusive development
has become more challenging as the world has become more interdependent. For many
countries, external shocks and the balance-of-payments constraint remain an obstacle to
growth, and for the poorest countries these are often the binding constraints. The
multilateral system that has evolved under FDG is underresourced, overpoliticized and too
fragmented to underpin effective development cooperation both to support more inclusive
and stable growth paths and to deal with new threats to global stability and prosperity. A
thorough examination of the governance of international economic relations and the
premises on which current policies have been built is long overdue.


(h) Global markets need global rules: In an interdependent world, diversity
and inclusiveness can be mutually supportive, providing there is room to establish a
judicious mixture of market forces, policy intervention and international cooperation
tailored to local needs and preferences. Still, to the extent that markets and firms operate
globally, there are grounds for having global rules and regulations. Just like domestic
markets, these are needed to establish the rules of the game and to curb actions that infringe
on the rules. They are also needed to help provide and manage global public goods that
markets are unable or unwilling to provide. The failure to establish such rules in some areas
has long been a source of incoherence and instability in the international economy. Dealing
effectively with emerging threats, such as climate change, would also appear to need global
rules and regulations. However, given the existing asymmetries and inequalities in the
global economy, designing appropriate rules and flexibilities is an even greater challenge
than at the national level. Moreover, if governments, at all levels of development, are to
cede some degree of influence to international bodies, then these must exhibit much more
transparency and democracy than is currently the case.


(i) The future matters: Taking excessive risks with other people’s resources
has been a defining feature of FDG; it has proved very costly in financial terms, but in
many respects the longer-term damage as a result of underinvestment in social and
ecological stability could prove even costlier. Where economic or environmental debts are
incurred, they should be accompanied by a clear and realistic plan of how they should be
paid off without jeopardizing the well-being of future generations. Financial markets are an


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imperfect instrument for making these decisions, in large part because they privilege short-
term private returns over longer-term social and development goals.


B. Norms and values


190. There is no disputing that money and finance have a critical role to play in any
market economy. The danger comes from allowing financial markets to set the policy
agenda and to dictate social values. This report has insisted that this makes for bad
economics; but it also makes for bad politics and bad ethics. Scholars from Smith to
Schumpeter to Stiglitz have all, in their different ways, understood that a self-regulating
market society would eventually give rise to deeply disruptive strains and crises and even
collapse. This is particularly true where finance takes charge, given its dangerous proclivity
to undermine two of the key values on which its own contribution ultimately depends,
namely trust and confidence. As Harold James (2009: 231–236) has observed, in a world of
finance-driven globalization, monetary crisis and uncertainty can lead to a “universal
questioning of every type of value”, including globalization itself.


191. An alternative approach should recognize that a society’s moral well-being depends
on its economic well-being and vice versa (Friedman, 2005: ch.13). Markets do not appear
to be able to make the connection on their own. Getting prices right is not enough; the real
challenge is to get the markets right. For Adam Smith, the solution was to nestle the
invisible hand in a visible set of public values (“moral sentiments”) nurtured by an educated
elite drawn to academic pursuits and sensibilities. Keynes, who believed that a dynamic
economy would require taming financial markets and the “euthanasia of the rentier”
(despite his own indulgence in speculative activities) entrusted this task to a technocratic
elite with artistic sensibilities. His intellectual rival, Joseph Schumpeter, offered a different
understanding of the workings of capitalism which nevertheless recognized its self-
destructive tendencies; but he believed that such an elite would harbour anti-market
sentiments and turned instead to the old aristocracy to save the market from itself. More
recently, Joseph Stiglitz and his colleagues have suggested that what is needed in the
contemporary era of highly interconnected markets is a whole new “metrics” that can turn
market-based societies away from their traditional (price- and income-based) measures of
economic performance and social progress to a more complex and sustainable notion of
community well-being.65


192. All these approaches share an emphasis on the importance of education and learning
in forging an alternative set of values that can help get the market right. A stress on learning
certainly goes hand in hand with a rejection of the more fundamentalist strains of economic
thinking that have accompanied the rise of FDG and with an acceptance of a more
pragmatic approach to the policy challenge of building new and more inclusive
development paths. This should also help to encourage respect for diversity of opinion and
approaches, which seems appropriate for a world of distinct but interdependent nations.66


