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Final Report VIII Annual Conference

of the Club of Madrid

The PoliticalDimensionsof the WorldEconomicCrisis

12-13 November 2009, Madrid




C/ Goya 5-7, Pasaje 2ªMadrid 28001 SpainTel: +34 911 548 230Fax: +34 911 548 240www.clubmadrid.org

©Club de Madrid • 2010

All rights reserved. No portion of thisdocument may be reprinted withoutprior permission of the Club de Madrid

The Club o Madrid is

grate ul to the RegionalGovernment of Madrid, orits support in the organization

o the Annual Con erence“The Political Dimensions o the World Economic Crisis”, held on November 12-13,

2009, in Madrid.




Contents

Foreword .....................................................................................................7

The Global Economic Crisis:Causes, Evolution and Crucial Policy Issues(By José Antonio Ocampo) ..........................................................................13

Democratic Practice and Governance: Instruments to Addressthe World Economic Crisis(By Jorge I. Domínguez) ...............................................................................29

Employment, Social Welfare, and Democratic Rights and Duties(By Richard Simeon) ....................................................................................37

The Citizen, the State and the Market(By Bolívar Lamounier) .................................................................................45

The Market, Regulatory Frameworks and Democratic Governability(By Lucinio Muñoz) ......................................................................................53

An Institutionalized and Effective International Governance System(By Andrés Rigo) ..........................................................................................67

Annexes .....................................................................................................75Final Declaration of the Annual Conference .....................................79

Agenda of the Annual Conference .....................................................81List of Participants ...............................................................................90Background Document for the European Roundtable(By Jean Pisani-Ferry) .............................................................................95Final Report of the European Roundtable(By Richard Youngs) ..............................................................................101Background Document for the Latin American Roundtable(By José Antonio Ocampo) ...................................................................118Final Report of the Latin American Roundtable(By Ted Piccone) ...................................................................................125Final Report of the Arab World Roundtable

(By Casa Árabe) ....................................................................................141Background Document for the African Roundtable(By the A rica Progress Panel) ...............................................................164Final Report of the African Roundtable(By Andie Davis) ....................................................................................173‘Adjustments to the Global Economic Crisis by India and China’(By Sanjay Peters) .................................................................................188‘The Road to Sustainable Growth: an East Asian Perspective’(By Yun-Han Chu) .................................................................................206

PAGE




Foreword




9

Foreword

The nancial crisis that sparked in the United States in mid-2007 and turned intoa global nancial and economic crisis a ter the collapse o US investment bankLehman Brothers in September 2008, brought the world close to another GreatDepression. The nancial collapse has had no precedents since the 1930s,bringing with it a collapse o international trade and the worst world recession ineight decades. It increased unemployment, deteriorated the quality and securityo existing employment, and hit migrant workers particularly hard in many partso the world. A protracted period o poor employment conditions may still lieahead and place our democratic systems under stress, encouraging socialunrest, xenophobic practices against migrants, and already visible protectionisttrends.

The crisis made mani est a myriad o problems. It prominently showed that theregulation o nancial markets was de cient in the most advanced economieso the world. The Financial Stability Forum created by the Group o 7 a ter the

Asian crisis o 1997 to prevent a new nancial collapse simply did not work,and central banks and regulatory authorities in industrial countries provedincapable o identi ying and taking action to counteract the emerging problemsthat led to the collapse. Above all, it demonstrated an excessive con dence inthe capacity o nancial markets to sel -regulate and sel -correct in the ace o major disturbances.

Furthermore, the nancial and economic crisis came on top o other crises:the threat o irreversible changes in our climate system, the ood crisis thatengul ed the world in 2008, and a social crisis evidenced by the large gapthat remains to meet the UN Millennium Development Goals, and to give thepoorest o the world a decent standard o living. This conjunction o crises hasrevealed that we lack the global institutions needed to manage our level o global interdependence. The ragile economic recovery being evidenced stilldependent on massive stimulus, should not lead to complacency about thedeep challenges that we continue to ace as a global amily.

During the VII Club o Madrid’s General Assembly and Annual Con erence, held inRotterdam in 2008, our Members decided to address the political impact o theworld economic crisis, con dent that their political experience could add valueto the international debate on this topic and pro-actively support, in orm andinspire current leaders in the design and adoption o practical recommendations

to tackle the political challenges arising rom the current crisis.

In preparation or our VIII Annual Con erence on “The Political Dimensions o theWorld Economic Crisis” , held in November 12-13, 2009 in Madrid, the Club o Madrid carried out a series o regional roundtables that brought our Membersand Advisors together with top international thinkers, to analyze the politicalimpact o the crisis rom di erent regional perspectives and to ormulate politicalrecommendations that could help ace the political and social challenges arising

rom the crisis. These messages and recommendations are being sharedwith relevant stakeholders in charge o responding to the social and politicalchallenges generated by the crisis. Four o these regional roundtables – onthe European (Barcelona, 26 March 2009), the Latin American (Santiago de




The Political Dimensions of the World Economic Crisis

10

Chile, 13 July 2009), the Arab World (Madrid, 28 October 2009) and the A rican(Accra, 3 November 2009) perspectives – were success ully held prior to theCon erence, and a similar exercise on the political dimensions o the currenteconomic crisis rom the BRICS (Brazil, Russia, India, China and South A rica)and Asian perspectives will be held in May and August 2010.

The main ndings and recommendations gathered in each o these regionalroundtables became the building blocks o the VIII Club o Madrid’s AnnualCon erence and enabled the ormulation o practical recommendations, rom aglobal perspective, thereby contributing to the consolidation o a “democracythat delivers” in the context o the current crisis. This publication presents thekey messages, conclusions and practical recommendations resulting rom the

Annual Con erence.

The Annual Con erence consisted o three plenaries and our working groups,each with a di erent ocus regarding the political and social e ects o the

world economic crisis: “Employment, Social Wel are, and Democratic Rightsand Duties”, “The Citizen, the State and the Market”, “The Market, RegulatoryFrameworks, and Democratic Governability” and “An Institutionalized andE ective International Governance System”.

This publication compiles the general background document prepared by the Academic Coordinator o the project, a snap shot o the exchanges that took place ineach working group and plenary, the nal reports o each o the regional roundtables,and two brie ng/issues papers on the crisis rom an Asian perspective.

The primacy o democratic politics

The crisis has brought politics back to center stage. It was political leadershipthat was called to manage the disruptions created by excessive con dence inthe markets. It was political leadership that was asked to rebuild the con denceshattered by the global economic crisis. At the national level, it was also politicalleadership that was called to keep the crisis rom turning into major social unrest.

And at the global level, it was called upon to coordinate e orts to manage thereality o interdependence in challenging times. In short, politics came backbecause States were asked to address the social and political consequences o the crisis, and to ensure that the crisis would not end up being yet another ‘GreatDepression’.

The crisis made patently clear that we need to redra t the relationship between

the Citizen, the State and the Market. This is, in a nutshell, the central challengeo democracies today, the essence o the paradigm o better governance thatwe are being asked to implement. It is only under the ramework o democraticpolitics that politicians have adequate incentives to listen, deliberate, negotiateand bargain. Democratic politics empowers the poor to develop the capacitiesthat allow them to infuence political outcomes that can eventually improve theirquality o li e. It is the only system that provides ull public accountability. And itis the only way to generate commitments that are backed by society and buildcon dence in our uture.

This most recent crisis has shown that unregulated markets can generate largecosts or citizens. Facing the social e ects o crises must, there ore, be at the




11

Foreword

center o all macroeconomic policy packages. Social protection systems mustbe strengthened in countries where they exist, and gradually created in thosethat lack them. Democratic politics should place the creation o employmentand social protection at the center o all recovery packages.

Moreover, democratic politics should recognize that we are experiencing aninstitutional crisis o global dimensions, and must bridge the huge gap betweenthe depth o our interdependence and the inadequacy o our global institutions.

The enhancement o democratic values at the global level requires strengthenedmultilateralism and equitable participation by developing countries, includingsmall and poor countries in global economic decision making. And democraticaccountability requires that States be responsible or the activities undertakenwithin their jurisdiction but impacting other countries or the global system as awhole.

New orms o global governance must be conceived. They should respect

existing multi-polarity, with the US and Europe as indispensable powers, butwhere developing countries must play a growing role. Cooperation in strongmultilateralism, rather than competition among States, is the best strategy toincrease and maximize the bene ts o our interdependence.

The recognition o the G-20 as the main international orum or coordinatingpolicies to deal with global nancial crises has been a step orward. Butgovernance, to be e ective, requires our elements: leadership, legitimacy,e ciency, and coherence. The G-20 lacks the ormal legitimacy that is at thecore o what we need or the uture, or no in ormal orum can replace well

unctioning global institutions. The institutionalization o a mechanism such asthe G-20, through the creation o a representative Global Economic Council,possibly under the United Nations but with the support o the Bretton WoodsInstitutions as specialized agencies o the United Nations system, and the World

Trade Organization should be given serious thought.

Regulation to create better markets

The crisis has made it clear that it is essential to correct the regulatory de citin nance – the major single cause o the recent crisis. This means promotingcomprehensive inancial regulations, covering institutions and inancialinstruments that were previously un- or under-regulated; designing counter-cyclical provisions that create cushions o capital, provisions and liquidityduring booms that will increase the capacity o nancial institutions to withstand

subsequent crises; enacting stronger supervision o systemically importantinstitutions; and de ending unsophisticated consumers against “toxic” nancialproducts. We must also create reliable institutions providing strong early warningsignals o emerging risk.

Good regulation is not inconsistent with but, rather, improves the unctioning o markets. In this sense, better democratic States also engender better markets– markets that avoid nancial and economic crises, distribute the bene ts o growth in equitable ways, and help to protect our climate.

Accountability and transparency must be required o those institutionsresponsible or protecting citizens against the mal unctioning o markets, as





12

part o the checks-and-balances that are at the heart o democracies thatdeliver. This also means that there should be strong barriers keeping institutionsthat regulate and supervise nancial markets rom being captured by theinterests o nance, that is, technical independence matched by strong politicalaccountability.

Financial markets are global in their reach and the nancial crisis has made itclear that the time has come or deep re orms o the global nancial architecture.

The institutions entrusted with the regulation o the global economy have provedragile and incapable o orecasting crises. They have also been unable to adopt

the necessary measures to prevent speculation rom contaminating all orms o nancing, thus creating a signi cant disequilibrium between nancial markets

and the real economy.

Beyond current e orts in the area o macroeconomic policy cooperationand regulatory re orm led by the G-20, the agenda should be broadened to

include: the adoption o strong global principles o nancial regulation; a wellde ned role or capital account regulations within the emerging broader systemo nancial regulation; the creation o e ective institutional mechanisms ormacroeconomic policy cooperation; a truly global reserve currency, based onthe Special Drawing Rights o the IMF; the creation o a special internationalcourt to mediate and arbitrate disputes associated with the over-indebtednesso countries; and enhanced international tax cooperation.

The major responsibility in all these areas should lay on truly representativeglobal institutions: a renewed IMF, charged with managing macroeconomicpolicy cooperation and the global reserve currency; a well unctioning networko regulators; recapitalized multilateral development banks (World Bank andregional development banks); and the creation o a debt restructuring court andimproved mechanisms or scal cooperation, perhaps building on existing UNmechanisms.

*****

No e ort should be spared to avoid the specter o global nancial collapse romhaunting us again. The crisis has been an opportunity to strengthen democraticpolitics as well as to create better markets. It has also been the opportunity tostrengthen global multilateral cooperation. It was in recognition o the urgencyo the situation and o the opportunities it nevertheless provided, that ourCon erence took place. We should make every e ort not to orget either, learn

rom our mistakes and act to prevent similar uture crises.

Ricardo LagosPresident o the Club o MadridFormer President o Chile




The Global Economic

Crisis: Causes, Evolutionand Crucial Policy Issues




15

The Global Economic Crisis: Causes,Evolution and Crucial Policy Issues

By José Antonio Ocampo 1

The nancial turmoil that erupted in the US in August 2007 became, a ter thenancial meltdown o mid-September 2008, the worst nancial crisis and the worst

global recession since the Great Depression o the 1930s. The severity o whatcame to be called the “Great Recession” and the collapse o international tradethat accompanied it surprised even experts. The crisis had global and systemic

eatures. It showed, in particular, how dys unctional the current internationalnancial architecture is to manage today’s global economy. The global policy

response was coordinated by the G-20 and had some novel eatures, but wasalso partial in scope, leaving aside major issues that must also be included in any

comprehensive re orm o the international nancial architecture. The macroeconomic and nancial policy responses to the crisis were strong thoughdiverse among major economies. The nancial meltdown was reversed and therewas a recovery o economic activity in some economies, particularly in Asia, duringthe second quarter o 2009 and o a broader group o countries during the thirdquarter. Overall, these results represent a major success o Keynesian counter-cyclical macroeconomic policies. However, at the end o 2009 the recovery was stillincomplete in the major industrial countries and, particularly, it continued to dependon the large macroeconomic policy stimulus being provided. Furthermore, creditremained subdued, nancial stability had not been ully restored, international tradewas still depressed and there was agreement that it will take a long time to reversesome o the social costs o the crisis, particularly the deterioration in employmentconditions. We may be subject to new unpleasant surprises.

This document summarizes the crucial issues related to the origins andmanagement o the current world economic crisis. The irst two sectionslook at the roots and spread o the crisis. The next two analyze the areaswhere government actions have concentrated: the macroeconomic stimuluspackages, nancial bailouts and regulation. The last section considers broaderre orms in the international economic architecture which have been excludedso ar rom negotiations and associated institutional changes.

1. The roots o the current crisis

The peculiarity o the current crisis is, o course, that it originated at the center o theworld economy. The collapse o the market or asset-backed securities in the USin August 2007, including the market or subprime mortgages, can be denoted asthe start o the nancial crisis. However, the European nancial system was also and

1. Pro essor and co-President o the Initiative or Policy Dialogue at Columbia University. Member o theCommission o Experts o the UN General Assembly on Re orms o the International Monetary and FinancialSystem. Former Under-Secretary General o the United Nations or Economic and Social A airs and ExecutiveSecretary o the Economic Commission or Latin America and the Caribbean, and ormer Minister o Financeo Colombia.





16

rom the beginning at the center o the turmoil. The rst major bankruptcies tookplace in Britain (Northern Rock) and Germany (IKB) at the end o 2007. This refectsnot only the signi cant port olio o US “toxic” securities held by European nancialinstitutions, but also their own problems associated with the collapse o housingbubbles in several countries, higher reliance by European institutions or undingin capital markets vs. deposits, and the serious nancial turmoil at the Europeanperiphery (Iceland and some Central and Eastern European countries).

The roots o the crisis will continue to be debated or a long time. The majorissue was undoubtedly the excessive con dence in the capacity o nancialmarkets to sel -regulate and sel -correct in the ace o disturbances. By nowit is clear that the dominant market liberalization paradigm provided a grosslyinadequate lens to analyze reality.

The regulatory de cit is now broadly recognized. This problem is most severein industrial countries, which continued to deregulate their nancial systems

while many emerging economies took steps to strengthen regulation a ter theirown past nancial crises. Equally important were the insu cient supervision o nancial institutions and, there ore, the unwillingness or incapacity o authorities

to en orce e ectively even those regulations that were in place.

At the international level, the Financial Stability Forum (FSF) was created by theG-7 in 1999 “to promote international nancial stability, improve the unctioningo nancial markets and reduce the tendency or nancial shocks to propagate

rom country to country, thus destabilizing the world economy”. Similarly, a terthe Asian crisis, the International Monetary Fund (IMF) was given, togetherwith the World Bank, enhanced responsibilities in the surveillance o nancialstability. Despite their very use ul technical work, the FSF and IMF patently

ailed in giving clear early warning o serious problems to come, as did theregulators and supervisors in major industrial countries. More serious warningscame rom other quarters, particularly, at the institutional level, rom the Bank o International Settlements (BIS) and the United Nations.

Aside rom the regulatory and supervisory de cit, other actors contributed tothe nancial meltdown. Major ailures in corporate governance and associatedincentive schemes are now widely recognized as key problems, particularly theexcessive ocus on short-term pro ts and shareholder value, and the tendencyto remunerate top managers on the basis o short-term returns.

The expansionary monetary policies o the rst hal o the 2000s are also acceptedas a major contributor to the crisis, though the interpretations di er among

analysts (which are not incompatible). Some see it as simply a policy mistakethat, through the attempt by nancial institutions to increase their returns in alow interest rate environment (the so called “search or yield”), led to very riskyinvestments. Others see it as a refection o the need to compensate or theweak aggregate demand generated by adverse trends in income distributionthroughout the world. Access to credit was needed, according to the secondview, to compensate workers or their low earnings, though it came at the costo building up unsustainable household indebtedness.

Global imbalances also gure prominently in the debate on the origins o thecrisis, again with contrasting views. According to one interpretation, Asian and,particularly, Chinese “mercantilism” generated massive surpluses that increased




17

The Global Economic Crisis: Causes, Evolution and Crucial Policy Issues

the demand or US nancial assets and kept interest rates – including long-term rates – low. The alternative interpretation emphasizes rather the act thatthe crisis that stated in Asia and other emerging economies in 1997 made itclear that the world lacks an e cient mechanism to manage nancial crises indeveloping countries, as the current system has been based on IMF lendingthat is too small relative to the size o today’s disturbances and carries excessiveconditionality. The world also lacks a mechanism to renegotiate in an orderlyway international debts similar to domestic bankruptcy courts. According tothis view, the rational response o developing countries to this institutionalde cit was to “sel -insure” themselves against crises by accumulating largeamounts o oreign exchange reserves, a policy that included, during the recentboom, saving a larger proportion o the commodity price boom and absorbing,through reserve accumulation, a larger portion o the excess supply o external

nancing than was typical in the past.

The role o the US as the “consumer o last resort” during the Asian crisis had

dramatically increased the US current account de cit. The very high de citsin later years made one eature o the international monetary system patentlyclear: the lack o discipline imposed on the major reserve currency country bythe current global monetary system, in which a national currency is used as themajor world currency. This system allows the US not only to pay or its de citby fooding the global economy with dollar assets but also to essentially imposeits monetary policy on the rest o the world. However, this major de ciency o the international nancial architecture has not been su ciently recognized inongoing debates.

2. Intensity and spread o the crisis

Viewed rom the perspective o US nancial markets and policy responses,the crisis had ve distinct phases. The rst started with the collapse o thesubprime market and, more generally, asset-backed securities in August 2007.

The response o the authorities in the US and Europe was to activate the roleo central banks as “lenders o last resort” by coordinated e orts to makeemergency nancing to banks more readily available and at lower interest rates.

The US also adopted an early though limited scal stimulus. The second phasestarted with the collapse and rescue o the investment bank Bear Stearns inMarch 2008. The lack o con dence among nancial institutions in the qualityo each others’ balance sheets increased sharply a ter that event, generating amuch greater use o available central bank credit lines.

The collapse o another investment bank, Lehman Brothers, during theweekend o September 13-14, 2008, and the decision o the US to not rescue it,marked the beginning o the third and, in regards to nancial markets, the mostdramatic phase o the crisis. During the week that ollowed, nancial marketsexperienced total paralysis (a “credit reeze”), which included interbank lendingand commercial paper. Many other major nancial institutions went bankruptin both the US and Europe and were generally rescued or taken over bygovernments, in a major correction o what was very soon perceived as a majorpolicy mistake – to let a systemically important institution, such as Lehman,go bankrupt. Authorities in industrial countries responded with an even moremassive increase in central bank credit to nancial institutions, including manynew acilities, strengthening deposit insurance, designing di erent schemes to





18

capitalize nancial institution with public sector unds and, to a lesser extent,buying toxic assets. Curiously, policies to alleviate household debts, particularlythose associated with mortgages, did not gure out in the policy packages;some were introduced later on.

The critical phase was overcome in late October, as refected in renewedinterbank lending and the reduction o interest rates in many segments o themarket. This may be denoted as the beginning o a ourth phase, in which

nancial panic was overcome but nancial institutions continued to be seriouslyundercapitalized or were outright bankrupt but continued to operate under theimplicit promise that in the end they would be bailed out. Since the secondquarter o 2009 we can talk o a th phase, which came to be known as“green shoots”, characterized by a signi cant reduction in risk premia and arecovery o stock prices but no signi cant revival or even continued contractiono private lending. In terms o new policy actions, the most remarkable actduring the ourth and th phases was the shi t by major central banks towards

“quantitative easing” – that is, the outright increase in the money supply oncecentral bank interest rates were brought down to zero (or near zero) andthere ore ceased to be a use ul instrument or urther monetary expansion. Italso implied that, aside rom maintaining high levels o liquidity , central banks also

ocused their attention on reactivating lending and reducing the interest ratesthat borrowers pay.

An economic slowdown was already visible but was not dramatic during the rsttwo phases o the crisis. Although the slowdown was stronger in Europe, therewas a tendency to underestimate it in political circles (except in Great Britain), a

act that was refected in the much more conservative attitude o the EuropeanCentral Bank and the weaker scal stimulus adopted by Continental Europeancountries. Responses in the US were more aggressive on both ronts. Thedramatic recession in the industrial world that ollowed the nancial meltdowno mid-September 2008 surpassed the most pessimistic expectations. GDP o industrial countries ell in the last quarter o 2008 and the rst quarter o 2009at an annual rate o 7 to 8%, similar to that during the early phases o the GreatDepression, but was ollowed by a break in the contraction o economic activityduring the th, “green shoots” phase. Growth recovery was initially unevenand, particularly, largely Asia-based in the second quarter o 2009, but becamemore broadly based in the third quarter. Most remaining laggards nally joinedthe recovery in the last quarter o the year, as growth speeded up in severalparts o the world economy, including the US.

Although developing countries were partly hit by the rst phases o the nancial

crisis, particularly through reduced availability and higher costs o borrowing,they continued to grow relatively ast during the rst semester o 2008 thanksto booming commodity markets and the perception that risks o lending tothem were low due to the high levels o oreign exchange reserves they hadaccumulated. The all o commodity prices since mid-2008 may be seen,there ore, as the turning point in the spread o industrial country recessionto the developing world. In any case, the September 2008 crash was a armore important shock, which was transmitted globally through two majorchannels: the collapse o international trade (including commodity prices) andthe paralysis o private capital markets. A third transmission channel, the allo migrant workers’ remittances, also became signi cant in several developingcountries.




19


The collapse in international trade was dramatic: the value o world exportsell 32% between the rst semester o 2008 and the same semester in 2009.

Although some recovery has taken place since the third quarter o 2009, tradecontinued to be depressed relative to pre-crisis levels. Indeed, in the thirdquarter o 2009, the value o world exports remained 26% and export volumes16% below the levels o the rst semester o 2008. Preliminary estimates andprojections by IMF and the United Nations in early 2010 indicate that worldtrade volumes declined by over 12% in 2009 and will only partially recover in2010 (only about 40% o what they lost in 2009). An implication o the collapseo international trade is that countries more open to international trade and,particularly, manu acturing exporters, were hardest hit in terms o economicactivity. This explains why Japan and Germany ended up experiencing verystrong recessions, and why most o the rst generation o Asian tigers (Korea,Singapore and Taiwan, in particular) and Mexico were also strongly a ected.Even China experienced a sharp all in exports and a virtual GDP stagnationduring the last quarter o 2008; although its exports continued depressed

through most o 2009, it started to boom again in the second quarter o theyear, thanks to its strongly expansionary domestic macroeconomic policies.

The sudden stop o private external nancing hit hard the middle incomedeveloping countries, including the emerging economies. A critical issue wasthe paralysis o trade nancing, which contributed to the collapse o worldtrade. Outfows o more volatile capital were severe in the developing worldduring the last quarter o 2008, leading to sharp depreciations o currencies inseveral countries. The capital account shock was particularly severe in severalcountries in Central and Eastern Europe, which had run risky macroeconomicpolicies during the boom, indeed reminiscent o Latin American patterns in thepast. This was refected in large current account de cits, weak accumulationo oreign exchange reserves, high external debt ratios and lending in domesticmarkets in oreign currencies, which made debtors very vulnerable to currencydepreciations during the crisis. In contrast, although East Asia and Latin Americawere also hit, the signi cant accumulation o oreign exchange reserves and thereduction in external indebtedness during the boom, together with healthier

nancial systems (thanks to stronger regulation adopted a ter their own priorcrises) provided a partial de ense against nancial contagion.

