External Openness and Employment: The Need for Coherent International and National Policies

DESA Development Forum on Productive Employment and Decent Work New York, 8-9 May 2006 Rolph van der Hoeven and Malte Luebker (ILO, Geneva)

Facets of external openness



External openness has two important facets:

 

Trade liberalization; financial openness.

Trade liberalization has been on the political agenda since the 1960s, financial openness since the 1980s. Both are part of Washington Consensus policy prescriptions and structural adjustment programmes.
2

Trade liberalization


Some signs of convergence in the debate on the social impact of trade liberalization:


Proponents of trade liberalization see their initial optimism disappointed and concede that trade liberalization alone does not create growth and employment. Critics accept that integrating countries have not entered a race to the bottom , but that nonintegrating countries have continued to have serious problems.
3

Trade liberalization


However, trade liberalization can



entail considerable adjustment costs and job churning, and can lead to greater wage inequality (experience especially in Latin America).

Benefits of trade liberalization depend on initial conditions and successful management of process (Lall).
4

Financial openness and employment

The consequences of mistakes in financial markets, where capital is volatile and mobile globally, far exceeds the consequences of mistakes in the labour markets, where labour is largely immobile across national lines. Richard Freeman (Harvard & LSE)
5

The rationale behind financial liberalization



Assumption: Investment in developing countries is constrained by the lack of capital. Freeing up the international movement of capital will give developing countries access to capital, and therefore increase investment, raise growth, and create employment.

Financial liberalization since the early 1990s: Capital account



Widespread capital account liberalization since the early 1990s. Many countries have removed all restrictions on international capital flows.

Countries with Capital Controls, 19802001 (in % of total IMF membership)

Source: IMF.
7

Trends in international capital flows and investment



Rapid expansion of international capital flows (both gross private capital flows and FDI). Stagnation or fall in worldwide investments (GFCF).

Gross Fixed Capital Formation and FDI, 1977-2003 (World)

30 25 20 15 10 5 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003
Gross fixed capital formation (% of GDP) FDI, net inflows (% of GDP)

Source: World Bank.

8

Distribution of private capital flows



Private capital flows are skewed towards highincome countries, and some middleincome countries. A similar trend can be observed for FDI (see graph).

FDI Inflows by Economic Grouping, 1980-2003 (in billion current US$)

1,400 1,200 1,000 800 600 400 200 0

Industrialized economies Twelve top-tier developing economies* Remaining developing economies

Source: UNCTAD.

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

World GDP growth, 1961-2004

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

World GDP growth, 1961-2004 (annual change in per cent)

Mean per decade (arithmetic)

World GDP growth (annual %)

10

Direct growth effects of financial liberalization



No solid relationship between capital account liberalization and growth performance can be established (IMF and UNCTAD research). Only some middle-income countries appear to have small growth impact through capital account liberalization. Growth performance mainly depends on other factors, such as good institutions and an adequate policy framework.
11

Indirect growth effects though increased reserve holdings



Financial openness makes larger foreign reserve holdings necessary. Opportunity cost of reserve holdings is high: Funds cannot be used for investments with higher returns.

Reserve Holdings by Developing Reserve Holdings 1970-2004 (in (in % GNI) Countries, by Developing countries, 1970-2004 %ofof GNI)
35
All developing countries East Asia & Pacific Latin America & Caribbean

30 25 20 15 10 5 0 1 98 0 1 98 2

Middle East & North Africa South Asia Sub-Saharan Africa

1 98 4

1 98 6

1 98 8

1 99 0

1 99 2

1 99 4

1 99 6

1 99 8

2 00 0

2 00 2

Source: World Bank.

12

2 00 4

Volatility and financial crises

 Financial liberalization in developing countries is associated with higher consumption volatility and increased growth volatility compared to developed countries (Prasad et al. 2004). Financial openness has made countries more vulnerable to crises, e.g.:
  

 

Argentina 1995 and 2001-02 Brazil and Chile 1998-99 Indonesia, Rep. of Korea, Malaysia, Philippines and Thailand 1997-98 Mexico 1994-95 Turkey 1994, 1998-99 and 2001
13

Impact of financial crises on long-run growth



Financial crises have a large, negative impact on GDP. Countries typically do not return to their old growth path (IMF research). GDP loss is largest for poor countries.

Typical Growth Path after Financial Crises in Rich and Poor Countries

Source: Cerra and Saxena (2005: 24)

14

Impact of financial crises on employment



Labour market consequences are evident from a number of indicators:

   

Higher unemployment; increase in share of informal employment; falling real wages and falling incomes; higher poverty (e.g. in South-East Asia, the number of working poor rose from 33.7 million before the crisis to 50.6 million in 1998).
15

Impact of financial crises on employment (examples)



Recovery of social indicators generally lags the economic recovery by several years.
Thailand (Financial Crisis in 1997/98)
10 125
5

Chile (Financial Crisis in 1998/99)

125 120 9 120

GDP per capita (1997 = 100, left scale) Unemployment rate (in %, right scale)

115

115

110

110

105

105

100

100

95

95

GDP per capita (1998 = 100, left scale) 90 Unemployment rate (in %, right scale) 85 2 85
1

90

80

80

75 1995 1996 1997 1998 1999 2000 2001 2002

75 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

16

Impact of financial crises on the labour share



Financial crises, and exchange rate crises in particular, lead to a decline in the share of wages in national income:


On study reports an average drop in the wage share of 5 percentage points per crisis. There is only a modest recovery after a crisis (three years later, the wage share is still 2.6 percentage points below the pre-crisis level). The frequency of financial crises is one factor that contributed to the accelerating decline in wage shares since the early 1990s.
17

Building a stable int. financial system for growth & employment

Our goal should be to build a stable financial system that stimulates global growth, provides adequate financing for enterprises, and responds to the needs of working people for decent employment.
(World Commission on the Social Dimension of Globalization, 2004, para. 404)
18

Three broad policy areas for policy coherence 1. Policies in industrialized countries 2. Multilateral rules 3. Policies in developing countries

19

1. Policies in industrialized countries

 

Greater G3 exchange rate coordination. Increased attention to stimulating growth in Europe (e.g. IMF stance on Growth and Stability Pact in EU) Recognition of the importance of employment in financial policies. Increase of development aid and other sources of innovative international finance.
20

2. Multilateral rules


Developing countries should be integrated into the financial system:

  

They are not adequately involved in reforms Progress is slow and limited New codes may make financial market access more difficult

 

Need for equitable mechanisms of debt resolution Capital account liberalization should depend on a country s circumstances. Reduce financial volatility and contagion in emerging markets: Supply of emergency financing should be speeded up.
21

3. Policies in developing countries: The policy trilemma



Nationally policy space circumscribed by so-called policy trilemma:

  

Open capital account Stable exchange rates Independent monetary policy

Something has to give? Or can we avoid the corner solutions? Or can we add more instruments?
22

Avoiding corner solutions: Active RER regime



The positive effect of an active real exchange rate regime on employment works through three channels:


Higher capacity utilization in times of unemployment (requires combination of macroeconomic and fiscal policies). Stimulate output growth (combination with industrial policies). Contribute to increased employment elasticity (shift in sectors).

Rodrik (2003): Growth Strategies. NBER Working Paper No. 10050; Frenkel (2004): Real Exchange rate and Employment in Argentina, Brazil, Chile and Mexico. Paper presented at the XIX G24 Technical Group Meeting.

23

Adding new instruments: Social pacts



Social pacts can lead to a more coherent economic and social policy, foster stability and hold inflation down. To reach consensus more attention needs to be given to distributional issues the missing element of the current development debate (e.g. MDGs)
24