193. Another feature of market fundamentalism is that it creates a false separation
between economics and politics, and assumes that the market can, with minimum
prerequisites such as peace and secure property rights, simply be left alone to create and
distribute wealth (Hirschman, 1995). Such an approach stresses the importance of personal



65 Stiglitz et al. (2009).
66 Market fundamentalists would do well to listen to one of the leading twentieth-century liberal


philosophers, Isaiah Berlin, who expressed his hope that “a world which is a reasonably peaceful coat
of many colours, each portion of which develops its own distinct cultural identity and is tolerant of
others, is not a utopian dream” (in Gardles, 1991), and I would add distinct economic identities as
well.


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freedom as a key attribute of the market economy. But this ignores the dangerous anti-
democratic tendency of the market to privilege exit over voice in shaping the decision-
making process. It can threaten the stability and effectiveness of the market through
growing inequality and insecurity. Part of the required response is for those adversely
affected to “voice” their disapproval, with the right to demand fairer outcomes and the
space to present alternatives.


194. Thus, in addition to a stress on learning and diversity, promoting the idea of
“freedom in a complex society” (Polanyi, 1944) also requires the values of voice and
justice. The dominant principle of modern politics is that legitimate authority is based in
some way or another on discussion which seeks the approval of those over whom it is
exercised. Although democratic principles are central, there is plenty of scope for variation
in the institutions of consultation, participation and accountability.67


195. Democracy is more than a set of formal institutions that can be put into place as a
result of elections and a new constitution. It is, rather, a broad political culture of voice that
requires time to evolve in such a way that it not only responds to the particular needs and
preferences of the population that chooses it, but also ensures sufficient institutional
independence to address unfair economic advantages and imbalances in economic power.
The series of social and political reforms that have given rise to today’s western
democracies were enacted, albeit discontinuously, over two centuries or more. But it should
also be appreciated that democratic processes and both formal and informal systems for
popular consultation are not unique to the western countries, and that the institutions of
voice in developing countries may be less fragile if they are encouraged to take root in
established national traditions.


196. In this report, particular emphasis has been placed on the building of developmental
states. Doing so will involve a close interaction between economics and politics. How that
interaction evolves will depend on local conditions and historical circumstances. However,
taking the inclusiveness agenda seriously will almost certainly mean extending the rights of
all citizens through greater voice, security and justice. Promoting these values, coupled with
learning and pragmatism, is likely to reinforce a sense of trust and confidence in the
institutions – both public and private – on which economic progress ultimately depends.


C. The role of UNCTAD


197. The breadth and depth of the rebalancing challenge spelt out in this report points to
the need for a transformative agenda that breaks with business as usual and looks, instead,
to build new and inclusive development paths. The political backing and policy support for
such paths will only emerge through a frank and open discussion of what has gone wrong
over the past thirty years, as well as an understanding of what has gone right. That will, in
turn, depend on recognizing, particularly at the international level, that there can be
different ways of realizing more balanced outcomes, and that it is undesirable to insist that
there is only one correct way to do so and to use international pressure to force countries
along that path.


198. UNCTAD was created to address imbalances and asymmetries in the global
economy, and to break the monopoly on economic thinking that dominated discussions at
the international level in the early 1960s and that ignored or marginalized the specific needs
of developing countries. Since then, the international development community has
expanded a good deal and become much more diverse. UNCTAD is one institution in a



67 It is difficult to generalize about the links between democracy and development, but see, for example,


Rodrik (2007) and Kozul-Wright and Rayment (2007).


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large family of United Nations agencies, funds and programmes dealing with development
issues. The rebalancing challenge, as set out in this report, will have to engage each and
every agency in an integrated fashion. “One UN”, which has emerged from a system-wide
effort to underpin the MDGs, points in the right direction, but the issues outlined in this
report suggest that a fresh perspective is needed to move the development agenda forward
and in more inclusive directions.