Only partial in ormation is available on remittances. The World Bank estimates thatthey ell by 6.1% in 2009. However, this averages very diverging per ormancesacross the developing world. The worst a ected were Central Asian countriesdependent on migrants’ remittances rom Russia. They were ollowed bycountries in Latin America, North A rica and Central and Eastern Europe that

depend on remittances by migrants to the US and Western Europe; in mosto these cases, reductions exceeded 10%, with some countries experiencingcontractions o over 20%. In contrast, remittances rom the Gul Countriesto South Asian and, to a lesser extent, some Sub-Saharan A rican countriesactually increased, and in some cases substantially so.

3. The macroeconomic policy response

The global recession called or strong policy responses. The International LabourOrganization (ILO) estimated early in the year that the crisis would increaseglobal unemployment in 2009 by 30 to 50 million people. This led ILO to launch





20

in June 2009 a “Global Jobs Pact”. The United Nations also estimated thatthere would be 72.5 million additional persons in extreme poverty, relative toa scenario where the growth expectation be ore the crisis would have been

ul lled. Although the strong recovery packages were able to avert the worstcase scenario, there is a clear consensus that employment conditions will takea long time to normalize.

Industrial countries adopted expansionary monetary, credit and scal policies,but with signi cant asymmetries among them. Continental Europe lagged in allthese dimensions relative to the US, the UK and Japan, as refected both in thesmaller size o scal packages and the lags o the European Central Bank inadopting more expansionary policies. China, along with a ew other developingcountries, also adopted strong expansionary scal and credit policies. Onaverage, however, industrial country programs were more aggressive, refectingthe more limited room o maneuver that emerging and developing countries haveto adopt counter-cyclical macroeconomic policies. The IMF estimated that the

average autonomous scal stimulus in the G-20 economies was around 2% o GDP. Industrial countries’ central bank interest rates were also set at historicalminima and all adopted some or o “quantitative easing”.

Beyond the short-term, the crucial question is whether there will be a prolongedperiod o slow economic growth. The strong adjustment in the port olioso private agents (including households), the broad-based desire to reduceindebtedness ( nancial deleveraging) and the excess productive capacityavailable indicates that private sector demand (both consumption andinvestment) will continue to be weak. This has been the experience with

nancial crises in many countries. The economic and social costs o thisscenario would be large, as the experiences o Japan and Latin Americaduring their “lost decades” indicate, as well as that o sub-Saharan A ricaduring its “lost quarter century”. The international and domestic politicalimplications are also deep, and could lead to a resurgence o protectionismunder di erent guises (a actor that has been limited so ar), as well asmounting political tensions within countries, which would stress the capacityo democratic regimes to address confict through institutional channels.

This implies that expansionary macroeconomic policies may be needed ora relatively long period and that withdrawing existing stimulus could be verycostly. In any case, the rapid rise o public sector debts that is taking placewill limit the possibility o maintaining aggressive expansionary scal policies

or prolonged periods.

Global imbalances decreased relative to the boom years but must be closely

watched, particularly in light o the renewed weakening o the US dollar since thesecond quarter o 2009. In any case, relying excessively on the expansionarypolicies o the world’s major de cit country, the United States, runs the risk o igniting (or, rather, reigniting) ears o disorderly adjustment to global imbalances,which would add another highly undesirable dimension to the current crisis.More generally, relying on export-led recoveries seems highly undesirable in the

ace o the collapse o world trade.

The act that many developing countries had accumulated large amounts o oreign exchange reserves during the recent boom and had lowered external

and public sector debts, imply that they had more space to adopt expansionarymacroeconomic policies than was typical during past crises. But there was




21


an initial consensus that some emerging and developing economies were ina weak position and, there ore, that new nancing mechanisms had to be putin place, given the strong retrenchment o private capital rom the developingworld that characterized the initial phase o the crisis. The problem herewas the size o the shock relative to that o existing multilateral nancingmechanisms. The Institute o International Finance (IIF) estimated early in2009 that emerging markets would receive net negative private capital fowsequivalent to $30 billion in 2009 vs. net positive fows o $632 billion in 2007.With the parameters that were in place be ore the crisis, multilateral nancialinstitutions would have added only $28 billion in net resources – i.e., about4% o the short all!

This was the reason behind the April 2 G-20 decision to launch a major initiativeto give additional resources to the major international nancial institutions. TheIMF was the recipient o most resource injections. A special issue o SpecialDrawing Rights (SDRs) or $250 billion was also adopted, with developing

countries receiving slightly under 40% o the allocation according to currentquotas. Together with a smaller allocation, or 21.4 billion SDRs, approved by theIMF in September 1997 but which was not e ective until it was nally approvedby US Congress in June 2009, SDR allocations reached the equivalent o $283billion.

The G-20 decisions were preceded by a major re orm o IMF credit lines inMarch, including the creation o a Flexible Credit Line, which allowscountries with strong policies to access precautionary resources on a largescale with no conditionality, the doubling o other credit lines and the decisionto make disbursements independently o whether countries meet structuralconditionality. Fiscal targets were also so tened relative to past IMF patterns.

There is, however, the ear that the new IMF credit strategy would provide undsonly or countries with very strong conditions, which may not need them, aswell as those in severe need, but leave most developing country memberswithout any support.

This is the reason why counter-cyclical actions by multilateral developmentbanks played a crucial role, as they bene ted a larger number o developingcountries. Multilateral banks stretched their lending capacity, but additionalcapitalizations are now required or all o them. For the poorest countries, ODAwith a signi cant component o trans ers was required to avoid a debt buildup,which would be highly undesirable a ter the major debt reduction programs thatwere implemented in recent years – the Heavily Indebted Poor Countries (HIPC)initiative and the Multilateral Debt Relie Initiative (MDRI). However, there was no

major G-20 initiative in this area, aside rom the weakly de ned ood securityprogram approved by the G-8 in Italy in July and supported by the G-20 in itsSeptember 24-25 Pittsburgh Summit.

A nal issue was the institutional ramework or macroeconomic policy coordination. The solution in this regard was not to place the IMF at the center o this e ortrather than continuing to rely on in ormal mechanisms – in this occasion the G-20.

The solution adopted at Pittsburgh designated the G-20 as “the premier orumo our international economic cooperation” but under multilateral surveillanceby the IMF. This solution only succeeds in a very partial way in placing the IMFback at the center o global macroeconomic policy coordination, as its originaldesign envisioned.





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4. Financial sector bailouts and regulatory measures

Industrial countries’ monetary and credit policies were generally more aggressivethan scal policies. Financial sector bailouts ell somewhere in between. Andwhereas Continental Europe dragged its eet on scal policy, the US was thereluctant partner in this case. There was also initially a clear lack o coordinationo nancial rescue packages at the global level. In the US, the bailout packageproposed by the Bush administration was approved with the support o theopposition, as a majority o Republicans re used to do so. Even then, therewas a revealed reluctance by the US government to take stakes in the banks.In Europe, governments announced in a disorganized way a series o initiativesthat competed with each other, particularly in terms o deposit insurance.Responses were placed on a better track a ter Great Britain announced itsbailout package on October 7.

The most important measure was the capitalization with public unds o

several nancial institutions, particularly those o systemic importance. The second ingredient was enhanced deposit insurance and governmentguarantees on new lending. The third was the creation o mechanismsto buy “toxic assets”, but this was limited in practice given the technicaldi culties in valuing complex and heterogeneous nancial assets. Therescue o Citibank in November 2008 and the British package o January2009 adopted a mix between the second and third types o interventions, asgovernments assumed a partial public sector guarantee on bank losses romtoxic assets. Curiously, as pointed out, ewer initiatives were taken to easedebtors’ burdens, particularly in the case o mortgages.

A major e ort to stabilize nancial institutions was crucial, to avoid a protracteddistrust in these institutions that a ected Japan during its lost decade. Therewere clear advances in this area but, as o early 2010, nancial stability had notbeen ully restored. Aside rom their scal costs, an equally important problemwas the limited transparency o the associated bailout packages. There wereclear de cits in this regard in several major countries.

An important issue was also the distortions in international nance and tradethat the bailouts generated. The act that industrial countries provided largeamount o resources to rescue their nancial system and o ered guaranteesthat developing countries could not match generated new asymmetries in theinternational system. Aside rom its nancial implications, these interventionsdistorted competition in international trade, particularly when subsidies weresectoral in nature, such as those granted to the automobile sector in several

countries. Fiscal and bailout packages also brought with them protectionistclauses, such as the “Buy American” provisions and the pre erence or hiring American workers included in the US scal stimulus.

A major advance in the international debate was the recognition that the currentcrisis was clearly associated with inadequate regulation and supervision o nancialactivities. It is in this area that the G-20 played the most use ul role, particularlyin agreeing on certain principles, though their concrete implementation wasstill subject to much debate as o early 2010. The rst agreed principle is thatregulations must be comprehensive or at least much broader in scope to avoidthe massive loopholes through non-banking intermediation that contributedto the current turmoil. This includes regulating hedge unds (or, more broadly,




23


alternative investment unds), security dealers and the types o transactionsthat led to the current crisis, particularly securitization and derivatives. It shouldalso orce all capital markets to be open and transparent and thus limit over-the-counter operations. It is also agreed that systemically important nancialintermediaries must be subject to particularly strict supervision, and perhaps tostronger regulatory standards, and that credit rating agencies and compensationpractices in nancial institutions should be regulated.

A second major advance was the recognition that prudential regulations shouldhave a counter-cyclical ocus, thus orcing nancial institutions to accumulateincreasing capital (or reserves that cannot be distributed as pro ts), provisions

or loan losses and liquidity cushions during booms. Many have also arguedthat absolute limits on leverage (the ratio o assets to the capital o institutions)should be established. Accounting rules continue to be subject to muchdebate. Pricing assets according to their market value (when it is available)may be pre erable or reasons o transparency, but this requires the adoption

o mechanisms (such as counter-cyclical loan-to-value ratios) to avoid assetprice bubbles rom eeding into the credit expansion, and asset price bustsrom speeding up the credit squeeze. Accounting rules as well as liquidity

requirements should also take into account the nature o the unding used bythe nancial institution (short- vs. long-term).

Consumer protection also gures prominently in some o the proposals, suchas the recommendation to create a Financial Sa ety Commission in the US.In light o the amount o toxic mortgages and highly risky investment vehicleso ered to unsophisticated households during recent years, this unction shouldbe clearly enhanced, as should the principle that nancial instruments o eredto unsophisticated agents should be as simple as possible, as complexitybrings with it in ormation problems and di culties or markets to price theassociated instruments. The current wave o bailouts is likely to result in higherconcentration in the nancial industry. The possibility o breaking up very largeinstitutions or severely restrict their risky activities has been incorporated insome proposals by US, UK and Swiss authorities. Finally, and very importantly,it is essential to guarantee that prudential regulations that are in place aree ectively implemented and, there ore, that supervision is done with the higheststandards. As pointed out, some o the major ailures that led to the currentcrisis came as a result o lack o supervision and implementation o existingregulations. So, increased surveillance and clear accountability mechanismswould also have to be introduced in all regulatory and supervisory bodies, bothnational and international.

As in the case o macroeconomic policy coordination, one o the major gaps inthe current regulatory debate relates to the institutional rameworks that shouldbe put in place. Creating a single world nancial regulator is probably not viableor, or that matter, desirable, given di erent regulatory traditions around theworld. So, the system that is designed in this area should be based on a well

unctioning network o national and regional authorities (which is still missing inthe EU) and include truly international supervision o nancial institutions with aglobal reach (such as the college o supervisors proposed by the G-20). Thereseems to be agreement that the IMF should not be at the center o the regulatorysystem. The Financial Stability Forum (now Board) and the Basle Committee onBanking Supervision and similar institutions are better placed. However, despitetheir recent broadening o membership to include all G-20 members, a major





24

problem o these institutions is the control by major industrialized countries,which even reserve or themselves the right to choose who is a member. Thus,the design o a truly representative institution that serves as the apex o world

nancial regulation should be on the agenda. One alternative would be to givethis responsibility to the BIS, but this would require making it a truly globalinstitution with political accountability.

5. The broader agenda

Current international negotiations have concentrated on the coordination o macroeconomic policy packages and strengthening nancial regulation. Theseissues do not exhaust, however, the agenda o international nancial re orm,which include at least three other topics: the need or a new internationalmonetary (or global reserve) system, the role o capital account regulations inthe global order, and the need or a debt workout mechanism at the international

level. Institutional issues are equally important. The pre erence or in ormalorganizations with restricted membership chosen by the major industrial countriesis problematic, as is the inadequate representation o developing countries ininternational economic decision making in general.

The current international monetary system, which ollowed the dual gold-dollarsystem created at Bretton Woods, is essentially based on the use o a national currency (the US dollar) as the major global currency. It is secondarily a systembased on the competition among national currencies (regional in the case o the euro) as reserve currencies. This system is inequitable and unstable. It isinequitable because it orces developing countries to trans er resources tothose issuing reserve currencies. This trans er has actually increased over timedue to the realization by developing countries that “sel -insurance” in the ormo large oreign exchange reserves is the only de ense they have in a world o acute nancial instability.

The system is also unstable because it is plagued by cycles o con dence inthe US dollar: periods in which the US runs large de cits and foods the worldwith dollar assets, ollowed by others in which the credibility in the dollar as areserve currency improves. During both phases o this cycle, the US adopts itsmonetary policies without any consideration as to their international impact. Asystem based on competing reserve currencies, such as the one we may bemoving towards, would not solve the inequities o the current system and couldworsen another element o instability: that among the exchange rates o thealternative reserve currencies.

The de ciencies o current arrangements are why the world monetary systemshould be based on a truly global reserve currency: a duciary currency backedby the central banks o the world. This is what was hoped or when the SpecialDrawing Rights (SDRs) were created in the 1960s. This process must thus becompleted, by trans orming the SDRs into such global currency and eventuallyallowing it to be used in some private nancial transactions. Among otheradvantages, this system would provide a mechanism or the IMF to play a moreactive role during crises, by issuing SDRs in a counter-cyclical way. Indeed, alarge counter-cyclical issue o SDRs is the best mechanism to nance largeo cial support to developing countries during crises. This would be the globalequivalent to what the major central banks o the world did on a massive scale




25


since September 2008. Regular issues o SDRs would also bring the size o IMF lending capacity to one more consistent with the magnitude o today’s

nancial shocks. A major re orm o IMF conditionality is necessary, anyway, tomake it attractive again or developing countries to use its acilities rather thanrely on “sel insurance” through oreign exchange reserve accumulation.

In relation to regulations o capital fows, it must be recalled that the IMFwas created on the presumption that capital account regulations could beused i necessary by any country to achieve its domestic macroeconomicand nancial policy objectives. The broad based trend towards capital marketliberalization has acilitated the spread (or contagion) o both booms andcrises. Since developing countries are subject to pro-cyclical swings (foodso capital during booms ollowed by scarcity o nancing during crises), theyalso have limited policy space to counteract such swings. Furthermore, sincethey usually borrow in oreign currencies, exchange rate depreciation duringcrises generates signi cant wealth losses (as several countries o Central

and Eastern Europe rediscovered during the recent crisis). Under theseconditions, external payments crisis are easily trans ormed into domesticnancial crises.

In the ongoing debate on the role o stronger nancial regulation, there shouldthere ore be an open discussion on the use o capital account regulationsto strengthen nancial stability. Those regulations can be use ul to mitigatecontagion during both booms and crises, playing there ore the role o “circuitbreakers” in international nance, in the same way such breakers play a use ulrole in electricity networks. They can also help improve nancial stability inindividual countries. There ore, the regulatory structure that must be developed

or nancial stability should include provisions that apply to cross-border capitalmovements, such as: making cross-border fows subject to taxes (the decisionadopted in October 2009 by Brazil) or reserve requirements (i.e., deposits incentral banks made by agents who bring capital into a country) to preventexcessive capital infows, particularly short-term infows during booms; minimumstay periods, similar indeed to those that mutual unds impose on investorsto guarantee the stability o their deposits; and prohibitions to lend in oreigncurrencies to economic agents that do not have revenues in those currencies.In this regard, the IMF should not only tolerate but actually advise countrieson what regulations could play a positive role under a given circumstance.

The absence o any discussion o capital account issues is, there ore, a majorde ciency o ongoing debates on nancial regulation.

The discussions that ollowed in the wake o the Asian crisis indicated that the

lack o an institutional ramework to manage debt overhangs at the internationallevel – i.e., a court similar to those created to manage bankruptcies in nationaleconomies, the decisions o which are legally binding – is one o the majorde ciencies o the current international nancial architecture. The only regularinstitutional mechanism in place is the Paris Club, which deals exclusively witho cial nancing. The system has relied in the past on traumatic individual debtrenegotiations or on ad-hoc mechanisms, such as the Baker and Brady Planso the 1980s and initiatives such as HIPC and MDRI since the mid-1990s. Theproblem o all these mechanisms has been that they generally come too late,a ter high indebtedness has had devastating e ects on countries. The systemis also inequitable, as it does not treat all debtors or all creditors with uni ormrules.





26

The discussion o the new international nancial architecture should solve thisproblem by creating an international debt court, which would serve both asmediator and eventual arbitrator o sovereign loans and, possibly, some privatesector loans. Negotiations would be triggered by de aults rom debtor countries,and should be based on the principle o a “ resh start”, which would leavea sustainable debt burden that would allow borrowers to make a (relatively)swi t return to markets. Furthermore, active use o multilateral developmentbank lending and guarantees could play a role in nancing countries whilenegotiations are in place and supporting their return to markets.

The major institutional drawback o current initiatives in several areas is thetendency to rely on in ormal structures. These arrangements are problematic,not only because they exclude small and medium-sized countries but alsobecause they lack institutionalized mechanism to guarantee a ollow up toagreed decisions. This is why the new governance system must be oundedon representative institutions , not on any “G”, which will always ace problems

o legitimacy. And it is necessary, or the same reason, to involve the UnitedNations, the most representative global institution, perhaps by taking the step,recommended in the past by many, o creating a Global Economic Council in theUnited Nations, with e ective powers o coordination over the system o globaleconomic and social governance. Such a body would have to be based on aconstituency system, to allow the indirect representation o small and medium-sized countries while keeping the size o the Council small enough to acilitatedecision making. In contrast to these proposals, one o the striking eatures o all three G-20 Summit communiqués was the almost complete marginalizationo the United Nations rom the emerging economic governance structures.

This process should, urthermore, place at the center o international re ormse orts the discussion o voice and representation o developing countries ininternational economic decision making and norm setting. This includes not onlythe IMF, the only place where some (though extremely modest) re orms havebeen adopted, but also the World Bank (where such discussion is ongoing), theBIS, the Basle Committee on Banking Supervision and other world regulatorybodies. The decisions taken by the G-20 at Pittsburgh, to shi t 5% o IMF quotaand slightly under 5% o that in the World Bank to unrepresented countries aresurprisingly modest relative to the inequities that characterize current quotasystems.

Finally, the institutional design should adequately take into account the role o regional institutions. Indeed, in a heterogeneous international community, thecreation o networks o global, regional and national institutions will provide

a better system o governance than arrangements based on single globalorganizations. Regional and sub-regional institutions give stronger voice andsense o ownership to smaller countries, and are there ore more likely to respondto their demands. In some areas this is recognized today, such as in the systemo multilateral development banks, where the World Bank is complemented byregional development banks and, in some parts o the world sub-regional (inLatin America and the Caribbean, in particular) and inter-regional banks (theIslamic Development Bank).

The recognition o the role o regional institutions is urgent in the monetary area,where the IMF should make more active use o regional institutions, such asthe Chiang Mai Initiative or the Latin American Reserve Fund, and support their




27


creation in other parts o the developing world. Indeed, the IMF o the utureshould be seen as the apex o a network o regional reserve unds – that is, asystem closer in design to the European Central Bank or the Federal ReserveSystem than to the unique global institution it now is. Similar institutional designcould be adopted or macroeconomic policy coordination, nancial policiesand or the international debt court.

The most ambitious agenda o re orm, which captures most o the issues outlinedabove, is that proposed by the Commission o Experts o the UN General Assemblyon Re orms o the International Monetary and Financial System (the StiglitzCommission). The June 24-26 UN Con erence on the World Financial and EconomicCrisis and Its Impacts on Development approved, in turn, the most ambitious agendaagreed so ar at the intergovernmental level to ace the current crisis. It should beadded that the 2002 Con erence on Financing had approved, in turn, the MonterreyConsensus, the most ambitious agenda in the area o global nancial re orm, butone that has been signi cantly lacking in implementation.

The June 2009 UN Con erence recognized, among other issues, the needto discuss re orms o the global reserve system and more ambitious debtrestructuring mechanisms, the need or deeper governance re orms in multilateral

nancial institutions and standard setting bodies, and the role o regionalorganizations. It also recognized the role o the United Nations in the re orme orts, particularly as an inclusive orum or debate, but shied away rom themore ambitious call by the Stiglitz Commission and similar proposals in the pastto create a Global Economic Council. All these issues should be brought intothe global agenda.




Democratic Practice and

Governance: Instrumentsto Address the WorldEconomic Crisis




31

Democratic Practice and Governance:Instruments to Address the WorldEconomic Crisis

By Jorge I. Domínguez 1

The world economic crisis that began in 2007 and exploded in 2008 made itapparent that nancial markets were insu ciently sel -regulating, transparencywas woe ully de cient, and the economics pro ession as well as central banksand international nancial organizations were slow to anticipate the economiccatastrophe, honorable exceptions notwithstanding. The consequences o the

nancial crisis on the economies across the globe have been severe or alland devastating or many, setting back the hopes o the prosperous, gravelythreatening the livelihood o the majority, and plunging the poor into despair.

Politics is back, there ore, as Ricardo Lagos, president o the Club o Madrid andChile’s ormer president, made clear in his opening remarks to the annual con erenceo the Club o Madrid in November 2009. Politics is back because only sovereigngovernments have been capable o pumping liquidity into the world’s nancialsystems to avoid a collapse o the payments system. Politics is back because onlystates could ensure through countercyclical policies that the crisis would resultonly in a Great Recession, not a Great Depression. Politics is back because abetter and tighter regulatory ramework must be designed to reduce the likelihoodo uture market imprudence and hold accountable those who have mishandledthe resources entrusted to them. Politics is back especially in democratic politicalsystems because states must address the consequences o the crisis on the poorand assist those o modest means to edge back rom the economic abyss.

The consideration o politics was back as well at the Club o Madrid con erencebecause its Members – ormer presidents and prime ministers o democraticcountries – are knowledgeable about various topics but in particular they aregood at politics.

Politics is not a magic wand to make deep structural problems disappear or tosugar-coat the tragedies o the present. The role o politics raises three broadquestions, and a speci c one, as we ponder what may be done next:

Will the public• elect the best leaders i politics is back?Will states respond e ectively to address the ongoing economic crisis?•

Will politicians choose wisely once elected and in charge o the state?•

More generally, will democracies deliver?•

1. The General Rapporteur or a con erence is like a futtering butterfy that walks in and out o working groupsessions, listens to plenary sessions, and seeks to milk the honey rom the very interesting ideas that theMembers o the Club o Madrid – ormer presidents and prime ministers o democratic countries – and theirguests discussed over several intense sessions. I heard only some discussions because working group sessionsmet simultaneously. The result is necessarily incomplete, reliant on impressions and themes, and not at all atranscript o what was said in detail. It is my hope to have been aith ul to the con erence purposes, accurate inconveying the points that I did hear, constructive in building bridges between somewhat disparate sessions, andloyal to the Club o Madrid’s commitments to democracies that deliver. I am grate ul to the Club o Madrid orgiving me this opportunity and to its Members or their insights. All mistakes, o course, are mine alone.





32

The public does not always elect the best leaders . Alas, the Members o the Clubo Madrid know this act too well; i the answer were yes, the Club o Madrid wouldhave many ewer members. Good politicians and responsible political parties o tenlose elections. Electoral politics, especially during hard times or economies andsocieties, o ten ace the risk that populist demagogues may be elected. As a resulto those elections, more severe hardships may appear in due course. Electoraldemocracy provides no guarantee that the public will choose wisely.

Democratic electorates can, however, hold presidents, prime ministers, andpolitical parties accountable. They do so when citizens engage in what is calledretrospective voting. They look back on government per ormance in the recentpast and, when they nd it wanting, de eat the incumbents. In national electionsheld in 2009, or example, electorates as di erent as those o Iceland, Japan,and Argentina de eated the incumbents who had governed them badly. Theymade the right decision.

Democracy may hold politicians accountable. Democracy may be a peace uland e ective instrument to re-chart the path to the uture.

States may respond badly . As the Club o Madrid was holding its con erence,there was news that Venezuela, one o the leading petroleum producers in theworld that is also endowed o vast natural gas and hydroelectric power resources,had been rationing electricity and su ering severe power shortages. States maygrow very big but that is no guarantee that they would be competent or e ective.States may, indeed, respond quite ineptly to economic circumstances.

Responses may be improvised. Responses may be so in ormal that citizensand social and economic actors cannot comprehend the rules by which theyshould abide. Heads o state may have limited time horizons and privilegeshort-term quick- xes to long-term solutions. The key, there ore, is to remain

ocused: In ormal solutions are o ten necessary in the ace o a severe crisis,quick-thinking may be essential, but political leaders should be committed to

ashion new structures or the longer run 2 .

States may also respond badly because public o cials are under-in ormed; inturn, this is so because the experts, too, are under-in ormed. It is o ten the casethe small changes may accumulate, converge almost imperceptibly, and leadin time to systemic catastrophes. The end-o -decade Great Recession beganin such a ashion, as trouble started in seemingly unrelated events until nearlyevery asset turned down and nearly every sa eguard ailed.

The utility o democratic constitutionalism . In order to think about how statesare governed, ocus on the kind and quality o the political regime. The Club o Madrid highlights the value o democracy or its own sake. In our discussions,we came to understand the utility o democracy as well.

Democratic constitutionalism is an invention o the last century and a hal . Itbecomes possible only with universal su rage. It becomes e ective only when

2 See statement by Wim Kok, ormer prime minister o the Netherlands and new president o the Clubo Madrid, in the nal report by Richard Youngs on the roundtable, ‘The Political Dimensions o the WorldEconomic Crisis: a European Perspective’, in the appendix.




33

Democratic Practice an Governance: Instruments to Address the World Economic Crisis

democratic majorities choose constitutional sel -restraint. Democraticconstitutionalism can legitimate state action with regard to markets in ways thatdictatorships cannot.

Democratic constitutionalism may provide checks and constraints on stateaction. It does so by means o the rule o law and the establishment o institutions,which have signi cant authority to deploy their su cient power. Democraticconstitutionalism may empower states to act and, in severe crises, emboldenthem to do so backed by national majorities. Constitutional democracies canand should regulate the banks and other systematic nancial institutions;they can and should provide supervision o individual banks in the context o regulated nancial markets.

Beyond the worldwide economic crisis . It would be better i the world weresimply mired in a worldwide economic crisis. Instead, this economic crisis hasalso generated a worldwide social emergency. The task is especially salient or

democracies because, above all, democracies must be committed to supportthe capacities o majorities to shape the uture.

Much progress had been made during the preceding decade and a hal inreducing poverty across the world. As a result o the Great Recession, therehas been a huge setback or the results o anti-poverty e orts and there isevidence o alarming retrogression.

Similarly, it is uncertain whether governments are addressing the economiccrisis e ectively. It is also uncertain whether they are addressing success ullythe political crisis that threatens the governing coalition. But it is certain thatgovernments across the globe have paid remarkably little attention to the socialcrisis, a point that the ormer primer minister o Portugal, Antonio Guterres,made orce ully at the Club o Madrid meeting.

The world’s commitment to address poverty in all its orms seems to haveweakened dramatically. There is a risk o the destruction o social protection inthe countries that have such institutions and a continued ailure to create sociallyprotective institutions in countries that lack them. Public services worldwidehave been impaired, nowhere more so than in sub-Saharan A rica.

States – especially those with democratic regimes – should act to sustain socialprotections amidst economic crisis. In particular, states should empower thepoor to develop their own personal capacities to take charge o their lives, andnot merely remain as the wards o others.

The ethical oundation o the relationship between markets and democracy isnot just the enrichment o the ew but, rather, the improvement o the capacitieso all.

How may politicians lead? Democracy is not established with the snap o ngers nor sustained merely through pious wishes. Democracy is not just thenal outcome o a long process o political change, though it may be so as well.

Democracy is not a political system in a steady state. Democracy is an ongoingprocess in which citizens and their leaders engage every day, not just everyso many years when elections are held. In particular, in democratic politicalsystems, politicians should be working at the ongoing process o democracy all





34

the time. Yes, politicians must engage in politics in democratic regimes and it isboth right and use ul that they should do so. Consider a couple o reasons.

First, in order to lead, leaders must also be good listeners. This is probablythe case in every society but even more so in democratic political systems.

The more pluricultural and multilingual the society, the greater its variety o communities o aith and other orms o belie , the more important it is thatpolitical leaders should be good listeners – a point made at the meeting romher own experience by New Zealand’s ormer primer minister Jenny Shipley 3 .

Democracies can deliver good outcomes because they give politicians power ulincentives to listen. I politicians do not listen, they will not win elections. I incumbents do not listen, they will lose power. I actions within a politicalparty or coalition do not listen, their capacity to win and rule will be seriouslyharmed. Democratic politics can serve us well in the economic crisis and socialemergency because democratic politicians must listen to their people, their

allies, and their adversaries. Democratic politicians must listen to long speechesand at times give some o their own.

Second, and just as importantly, democratic politicians, as a normal part o their job, must deliberate, must negotiate, and must bargain. Democratic politiciansmust look or ways to build a consensus large enough to make it possible orthose who rule to do so responsibly and e ectively. The more they deliberateand negotiate, the more democratic politicians are likely to deliver policies thatthe society would support.

Committing the uture . Democracies do not work like a vaccination against anillness. Democracy is not a vaccination against political stupidity, state ineptitude,plutocratic greed, and public cynicism. But democracies are especially e ectiveat committing the uture.

Leading public o cials in democratic countries work with various political partiesand, in parliamentary systems, must o ten negotiate coalitions. The process o construction o a coalition, or o a party large enough to win by itsel the consento the governed, must o ten incorporate people who may disagree on signi cantquestions. Large political parties or coalitions o ten include dissonant voices.In making agreements among those who agree on core concerns though noton every details, democratic politicians are not just committing themselves.

They are not just committing their action or their political party. Democraticagreements between parties or actions seek to bind the other politicians,

actions, or parties that belong to the coalition, with regard to the uture.

In an authoritarian regime, the dictator can commit his government only untilthe day he dies or is overthrown.

Democratic politics is uniquely e ective at making su cient agreements todayto ensure that the most important will endure into the uture. This is not aguarantee, but it is a political process at which democracies may be moree ective than dictatorships. Democratic politics requires a lot o work and

3. Shipley, and the ormer president o Mauritius, Cassam Uteem, co-chair the Club o Madrid’s project on“shared societies,” which ocuses speci cally on societies o this sort.




35

Democratic Practice an Governance: Instruments to Address the World Economic Crisis

commitment during campaigns or public o ce and in government itsel . Akey objective o such work in democratic political regimes is to increase thelikelihood that the policies o today will remain the policies o tomorrow thanksto the consent o the rulers, their occasional adversaries, and the ruled.

Conclusions . Democratic politics, there ore, may help our countries addressthe economic crisis and social emergency in a number o ways, several o which deserve reiteration.

Democratic politics is more likely to provide or means o public accountability1.because retrospective voting in ree and competitive elections may remove

rom o ce those who have governed badly.Democratic politics is more e ective at legitimating state action in regulating2.

nancial markets and supervising the banks because o ce holders aresustained by the support o the majority, not the mere whim o somerulers.

Democratic politics may empower the capacities o the poor so that they3. take charge o their lives precisely because in most countries those with lowincome constitute the democratic majority.Democratic politics generates power ul incentives or politicians to listen so4.they can win elections and reelections.Democratic politics osters deliberation and negotiation as a public strategy5.to enable politicians to govern as they must.Democratic politics may be uniquely e ective at committing the uture6.credibly because it does so by means o the consent o the governed.

Democracies can deliver, there ore, more e ective responses to this economiccrisis and social emergency. Democracies can deliver because they are especiallyadept at shaping the wise restraints that make us ree.




Employment, Social

Wel are, and DemocraticRights and Duties




39

Employment, Social Wel are, andDemocratic Rights and Duties

By Richard Simeon

The sweeping global economic crisis, rom which we are only beginning torecover – tentatively and unevenly – has had, and will continue to have, multipleconsequences or employment, social and economic well-being, and or democraticpolitics. These were the central concerns o Working Group 1.

The group explored rst the repercussions and implications o global economiccrisis. These repercussions o course play out di erently in di erent countries.Some survived the crisis relatively unscathed; others were deeply a ected. But

in every country, in its own way, the crisis posed major challenges to democraticinstitutions, and to political leadership.

Second, the group explored institutional and policy changes that might helprenew the social contract and oster relationships o trust and con dence thatwill allow governments to act e ectively to mitigate the consequences o short-run ailure, while building the oundation or long-term growth and equality.

Democracy and economic success, members o the working group agreed, gotogether. But we also agreed that the relationship is seldom simple.

This Report has two sections. The rst is diagnosis: what are the consequenceso economic crisis or employment, wel are, and democratic rights and duties?

The second is prescription and recommendation : what is the role o government in the ace o economic crisis? I the crisis threatens workers orincreases inequalities, what is then the responsibility o government to mitigateits e ects, and, more importantly, to plan or uture economic growth?

I. Diagnosis

Seven e ects o the crisis were especially important to the group.

1. Increased poverty and unemployment

In the decade prior to the economic crisis, economic growth in many parts o theworld was impressive. Some developing economies stood out – China, India,and Brazil, among others – but growth was also strong many other countriesin A rica, Latin America, and Asia. These successes were also associatedwith quite dramatic reductions in levels o poverty in many o these countriesand with higher levels o investment and improved employment prospects orworkers.

Moreover, the economic crisis appears not to have been as deep and long-lived as many had eared. Government policy responses in many parts o theworld – both developed and developing – appear to have stanched the worsto the wounds.





40

Nevertheless the speakers, commentators, and participants in Group 1 wereanything but complacent. They noted how uneven earlier growth had been. Theyrecalled how recent was an earlier ‘lost decade’ o growth, and how importantit was to avoid another. They emphasized that recovery in employment o tenlags earlier indicators o recovery. They pointed to continuing high levels o unemployment and under-employment, especially among youth.

2. Increased inequality within and between nations

Participants in Group 1 also stressed how dramatic and persistent economicinequality remains, both within countries and between them. Little progresshad been made in this respect, even in the preceding growth years; indeed insome countries inequality had increased with most o the bene ts fowing tothe wealthy and the most highly skilled and educated. The worry now is thatany progress the world may have made is likely to be reversed by the economiccrisis. Participants believed that while the evidence shows that democracy

had survived, even under conditions o high inequality, in the long run deepinequality is a threat to democratic values, and its persistence is an indicatoro a democratic de cit. As the Club o Madrid has stressed, ‘democracy thatdelivers’ is critical to its long-run success.

3. Increased vulnerability and insecurity or many citizens

The economic crisis underlined how volatile the global economy has become.Citizens and whole countries are vulnerable to shi ts in technology, trade fows,investment patterns, and the like. And no longer can workers depend onthe social sa ety net to protect them against the winds o economic change.Whether it be employment insurance, pensions, child wel are, or health care,governments have ewer resources to protect their citizens and prepare themto compete more e ectively in the uture.

4. A resulting increased ocus on sel -preservation and protection, and a potential erosion o the social contract

Citizens and workers are increasingly thrown back to depend on their ownresources. The danger in a volatile, uncertain world o scarce resources is thatthe social contract that binds citizens to citizens in a kind o gigantic mutualinsurance scheme may erode. The Group worried about a world o ‘every man(too o ten only men) or himsel ’. This mani ests itsel both in the actions o individuals (‘sauve qui peut’) and countries, where the temptation to protectone’s own industries through protectionist measures is understandably strong,

and o ten hard or governments to resist

5. As a result, an increasing potential or con ict not only between rich and poor, but also between ethnic, linguistic, religious and cultural groups within states

Here is where the Club de Madrid’s commitment to reconciling di erencesthrough its Shared Societies program and its concern about the e ects o theeconomic crisis come together. Conficts rooted in language, ethnicity, race, andreligion almost always have behind them an economic dimension. This can range

rom struggles between pastoralists and armers over land and water in many A rican countries (deeply aggravated by other actors such as climate change),




41

competition over ownership and control o natural resources in contested areasin A rica, the Middle East and Latin America, or competition between nativeresidents and immigrants or jobs in Europe and North America.

Such conficts are by no means new, but they are very likely to be exacerbatedby the economic crisis. This plays out in many ways. To take one example, theyears o economic boom brought many workers rom A rica and Asia to WesternEurope, uelling a number o anti-immigrant political parties and harsher lawsagainst immigrants and re ugees. The economic crisis had several urther e ects.First, there has been a dramatic decrease in remittances rom immigrant workersto their home countries – these make up signi cant proportions o GDP in manypoorer countries, so the reduction in trans ers may have serious consequences.Second, a large fow o newly vulnerable workers rom richer countries havetraveled back to their home countries, likely increasing employment problemsthere. And third, there may be sharply increasing tension between immigrantsand native workers in many countries. Managing these tensions is a major

challenge acing governments in these countries.6. A potential loss o confdence and trust in governments,with a resulting loss o legitimacy and e ectiveness

Much o this report has emphasized the broad conclusion o this con erence –that politics is back. The crisis creates an enormous agenda that governmentsand leaders must con ront. Yet much evidence demonstrates that trust in politicalleaders, and aith in their competence and honesty, has declined dramaticallyin many parts o the world. Herein lies a dilemma: at the very moment whene ective, dynamic political leadership seems most essential, the potential orsuch leadership is lacking. Thus the capacity o governments to mobilize theresources to manage the crisis and its long-term e ects is weakened, as istheir ability to negotiate in the international arena and to motivate citizens in thecommon challenges they now ace.

7. And, as a result, there is the danger that populist, authoritarian leaders claiming magic solutions will come to the

ore, potentially challenging democratic rights

In this context, there is always the danger that populist, authoritarian leadersmay exploit the crisis in order to strengthen their own rule. While such e orts maywin short-run success and support, the likelihood o long-run success is low. Inmeantime, ree speech and the rights o minorities are likely to be suppressedand corruption to be increased. As has been noted by many commentators,

threats to human rights are likely to be low when things are going well, and tobe threatened in hard times.

None o these challenges is new; they have long been challenges to democraticgovernance. But the crisis is likely to deepen and intensi y them, and to makesolutions more di cult.

II. Seeking Solutions

This was not a group o economic policy experts, primed to provide a road-mapto renewed prosperity. But the group did agree on certain basic principles that

Employment, Social Wel are, and Democratic Rights and Duties





42

should underpin policy developments; and made it clear that in the long rundemocracy, openness, accountability, and citizen participation provide the mostsolid plat orm or sustained economic success that will share its bene ts widelyacross the country. It is alse to claim that in an economic crisis ‘democracy isa luxury we can no longer a ord’. On the contrary, democracy provides potentsa eguards against political error, and provides government with the popularsupport and legitimacy that is required or them to act e ectively.

1. Renewing the social contract, or social compact

This was perhaps the strongest commitment o participants in Group 1. This,they said, was not the time to be weakening or abandoning the social contractbetween governments and workers. Rather, this is the time to be rein orcingand strengthening it. This is a role or businesses, unions and civil society ingeneral, but it is also a central role or governments.

2. Protecting the rights o workers

The group stressed that workers especially at the lower end o the incomescale and the young have borne the brunt o the crisis – a crisis they did notcause and over which they have very little control. Hence, there is a central role

or governments.

3. Managing migration in an era o wrenching economicchange

The mobility o workers is one o the most important phenomena o our times. Itoccurs within countries, as in the massive movement rom rural to urban areas,and between countries. It is o ten benign, o ering skilled workers opportunitiesthat may not be available to them at home, and thereby enhancing the reefow o ideas in a global economy. But it also has a dark side, as in humantra cking, exploitation o migrant workers, and ‘ethnic cleansing’ that resultsin large number s o internally displaced persons in many countries. This toois a pro ound challenge both to individual governments and to internationalinstitutions.

4. Re-balancing the relationship between state and market

The relationship between the state and the market is always in fux. When thestate appears to be ailing, market solutions come to the ore; when the market

ails, the state must step in. This is one o those times. In the post World War

Two period, western countries, mind ul o the excesses o the Great Depressionand the Nazi period turned to building the social sa ety net and managing theeconomy through Keynesian economics; post-colonial developing states lookedto strong central government leadership in promoting economic development. Bythe 1970s, both these trends were called into question, and market liberalism,hostile to the state, emerged as the dominant driver o policy. Now the wheelhas turned once again as the costs o the un ettered market became apparent.Once again, the state is back in.

But it is never all or nothing; and each country – hope ully coordinated withinternational economic institutions that are responsive to the whole globaleconomy, and not just a ew – will have to nd their own way. Group 1 suggested




43

Employment, Social Wel are, and Democratic Rights and Duties

two primary roles or the state in a globalized the economy. The rst is to bea bu er between its own citizens and the vagaries o the global market – thissuggests strong social sa ety nets. The second is to prepare their citizens toparticipate ully and success ully in the global market-place. This implies apower ul emphasis on training and education.

5. Re-building relationships o trust and confdence betweencitizens and citizens, citizens and governments, and governments

and governments in the international arena

This may be the most challenging, but also most undamental, task. For it isout o the combination o the energy, dynamism, imagination and creativity o individuals as citizens and workers, with the leadership o organizations such aslabor and business, and the mobilization o resources by governments that areskilled, competent, open and accountable that economic growth and politicaldemocracy thrive together.




The Citizen, the State

and the Market




47

The Citizen, the State and the Market

By Bolívar Lamounier

The impact o the worldwide economic crisis was not homogeneous acrossregions and countries. This accounts or some variations in the post-crisisclimate, more pessimistic in some countries than in others. The Group called“Citizens, States and Markets” refected such variations, but, on the whole, thetone o the meeting was rather pessimistic.

Participants expressed strong concern about the sequels o the crisis. Arecurring theme was that the crisis impacted deeply on social and politicalstructures, converging with other crises and thus leaving long lasting scars.Geraldine Fraser-Moleketi suggested that we should think in terms o multiple

crises taking place all at once. Bondevik, ormer prime minister o Norway,agreed. In the short run, he indicated, “increasing poverty is unavoidable, andit is already taking place; a deep and long economic recession looms with highunemployment, shrinking tax receipts, lower exports and trade, decreasingtourism, less consumption and ultimately the spectre o defation”. Indeed,“the nancial crisis must be seen in connection to other crises in the world o today. Because we are experiencing an accumulation o at least our crisesmutually eeding on each other, namely the nancial and economic crisis,the climate change crisis, the ood and hunger crisis, and the oil and energycrisis”. Along the same lines, Patterson, ormer prime minister o Jamaicastressed that the crisis “... goes well beyond nancial and monetary; what weare dealing with is really a threat o a collapse o the whole global system o governance”.

Democracy, o course, was at the center o the debate. Kim Campbell, ormerprime minister o Canada, expressed concern that the notion o democracyitsel could be damaged, i people were to lose con dence in the ability o the democratic state to deal with the problems created or aggravated bythe crisis. Ingrid Srinath concurred: “I think the whole risk o seeing market

ailures as ailures o democracy is huge”. In many countries, she said, a modelo authoritarian or State capitalism may garner more support than capitalistdemocracy properly.

Several participants took up these issues in more positive terms. “In essence” –said Fraser-Moleketi, somewhat holistically – “... [there is a need] to reenergize

the human rights approach to human development, readjust the current globalgovernance accountability arrangements, recon gure current social processes,and consider the global social compact around common issues such as hungerand other areas, bearing in mind that such a global social contract is requiredi we want to ensure that we are able to ameliorate such crisis”. Patterson

ocused on the role o the State and on the individual. “The choice that weace today is not between State ownership and dominance o the State vs.

the avarices o nancial conglomerates (...); we have to nd the right mix, theright balance”. “The citizen – he said – ought to come rst: what we are dealingwith is the primacy o people, [o ] the human being”. In a democratic society,he added, the citizen has at least three distinctive roles: voter, consumer andtax-payer.





48

For Fraser-Moleketi, “... the State [should be seen] as the bridge between what Ire er to as the process, which is the markets, and the outcomes which is what Ire er to human well-being”. Patterson, again: “we can all agree that the state has theresponsibility to create the environment that stimulates economic growth and socialdevelopment, and the building o human capital. It also has to provide the legislative

ramework. The State has to develop the institutional capacity to monitor and ensureaccountability; accountability to the people in which the market conditions prevail.

The State itsel is a major provider o services, and a very signi cant player in thepurchases o both goods and services. Civil society has to make the critical di erence.It is, i I may say so, the grease between the State, the market and the rights andliberties o the Citizen.”

The moderator, Peter Eigen, summarized this part o the discussion as ollows:“It’s air to say we’ve all agreed that there has to be a better and strongerguidance to the private sector by the State. And that it has to strengthenthe state, not necessarily enlarge it, not necessarily invite it to participate in the

economic activities themselves as commercial actors. Most o us also agreedthat civil society organizations can become important actors to help the Stateto recover the capacity to spread its wings as wide as necessary in order toregulate a globalized economy which has to a large extent, escaped politicalshaping”.

Bondevik emphasized the depth and destructiveness o the crisis, but he alsopraised the commitment o the G-20 to an open global economy, rejectingprotectionism and the temptation o turning inwards in times o uncertainty.“Essential to economic growth and prosperity”, he said, the economic openingo the last ew decades has li ted millions out o poverty the world over. Inhis presentation, Victor Rico also stressed poverty reduction and refected onits signi cance in the Latin American context: “The reduction in poverty hasbeen more or less homogeneous across Latin America. It has permitted Latin

American countries to respond more e ectively to the current economic crisisin its political and social aspects but also in economic terms … because oneo the positive legacies o the so-called Washington consensus has been themacroeconomic equilibrium has also come to be seen as a social good. Noone disputes any longer that a macroeconomic equilibrium is a good thing”.Regrettably, however, the positive trends to which Rico re erred coexistedwith the reemergence o anti-democratic governments in some countries.In his own words: “Un ortunately, the development o social and economiccitizenship has occurred to the detriment o social and political citizenship,which has su ered constraints on reedom o expression, political associationand political participation. The challenge, there ore, is how to shape a virtuous

cycle involving a strong State, a strong Market, and a citizenship empowered inits political economic and social dimensions”.

It is evident, there ore, that the title “Citizens, States and Markets” adequatelyexpressed the cast o mind o the participants. They elt uncom ortable withthe traditional state-market dichotomy and agreed that we should analyzea conceptual triangle involving the State, the market and civil society – thelatter term, in my view, including the citizens, associations, and representativeinstitutions such as legislatures and political parties.

At the ideological level, a result o the crisis was o course the resurgenceo anti-market conceptions. With these in mind, Kim Campbell o ered a




49


refection on the role o markets: “The market is the mechanism by which themany thousands and thousands and thousands o decisions that go in to theeconomic interactions o people, can be carried out. And one o the thingsthat is very clear is that States are not good at that, governments cannot runeconomies, the people who manage bureaucracies do not have the skills or theunderstanding to take risks, or make the many decisions every day that go intointeractions, trade and investments. I would also point out that regulation doeswork. In other words, there are things that we can do to try to make marketsoperate in ways that are honest, transparent and unctional”.