199. The thread connecting UNCTAD mandates, from UNCTAD I to UNCTAD XIII, is
the way in which trade and development have been shaped by the interdependent forces
linking nations at different levels of development. The originating mandate set out a
programme of work which has evolved as subsequent conferences have sought to address
the new threats and challenges facing developing countries. But, like any foundational
charter, the Final Act of UNCTAD I provides a reference for shaping subsequent changes.
In that regard, four points stand out in defining UNCTAD’s continuing role and relevance:


(a) Economic development and social progress should be the common concern
of the whole international community.


(b) Addressing imbalances, particularly at the global level, that hinder trade and
development requires cooperation among all countries.


(c) Offering alternative policy perspectives to deal with those imbalances needs
to be sensitive to the individual characteristics of countries and their
different stages of development.


(d) International financial, monetary and investment policies should be designed
as part of an integrated framework to take full account of the trade,
investment and development needs of developing countries.


200. On this basis, UNCTAD has developed a rich and varied body of independent
research, and has been able to remain ahead of the curve in identifying emerging trade and
development challenges, even when this has meant going against conventional wisdom.
Our policy proposals have always paid particular attention to international measures and
collective actions supported through multilateral arrangements and international
development cooperation, while insisting that their implementation at the national level
must respect the diversity and specificity of local conditions. As a result, UNCTAD has not
shied away from the political biases and asymmetries that have, at times, undermined the
effective governance of an interdependent global economy. Indeed, highlighting the
importance of policies, and the role of international economic institutions in promoting one
set of policies and ignoring others, has served as an important correction to the view that
globalization is an autonomous, irresistible and irreversible process driven by the
impersonal forces of markets and machines.


201. The scale, complexity and urgency of the rebalancing challenge outlined in this
report cannot be overstated. This is familiar territory for UNCTAD. What is different this
time is how closely interconnected the crises in finance, food and fuel, along with growing
demographic pressures and the mounting threats from a warming world, have become.
Together, these have already caused untold hardship across the world economy, and
continue to stretch the social, economic and environmental fabric towards breaking point. It
is a truism that policymakers, at the national and the international level, failed to see this
coming. It will require the full and dedicated commitment of the entire international
community to put things back on track.


202. UNCTAD will approach the challenge of rebalancing the global economy from its
integrated approach to development policy in an interdependent and open world economy.
The crisis has made it abundantly clear that the imbalances that have built up in recent
years – whether between a hypertrophied financial sector and a stagnant real economy,


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between greater openness and diminished macroeconomic options, between countries that
sell more than they buy and those that consume more than they produce, between less
regulated markets and more restricted social opportunities, between the technological haves
and have-nots, or between rising living standards and environmental decay – can no longer
be tackled separately or sequentially or by countries acting alone or even in tailored
alliances of the favoured few. The immediate challenge of containing the damage from
financial meltdown, establishing a sustainable recovery and preserving an open
international economic system will necessarily have to address some hard questions about
reforming global governance, revitalizing international development cooperation, and
strengthening the provision of global public goods.


203. UNCTAD’s mandate is sure to evolve as it addresses new threats to inclusive
development – whether from gender inequality, climate change, or the urbanization of
global poverty – as well as the changing features of the global economy, whether the
Northern debt crisis or the rise of emerging economies, which have a direct bearing on
prospects for trade and development. However, in doing so, our attention remains firmly
fixed on the asymmetries and biases in economic power and influence which continue to
limit those prospects even as the call grows for developing countries to assume more
responsibilities for achieving a sustainable and stable future. Durable solutions will only
emerge if the economic gaps that persist within and across countries begin to close and in
ways that allow all boats to keep on rising.




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on Trade and Development




January 2012
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GE.12-





Report of the Secretary-General of UNCTAD to UNCTAD XIII


Development-led globalization: Towards sustainable and inclusive
development paths





Corrigendum



Paragraph 60


The first sentence should read


60. An early sign of the problems with this growth model was the rising “global
imbalances” between deficit (largely the United States) and surplus (more dispersed
but led by China, Germany and Japan) countries, which emerged in the mid-1990s
and escalated dramatically in the new millennium.











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