Concerning the nancial system, Mmasekgoa Masire-Mwamba, Deputy Secretaryo the General Commonwealth Secretariat, observed that the issue is morecomplex, because there has already been a lot o regulation; the main challenge,given the scope, scale and complexity o the crisis, is that a lot o what hasoccurred did happen within the rules. What has been lacking is the State’sability, willingness and maybe even capacity to hold the nancial markets

accountable”. She also stated that “we need a more value-based system o regulation”.

In this rapporteur’s view, there was in the group a consensus that States needto do more and better. The problem, o course, is that we must guard againstdei ying the State, either because in many cases they are corrupt or patrimonial,or because they simply lack the resources and capabilities to regulate themarkets adequately. Kim Campbell: “So we have to look at how to strengthenthe State, that is, how the State can have the capacity to create the neededpolicies, how to make politicians more knowledgeable and understanding, andbe supported by skilled people, and how the government and the [regulatory]agencies independent and not corrupt”.

Grzegorz Ekiert also emphasized the role o national States. The consequenceso this economic crisis – he said – “are and will be greater or nationalgovernments, which will have to deal with poverty, unemployment and theappearance o tensions. We really need to ocus on how the states need tobe recon gured as the result o the current crisis. I plea or thinking not onlyabout the international system, not only about civil society organizations, notonly about citizens and the rights o citizens, but also about capacities o theState and how the State needs to change in the coming years and decades, inorder to be able to respond to those challenges”. Ekiert’s view was quali ed byMario Pezzini (Deputy Director, Public Governance and Territorial Development,OECD) who raised the issue o investment targeting more generally: “We aresaying that public investment is to be targeted temporarily and in timely ashion.

We have discussed a lot about the transient and matters o timing but notenough about the targeting; how this stimulus money has been spent up tonow. For many years, we cut public investment: now we are con ronted witha big mess and we have to decide where to locate this investment”. At leastin Europe, Pezzini insisted, local governments have a undamental role, andshould share resources accordingly.

Peter Eigen welcomed the triangular conceptual ramework, which the whole groupalso supported. The paradigm o the nation-state as the main source o legitimatepower and governance requires complementation, Eigen said; indeed, the triangularrelationship between State, private sector and civil society organizations [must beviewed] as a new paradigm or better governance in the uture.





50

We must be care ul, however, not to overestimate the capacity o civil society;at the very least, we should not orget the large body o literature on collectiveaction problems – i.e. di culties that organizations ace when trying to acttogether as i they were unitary actors. Ingrid Srinath (Secretary General o Civicus) called attention to the matter o resources: “We have yet to grapplewith the problem o resource asymmetry across these three players. The moredirectly a civil society organization or group o organizations actually engagein playing that watchdog role, the less likely it is to attract unding rom theother two sources”. Peter Eigen expanded on this point: “one has to makesure that civil society wants to play an important role as part o [the system o ]governance. Such organizations have to grow into this role, become in ormedand strengthened in terms o modernizing their management transparency, andtheir own governance, which o course includes the question o the unding”.

Campbell o ered an important remark on the relationship between individualsand associations: “civil society is a great thing, but the ultimate unit o a society

is the citizen. And in ree societies the citizens are the ultimate decision-makersthrough their voting, and their choices regarding joining civil societies andvarious organizations”.

Apart rom rethinking the system o nancial regulation – a cross-cuttingrecommendation in the whole con erence –, and recognizing that speci cpractical recommendations were not our objective in view o the enormousdiversity o national contexts, group participants made several valuable indicationslikely to be valuable rom the standpoint o broader policy choices.

Ekiert suggested that we should not expect too much rom the State. Theproblem, he added, is not just that the capacity o States is limited but also thatthey create or aggravate problems when they try to do too much. Such adviceseems particularly important in connection with the crisis because Ekiert at thesame time recognizes that states must now be proactive, vigilant, and able torespond rapidly to unexpected challenges.

Also prescriptively, Yun-Han Chu (Research Fellow, Institute o Political Sciences, Academia Sinica) made thought ul remarks. In the short run, he argued, themost urgent task is to restore the checks and balances between the Stateand the markets, especially between the State and the nancial market. We allrecognize, he noted, that the scope, scale, and complexity o the challenge arevast, global in nature and well beyond the jurisdiction and capacity o the nation-state. They require national, regional, and global responses at the same time.We have to restore the nation-state as one o , not the only, but one o the critical

and relevant important actors. The nation-state can be empowered througha proper multilateral and regional arrangement. Otherwise, the multinationalnancial market and multinational corporations are simply too power ul or any

national government to attempt to regulate.

Another undamental task, he argued, is to develop a common vision or abalanced, sustainable and virtuous triangular relationship between citizens,market, and State. For Chu a balanced, sustainable, and virtuous triangularrelationship entails two elements. On one hand, a constructive partnershipmust develop between each o the three parts, through dialogue, engagement,mutual accommodation and collaboration. On the other, a prudential systemand practices o checks and balances must also develop in each o the three




51


poles o the triangle. Each pole should have its own autonomy, identity, andobjective, and try to work with the other two seeking common ground. All threeactors have responsibilities.

Nongovernmental organizations (NGOs) can exert checks on the conduct o thecorporate sector, on behal o consumer, labor, local community, and environmentalinterests. However, each pole in the triangular relationship ought to exercise suchchecks with reasonable restraint. Without prudence, the democratic system tends tobe overburdened and problems o excessive polarization, politicization, or even lacko governability tend to appear. So, Chu argued, the most important responsibility o the State and o civil society actors, under the current circumstances is truth ulnesswhich is essential i political leaders are to turn the crisis into a window opportunityto introduce undamental re orms.

Finally, Chu pointed out that none o these suggestions is ideologically anti-market. These are market-oriented prescriptions because they are meant to

enhance the long-term sustainability o the ree-market and ree-trade.Campbell also sketched a philosophy regarding the primacy o politics, staying away

rom holistic theories o the State while emphasizing the importance o values orpolitical action: “The responsibility to make decisions and to direct institutions– she said –, never goes away. In democratic societies, the State is what we makeo it, it has the powers that we give it, the ideological predispositions that we bring toit, and whether the government is big or small. It is the skill o the people who are inthe government and the ability and ethics o the people who operate in it”.

Indeed, the quality o the “political class” and the degree o allegiance andesteem it gets rom the public are key elements in the unctioning o a democracy.Rojas Aravena (director o the Latin American Faculty o Social Sciences-Flacso) rightly observed that the decline in support or politicians, legislatures,and political parties is one o the most worrisome aspects o democracy incontemporary Latin America.

Indeed, what undermines the legitimacy o democratic institutions in the regionnowadays is not the lack o political rights or participation opportunities (except

or some cases o authoritarian populism and the case o Cuba), but ratherthe lack o e ectiveness o the states and the precarious standing in whichpoliticians and representative institutions are held.

In Brazil, or example, the vote is allowed rom the age o 16; the total electorateis now over 130 million voters, 70% o the population. There is no question that

political rights are in place. What undermines the legitimacy o democracy, rstand oremost, is the ine ectiveness o the governments, at all three levels o theederation, in meeting people’s needs and expectations.

The other actor, as indicated, is the low standing in which politicians are held. The Group emphasized the observation that citizens devalue politics, with orwithout reason, but also that the politicians themselves do a lot to rein orce thepublic’s negative evaluations. Politicians also devalue politics. I would there orelike to conclude this report on the idea o the primacy o politics. There is a need

or political will and leadership but this may well require e orts to recapture thevalue o political activity and to re-value the vocation o politics. This may wellbe one o the conditions to turn the crisis into opportunity.




The Market,

Regulatory Frameworksand DemocraticGovernability




55

The Market, Regulatory Frameworksand Democratic Governability

By Lucinio Muñoz

“Nobody was prepared or this type o tsunami that all o a suddenoccurred; we didn’t see it coming” Wim Kok, ormer Prime Minister o the Netherlands

The most recent global nancial crisis “tsunami” had its epicentre in the nancialmarkets o the United States and Europe but its impact has been su ered on aglobal scale and its seismic waves have a ected not only international nancial

markets but also national economies and citizens all over the world. Substantialamounts o taxpayers’ money have been trans erred rom public budgets toprivate institutions, as governments have elt compelled to bail out banks andinsurance companies in order to avoid the collapse o their nancial systems.

This nancial cataclysm has caused severe economic disruption and it has hadpro ound worldwide political implications.

Pain ul as it has been, the crisis could be an opportunity to refect on hownancial markets can be managed more e ectively through the use o highly

technical standards and regulations that address the de ciencies that causedthis crisis in the rst place and protect citizens rom the most pernicious e ectso uture potential nancial troubles, while at the same time allow or the e cient

unctioning o those nancial markets. In the light o this nancial crisis, theaim o this working group was to review the relationships between the marketand democratic governance, explore the role o regulatory rameworks in thiscontext, and suggest some concrete policy proposals.

This account o the discussions o Working Group 3 is divided into three parts:the rst is dedicated to the diagnosis, reviewing the causes o the crisis; thesecond summarizes the discussions dedicated to draw some “lessons learnt”and suggests some policy proposals; the nal section reports the refections o the Working Group on the impact o the important challenges that the crisis hasposed to democratic political leadership.

1. Diagnosis: The causes o the fnancial crisis

Jorge Quiroga, member o the Club o Madrid and ormer President o Bolivia,highlighted important global macro-economic imbalances that contributed to thecreation and widening o the crisis. The pre-crisis international nancial bonanzawas built on weak oundations as it was based in what Niall Ferguson had called“Chimerica” i. Global wealth creation was the result o saving by the Chinese andoverspending by the Americans, a situation that was not sustainable in the longrun and that may have been the breeding ground or the crisis.

De cient regulation, lack o e ective supervision, and excess con dence inthe sel -regulatory capacity o the nancial markets were highlighted as having





56

played a crucial role in the making and in the subsequent development o thenancial crisis. De cient regulation and lack o e cient supervision re erred

both to situations utterly lacking in regulation (such as the so-called shadownancial system) and to those where existing rules were implemented either

inadequately or not at all (rules on minimum capital requirements were notapplied in some major jurisdictions).

President Quiroga argued that even certain regulations in the United Statescontributed to the creation and ampli cation o the crisis. Among those, Quirogamentioned: the 1999 repeal o the Glass-Steagall Act (the 1933 Act that mandatedthe separation o commercial and investment banking), the 2000 CommodityFutures Modernization Act that allowed the unregulated explosion o creditde ault swaps contracts ii, and the US legislation, developed through the years,that allowed Fannie Mae and Freddie Mac to reach leverages o 100 to 1 iii.

Another o the concurrent causes or the crisis, WG members agreed, was

the role played by credit rating agencies, which ailed to play their unctionin diagnosing the increased level o risk and predicting the crisis. Someanalysts accused them o having contributed to the nancial debacle by theirtoo-complacent attitude and even complicity with the issuers o some o theinstruments that later de aulted.

Javier Santiso, Director o the OCDE Development Centre and Nkosana Moyo, Vice President and Executive Operating O cer o the A rican Development Bank,both experts serving this Working Group, also pointed out to the very importantrole that the lack o in ormation or had played in the origins o the crisis. Santiso iv stressed that this has been a “cognitive crisis”. The systemic risk had been grosslyunderestimated by most supervisors. This de cient assessment, Santiso noted,could have been caused by “cognitive collusion” whereby dissonant voices mayhave been purposely sidelined or even silenced. Nkosana Moyo v highlightedsome important de ciencies in the actual implementation o supervision. On theone hand, in-house supervision within banks ailed because internal supervisorsdid not have the necessary knowledge to supervise e ciently the job o thetraders and practitioners; on the other, external supervision by public authoritiesmay have also ailed because o the asymmetry o knowledge and in ormationbetween day-to-day private traders and public supervisors.

The lack o a comprehensive, coherent, and coordinated approach amongregulators and supervisors at the national and international levels may have addedto the extent and gravity o the crisis. In the very beginning, in the absence o an internationally coordinated ramework, some countries even resorted to some

“beggar-thy-neighbour” policiesvi

. The creation o the G-20 as the main internationalorum or coordinating policies to deal with the international nancial crisis,although ar rom per ect in terms o its global representativeness, was seen as animprovement over the preceding situation. Participants acknowledged that it hadsucceeded in containing the crisis and delivering some signi cant outcomes.

Greed, excess, unconstrained ambition and even criminal misbehaviour vii were also mentioned among the causes o the nancial crisis. The pre-crisisenvironment was ocused almost exclusively on short-term bene its andprivileged risk-taking casino-like nancial activities at the expense o long-termtraditional utility-type banking. The incentives that prevailed in the nancialsector encouraged the global craving or risk, nurturing the crisis. While incentive




57

The Market, Regulatory Frameworks and Democratic Governability

systems in ercely competitive nancial markets increasingly encouraged risk-taking behaviours by rms and individuals, the existing supervisory systemscould not cope with this higher level o risk and complexity.

In relation with the incentives to individuals, the issue o bonuses and compensationspaid in the nancial sector has also o ten been mentioned as one o the causeso the crisis. However, some participants in the Working Group pointed out that,despite its popular impact and media interest, this issue should be consideredwithin the broader ramework o incentives and that it should not be regardedas “the main” item on the re orm agenda viii.

2. Prescription: Lessons learnt and policy proposals

The rst part o this section summarizes the WG’s conclusions on the lessonslearnt and the main general principles drawn rom the discussions. Speci c

policy proposals are discussed in the second part. 2.1. Lessons learnt and general principles

Participants in the WG broadly agreed on the ollowing: (i) There is no contradictionbetween the state and the markets; quite the contrary, e cient states are necessaryto have e cient markets; (ii) Regulation is not an ideology, but a pragmatic wayto reconcile the need or state intervention with the e cient unctioning o themarkets (iii) A care ul design the regulatory systems is crucial.

(i) There is no contradiction between state and markets

One consequence o the nancial crisis has been the revival o the recurringdebate about the relationship between the state and the markets. On one end,staunch critics o capitalism stress market ailures and argue that this nancialcrisis has given a atal blow to the capitalist system as a whole and provedthe ailure o the market system, which is intrinsically based on the un ettered

orces o nance. At the other end, critics o state intervention in the economystress state ailures and retort that, in act, the nancial sector is one o themost heavily regulated in modern economies. This crisis has not been caused,they argue, by the ree unctioning o markets but, on the contrary, by ill- atedstate’s intervention through de cient regulation.

The Working Group’s main conclusion was that there can be no contradictionbetween the state and the markets. Otaviano Canuto, Vice President or Poverty

Reduction and Economic Management at the World Bank, noted: “We simplycannot understand this con rontation between state and markets; there isno such thing. Markets do not exist in a vacuum. E ective governments arenecessary to e ectively manage market risks and enable the proper unctioningo markets. Sir Arthur Lewis, the Nobel Prize winner, said once that “governmentscan ail either because they do too little or because they do too much.” Whatmatters is that “one needs e ective government to have e ective markets”.

This mutually rein orcing relationship between e ective markets and e ectivegovernment is directly related to the Club o Madrid’s mission o promotinge ective democracies or, as stated in the organization’s motto, “promotingdemocracy that delivers”.





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Former Ghanaian President and Club o Madrid member John Ku our alsoemphasized the utility o the discussion o the state versus the markets andpointed out that politicians should act in a more pragmatic way and “shouldstop demonizing the markets”. He suggested the possibility o bringing back theclassical term “political economy” to underscore the necessary interdependenceo politics, economics, and the markets.

Former Prime Minister o Bosnia Herzegovina and member o the Club o MadridZlatko Lagumdzija also touched on this point. “Not so long ago”, he said, “thewidespread belie among many economists and politicians was that government hadto get out o business and that market laws were like natural laws: you do not discussmarket laws as you do not discuss the law o gravity”. He also stressed the need o

nding the right balance between markets and state intervention through regulation ix. Regulation should rein those potentially un ettered market orces and make sure thatthe right balance is struck so markets have a positive impact on society.

(ii) Regulation is not a matter o ideology

“Regulation is no longer a matter o ideology; it is a matter o pragmatism”.Otaviano Canuto thus summarized another one o the general conclusions o the Working Group. He stressed that it is not a matter o more regulation but o better regulation; he emphasized the need or a care ul design o the regulatorysystems. Markets may rst have been over-regulated, then de-regulated, andnow they need to be re-regulated.

(iii) Need o a care ul design o the regulatory systems

The design o the regulatory system is critical. Canuto pointed out, rst, that theright kind o incentives had to be set or nancial institutions, nancial managers,and the regulators x. Second, the system should have embedded a high degreeo crisis preparedness, as nancial crises and catastrophic events are bound tohappen again. Third, regulators need to draw on market signals to overcomein ormation problems and improve their ability to track risk in and out o crisis.

Another important prescription was that any regulatory ramework has to bedesigned to be both comprehensive and inclusive. It should be comprehensivein order to include all parts o the nancial systems xi. As stated be ore, one o theperceived causes o this last nancial crisis was the act that some institutionso the “shadow nancial system” escaped regulation and supervision throughthe many holes and gaps o the system.

Regulation has to be inclusive too. Regulation should not be just a matter betweengovernment o cials and the banks. It has to actor in the voice and interests o the multiple stake-holders that are a ected by it. The roots o the problem maylie in a ew actors but the consequences o this crisis are systemic, a ecting avery wide range o people. Former President Ku uor linked this point to the veryheart o political representation xii: “When working on regulatory issues”, he said,“we have to make sure that we address this matter so that, besides listening tothe technocrats, the entire community is taken into account and would get thenecessary hearing through the political system”.

Joseph Janning, Senior Director o the International Governance Program o the Bertelsmann Foundation, who acted as moderator o the Working Group,




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took the discussion a step orward and re erred not merely to the actual designo regulation but to the “social environment” in which regulation has to beapplied. Thus he advocated the inclusion o values and moral judgements intothe equation to strengthen the e ectiveness o regulation xiii. There is a need toinclude a moral dimension to regulation, which should be based on commonlyshared values such as that legitimate short-term individual interests shouldbe compatible with the longer term interests o the society and its citizens.In addition, Andrea Monari, responsible or the European o ce o the AsianDevelopment Bank, stressed the need to incorporate in the discussion theissues o competence and responsibility in the nancial sector.

2.2. Lessons learnt and policy prescriptions xiv

(i) New tools and early warning systems

As Javier Santiso pointed out, this has been a cognitive crisis. The un olding o the

crisis has eatured unusual speed, reach, and impact. The global system ailedin its predictive and preventive capabilities. With a very ew exceptions, nobodysaw the imminence or the gravity o the crisis until it was too late. Moreover,there was little tolerance or “cognitive dissonance” rom those institutions andindividuals who warned against the mounting amount o risk in the system. Thus,one lesson learnt is the need to develop new predictive tools and new earlywarning measures to increase the system’s prevention and risk-managementcapabilities. Cognitive dissonance may play an important crisis-preventing role.

These new tools, measurements, and indexes must be more comprehensive,taking into account not only economic parameters like gross domestic productbut also other social, cultural, and developmental aspects, such o thoseconsidered in the human development index. xv

(ii) A balanced global economy, a less asymmetric approach

Participants believed that the existence o important global macro-economicimbalances had contributed to the creation and widening o the crisis. Memberso the WG suggested that one prescription should be to build the new systemon more solid global macro-economic oundations. In this respect, having a morebalanced global economy would make the system less crisis-prone, more resilient,and less vulnerable to sudden changes in market conditions. Former PresidentQuiroga highlighted the medium term risk-generating potential o the current globalexchange rate system and he suggested changing to a system based on a currencywith a more diversi ed base such as the SDRs (Special Drawing Rights) xvi.

Regarding the reaction o international nancial institutions to the measures takento deal with this crisis by the governments o industrialized countries, PresidentGarcía highlighted the asymmetry between international policy-makers’ currentblessing o the resulting huge scal de cits and their reactions in previous crisisthat had mainly a ected developing countries xvii .

(iii) Coordinated, comprehensive and coherent newsupervisory and regulatory Frameworks

The nancial crisis has evidenced the ailure o the national and global nancialsystems to properly assess and deal with the adverse consequences o





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increased systemic ragility, which is a negative by-product o the integrationo nancial markets. This evidence may have provided the sense o urgencyto propel national governments to undertake a complex but much-neededre orm in their nancial supervisory and regulatory systems. Moreover,one “positive” result o the recent international nancial crisis may be theemergence o a new worldwide awareness o the need to overhaul andstrengthen the global nancial system in a coordinated way. Authorities mustseize the opportunity to trans orm the negative energy generated by thecrisis into a positive thrust to make the international nancial system moree cient, resilient, and just.

There was a broad agreement on the need to support the development o newsupervisory and regulatory rameworks, which are e cient (regulators have tomake sure that policies are actionable, reasonable, cost-e ective, and cost-e cient), coordinated (internationally coordinated solutions to address problemsin the global and highly interconnected inancial markets), coherent and

consistent at national level and on a cross-border basisxviii

, and comprehensive(no regulatory gaps should allow institutions to circumvent regulations andthe perimeter o regulation and supervision should be extended to all nancialinstitutions).

The rules that exist should be e ectively applied in practice. Some participantsargued or a “back to basics” approach in nancial regulation. There was a

eeling that, i existing rules xix had been applied be ore the crisis, some o theensuing problems might have been avoided.

President Enrique García also stressed that nancial policies and regulationshould take into account both the short-term issues o market stability and alsoe ciency and growth in the medium and long-term, taking into considerationas a general policy both equity and inclusion xx .

The three ollowing speci c issues were also discussed bearing on regulation.

a) “Too-big-to- ail issue”/“universal versus narrow banking”

There was intense discussion in the WG about the risks posed to the globalnancial system by the “too big/too inter-connected to ail institutions” xxi . These

institutions based their growth on the concept o universal banking, whichencompasses both commercial banking and investment banking.

Some participants elt strongly that one lesson learnt rom this crisis is the need

to challenge the concept o universal banking. For instance, Nkosana Moyovehemently de ended the convenience o splitting traditional commercial banking(also re erred to as public utility banking) rom investment banking (pejoratively called“casino banking”) xxii . Others, such as Otaviano Canuto, doubted that adoptinga “narrow banking” model, with a very sharp division between commercial andinvestment banks, would help to cope with uture crisis; he warned that a too clear-cut separation might make things even worse, increasing overall instability xxiii.

In any case, there was broad agreement that any regulation both at macro- andmicro-prudential levels should require rom nancial institutions an adequatelevel o risk-adjusted capital xiv .




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b) Need to increase crisis preparedness and developmitigation measures

At national and international levels, institutions should increase their degree o crisis preparedness. We cannot prevent catastrophes but we have to be preparedto ace them” xv . “The belie that appropriate regulation can ensure that speculativeactivities do not result in ailures is a delusion”, Mr. Moyo concluded.

As we cannot prevent the “impossible” rom happening, more attention shouldbe paid to mitigation measures that reduce the negative impact o thoseunexpected events, participants agreed. As an example o those mitigationand prevention measures, Mr Koyo advanced the concept o “balkanization” xxvi meaning that nancial regulation should be designed to ensure that thepotential impact o a catastrophic event can be kept as isolated as possibleso that it does not spread and cause atal damage to other parts o thesystem.

c) Reconcile the need o technical independent supervisoryauthorities with the needs o democratic political accountability.

One issue was identi ed rom the start regarding how regulation and supervisionshould be organized in democratic societies. Two objectives must be reconciled,namely, to ensure that supervision remains in the hands o highly competenttechnical bodies independent rom political inter erence while, on the otherhand, also ensuring that they be democratically accountable.

Regulation must meet high technical standards, which can only be guaranteed i they are in the hands o independent and highly technical bodies, detached romdaily political pressure. President Ku uor stated the general principle regardingthe need to reconcile technical independence with political accountability:“There needs to be pragmatic governance and, at the same time, we need tobring in people’s interests as represented through parliaments”.

President García postulated some basic principles to deal with this reconciliationbetween independence and democratic accountability. He argued that too muchpolitical inter erence should be avoided, yet parliaments should participatein the appointment o the directors o the supervisory agencies and in thesubsequent control o their activities. Supervisory agencies should have clearmandates and keep their independence rom the executive branch. Theirdirectors should be given guarantees that they cannot be arbitrarily removed

rom their positions.

There was a debate regarding how to organize supervision at a national leveland the role o central banks and supervisory authorities. Some de ended asharp division o tasks and the exclusion o central banks rom day-to-daysupervisory tasks while others argued that central banks should be directlyinvolved in the supervision o individual banks to control systemic risks xxvii .

No matter what model is nally adopted, the system must be e ciently organized. There should be a clear identi cation and assignment o competences, tasks,and responsibilities among supervisors. The system should also be as simple aspossible. This crisis has shown that a too-complex system with many di erentoverlapping supervisory agencies may have resulted, paradoxically, in a lack





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o e ective supervision. Peter Kelly, Chairman o the Board o Directors o theInternational Foundation or Electoral Systems, noted: “Where everyone is incharge o everything, no one is in charge o anything” xxviii .

(iv) Strengthened international fnancial architecture

The global nancial crisis has raised international awareness that supervisionand regulation must be internationally coordinated in order to be e ective. Acoherent global ramework should replace the current patchwork o juxtaposednational systems.

One obvious impediment to achieve this goal o international coordination is thelack o an adequate international institutional ramework. This crisis highlightedthe utility o adapting the international nancial architecture to the new challenges

aced by the international community.

The existing Bretton Woods institutions lacked the capacity to respond at thespeed and with the intensity required. The world aces the ever-pendingissue o re orming international governance. Participants recognized theimportant role played by the G20, which managed e ectively to coordinate theinternational response to the global nancial crisis, despite its lack o worldwiderepresentativeness xxix .

The roles o the international nancial institutions (IFIs), including the InternationalMonetary Fund, the World Bank, and all the regional banks, should be reviewed.

The roles o the di erent institutions in the new international landscape drawnby the crisis should also be clari ed.

The WG also stressed the urgent need to recapitalize the IFIs so they cancontinue playing their role in the new international environment. Participants

eared that the nancial consequences o the crisis may result in a situation o scarce resources that may hit poor countries particularly hard. I not adequatelycapitalized, the IFIs may be unable to provide nancial trans ers and socialsa ety nets to poor countries. They may also ail to assist such countries withtechnical assistance and advisory support xxx .

(v) New Regulation or Rating Agencies

The role o rating agencies should be reconsidered in the light o their poorper ormance during this nancial crisis. President Quiroga proposed that theyshould either be converted into public services or, to avoid conficts o interest,

be paid by some entity other than the issuers o the securities to be rated.

3. Conclusions: Big challenges to democratic politicalleadership

Wim Kok, Former Prime Minister o the Netherlands, summarized the mainchallenges to political leaders in democratic countries: “In Europe, this crisishas caused a general lack o trust in leadership in the nancial sector, morebroadly in the corporate sector, and even more broadly, in political leadership.Private nancial systems have created such a mess that governments and




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public authorities have had to get involved and put huge amounts o publicmoney to bail out nancial institutions. Ordinary people in our countries say:‘the rich and the privileged have caused the crisis, the government pays orrepairing the more severe consequences and, nally we pay the bills’”.

This crisis has posed di cult challenges to democratic political leaders who mustmanage its political, social and economic consequences by trying to reconcilee ciency and equity. The crisis has created a pro ound sense o un airness.People perceive a socialization o the losses versus the private appropriation o bene ts by nancial institutions.

Democratic leaders ace the di cult challenge o regaining the credibility andwill to seize the opportunity to lead toward much-needed re orm while at thesame time not succumbing to populist short-term pressures that may stifeeconomic prospects and endanger the possibilities o growth via innovationand productivity. Politicians will ace increased pressure to be more strict and

rigid in regulating nancial markets; this rigidity may limit the growth potentialo our economies. Public support or the nancial system has created big scalde cits; only sustained growth may reduce those de cits.

Enrique García warned about the danger that policy makers may not pay enoughattention to the medium and long-term economic challenges i they concentrate

just on short-term highly sensitive political issues. The sheer magnitude o thescal stimulus makes it a “one-shot” policy; unless it succeeds in revitalizing our

economies, the world’s uture may look bleak xxxi .

The WG ended with two notes o caution. First, some expressed concern thatthe next bubble may already be in the making and that, as nancial marketsreturn to normality, policy makers may return to a “business-as-usual” mode.Second, at the end o the meeting, the moderator polled the participants,asking them to raise their hands i they believed that the crisis will be over andthat the much-heralded re orm measures will have been taken by the Spring o 2011: not a single hand was raised. May history prove us wrong.

NOTES

i In President Quiroga’s terms: “China manu actures, China saves, China has an appreciated exchangerate. The Americans consume, they run up debts, they built up houses, they buy fat screens, re rigerators,microwaves…”

ii Quoting ormer New York Insurance Superintendent, Eric Dinallo , those contracts that allow investorsto speculate on the creditworthiness o borrowers “were more dangerous than gambling as, unlike whathappens with casinos, swaps sellers aren’t required to keep unds to pay losing wagers”.

iii Much higher than the 8% Basel ratio o capital to assets that had been widely applied in Latin America,which was less severely hit by the crisis as a result.

iv Javier Santiso had centred his presentation on the inter-actions between nancial markets and elections inLatin America. He concluded that the data show that elections have had a very signi cant impact on nancialmarkets acting as “con dence multipliers”

v Nkosana Moyo argued that markets in general, and nancial markets in particular, work and adjustand make corrections even a ter catastrophic events. He pointed out that many commentators may havecon used catastrophic adjustments with lack o market correction because generally accepted assumptionshad never taken into account the possibility o a catastrophic market correction.





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vi At the outset o the crisis, some countries announced “buy-national” clauses. Participants warned againstthe global threat o a rise in protectionism. “We have to protect ourselves rom protectionism”, PresidentQuiroga strongly advocated.

vii President Quiroga said that some o the episodes o the crisis should not be described as market ailuresbut as mere “rip-o s and swindles”.

viii “Every time the G-20 meets, one o the top issues on the public agenda is the issue o bonuses andcompensations in the nancial sector. I don’t want to underestimate the importance o bonuses”, said PrimeMinister Kok , “but that’s not the heart o the problem”.

ix PM Lagumdzija advanced a telling analogy between markets and atomic energy. “Fi ty years ago atomicenergy was the rst invention o mankind that could be either used or destruction or or the well-being o oursocieties. I think we need to treat markets as atomic energy”.

x “Be ore giving them more power, one needs to take into account the complexity o the political andeconomic relationships between the regulators and their regulated subjects”, Canuto said.

xi Former President Quiroga expressed this need or comprehensiveness as ollows: “I think that havingprudential capital regulations applied to nancial institutions, under whatever guise they may presentthemselves, is something that has to be at the ront and at the centre o any market regulation”.

xii President Kufuor also touched on this point: “The stakeholders are not just the bankers. Financial collapsehas repercussions on other stakeholders like the employees in the banking system, bank customers andmortgage holders, taxpayers and a whole lot o people” “Regulation”– continued President Ku uor – “has totake into account what it needs to protect and the political system must be there in order to protect, rst and

oremost, the people that tend to be the biggest su erers in any nancial crisis”.

xiii “What we’ve learned in this nancial crisis”, Janning said, “is that it seems that market decisions aretaken, absolutely ree o any value base. There is no other element o constraint when seeking to optimizepro ts that speci c laws and regulations. In our normal actions as citizens people do exercise some sel -constraint and do not only not do those things that are explicitly orbidden by law, but we also abide by a seto common values or social codes o conduct”

xiv Prime Minister Lagumdzija , argued that current State interventions have to be treated as “surgery a terhaving had a very bad car accident. We cannot allow ourselves to drive the car in the same way anddirection. The question is whether we shall drive the same car. But, de nitively, we have to repair the car andstart thinking about driving to a di erent direction and with di erent purposes”.

xv Former Prime Minister Lagumdzija quoted Robert Kennedy’s a rmation that the new indexes should gobeyond GDP because “GDP measures everything except that which makes li e worthwhile”

xvi The current system, based on the US dollar and on the pegging o the Chinese yuan to the U.S. dollar,perpetuates the imbalance. I any country”, said Quiroga , “had the trade balance de cit and the nancialproblems o the US and had to issue the amounts o debt that America has had to issue, it would need to gobe ore the Paris Club o international creditors”.

xvii “The IMF would have killed us i it had been us, developing countries, who had run those de cits”,President García mentioned hal -jokingly.

xviii Drawing on what happened during the crisis, President Quiroga highlighted the need o coherenceand consistency, not “changing the rules at the middle o the game”: “You can’t keep on changing therules (...) I a ormer Chairman o a private bank in Latin America became Finance Minister and then, rstsaved a small bank, then let a medium bank crash, and then saved some bigger ones, he’d be accusedo crony capitalism, he’d be shot and thrown into jail, but that is what’s happened in the US; and it iscontagious…)

xix Such as those on minimum capital requirements or some “common sense” limits to leverage ratios

xx Both traditional micro- prudential and macro-prudential regulations should be strengthened. One o themain lessons rom this crisis is the importance o sound macro-prudential regulation to keep systemic riskunder control and mitigate the impact o contagion rom the nancial sector to the rest o the economy. Onthe micro-regulation side, there should be stricter rules on rules to prevent currency and maturity mismatchesand to ensure that nancial institutions are adequately capitalized.




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xxi Too-big-to- ail or “systemically important nancial institutions” are nancial intermediaries with globaldimension, or at least, with signi cant cross-border activity, engaged in some combination o commercialand investment banking whose ailure poses a systemic risk or negative externality to the nancial system asa whole, which in turn a ects the real economy

xxii “The combination o a casino bank and a utility bank just doesn’t make sense. I think we need to goback and separate the two, so that people who deposit their money in what they consider to be utility banksshould not be exposed to the risky activity o the casino banks”, said Moyo .

xxiii “As things normalize”, the argument went, “the search or a yield might lead the wealth holders toshun deposits at the “utility” banks and move to “casino”-banks when, on the contrary, in a crisis situationeveryone should seek re uge in the utility-protected banking system; these movements might increase theinstability o the banking system” Thus Canuto advocated pursuing an instruments-based rather than aninstitution-based approach, making sure that that the risk pro le is refected in capital requirements in adynamic ashion rather than making a distinction according to the type o institution.

xxiv “The nomenclature should not do away with the act that i you are handling people’s money, you needa certain level o risk adjusted capital, whatever you want to call an institution”, in President Quiroga’s words.

xxv In the words o Otaviano Canuto : “Phenomena like the black swans that we saw are bound to happenagain and one should be prepared”. Nkosana Moyo used the metaphor o earthquakes, tsunamis, andmovements in tectonic plates; he made the point that, even i we could predict them, catastrophes willhappen and markets will adjust to the new situations. Accidents are still going to happen and it might bebetter to concentrate on how to deal with those risks that we cannot avoid. In the words o Prime MinisterKok : “not even the most sophisticated and internationally coordinated systems o regulation and supervisionwill be able to prevent certain events happening in the uture. Everywhere where risk is taken there is thepossibility that something might happen that cannot be kept under control; this is intrinsically related to the

unctioning o the market.”

xxvi Moyo advanced this example to explain the concept o balkanization : “In the shipping industry, whenyou build a supertanker whilst you don’t expect accidents to happen, you nevertheless use an architecturethat ensures that, i in act an accident were to happen, the damage would be limited. That is re erred to as“balkanization”, which means that the ship is constructed in such a way that is broken down into smaller

tanks or departments so that, i some accident happens, you lose a small amount o the cargo, or i wateringresses then it doesn’t take over the whole ship and it sinks”.

xxvii Enrique García , President o the Andean Development Corporation, de ended the assignment o clearly separated unctions to the central bank and the other supervisory agencies. The central bank wouldhave the competence over monetary and exchange rate policies and the setting o the general nancialpolicy ramework, while the actual ollow-up and day-to-day supervision would be assigned to a di erentsupervisory agency. Otaviano Canuto mentioned that when it comes to the supervision o systemic risk, thecentral bank will have to work in very close coordination with other supervisory agencies and that a too-sharpand a clear-cut regulatory division might make this necessary coordination more di cult.

xxviii In order to enhance independence and make sure that the boards play their role as the rst line o control over the banking activities, there should be rigorous criteria or being a member o the board o a

nancial institution “You have in some boards in the nancial sector, people who know nothing at all aboutmanagement o a bank and they are the ones that will make the critical decisions”, some pointed out. It wasalso suggested that there should also be measures to avoid having the boards ull with political appointees.

These appointments may compromise the board’s independence and create incentives or corruption, asthe remunerations that those “political” appointees perceive or their board membership may be much higherthan their public or political salaries.

xxix “The G20 is better than the G8, but worse than the G 190”, was heard during the Club o Madrid’sGeneral Assembly.

xxx President Quiroga said: “I think that what the IMF has done is ne, but those o us who have dealtwith the IMF know that, 10 years ago the IMF was really the ABTMF (Argentina, Brazil, Turkey MonetaryFund). It is now the EE MF, the Eastern Europe Monetary Fund. And I think the Eastern European situation isgoing to absorb most o the resources that are being put or the IMF. We are going to be lacking resources

or development, roads and in rastructure; social sa ety nets may not be available around A rica and Latin





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America”. Separately, some also argued or extending to the subnational level the scope o regulation andsupervision in decentralized countries, such as Spain and Germany where there is a strong presence o regional banks.

xxxi “The act o the matter –García said- is that we have to restore growth; growth in developing countriescannot remain at 4% or 5% but has to reach 7% or 8%”. As the saving capacity in developing countries isstructurally insu cient to cover their investment needs and as industrialized countries are also going to need

unds to nance their current scal de cits o 10%-12% o their GDP, there is going to be great competitionin the uture or those scarce resources”. In addition, at an international level, John Kufuor , member o theClub o Madrid and ormer President o Ghana, stressed the need to maintain the “sa ety nets or the poorerparts o the world so that poor countries are not caught o -guard by problems, such as this, that startedin the industrialized countries and whose main su erers may be end up being those who didn’t contributeto making them”. Sanjay Peters , Director o the Centre or Emerging Markets at ESADE Business School,called attention that we should not orget other “residual” e ects o the crisis, such as the impact that growingpoverty levels may act as power ul catalysts o global instability through the channels o large scale migrationfows and through its impact on security issues.




An Institutionalized

and E ective InternationalGovernance System




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An Institutionalized and E ectiveInternational Governance System

By Andrés Rigo

First Session

The discussion ocused on the analysis o the large asymmetries betweenglobalization and institutions, and the concrete e orts being made to solve them.

Mr. Buzek, president o the European Parliament, opened with the ollowingpoints: rst, the need or a network o global institutions; networks are better orsmaller countries and give them a sense o participation in the decision-makingprocess; second, the value o rein orcing regional integration; and third, theimportance o increasing the role o parliaments in the global architecture, i.e.,

through pre-summit meetings o parliaments. The expert on the panel, Mr. L. Martínez o the Brookings Institution, asked,what went wrong?, and explained that, like in the case o the Great Depression,it will take a long time be ore we have ull answer. In the meantime, we need tounderstand the gaps in the current system and how they have developed.

First gap : the ocus o the current system has been on the emerging markets,where crises have erupted in the past (e.g., the East Asian crisis), and noton where nancial instability developed on this occasion. In particular, theUnited States re used to submit to a nancial sector assessment program, aninstrument devised a ter the East Asia crisis to monitor the nancial policies o individual countries. Second gap : there is no-ruthless-truth-teller. The InternationalMonetary Fund (IMF) is supposed to have this role but ails to ul ll it in respecto the larger players. Third gap : domestic regulators are the rst and last lineo de ense, but in the case o the insurance giant, AIG, $500 billion ell outsideregulatory supervision; similar problems are present throughout the system.Fourth gap : international regulators cannot keep up with the dynamism andsophistication o the private sector networks and as a result nobody can seethe whole picture. Fifth gap : the regulatory system is pro-cyclical; when thetimes are good regulation is weakened, and vice versa.

Then Mr. Martínez addressed what is needed or the uture: rst, a grandbargain where the US would remain the indispensable nation, Europe would beguaranteed a measure o control, the major emerging nations would be ensured

that participating in the system is less costly than staying on the sidelines, andpoor countries would be guaranteed representation around the table; second,application o peer pressure to nancial regulation and the management o global imbalances; and third, institutions which can see the whole picture.

The rst discussant, Mr. Prodi, explained that there are three methods o buildingan international governance system: top-down, by agreement, and growing byexample. He contrasted Kyoto and Copenhagen, where he noted the progressmade in the world opinion in the time lapsed between the rst and the second.He also re erred to the European Union (EU) as an example o a super-nationthat exported democracy. In this respect, he lamented that in recent times theEU seems to have evolved rom a laboratory into a museum, weakening the





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capacity o Europe to be at the ore ront o re orm o the international system.Mr. Prodi emphasized that the economic development o A rica, this will nothappen unless there is rst a strong political agreement among A rican states.

This is surely one o the most crucial issues in the contemporary world to whichany governance system must respond.

The second discussant, President Cardoso, noted that the nancial crisis unveiledsituations that already existed. It is not true that nobody saw the coming crisis;many economists pointed out the unsustainable de cits o the United States. Inturn, the nancial crisis has permitted us to see better the pro ound economictrans ormation that took place during the last decade. However, it is not clearwhether China is ready to share global responsibilities. President Cardoso wasimpressed by how soon the crisis was declared to be over. The nancial orbanking crisis may be over but the rest o the economic crisis is still evident inthe orm o unemployment, possible infation caused by the massive liquidityinjected in the system, and the weakness o the dollar.

According to President Cardoso, the crisis has created disequilibrium. The UnitedStates cannot impose decisions without consultation, which is an opportunityto introduce changes. He supported the idea o a network o institutions ratherthan the creation o another hierarchic organization. The IT revolution makesit easier to think about the possibility o a more democratic world order andseems to be apposite to the shi ting o power rom one or two poles to amore dispersed orm o power. He emphasized the need or leadership and theneed or discussion, which can contribute new ideas because it is not clear yetwhat should be done. It is a process without decision yet. In act, i there wereone, it would mean that it had been imposed by a superpower, which has notoccurred. There ore, it is an opportune moment to think about and discuss new

orms o governance.

Participants’ comments

There is an issue o political will – the will to create a governance system totackle the list o global problems that no country can solve by itsel . As statedby S. Ho mann, “everybody knows what has to be done and everybody knowsthat what has to be done cannot be done.” The disproportionate weight o Europe in the international organizations may be an asset or Europe in thenegotiation o international governance. There is a need or multi-state or multi-group leadership (D. Hidalgo).

For the nancing o public goods, it is essential to move to an automatic system that

is not dependent on the payments rom rich donor countries (M. de la Rocha).

At the international state level, there is a trend towards di usion o powerand democratization but, at the national level, the credibility or legitimacy o governments depends on the approval o voters. I they do not approve, thesituation has real consequences in international relations, witness Honduras or

A ghanistan. There is a huge gap in the discussion o this dynamic democratizationo global governance (T. Piccone).

It is not possible to ask China, Brazil, etc. to take action on climate change, currencymatters, or nancial markets unless they get, or instance, commensurable powerin the IMF. A grand bargain has to take place. For this to happen, states have to




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An Institutionalized and E ective International Governance System

cede some o their sovereign rights. While most countries would recognize this,it is doubt ul that the US Congress would (A. Jara).

The impotence o the A rican countries aced with the crisis may be seen as anopportunity to spur them to come together to participate in the global economy.In this respect, is there a hierarchy in terms o what needs to be done? Mustcertain things be in place to acilitate a higher degree o integration? For instance,unless democracy across areas exists, it becomes di cult to work together

rom an economic development point o view (M. Masire-Mwamba).

More generally, A rican countries had ollowed the rules and were nonethelesshit by the crisis because the richer countries did not ollow the rules that theyhad set presumably or all to ollow. Who should pay or the bad advice theyhave received?

Mr. Martínez had the ollowing observations on the discussion:

First, we overestimate the extent o a shi t in power. The real question is theextent to which a country may exercise its power independently. China has littleroom to use its power without a ecting the system on which it is based.

Second, we overestimate the degree to which the system has to refect theunderlying balance o power, the so-called “stickiness” o institutions.

Third, countries such as China or Brazil do not have a sophisticated globalvision o their own interests.

Finally, because the nancial system is concentrated in a ew countries and sotoo are carbon emissions, i those countries address these issues e ectively,then there is less concern at the global level.

Mr. Prodi refected on the problem presented by the short-term concerns o politicians in a democracy and how can then they tackle the long term issues.It is again a matter or strong leadership.

President Cardoso recalled that he had proposed that the UN adopt adeclaration on interdependence in order to move the sovereign state towards amore cooperative order. Leadership does not need to be uni ed; one thing is totake leadership regarding the environment while another is to take it regardingthe struggle against racism. He noted that Brazil has suddenly discovered thatit is more power ul than it ever imagined and doubted whether Brazil is capable

o understanding its new role in a new era: a seat at the Security Council ( orwhich Brazil has been striving or) is a long-standing concern. Power ul statesneed to take a di erent approach to be help ul at the global level.

Second Session

The rst expert, A. Jara, explained that governance requires our elements:

First, leadership, the G-20 has lled a leadership vacuum during the crisisbut it should not be institutionalized because o the need to respond fexiblydepending on the challenge.





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Second, legitimacy concerns, speci cally the democratic de cit, call attention tothe distance between the citizen and global governance. Given its composition,the G-20 lacks legitimacy.

Third, e ciency – the system needs to show results or the bene t o all citizens. This element will require some shared or trans erred jurisdiction, o which theEuropean model is an example.

Fourth, coherence – there are competing objectives and challenges that requirecompromise and communication among the international agencies.

Mr. Jara spoke o a triangle in which the G-20 provides political leadership,the specialized international agencies contribute their expertise, and the UNprovides accountability. In addition, an ethical dimension is needed to buildtrust.

The second expert, Pro essor Kaul, observed that there is a multiplication o crises: nancial, environmental, etc., and global governance needs to addressthem. She pointed out that international cooperation is stuck because o twocrosscutting basic problems. First, we have no theory that allows us to analyzethe policy loops that today’s world order o openness would require. Second,we have the incumbents, which are the strong powers that bene t rom a closedorder. To escape this situation, Ms. Kaul made the ollowing recommendations:

rst, we have to correct the notion that national interest is best pursued throughunilateralism. Based on her studies, cooperation rather than competition withother states is the best strategy to increase and maximize bene ts. Second,the state must respond to the global expectations, acting not as the classicalWestphalian state but take into account the outside context. Third, we needto speak o responsible sovereignty; states have to be accountable or theactivities that are undertaken within their jurisdiction that have an impact on theglobal public domain.

Pro essor Kaul proposed that the UN be used to make these recommendationsoperational. The UN has in e ect put the nishing touches on the Westphalianstate order. Because o that and its experience in recognizing states assovereign and equal, the UN could take the role o re orming the concept o sovereignty. To this e ect, a Leadership Council would be created based on a

ully representational charter; its task would be to help make evident that wehave stepped into a new world order. Ms. Kaul was optimistic because thehegemonic power was getting tired and ready to move into a world o greatermultipolarity.

The discussant, President Vike-Freiberga, pointed out that we can build singlerisk mechanisms to prevent crises, maybe we can hope to have a double levelo protection, but by the time you get hit by three di erent things it is exceedinglydi cult to come out with an answer and predict it in advance.

The second discussant, President Uteem, commented that the UN had apoor record in matters o sovereignty and lamented how poor countries arethe victims o nancial or environmental crises but rich nations do not ace upto their responsibility. In this respect, he re erred to the staggering amountsused to salvage the banking systems as compared to the G-20 budgets ordevelopment aid.




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An Institutionalized and E ective International Governance System

Participants’ comments

Mr. Solbes considered a three-level model: political legitimacy at the UN level,a body in between that presents ideas, and a third level to ensure the need orconsistency between the rst two. Then he re erred to the European experiencein terms o shared responsibility and leadership. Some leading countries mayneed to be always engaged but they would not be able to impose any solutionson their own (i.e. France and Germany in Europe). He warned that we willnot be able to advance i our ambition is to have one system to solve all theproblems. We need to advance step by step in di erent organizations trying to

nd solutions to di erent problems.

Another participant argued that the Westphalian state is still needed. Strongstates are needed to promote international cooperation. Issues o identity needto be addressed because the transit to globalization has produced anxiety in thecitizens. Maybe Westphalian states are still needed to give identity to people.

He expressed doubts regarding international cooperation and how it had ailedin A rica. There is much work to be done to convince states that cooperationis good or them.

Still another commentator pointed out that we are moving to a multi-polarworld o big states (US, China) and regional units (EU, A rican Union). Whatorganization will stir such a world? The General Assembly may give legitimacybut it is not the right stirring body. The G-20 is not legitimate, but it is a symbolo what is needed or the uture.

Also, we have to go beyond states and change perceptions at the public levelthrough civil society, academia, and the business community in order to openpolitical space which in turn will permit politicians to take risks and make thenecessary concessions to nd solutions.

Pro essor Kaul commented that sovereignty can be strengthened through thetypes o international cooperation that she had outlined. The logic o the worldorder has changed. Under the openness o the new system, sovereignty has to bedealt with di erently rom when borders were closed. The concept o responsiblesovereignty does not suppose a generalized approach but a change o logic tobe applied to particular institutions and issues. One has to go case-by-case butaccording to the new logic. We have already slipped out o the Westphalian stateorder. Because o openness and interdependence, policy makers today cannotassure us access to all the public goods that they pretend they want to give us.

The type o cooperation advocated here makes the state strong. Where states

try to do it alone, they lose opportunities. We have le t the Westphalian state butwe need strong intermediary states. One should also allow time or this transitionto happen and not be disappointed. One should not orget that it has taken 400years or the completion o the Westphalian state.

Final comments rom the participants:

Where it is a matter o power distribution, it is prudent to go package by packageso that no one goes home empty-handed.

The importance o the truth teller was emphasized and the need or ormal,regular, responsible in ormation analysis. When the agenda or international





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cooperation is set, there is the need or impartial analysis in terms o whateconomists call distribution o costs, in particular their impact on speci ceconomies and societies.




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Annexes

The Club o Madrid is grate ul to:

The• Regional Government of Catalunya or its support in the organizationo the European Roundtable

The• United Nations Economic Commission for Latin America andthe Caribbean (ECLAC), the Andean Corporation for Development (CAF), the Iberoamerican General Secretariat (SEGIB) and BrookingsInstitution or their support in the organization o the Latin AmericanRoundtableCasa Árabe• or its support in the organization o the Arab WorldRoundtable

Casa África•

, the Africa Progress Panel and the African DevelopmentBank , or their support in the organization o the A rican Roundtable




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Annexes

Final Declaration o the Annual Con erence

‘The Political Dimensions o the World Economic Crisis’

We, Members o Club de Madrid, met in Madrid on November 12-13, 2009, todiscuss ‘The political dimensions o the world economic crisis’ and agreed onthe ollowing:

The fnancial and economic crisis experienced over the past two years has made mani est a much deeper and complex systemic crisis and a realignment o world

orces that requires democratic leadership to move beyond the outdated and simplistic , but still present, dichotomies o East/West, Developed/Developing,Old World/New World to fnd new solutions.

The crisis has highlighted the need or a more e ective balance between the state and the market . Unregulated markets can generate large costs or citizens. The state must be more e ective, more e cient, scally responsible, capableo empowering its citizens and promoting prosperous economies and policiesthat oster democratic societies. Better states, accountable to democraticinstitutions, engender better markets.

We welcome the incipient recovery in most parts o the world but there should be no complacency. We cannot go back to business as usual. Unemploymenthas risen and the quality o employment deteriorated. Protracted weaknessin the job market may generate increasing social and ethnic tensions andprotectionist trends, all o which may place democratic systems under stress.

Addressing the social impact o the crisis should be ront and center o economic recovery and macroeconomic policies . Democratic polities muststrengthen social protection systems where they exist, and gradually createthem where they do not. Democratic dialogue, participation and representationhelps to manage the social demands created or exacerbated by the crisis andto strengthen inclusive democratic institutions.

All countries must be part o the solution . Emerging economies have e ectivelyacilitated a budding recovery. There is a persisting need, however, to maintain or

increase levels o o cial development assistance to help low income countriesto overcome the crisis and more readily develop the capacity to constructdemocracies that deliver.

Addressing the crisis requires public accountability, e ective fnancial regulatory rameworks and democratic checks-and-balances. We support initiatives to

promote e ective and comprehensive nancial regulations, within and acrossborders, covering institutions and nancial instruments previously un- or under-regulated, and also counter-cyclical policies to generate cushions o capital,provisions, and liquidity during booms to increase the capacity o nancialinstitutions to withstand subsequent crises. Central banks and regulators mustmeet the highest technical standards and operate under rules designed toavoid their co-option by nancial interests. As public entities, they must beaccountable to the democratic institutions responsible or setting their objectivesand scope o action.





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The time has come or in-depth re orm o the global fnancial architecture. The institutions entrusted with the regulation o the global economy haveproved ragile and unable to adopt the measures needed to prevent nancialspeculation rom contaminating all orms o nancing. Their re orm requiresurgent attention.

The enhancement o democratic values requires strengthened multilateralism and the participation o all countries in decision making processes. This will require broader representation o developing countries in the international governance system. The G20 is addressing important current issues but should be seenas a transition to a more representative and legitimate architecture. Existinginternational organizations should not be seen as mere service providers o theG20. The new multilateralism also requires strong and well unctioning regionalinstitutions.

Democracies must deliver: Improve the well being o peoples, empower the

capacities o everyone to participate in reconstructing the present and developing the uture, avoid the nightmare o another global fnancial collapse, and recognize that democracy is an instrument to address the crisis as well as a key objective o its success ul resolution.




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Agenda o the Annual Con erence

Thursday, November 12 – Annual Con erence (Part I)

10:30 Trans er o participants rom thePalace Hotel to the Palacio Municipalde Congresos

09:00 – 11:30 Registration. NOTE : Participantsmust be seated at the Sala Madrid by11:30. A ter this time access to SalaMadrid will not be allowed till a ter theWelcoming Words.

12:20 – 13:00 Annual Conference WelcomingWords

• Ricardo Lagos , Former Presidento Chile. President o the Club o Madrid

• Alberto Ruiz-Gallardón , Alcalde deMadrid

• Manuel Chaves , Third Vicepresident o the SpanishGovernment

• Esperanza Aguirre , President o theRegional Government o Madrid

• His Majesty King Juan Carlos

** Sala Madrid

13:00 – 13:45 Greeting o His Royal Majesties to allparticipants and cocktail

** Hall SalaMadrid

13:45 Trans er o participants to Sala Parisor the lunch

13:45 – 15:00 Lunch ** Sala Paris





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15:00 – 16:15 Plenary Session I

The World Economic Crisis andthe Beginning of a New Paradigmin Global Governance?

Facilitator :• Michael Keating , Director A rica

Progress PanelPanellists• Ricardo Lagos , Former President

o Chile. President o the Club o Madrid

• Mary Robinson , Former Presidento Ireland and Vice President o theClub o Madrid

• Antonio Gutérres , Former PrimeMinister o Portugal and UN HighCommissioner or Re ugees.Member o the Club o Madrid

• Jenny Mary Shipley , Former PrimeMinister o New Zealand. Membero the Club o Madrid.

• José Antonio Ocampo , Pro essorat Columbia University; FormerUnder-Secretary-General o theUnited Nations or Social andEconomic A airs

** Sala Madrid

16:15 – 16:30 Co ee Break

16:30 – 19:00 Working Groups Session I:DiagnosisPurpose: To identi y the 5 maine ects the economic crisis is havingin each o the respective areas.Each session will be divided into twoblocks, national and international ,in order to address the issue romboth perspectives.




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1. ‘Employment, Social Welfare,and Democratic Rights andDuties’

** Sala Berlin

Moderator :• Vidar Helgesen , Secretary General,

International IDEAPanellists :• Alicia Bárcena , Executive

Secretary, Economic Commissionor Latina America and the

Caribbean• Eddy Lee , Economic Adviser,

Institute o Labour Studies,International Labour Organization

Discussants :

• Mary Robinson , Former Presidento Ireland. Vice-president Club o Madrid.

• Alejandro Toledo , Former Presidento Peru. Member o the Club o Madrid.

Rapporteur :• Richard Simeon , Pro essor o

Political Science and Law, Universityo Toronto. Advisor to the Club o Madrid.

2. ‘The Citizen, the State and theMarket’

** Sala Londres

Moderator :• Peter Eigen , Former Chairman and

Founder, Transparency InternationalPanellists :• Víctor Rico , Secretary o Political

A airs, OAS• Geraldine Fraser-Moleketi ,

Director o Democratic GovernancePractice, Bureau or DevelopmentPolicy (UNDP)

Discussants :• Percival N.J. Patterson , FormerPrime Minister o Jamaica. Membero the Club o Madrid

• Kjell Magne Bondevik , FormerPrime Minister o Norway. Membero the Club o Madrid

Rapporteur :• Bolívar Lamounier , Director o

Augurium Consultores. Advisor tothe Club o Madrid.





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3. ‘The Market, RegulatoryFrameworks, and DemocraticGovernability’

** Sala Amsterdam

Moderator :• Joseph Janning , Senior Director o

International Governance Program,Bertelsmann Foundation

Panellists:• Javier Santiso , Director, OECD

Development Center• Nkosana Moyo , Vice president

and Chie Operating O cer, A ricanDevelopment O cer

Discussants :• Jorge Quiroga , Former President o

Bolivia. Member o the Club o Madrid.• Wim Kok , Former Prime Ministero the Netherlands. Member o theClub o Madrid.

Rapporteur :• Lucinio Muñoz , Senior Advisor.

Spanish Treasury. Ministry o Economy and Finance. Advisor tothe Club o Madrid

4. ‘An Institutionalized andEffective InternationalGovernance System’

** Sala Roma

Moderator :• José Antonio Ocampo , Pro essor,

Columbia University; Former Under-Secretary-General o the UN orSocial and Economic A airs

Panellists :• Enrique Iglesias , Secretary General,

Iberoamerican General Secretariat• Leonardo Martínez Díaz , Fellow

and Deputy Director, GlobalEconomy and Development

Program, Brookings InstitutionDiscussants :• Romano Prodi , Former Prime Minister

o Italy. Member o the Club o Madrid.• Vicente Fox , Former President o

México. Member o the Club o Madrid

Rapporteur :• Andrés Rigo , Former Deputy

General Counsel o the World Bank.International Arbitrator. Advisor tothe Club o Madrid




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19:15 Trans er rom the Palacio Municipal deCongresos to the Palace Hotel

19:45 Trans er rom the Palace Hotel to theCaixa Forum

20:00 – 22:00 Exhibition o “Palladio” and Dinner Caixa Forum

22:00 Trans er rom the Caixa Forum to thePalace Hotel

Friday, November 13 – Annual Con erence (Part II)

08:30 Trans er rom Palace Hotel to thePalacio Municipal de Congresos

09:00 – 10:30 Parallel Special Sessions on Clubof Madrid Initiatives:a) “Global Leadership for Climate

Action”: This Initiative seeksto mobilize political will or acomprehensive, e ective and airglobal post 2012 climate agreement.

Chair : President Ricardo LagosPanellists:• Mohamed El-Ashry , Facilitator

Global Leadership or Climate Action Initiative. Senior Fellow, UNFoundation. Former Chair and CEO,Global Environment Facility.

• Michael Zammit Cutajar, Ambassador on Climate Change,Malta

• Martin Lees , Secretary General.Club o Rome.

• Teresa Ribera Rodríguez, Secretary o State or ClimateChange. Spain.

• Manuel Marín , President o Iberdrola Fundation.

** Sala Londres





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1. ‘Employment, Social Welfare, andDemocratic Rights and Duties’

** Sala Berlin

Moderator :• Vidar Helgesen , Secretary General,

International IDEAPanellists :• William Lacy Swing , Director

General, International Organizationo Migration

• Sharan Burrow , President,International Trade Union

Con ederation (ITUC)Discussants :• António Guterres , Former Prime

Minister o Portugal. Member o theClub o Madrid.

• Chandrika Kumaratunga , FormerPresident o Sri Lanka. Member o the Club o Madrid.

Rapporteur :• Richard Simeon , Pro essor o Political

Science and Law, University o Toronto. Advisor to the Club o Madrid.

b) “The Shared Societies Project”is a global initiative that providesleaders with greater understandingo the bene ts o social cohesionand the incentives and means toact to advance it.

Chair: Prime Minister Jenni erShipley , Co-Chair o the projectDiscussant : President CassamUteem , Co-chair o the projectPanellists :• Rolando Luque , Deputy

Ombudsman or the prevention o social conficts and governability,Ombudsman O ce, Peru

• Clem McCartney , The Shared

Societies Project ContentCoordinator• Sean C. Carroll , Director o

Programs, Club de Madrid

** Sala Roma

10:30 – 12:30 Working Groups Session II:PrescriptionsPurpose : To ocus on identi ying 3speci c recommendations to tackle eacho the 5 main repercussions o the crisis,previously identi ed in the rst workinggroup session, at the global level.




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2. ‘The Citizen, the State and theMarket’’

** Sala Londres

Moderator :• Peter Eigen , Former Chairman and

Founder, Transparency InternationalPanellists :• Jerzy Buzek , President o the

European Parliament• Yun Han Chu , Research Fellow,

Institute o Political Science, Academia Sinica

Discussants:• Kim Campbell , Former Prime

Minister o Canada. Member o theClub o Madrid.

• Olusegun Obasanjo , FormerPresident o Nigeria. Member o theClub o Madrid

Rapporteur:• Bolívar Lamounier , Director o

Augurium Consultores. Advisor tothe Club o Madrid.

3. ‘The Market, RegulatoryFrameworks, and DemocraticGovernability’

** Sala Amsterdam

Moderator :• Joseph Janning , Senior Director o

International Governance Program,Bertelsmann Foundation

Panellists:• Enrique García , President o

the Andean Corporation orDevelopment (CAF)

• Otaviano Canuto , Vice Presidentor Poverty Reduction and

Economic Management, WorldBank

Discussants :

• Zlatko Lagumdzija . Former PrimeMinister o Bosnia Herzegovina.Member o the Club o Madrid

• John Kufuor , Former Presidento Ghana. Member o the Club o Madrid

Rapporteur :• Lucinio Muñoz , Senior Advisor.

Spanish Treasury. Ministry o Economy and Finance. Advisor tothe Club o Madrid.





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4. ‘An Institutionalized andEffective InternationalGovernance System’

** Sala Roma

Moderator:• José Antonio Ocampo , Pro essor

at Columbia University; FormerUnder-Secretary-General o theUnited Nations or Social andEconomic A airs

Panellists :• Alejandro Jara , Deputy Director

General, World Trade Organization• Inge Kaul , Adjunct Pro essor on

Global Policy Studies. Hertie Schoolo Governance

Discussants:• Vaira Vïke-Freiberga, FormerPresident o Latvia. Member o theClub o Madrid.

• Cassam Uteem , Former Presidento the Republic o Mauritius.Member o the Club o Madrid

Rapporteur :• Andrés Rigo , Former Deputy

General Counsel o the World Bank.International Arbitrator. Advisor tothe Club o Madrid

12:30 – 12:45 Co ee break ** Hall SalaMadrid

12:45 – 14:00 Plenary Session II: Report onWorking Group Discussions

** Sala Madrid

Moderator :• José Antonio Ocampo , Pro essor

at Columbia University; FormerUnder-Secretary-General o theUnited Nations or Social andEconomic A airs

General Rapporteur:• Jorge Domínguez , Vice Provostor International A airs, Harvard

University. Advisor to the Club o Madrid

Rapporteurs from all WorkingGroups

14:00 – 15:30 Lunch ** Sala Paris




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15:30 – 17:00 Plenary Session III:What is to be Done Next:Democratic Practiceand Governance asInstruments to Addressthe World Economic Crisis

Facilitator:• Lord Mark Malloch Brown , Senior

Advisor World Economic ForumPanellists :• Felipe González Márquez , Former

President o the Government o Spain. Member o the Club o Madrid

• Joaquim Chissano , Former

President o Mozambique. Membero the Club o Madrid.• Fernando Henrique Cardoso ,

Former President o Brazil. Membero the Club o Madrid

• Ricardo Lagos , Former Presidento Chile. President o the Club o Madrid

• Wim Kok , Former Prime Ministero the Netherlands. Member o theClub o Madrid

** Sala Madrid

17:00 – 17:30 Closing Ceremony• Ricardo Lagos , Former President

o Chile. President o the Club o Madrid

• Vincenzo Scotti , Secretary o Stateor Foreign A airs, Government o

Italy• Miguel Ángel Moratinos , Minister

o Foreign A airs, Government o Spain

** Sala Madrid

17:30 Trans er rom venue to Hotel

PM Departure o participants and Club o Madrid Members





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List o Participants

Members of the Club of MadridRicardo Lagos Former President o Chile. President

o the Club o Madrid Valdis Birkavs Former Prime Minister o LatviaKjell Magne Bondevik Former Prime Minister o NorwayKim Campbell Former Prime Minister o CanadaFernando Henrique Cardoso Former President o BrazilJoaquim Chissano Former President o MozambiquePhilip Dimitrov Former Prime Minister o BulgariaJosé María Figueres Former President o Costa Rica

Vicente Fox Former President o MexicoFelipe González Márquez Former President o Spain

Antonio Guterres Former Prime Minister o PortugalOsvaldo Hurtado Former President o EcuadorWim Kok Former Prime Minister o the NetherlandsJohn Ku uor Former President o GhanaChandrika Kumaratunga Former President o Sri LankaZlatko Lagumdzija Former Prime Minister

o Bosnia Herzegovina Antonio Mascarenhas Monteiro Former President o Cape VerdeRexhep Meidani Former President o AlbaniaFestus Mogae Former President o BotswanaOlusegun Obasanjo Former President o NigeriaPercival Patterson Former Prime Minister o JamaicaRomano Prodi Former Prime Minister o ItalyJorge Quiroga Former President o BoliviaMary Robinson Former President o Ireland.

Vice-President o the Club o MadridPetre Roman Former Prime Minister o RomaniaJenni er Shipley Former Prime Minister o New Zealand

Alejandro Toledo Former President o PeruCassam Uteem Former President o the Republic

o Mauritius Vaira Vike-Freiberga Former President o Latvia

Institutional Members

Esperanza Aguirre President, Regional Governmento Madrid Alberto Ruíz-Gallardón Mayor of Madrid

Honorary MembersKo Annan Chairman, Ko Annan Foundation

and Former United Nations Secretary-General




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Members of the Constituent FoundationsDiego Hidalgo President, Fundación para las

Relaciones Internacionales y el DiálogoExterior (FRIDE)

Anthony Jones Vice-President and Executive Directoro the Gorbachev Foundation o North

AmericaGeorge Matthews Chairman o the Gorbachev Foundation

o North AmericaJosé Manuel Romero Vice-President o FRIDE

Advisors of the Club of MadridJorge Domínguez Antonio Madero Pro essor o

Mexican and Latin American Politicsand Economics. Vice Provost or

International A airs, Harvard UniversityRut Diamint Pro essor o Political Science,Universidad Torcuato Di Tella, Argentina

Grzegorz Ekiert Pro essor o Government, Center orEuropean Studies, Harvard University

Bolívar Lamounier Director o Augurium Consultores Alexander Likhotal President & CEO o Green Cross

InternationalLucinio Muñoz Senior Advisor. Spanish Treasury.

Ministry o Economy and Finance Ted Piccone Senior Fellow and Deputy Director o

the Foreign Policy Program, BrookingsInstitution

Andrés Rigo Former Deputy General Counsel o theWorld Bank

Richard Simeon Pro essor o Political Science and Law,University o Toronto

Experts and InviteesJosé Antonio Ocampo Pro essor at Columbia University; Former

Under- Secretary-General or the UnitedNations or Social and Economic A airs;

Academic Coordinator o the Programmeon “The Political Dimensions o the World

Economic Crisis” Alicia Bárcena Executive Secretary, EconomicCommission or Latin America and theCaribbean (ECLAC)

Bernardo Bortolotti Executive Director, Fondazione EniEnrico Mattei

Sharan Burrow President, International Trade UnionCon ederation (ITUC)

Jerzy Buzek President, European ParliamentOtaviano Canuto Vice President or Poverty Reduction

and Economic Management, World BankEmilio Cassinello Director General, CITpax





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Manuel Cháves Third Vice President o the SpanishGovernment

Taeyul Cho Ambassador o Korea in Spain Yun-Han Chu Research Fellow, Institute o Political

Sciences, Academia SinicaGeorges Cou gnal Director, Institut des Hautes Études pour

l’Amérique Latine Andie Davis Communications Strategic Consultant Terry Davis Former Secretary General, Council o

EuropeRicardo Díez Hochleitner Honorary President, Club o RomeLinda Du eld Chie Executive, Westminster

Foundation or DemocracyPeter Eigen Former Chairman and Founder,

Transparency InternationalMohamed El Ashry Senior Fellow, UN Foundation

Gilda Farrell Acting Head o Department, DG SocialCohesion, Development Division,Council o Europe

J. Christer El verson Senior Diplomatic Advisor, Concordia 21Javier Fernández-Lasquetty Counsellor on Immigration and

Cooperation, Community o MadridGeraldine Fraser-Moleketi Director o the Democratic Governance

Practice, Bureau or DevelopmentPolicy, UNDP

Enrique García President, Andean DevelopmentCorporation

Antonio García Ferrer President, Fundación ACSSacha Goldman Secretary General, Collegium InternationalCarlos González Shánel Founder Member, Center or Analysis and

Studies or Latin America , Respekt InstituteJosé Antonio Griñán Martínez President o the Regional Government

o AndalucíaKai Grunanuer-Brachetti Philanthropic Services, UBS

Antonio Gutiérrez Vegara President o the Commission orEconomic and Financial Matters.Spanish Congress

Miguel Hakim Secretary or Cooperation,Inter-American General Secretary

Vidar Helgesen Secretary General, International IDEASilvia Hidalgo Director, DARA

Enrique Iglesias Secretary General, Ibero-AmericanGeneral SecretariatJoseph Janning Senior Director o the International

Governance Programme, BertelesmannFoundation

Alejandro Jara Deputy Director General, WTOGermán Jaramillo Director-Representative in Spain,

Andean Development CorporationInge Kaul Adjunct Pro essor on Global Policy

Studies, Hertie School o Governance,Berlin

Michael Keating Director, A rica Progress Panel




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Peter Kelly Chairman o the Board o Directors,International Foundation or ElectoralSystems (IFES)

Margaret Kilo Fragile States Unit Head, A ricanDevelopment Bank

William Lacy Swing General Director, InternationalOrganization or Migration

Roland Lappuke Ambassador o Latvia to SpainEddy Lee Economic Adviser, International Institute

o Labour Studies, International LabourOrganization

Martin Lees Secretary General, Club o RomeJos Lemmers Head o the Department or Democratic

Participation, Council o EuropeJosé Luis Machinea Former Executive Secretary General,

ECLAC, and Pro essor at IELAT,

University o Alcalá de HenaresMark Malloch Brown Senior Advisor, World Economic ForumPercival Manglano General Director, Cooperation or

Development, Regional Government o Madrid

Cristina Manzano Director, Foreign PolicyMario Marconi Head o Philanthropic Services, UBSManuel Marín President, Iberdrola FoundationRodol o Martín Villa President, SogecableLeonardo Martínez Díaz Fellow and Deputy Director, Global

Economy and Development Program, The Brookings Institution.

Ricardo Martínez Vázquez Director General, Casa A ricaMmasekgoa Masire-Mwamba Deputy Secretary General,

Commonwealth SecretariatRa ael Miranda Robredo President, Foundation ENDESA

Andrea Monari Resident Director General, AsiaDevelopment Bank EuropeanRepresentative O ce

Isabel Mota Trustee, Calouste GulbenkianFoundation

José Manuel Morán Associate Member, Club o RomeNkosana Moyo Vice president and Chie Operating

O cer, A rican Development BankCarlos Mulas Granados General Director, Fundación IDEAS para

el ProgresoHerman Mulder Senior Advisor, UN Global CompactSalvatore Nigro Executive Director, EUROPEFEOlivia Orozco Coordinator, Socio-Economic Program,

Casa Árabe - IEAMLuis Padilla Secretary General, Casa A ricaSujala Pant Governance Specialist, Bureau or

Development Policy, UNDPCarina Perelli Executive Vice-President, International

Foundation or Electoral Systems (IFES)Sanjay Peters Associate Pro essor o Economics, IESE

Business School





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Mario Pezzini Deputy Director, Public Governance and Territorial Development, OECD

Germán Quintana Secretary, Inter-American DevelopmentBank

Teresa Ribera Secretary o State or Climate Change,Government o Spain

Víctor Rico Secretary or Political A airs,Organization o American States (OAS)

Francisco Rojas Aravena Secretary General, FLACSOJosé Juan Ruiz Gómez Director, Strategy and Analysis for Latin

America, Grupo SantanderSimon Rye Director o the Oslo CentreJesús Sainz President, PromomadridMarion Salines Economist, EU Institutions and For a

Division, European Central BankJavier Santiso Director o the Development Centre

(OECD)Jesús Sánz Director, Casa Asia Vincenzo Scotti Secretary o State o Foreign A airs,

Government o ItalyNarcís Serra President, Centre or International

Studies in Barcelona (CIDOB)Edward Shapiro President, Foundation o the Club o

MadridSarah Silver Director, Sli ka Foundation

Youba Sokona Executive Secretary Sahara/SahelObservatory

Javier Soria Chie o the Area or Middle East,Spanish Ministry o External A airs andCooperation

Ingrith Srinath Secretary General, CIVICUSGustavo Suárez Pertierra President, Real Instituto El CanoBill Sweeney President, International Foundation or

Electoral Systems (IFES)Laura Tedesco Visiting Pro essor, Universidad

Autónoma de MadridJosé Ignacio Torreblanca Director, European Council on Foreign

A airsRoel von Meijen eldt Executive Director, Netherlands Institute

or Multiparty DemocracyCarlos Westendorp y Cabeza Former Minister o Foreign A airs o Spain

Richard Youngs Director o the DemocratizationProgramme (FRIDE)Michael Zammit Cutajar Ambassador on Climate Change, Malta

Club of Madrid DirectorsFernando Perpiñá-Robert Secretary General o the Club o MadridMaría Elena Agüero Director o Special Projects and

Institutional RelationsSean Carroll Programmes DirectorRicardo Hidalgo Chie Financial O cerNicolas Rougy Director o the Brussels O ce




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Background Document or the EuropeanRoundtable

The Crisis and the Challenges or InternationalGovernance: A European Perspective 4

By Jean Pisani-Ferry (Bruegel)

It is meaning ul that one o the very rst decisions taken a ter the crisis erupted inull orce in September 2008 was to re orm international governance by creating

the G20. This long overdue decision was in part accidental, but it was neverthelessindicative o the consensus within the international community that designing andimplementing an appropriate response required creating a more legitimate and more

e ective body than the G7. The upcoming G20 meeting in London is expected toresult in urther re orms, this time o the international nancial institutions.

The relationship between the nancial crisis and international governance is notentirely straight orward. The crisis is certainly by now a global one but it hasbeen at root a crisis o the US banking system that immediately contaminatedthe European banking system. It is only when the crisis took a turn or theworse in September 2009 that the rest o the world started being really a ectedby capital fow reversals and the collapse o world trade.

A ew numbers may illustrate the point. According to the IMF, US banks havesu ered 57% o the losses on US-originated securitised debt and Europeanbanks 39%, leaving only 14% or the rest o the world. More generally, North

America and Europe jointly represent 70% o the global supply o nancialassets and they probably account or an even larger share o nancial regulation,which again would suggest that managing the nancial crisis and even morepreventing uture ones could have essentially remained a transatlantic a air.

The need or a global economic venue where the leaders o the major industrialised,emerging and developing countries meet and discuss directions or internationalgovernance is in act much more pronounced in other domains like ood security(with Europe and North America jointly accounting or less than one-third o worldcereal demand), energy and climate (with the same regions accounting or 40%only o CO 2 emissions), and trade (where, again, Europe and North Americaaccount or somewhat more than 40% o world total only).

It was nevertheless the nancial crisis that triggered a change in global governance. The question is now whether the G20 will be able to deliver on the expectations ithas created.

To discuss the consequences o the crisis or global governance the rst sectiono this note addresses the regulatory agenda. Macroeconomic dimensions aretaken up in section 2. Conclusions are o ered in section 3.

4. This paper was prepared as in input document or the Club o Madrid’s Roundtable on “The PoliticalDimensions o the World Economic Crisis: a European Perspective” held March 26, 2009 in Barcelona, Spain.





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1. The regulatory agenda

It is widely recognised that the crisis in large part originates in the de ciencyo nancial regulation – knowing that “de ciency” can mean absence orinsu ciency, but also inadequacy. Was this ailure o governance primarily anational ailure, or a ailure o international cooperation to which stronger globalgovernance can remedy?

De ciencies were no doubt in many respects entirely national. To give only aew examples, the belie that regulators cannot know better than markets had

little to do with external developments and the competition between publicagencies that resulted in an excessively lax supervision o US banks was apurely internal de ciency. By the same token, the very uneven exposure to toxicassets o banks within Europe illustrates that it was in the power o nationalauthorities to exercise strict oversight o their banking systems – as done withsuccess in Spain. Failures o national authorities cannot be blindly ascribed to

international de ciencies.Weaknesses in international governance have however also contributed toregulatory and supervisory de ciencies. Three important channels have been:

• Competition among regulators resulting in “regulatory shopping” by transnational players and as a consequence in a loosening o national

regulations or a weakening o their e ectiveness. For example, the o -balancesheet conduits o some German banks were established in Dublin, whichexplains in part why they were neglected by supervisors. The same applies tothe operation o weakly regulated and supervised Icelandic banks in the UKand elsewhere.

• Disagreements among regulators resulting in weak global rameworks,excessive reliance on sel -regulation or the subcontracting o important parto regulation to private organisations . A key example here is the rulebook orinternational banking supervision issued by the Basel Committee or BankingSupervision. The pain ully negotiated ramework has been largely invalidatedby the crisis because o its excessive reliance on ratings and the banks’internal risk assessment models.

• Resistance by national authorities to the trans er o signifcant responsibilitiesto supranational bodies, resulting in incoherent and/or vulnerable rameworks .

The key problem here has been the supervision o transnational nancialinstitutions. Some global banks have grown too large to be supervised by anynational authority and even more to be bailed out by any national treasury.

Despite its extensive legislative apparatus, the EU itsel has not been immunerom these problems. Especially the third one is acute as the number o pan-European banks has grown in recent years, but supervision remains essentiallynational and coordination among national agencies is o limited e ectiveness.However there is no willingness to contemplate radical re orms. The recentLarosière report commissioned by the European Commission and endorsed bythe European Council does not envisage centralising the supervision o pan-European banks and advocates instead closer cooperation between nationalauthorities.

Crisis management since summer 2007 has con rmed that the tension betweenthe globalisation o nance and the weakness o international governance is




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a major problem in the current crisis. Cooperation between central banks inthe provision o liquidity to distressed banks has been remarkably smooth butinternational cooperation in the resolution o banking rises has been less exemplary.Many problems have emerged, or example as regards the coordination o deposit guarantee schemes, but the most di cult one is no doubt the rescue o banks with signi cant cross-border operations. This raises major di culties orsmall countries with large, internationalised banking systems, such as Austriaor Ireland.

The issue is especially acute within Europe where it has only been given partial,ad-hoc solutions ( or example when the Belgian-Dutch group Fortis was jointlybailed out by the two governments). The crux o the matter is that the taxpayerremains ultimately national and that or this reasons governments reject thenotion o a burden-sharing scheme that would commit them to contributing tothe budgetary rescue o a non-national bank.

The upshot is that even in the EU, the tension between economic internationalisationand political accountability has not been resolved in a satis actory way. Aspointed out by the recent report o Lord Turner, chairman o the British FinancialServices Authority, “The current arrangements […] are not a sound basis or the

uture regulation and supervision o European cross-border retail banks. Sounderarrangements require either increased national powers, implying a less opensingle market, or a greater degree o European integration”.

From this perspective the G20 agenda provides only a partial response. TheEuropean insistence on extending oversight to all nancial institutions in allcountries and on cracking down regulatory and tax heavens can be seen as astepping stone towards a comprehensive regulatory architecture. The Europeanshave learned rom experience that it is only in exceptional circumstances thatentrenched special interests o this sort can be overcome and they have everyreason to push their agenda ahead. This should not hide, however, that taxand regulatory heavens are not the core o the issue. Rather, the ate o global

nancial regulation depends on the attitude o the main players – the US, theEU and its member states, Switzerland, Japan, and China.

So ar, these players have not departed rom their traditional stance. The G20November declaration insisted that “regulation is irst and oremost theresponsibility o national regulators” and on regulatory re orm it emphasisedthe role o the Financial Stability Forum, a club o regulators, rather thanthat o the International Monetary Fund, a structured institution equippedwith decision-making powers. The Obama administration is certainly more

sympathetic to global institutions than the previous one but Congress isunlikely to delegate signi cant regulatory powers to supranational bodies. It isthere ore likely that cooperation will be intensi ed urther and that regulationwill be tightened but that the distribution o powers between national andinternational institutions should remain broadly intact.

What is uncertain is the attitude o private institutions. As Mervyn King, thegovernor o the Bank o England, said, banks have experienced that they are“global in li e but national in death” and the perception that this is a reality isbound to infuence their internationalisation strategy. At the time o writing it isunclear whether the trends towards the creation o global nancial players willcontinue or be signi cantly tamed by the experience o the crisis.





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2. The macroeconomic agenda

The macroeconomic roots o the crisis are less unanimously recognised thanits regulatory roots, but a growing number o contributions has emphasised therole o global macroeconomic conditions in creating an environment auspiciousto nancial instability.

From the immediate a termath o the Asian crisis up to the outbreak o the globalcrisis, the world economy has been characterised by an unusual but seeminglystable pattern o savings fows. Throughout a decade the poor countries,chiefy China, have been nancing the rich ones, chiefy the US, whose savingsde cit represented some 2% o world GDP. Instead o resulting in capital fows

rom capital-rich to capital-poor countries as expected, nancial globalisationwas letting capital fow in the opposite direction. In 2005 Fed governor (nowpresident) Ben Bernanke amously spoke o a “global savings glut”.

Several, possibly complementary explanations have been o ered to account orthis surprising pattern. Emerging countries, especially China, have been accusedo keeping their exchange rate arti cially low in order to stimulate exports andrun an external surplus. Following the traumatic experience o the 1997-1998crisis, the accumulation o oreign exchange reserves by the same countrieshas been seen as a orm o sel -insurance that would avoid them recourse tothe IMF i con ronted with macroeconomic and nancial shocks. Finally, it hasbeen argued that households and companies in those countries had little trustin the value o domestic nancial assets and that they had pre erence or US-made assets o reportedly better quality and sa ety.

Whatever the weight given to these explanations, the massive fow o oreignsavings into the US was bound to impact interest rates, savings behaviour,and the market or nancial assets. Indeed it contributed to keeping long-terminterest rates low, thereby uelling the real-estate boom, to lowering domesticsavings, thereby eeding the consumption boom, and to increasing the demand

or US-made sa e assets, thereby contributing to leverage and the manu acturingo assets o dubious quality. It is these conditions that, combined with a laxregulatory environment, provided the per ect incubator or boom-and-bust.

This type o analysis leads to emphasise the lack o global macroeconomicsurveillance and the role it could have played, had the world economy beenequipped with e ective global institutions. In particular, exchange rate surveillanceshould have prompted policy corrections in the presence o massive and lastingexternal surpluses and de cits; trust in the multilateral regime should have made sel -

insurance unnecessary; and, although less straight orward, alternative assets couldhave been o ered to surplus countries. The world pattern would have been di erentand arguably less auspicious to complacency towards the risk o instability.

This suggests that the re orm o the international nancial institutions should havea role in creating conditions or uture nancial stability. This dimension o the globalagenda was largely overlooked by the G20 meeting in November but its main tenetshave since then emerged. Global nancial institutions, especially the IMF, need:

• To warn against economic and nancial developments that involve risks o instability and send signals to governments and supervisory institutions sothat they can tighten oversight accordingly;




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• To provide e ective insurance against private capital fow reversals and orthat they must be equipped with su cient repower. This implies increasingtheir resources to a level commensurate with potential needs in a contextwhere crises are characterised by massive outfows;

• To exercise even-handed surveillance over the policies o the major countriesand blocks and issue warnings when these policies contribute to globalinstability. This implies making the institutions legitimate through a more adequaterepresentation and weight o the participating countries.

What this sketchy analysis suggests is that issues o governance and o e ectiveness are very closely linked. Keynes used to say that the job o the IMFis “ruthless truth-telling” but the Fund today lacks e ectiveness in dealing withglobal problems because it does not have the legitimacy that would allow it totell the truth to China and the independence that would allow it to tell the truthto the US.

Ultimately, the re orm o global nancial institutions should be seen as a steppingstone towards a balanced international monetary system o the sort recentlyadvocated by people’s Bank o China’s governor Zhou. It is crystal clear that aprerequisite or such a system is a bold institutional re orm.

The recent re orm o quota and voice at the IMF has evidently not beencommensurate to these needs. It has not even been su cient to create orrecreate the needed ownership in the institution among emerging anddeveloping countries. The G-20 has mandated that ministers prepare proposalsto re orm international nancial institutions, including giving greater voice andrepresentation to emerging and developing economies, and G20 ministershave agreed that it should be done by early 2011. This indispensable re ormneeds to go ar beyond the incremental changes agreed upon in 2008. It impliesin practical terms a reduction in the number o European votes and seats,possibly leading to a consolidation, and the renunciation to the U.S. veto power.Without such a re orm the IMF will continue to be perceived as an instrumento yesterday’s powers and it will be unable to play the macroeconomic role itneeds to play.

I there is a venue where such re orms need to be discussed, it is the G20summit. The matter is not a technical, but a political one. The question put to theheads o state and government is whether they agree on a major redistributiono powers within the institution and at the same time on a strengthening o itsrole and e ectiveness.

3. Conclusions

Back in November, global governance re orm was the world leaders’ chosenresponse to the outbreak o the crisis. They now have to deliver and theyare at risk o disappointing. This would be a very unwelcomed development,because it would signal a collective inability to act and could trigger retreattowards national, possibly nationalistic solutions. History teaches us that ailedinternational con erences in times o deep crises are to be avoided.

The G20’s agenda so ar has put emphasis on regulatory re orm. There isno doubt room or sensible initiatives, some o which are remotely related





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to crisis prevention and some o which could have more e ectiveness. Butthere are limitations to what the G20 can do in this eld. First, most o theissues to be solved are o the responsibility o the narrow group o countrieswith sophisticated nancial systems. It is appropriate to involve emerging anddeveloping countries in the discussion but their participation is unlikely to changethe outcome signi cantly. Second, regulatory cooperation can be improved butthere is little room or radical re orm. Problems within the EU are an indicationthat the supervision o nancial institutions remains a undamentally nationalresponsibility. Third, re orms are technical in nature and this adds to the risk o disappointing.

The re orm o international nancial institutions, rst and oremost the InternationalMonetary Fund, is a more promising avenue. I signi cant enough it could helpcontain developments conducive to instability. It could embody the transitionto a US-dominated world economy to a more balanced, multilateral regime.

And it is the condition or rebuilding trust in the system among emerging and

developing countries and thereby or avoiding the kind o quasi-secessionistbehaviour observed in recent years.

This is at core a very political issue where only heads o states and governmentscan take initiative. The G20 meeting in London o ers a rare opportunity orlaunching a bold re orm process. It belongs to the United States and to Europeto take the initiative, because their power and representation in the international

nancial institutions prevents the rest o the world rom ownership in them.

Re erences

Larosière, Jacques de, et al. (2009), Report o the High-Level Group on Financial Supervision in the EU.Pisani-Ferry, Jean, and Nicolas Véron (2009), “The re orm o global economic and nancial governance”,

contribution to Progressive Governance volume, orthcoming. Turner, Adair (2009), The Turner Review: A regulatory response to the global banking crisis, Financial Services

Authority.Zhou, Xiaochuan (2009), Re orm the International Monetary System , People’s Bank o China, March.




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Final Report o the European Roundtable 5

‘The Political Dimensions o the WorldEconomic Crisis: A European Perspective’ 6

The political dimensions o the nancial crisis are still being played out. Judgingtheir impact requires much speculation or the present. But the outlines o the challenges are beginning to be detectable. As stated by Ricardo Lagos,President o the Club o Madrid ‘ Politics is back ’. Politically, Europe is embroiledin the nancial crisis at three di erent levels. A rst concern is with the impact o the nancial crisis on the politics o integration within Europe itsel . As secondissue relates to the way in which the crisis threatens to pull the European Union

(EU) back rom a broadly liberal policy in its external economic relations and itsviews on multilateralism. A third trend is towards a less cosmopolitan politicaldimension o European oreign policies.

On March 26, 2009, the Club o Madrid 7 launched its programme on ‘ThePolitical Dimensions o the World Economic Crisis’ with a Roundtable ocusingon the European perspective o this crisis. This event gathered Club o MadridMembers, all democratically elected ormer Heads o State or government,with high-level representatives o intergovernmental organisations, civil societyand academia, to discuss the issues outlined above. The ollowing report o ersa summary o the key points and recommendations addressed during themeeting, exploring these three levels o linkage between the economic crisisand considerations o a more political nature.

‘This is not just a crisis but a change in paradigm ’

Diego Hidalgo,President, Fundación para las Relaciones Internacionales y el Diálogo Exterior

(FRIDE) and Member o the Board o Directors o the Club o Madrid

5. This summary report was prepared by Richard Youngs, Coordinator o the Democratisation Program, o the Fundación para las Relaciones Internacionales y el Diálogo Exterior (FRIDE) and Agustina Briano, JuniorProgramme O cer at the Club o Madrid.6. The Club o Madrid is grate ul to the Regional Government o Catalunya or its support in the organizationo this Roundtable discussion7. The Club o Madrid promotes “Leadership or Democracy that Delivers”. It is an independent organizationdedicated to strengthening democratic values and leadership around the world to meet political challenges atthe local, national, regional and global level. Drawing on the unique experience and resources o its Members– more than 70 democratic ormer heads o state and government rom 50 countries – and in partnershipwith organizations, governments and individuals that share its goals, the Club o Madrid addresses issueso global concern and provides peer to peer counsel, strategic support and technical advice to leaders andinstitutions working to urther democratic development. The Club o Madrid constitutes the world’s largest

orum o ormer Presidents and Prime Ministers and o ers today’s leaders an unequalled body o knowledgeand political leadership.





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Cracks in European solidarity

First, the crisis has impacted in a pro oundly political sense on the dynamicso integration within Europe itsel . Few days have gone by without Czech,French, and other ministers crossing swords in public. The spirit i not theletter o the single market has been torn asunder. State aid rules have beenrelaxed. France has o ered so t loans to companies on condition they uselocal suppliers 8 . Competition rules in the nancial sector have been suspendedand consideration o advancing liberalisation in the services sector – whichaccounts or two thirds o economic activity in the European Union (EU) – isnow o the agenda. 9

The Commission has speeded up the delivery o structural unds to central andeastern Europe and made rules more fexible (dropping so-called ‘co- nancing’requirements). But requests or new money rom these sources were re used.

These new member states still eel embittered at how they have had to turn to

the IMF in the absence o more generous EU assistance. Such support wasbelatedly increased at the April G20 summit. But, the core eeling o solidarityhas been ruptured.

‘My proposal is that all these countries (Members o the EU) that are to committo an agreement with the IMF do so through the EU. That would be a guarantee.The anger o the population, this eeling that they are paying or broken china,could be very damaging or our democracies’ .

Petre Roman,Former Prime Minister o Romania

and Member o the Club o Madrid

‘There is still a discrepancy between the degree o integration we have (atthe EU) and the governance system…clearly the European system is not

built to respond to a crisis…So in act the problem so ar has been solved by improvisation and leadership. ’

Jean Pisani-Ferry,Director o the Brussels European and Global Economic Laboratory

Within the EU the crisis has unleashed a undamental tension between theeconomic and political spheres. Rescue packages and broader stimulusmeasures have been introduced at the national level. The political impact is tohave increased the pressure o accountability on governments to their nationalpopulations. Observing the EU’s di culties in articulating a common response tothe crisis, some have observed a re-nationalisation o economic policy-making.But at the same time it is recognised that e ective solutions to the crisis requiredeeper coordination between governments. This tension requires European

8. Financial Times, 5 February 2009, p. 99. Simon Til ord, How serious is the threat to the single market? CER Bulletin, 19 March 2009.




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governments to recognise that ‘more Europe’ in the economic and nancialspheres is not enough. Such measures cannot be divorced rom the need tore-energise the EU’s democratic legitimacy. The lesson o European integrationis that economic divergence can easily spill over into political divergence. Thecrisis cannot be solved while parking the political dimensions o integration.

‘ A system in which profts are private but losses are socialised cannot possibly be sustained politically .’

Vitor Gaspar,Director General,

Bureau o European Policy Advisers, European Commission

Intra-EU and broader international considerations have conditioned each other.

Many o the most acute tensions have revolved around challenges within Europe.Member states have accused each other o adopting protectionist measuresthat undermine the single market. Hard-hit central and eastern European stateslament the lack o support rom their EU partners, especially Angela Merkel’sre usal to assent to a common rescue plan or the region. At the same time,there has been a clear read-over to the EU’s global agenda. Deepening divisionswithin Europe have nourished a return to beggar-thy-neighbour thinking withinthe EU’s external relations too.

‘I we look at the situation in various countries we can see how they di er intheir responses…nation-based policies do not mean ailure and…coordinated ones do not mean success ’.

Antonio de Lecea,Director o International Economic and Financial A airs,

European Commission

Moreover, the crisis has intensi ed the debate over the borders o the EU. Moresolidarity is needed towards the new member states o central and EasternEurope. But the EU must address the act that the countries beyond its boardershave been hit hard. This applies especially to Ukraine and the Balkans. The EUcannot solve its own problems i it abandons these ragile new democracies. ACrisis Response Package was ormulated under the Pre-Accession Instrument.

However, member states have become more reluctant to accept urtherenlargement just when the political costs o retracting rom their promises to theBalkans and Turkey will be even higher. Angela Merkel has insisted that the crisisrequires a ‘time-out’ on enlargement, a ter Croatian accession. In the middleo the crisis the EU has rolled out its new Eastern Partnership o ering variousareas o cooperation with six countries on its eastern periphery. But France andother states have re used to grant this partnership more signi cant amounts o money, insisting that two-thirds o overall Neighbourhood Policy money go tothe Mediterranean. This looks like infexible clientelism. The Partnership needsto be linked much more tightly to the means needed to combat the crisis inUkraine and other eastern states.





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‘We must recognise that in the ace o this crisis the EU and its neighbours are in act sailing in the same boat, a maybe ‘Shengenized’ boat…We must think about South-East Europe and what would happen i we continue to widen the gap between the waiting room or the EU and the EU as such ’.

Zlatko Lagumdzija,Former Prime Minister o Bosnia and Herzegovina


Furthermore, this issue is also related to the idea o a ‘Social Europe’ and thee ects the crisis is having on unemployment, inequality and poverty, both insideand outside the EU borders. As part o its response to the crisis, the EU mustnot orget to keep its active population as close to the market and employmentas possible in order to contain social unrest and increase competitive prospects

or the uture, once the economy starts to grow again. Inter-generational

issues and social cohesion are an increasing concern as Europe experiencesincreasing social inequalities and the middle class begins to whither. These maybe ertile ground or unexpected political consequences across the EU wherewe are already beginning to witness serious threats to and even the collapseo incumbent governments. It is vital or the governmental stimulus packagesto envisage budgetary projections to protect the most vulnerable sectors o society and the social security sa ety nets.

‘I there is no money to create new jobs, i there is no money to create new business, there is no uture at all ’.

Valdis Birkavs,Former Prime Minister o Latvia and

Member o the Club o Madrid

‘The e ects o the crisis on Europe may widen the gap between and within states along poverty and wel are lines. This may not only jeopardise economic prospects but the very basic idea o a shared society in Europe. We may, in theend, resolve the economic crisis but also have a new social crisis .’

Zlatko Lagumdzija,Former Prime Minister o Bosnia and Herzegovina


Reshaping the global economy

‘Global complexities and global problems can only be solved by global solutions.What we do at the European level should always be with a mindset o helping

global structures .’

Wim Kok,Former Prime Minister o the Netherlands





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Second, the nancial crisis has deepened the illiberal dri t in EU externaleconomic policies. In general terms, the a termath o the crisis has witnesseda massive decrease in cross-border nancial exposure and contraction ininternational trade. A number o speci c responses to the nancial crisis havecompounded the general tendency to protectionism. Since the outbreak o the crisis, European ministers have ritually promised that there will be no slidetowards protectionism. They did so at the G20 summits in both November 2008and April 2009. The more ardently they state this, the more they contemplate

just such measures.

‘In a globalised economy, the State cannot simply be the saviour called upon inexceptional circumstances. States have an organizing purpose and a regulatory

role to be exerted in normal times ’

Lionel Jospin,

Former Prime Minister o France andMember o the Club o Madrid

O course, the nancial crisis represents a major case o market ailure. In theace o over-extended debt, markets clearly were not sel -correcting. There

is widespread agreement that tighter regulations are required in the nancialsector. Sceptics insist that any urther economic liberalisation would be akin to‘trying to cure a state o inebriation by having another whiskey’ 10 . Prior to thecrisis, economic policies were based on the West providing capital to emergingeconomies and supporting a liberal trading regime as a means o importing goodsback into European markets. The whole geopolitical balance o this bargain hasnow shi ted. The West is set to export less capital, while China’s unparalleledliquidity will enhance its power. The ‘liberal equation’ has been undermined 11 .

And a de ensive scepticism o markets has certainly pervaded European reactionsto the crisis. The trend is towards ‘protection lite’ – or what some practitionersnow re er to as new means o ‘covert’ or ‘accidental’ protectionism. The EU hasnot adopted out-and-out trade restrictions but a series o actions that militateagainst international interdependence. The EU reacted vigorously against the‘Buy America’ provisions launched under the new Obama presidency, butseveral similar ‘buy national’ campaigns have been supported in Europe too.

Financial bail outs have gone hand in hand with governments exhorting banksto lend only to national markets. The retrenchment o private capital encouraged

by European countries is set to hit emerging economies particularly hard, andin some cases has already done so. The new protectionism is in nance ratherthan trade 12 . Western governments’ guarantees o deposits in their banks havehad the perverse e ect o dragging capital out o emerging economies intothe developed world. Some also accuse the UK o letting the pound all as aprotectionist measure.

10. Robert Skidelsky, ‘Where do we go rom here?’, Prospect, no. 145, January 200911. Roger Altman, ‘The Great Crash 2008: A Geopolitical Setback or the West’, Foreign A airs, Jan-Fen200912. George Soros, ‘…..should be the central concern’, Financial Times, 23 March 2009, p.9





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The French nance minister urges protectionism as ‘a necessary evil’. 13 O the twenty governments signing up to G20 statements, solemnly rebuttingprotectionism, seventeen have adopted protectionist measures. EU populationsnow perceive open trade very much as a risk more than opportunity. The riseo the Linke party under Oscar La ontaine in German polls is seen as the resulto its highly protectionist plat orm. Much ocus has centred on di erencesbetween member states on the right balance needed between more stimulusand more regulation – the UK pushing harder or more spending, France andGermany or more regulation. But these di erences mask a common retreat

rom economic liberalism.

‘The World Trade Organization should be empowered to monitor the applicationo policy measures in this crisis resolution, and to avoid again tari barriers and other orms o market distortion and spill overs ’.

Paola Subacchi,Research Director o the International EconomicsDepartment, Chatham House

Gordon Brown lectures the world on the dangers o protectionism; but, orone commentator, the prime minister’s own inward-looking policies renderhim ‘hypocrite-in-chie ’ 14 . In the US, Democrat ree traders have re used tocriticise the ‘Buy America’ initiative in part because they insist that Europeanprocurement rules are still ar more restrictive 15 . It is notable that the supposedlywell integrated transatlantic business class has not emerged as an infuentialbrake on these trends. Middle Eastern, Russian and A rican interlocutorshave all ironically suggested to diplomats that the European spree o banknationalisations mirrors the statist route or which the EU has or so longadmonished developing countries.

Member states such as Germany, France and Italy have introduced restrictionson Sovereign Wealth Funds – at the very least sitting uneasily with a Commission-led code o conduct o ering access to SWFs where a minimal degree o transparency exists in such unds. A new German law restricts access o

oreign buyers, in particular big Chinese and Middle Eastern SWFs. PresidentSarkozy has moved ahead with creating a French und explicitly to end o such oreign ‘predators’. The so-called Santiago principles agreed in October2008 to open up east-to-west investment are now in doubt. Some memberstates have ought or more governmental control over IMF loans, wishing to

move away rom a ocus on liberal re orms.

The EU has come to back some re orms to international nancial institutions.European governments have backed G20 statements agreeing to bring

orward a reweighing o IMF votes rom 2013 to 2011. But in practice, theyhave contemplated change within a relatively limited range, resisting anycommitment to ar-reaching change in 2011. The EU has been able to hide

13. Le Monde, 4 February 200914. Martin Wol , ‘Why Davos man is waiting or Obama to save him’, Financial Times, 4 February 2009, p. 11.15. Financial Times, 6 February 2009, p. 6




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behind the US’s long-standing reluctance to accept reduced power at the IMF. This has enabled European countries to maintain a studied ambivalence onthe question o their own willingness to accept diminished sway. At the end o March 2009 a signi cant re orm o IMF lending was agreed, involving a dilutiono conditionality. With parts o Europe itsel in need o emergency unding, orthe rst time most EU states sided with developing states in advocating such aweakening o structural conditions.

‘I ear Europeans are underestimating the magnitude o the crisis. The EuropeanCentral bank is very cautious, even with the Eastern European Crisis. TheFederal Reserve is very aggressive and very ear ul, ready to ace a problem

anywhere. So I think the problem is that we have a di erent perception o what may happen to the world economy’

César Gaviria,

Former President o Colombiaand Member o the Club o Madrid

Options or broad coordination o macroeconomic policy at the global level havebeen resisted. The EU, and especially European Central Bank, have laggedbehind in policy easing and the size o scal stimulus recommended by theIMF. The crisis has made policy-makers in key European nancial institutions,i anything, more adverse to losing control o decisions and being dragged intopolicies they deem not to be in the immediate European interest. No Europeansupport has been orthcoming or a power ul Economic and Social Council atthe United Nations. European states are now even more reluctant to give uptheir vetting o membership to the Basel Committee or Banking Supervision. Apre erence or in ormal groupings o the G7, G20 and Financial Stability Forum(a club o regulators) has taken precedence over a genuine multilateralisation.

The April 2009 G20 summit held in London a ew days a ter the Club o Madrid Barcelona Roundtable was generally hailed as a success. The G20agreed to triple unds to the IMF; $75 billion o the increase is to come romEU governments. It also committed to boosting trade nance by $250 billionand extending additional credit to poor countries. The Financial Stability Forumwas broadened out into a Financial Stability Board that would incorporatedeveloping countries in the G20. But genuinely rebalancing re orm was o theagenda. The Spanish and Dutch governments have squeezed their way intoa ‘G20 plus’, rendering Europe even more over-represented – to the openly

expressed chagrin o emerging powers.

‘The Doha Development Round is low hanging ruit. We have the text, thedivergences are not big, we still need the political decisions to be made. Wedo not need more technical time. We need political attention that has to come

rom the highest level .’

Alejandro Jara,Deputy Director General, World Trade Organization





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In most European states the G20 summit was hailed as a victory over ‘Anglo-Saxon ree market capitalism’. The regulatory route was given more emphasisthan measures to stimulate spending and trade. The UK moved some wayto accepting the need or heavier regulation, closing the gap in positions thathad loomed in the run up to the summit. Trade was the glaring omission romthe G20 – beyond another non-committal pledge to avoid protectionism. Noconcrete steps were taken towards restarting the Doha round. Positions in thatround had already reached a lowest common denominator. Yet revisiting thisand re-loading the trade dossier was declared o the agenda in London 16 .

As European countries look to the IMF or economic help this has geopoliticalconsequences. It requires the EU to have a ar more proactive and coherentposition on e ective multilateralism. The EU has talked or a long time about theimportance o the latter but still has not been willing to take the steps necessaryto achieving it. Immediate ad hoc policies are necessary to deal with the worsto the crisis.

‘In ormal solutions are necessary but we should urge our leaders to keep in mind that whilst taking action at the short term, they should also work on the new structures or the long run because we cannot a ord to wait till these new structures are in place .’

Wim Kok,Former Prime Minister o the Netherlands


But these must not divert attention rom the structural changes that are neededin the international system. Crucially, re orm o the nancial institutions is notenough. This cannot be divorced rom the need to re orm the broad range o multilateral institutions that cover the political sphere as well.

‘We need to have a ‘G’ that is legitimate in the context o an international institutional ramework, not an ad hoc group o countries who selected themselves and selected who participates in the meetings. Europe should claim or institutional mechanisms to manage global governance ’.

José Antonio Ocampo,Content Coordinator o the Club o Madrid programme on

‘The Political Dimensions o the World Economic Crisis’and Director o the Program on Economic and Political Developmentat the School o International and Public A airs, Columbia University

There is a long running debate over whether the EU is a generator o globalisationor a de ence against it. The scales may be tipping towards the latter point o view. The crisis reveals serious market ailures but the baby should not be

16. Lucy Davis, ‘G20, where is the trade?’, European Voice, 1 April 2009, www.europeanvoice.com




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thrown out with the bathwater. At the same time, the crisis has revealed thatthis dichotomy – EU as a dimension o globalisation versus EU as bulwarkagainst globalisation – is a alse one. The policy change needed is to make surethat the EU contributes to a di erent type o globalisation, e ectively linking thenation state, regional and global levels.

Europe’s geopolitical vision

Third, internal tensions and uncertainties over re orm to the international nancialinstitutions in turn pose acute challenges or the EU’s more political, externalrole. More unity and e ort is needed on other issues such as climate change,energy security, demographic trends and non-proli eration. The nancial crisismust be understood as embedded in this broader set o international challenges,not separate rom them. There are signs that the EU’s commitments to climatechange, security and human rights are su ering as a result o the crisis. This

incipient trend must be reversed.

‘We should not look into the economic crisis alone because what we areexperiencing today is the accumulation o our crises that are mutually eedingeach other: the climate change crisis, the ood and hunger crisis, the oil and energy crisis and the economic and fnancial crisis. We have to see all our asthe ramework o the current economic situation .’

Kjell Magne Bondevik,Former Prime Minister o Norway and


The crisis risks leading to a pre erence or ‘strong government’ in a way thatundermines democratic quality – both within and beyond Europe. Those o a‘realist’ bent will ask, does the nancial crisis not make the issue o democracyseem rather irrelevant? Can we really preach democracy’s advantage as theWest’s economic systems come crumbling down? Are we not even moredependent on Chinese liquidity to kick start recovery? Can we talk democracyin A rica with cash-rich China poised to extend its infuence there even urther?Some experts argue that a ter the nancial crisis the EU needs to stop tryingto support democracy beyond Europe and simply sa eguard it within its ownmember states 17 .

And indeed, as the international context has changed, the EU appears lesswilling to sacri ce engagement with autocratic regimes. European approachesto democracy rely heavily on the positive, modernisation scenario that as China,Russia and other non-democratic states extend their trade and investment linksthey will come to press or better governance to protect their own investmentin third markets.

European governments and the Commission have become increasingly lessminded to exert pressure or democratic re orm. They increasingly eschew

17. Anatol Lieven, ‘Europe has to guard democracy amid crisis’, Financial Times, 10 December 2008





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sanctions related to democracy and human rights issues. Many would say thatthe reluctance to use critical measures and sanctions is a good thing – not asign o any lack o commitment to democracy and human rights but a correctrecognition that such measures are o ten counter-productive. The problemis that neither has the EU engineered its positive engagement e ectively tosupport liberal democratic values. The rewards and incentives the EU o ers ordemocratic re orm remain limited, in some cases increasingly so.

‘In Europe the casualty may be integration. In Eastern Europe it may bedemocracy. In the rest o the world the casualty may be ailed states… and we might ace an increasing number o time bombs. One should look at theEuropean contribution outside the concerns o the G20, o course to the short-term resolution o the crisis, but also the longer term issues like development,

poverty or the environment. ’

Sadiq Al Mahdi,Former Prime Minister o Sudan andMember o the Club o Madrid

The Czech oreign minister laments that the EU is ‘backtracking on democracy’.Germany increasingly prioritises its role as a ‘coalition builder’ rather thanvalues-advocate in oreign a airs 18 . One UK minister welcomes the returno the US to ‘good old ashioned policies o national interest’ 19 . France andSpain remain generally unconvinced o the democracy agenda. In Italy, SilvioBerlusconi tilts towards Atlanticism, his rivals on the le t towards Europeanism;neither side distinguishes itsel in pro-democracy e orts. Diplomats rom manymember states argue that the nancial crisis places more o a premium onpolitical stability. Doubts have sur aced during 2009, as the Czech and Swedishpresidencies have tried to galvanise support or a new European Consensus ondemocracy: many member states have reacted ambivalently, reluctant to rmup current policy instruments.

‘The crisis and the problem is economic but the solution remains primarily a political choice so we have to consider the whole matter rom a political perspective .’

Hong Koo Lee,Former Prime Minister o Korea and


But it would be wrong to conclude that the nancial crisis renders open politicsirrelevant, even harm ul. Crisis o ten acts as the trigger or political breakthroughs.In the midst o a crisis the ‘strong leader’ might gain currency. But democracieso er the accountability and open deliberation that are necessary or stabilisation

18. Hanns Maull, ‘Germany and the Art o Coalition Building’, in Erik Jones and Saskia van Genugten (eds.) The Future o European Foreign Policy, London, Routlegde, 2009.19. Lord Malloch Brown, BBC World, 30 March 2009.




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over the longer term. Despite the crisis it remains the case that sustainableeconomic development is best built on democratic oundations. Obama’scaution on democracy makes it more not less imperative that the EU showsome determined and enlightened leadership in supporting global democracy.

‘More institutions are needed but they are no substitute to political leadership and courage .’

Antonio de Lecea,Director o International Economic and Financial A airs,

European Commission

Better understanding o the ways in which the crisis could undermine democraticquality, transparency and accountability must be rein orced. Nationalism and

inequalities must be rebutted. The normative appeal o democracy must beenhanced; democracies must demonstrate they can manage the crisis in amore open and air way than non-democratic regimes. An e ective democracymust be built on a balanced and mutually rein orcing relationship between state,market and civil society. There is no trade o between e ective management o the crisis and deepening democratic quality.

‘Democracy that delivers requires a mutually rein orcing balance betweenthe state, the market and the individual. The undamentalisms o the binomial

system have ailed. The crisis is a result o a world without rules ’.

Ricardo Lagos,Former President o Chile and

President o the Club o Madrid.





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Final Declaration

We, Members o Club o Madrid, met in Barcelona on March 26 to discuss thepolitical dimensions o the world economic crisis rom a European perspective.We agreed on the ollowing diagnosis and recommended actions:

We recognize1. that the mega-crisis that the world is experiencing is global and systemic in character . It is the most devastating nancial crisis sincethe Great Depression, generating the worst recession since the SecondWorld War; a veritable collapse o international trade, and serious socialconsequences, as seen in the rise o unemployment and poverty. Theseeconomic and social implications are producing important political impacts,putting democratic systems under stress in many parts o the world.In these circumstances,2. public sector response must be strong and timely .Underestimating the severity o the crisis could lead to the worst possible

scenario, another “lost decade” in world development, with signi cantsocial and political e ects. We there ore welcome the expansionarymonetary policies being adopted by various industrialized countries butare concerned with the small stimulus packages being implemented bymembers o the European Union; the delay o the European Central Bankin adopting more aggressive policies, and the inadequacy which nancialsector bailouts have demonstrated so ar. The upcoming meeting o theG20 in London should not miss the opportunity to agree on strong andcoordinated macroeconomic stimulus in industrialized countries.Facing the social costs o the crisis should be at the centre o all 3.

macroeconomic policy packages . Social protection systems must bestrengthened in those countries where they exist, and gradually created inthose where they are not in place. Managing high levels o unemploymentand underemployment will be their most challenging task. Social dialoguecan be extremely use ul in managing the social demands created by thecrisis, simultaneously helping to strengthen our democracies.It is essential to correct the regulatory defcit 4. , the principal, individual causeo the current nancial crisis. We hope the G20 will agree to promotecomprehensive nancial regulations, covering institutions (such as hedge

unds) and activities (derivates) previously unregulated; to include counter-cyclical provisions in these regulations; to enact stronger supervision o systemically important institutions, including the use o colleges o supervisorsto oversee nancial institutions operating worldwide; and to oster strongconsumer de ense, refected in the nancial sa ety o assets and loansmade available to unsophisticated agents. Financial bailouts are costly and

have signi cant distributive e ects. Transparency and accountability shouldthere ore be rigorously applied.Emerging and developing countries must be part o the solution5. . The sharpinterruption o capital fows to developing countries is a major sourceo concern. Economies that were healthy just a year ago have comeunder severe strain. The G20 should there ore also agree on increasedcapitalization o the IMF and the major multilateral development banks.Developing countries are reluctant to use IMF resources due to the intrusiveconditionalities o the past. A major review o these conditionalities isessential and positive steps are being taken in this direction.The decrease o international trade since the third quarter o 2008 is a6.

major source o concern . Nationalism is being refected in strengthened




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protectionism, o ten introduced in indirect ways. For example, rescuepackages or the nancial sector or some productive activities are creatingsubsidies that a ect the competitive position o developing countries unableto match the nancial support that industrial countries can provide. Wethere ore propose a total reeze on these protectionist trends and a specialmeeting o the WTO to create e ective mechanisms to ensure this.

A strengthened global architecture requires a special e ort in institution7. building . While G20 meetings have been a step orward, global governancecannot rely on in ormal mechanisms lacking representation rom mostcountries o the world. The institutionalization o the G20 through the creationo a representative Global Economic Council, under the UN but with thesupport o the global nancial institutions could be a solution. The latter,particularly the Bretton Woods institutions and existing regulatory bodies,should also be strengthened. This process could help address the issue o voice and representation o developing countries in international economicdecision making. And, as the European history refects, stronger regional

institutions are an essential complement to world institutions in building abetter global order.Beyond the need or an urgent response, we recognize that this is an8.

institutional crisis o the global order . The world cannot postpone creating aninternational nancial architecture consistent with the deep interdependencyo our globalized economy. The agenda should be broadened to include:the creation a truly global reserve currency, which could be based on theSpecial Drawing Rights o the IMF; the creation o institutional and e ectivemechanisms or macroeconomic policy coordination; the role o capitalaccount regulations in the emerging system o nancial regulation; thecreation o a special court to mediate and eventually arbitrate disputesassociated with over indebtedness at the international level; and enhancedinternational tax cooperation.





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Abstract

The nancial crisis that hit the world in 2008 has become global and triggeredthe start o a worldwide economic recession. By the ourth quarter o 2009,most countries will have been in economic recession or nearly a year. Wealthycountries will have become less wealthy and the poor even poorer. Nationalgovernment and international nancial institution attempts to cope withthe nancial crisis and other economic troubles will have inevitable politicalconsequences and may put the procedures o constitutional democratic politicsat risk, create conditions or heightened social unrest and possible violence,and deepen the inequality and injustice in which many continue to live. Financial andmacroeconomic troubles cannot justi y the de erral o equally crucial challengesbeing aced by humanity today, ranging rom poverty to global warming,

rom human rights to peace building, all key to sustaining democracy, goodgovernance and development.

Above and beyond the urgency to design and implement policies and measuresto address this mega-crisis in the short-term, a recurrent theme appears in alldiscussions – the need to look ahead and welcome the crisis as an opportunity toaddress much deeper, medium and long-term concerns, at multiple levels. Thedesign and adoption o a new, more e ective international nancial architectureis seen as a vital step in preventing uture meltdowns and attaining international

nancial stability, as well as a more credible, truly multilateral and democraticgovernance structure in the international nancial institutions.

But concerns are not limited to nancial institutions. The governance structure o nearly all international organizations and o the various global ‘groupings’ is alsobeing questioned. Can this crisis become the opportunity to e ectively addressthis issue? To rethink entrenched ways o doing things and to promote re ormsthat strengthen democracy? A post-crisis, multiple level strategy and approachwill be essential both in structural and leadership terms. Will this strategy beunderpinned by existing structures and groupings or will new or renewed onesemerge? De ning and agreeing on how, when and what in a course o correctiono this magnitude will need leadership and experience, sagacity and audacity.Other important issues such as those highlighted above – climate change, povertyalleviation, good governance – must not be le t by the wayside in the necessarilybold and oreseeable process o change and re orm that lies ahead.

The current crisis is extremely complex. It a ects various countries and regionsdi erently depending on their level o development, location and inclusion

in the global economic networks, among others. Dealing with it will requiredi erent solutions and strategies or each region and each group o countries. This is why the proposed work program is based on regional round-tables inpreparation or a global discussion in our Annual Con erence 2009. Participantsare convened not to discuss the speci cities o particular nancial or economicmeasures. As politicians and experts in policy and decision-making, participantsare encouraged to ocus their attention and analysis on the policies beingadopted by governments and multilateral institutions to meet the challengesposed by the economic crisis, as they bear on the imperative o strengtheningand sustaining democratic values, democratic leadership and the quality o polities and policies.




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Programme

Thursday, 26th March

13:30 – 14:00 Welcoming words : (Sala Tàpies)Ricardo Lagos , President, Club o Madrid. FormerPresident o Chile.

José Antonio Ocampo , Programme AcademicCoordinator. Pro essor at Columbia University. FormerUnder Secretary General o the United Nations orSocial and Economic A airsJosé Montilla i Aguilera , President o the

Autonomous Government o Catalunya

16:00 – 20:00 Roundtable ‘ The Political Dimensions o the WorldEconomic Crisis – A European Perspective’ ( Sala deMúsica )

Block 1: The Situation within Europe:the National and SupranationalBlock 2: Europe’s New Rolein the International ArenaModerator: Philip Stephens , Associate Editor andSenior Commentator, Financial TimesWelcoming Words: Hon. Antoni Castells , Minister o Economy o the Autonomous Government o CatalunyaSpeaker: Jean Pisani-Ferry, Director o the BrusselsEuropean and Global Economic Laboratory, Member o the European Commission’s Group o Economic Policy

AnalysisRapporteur: Richard Youngs, Coordinator o theDemocratisation Program, Fundación para lasRelaciones Internacionales y el Diálogo Exterior (FRIDE).

20:00 – 21:30 Cocktail o ered by the Hon. Josep Lluís Carod-Rovira, Vice President o the Autonomous Government o Catalunya (Biblioteca)





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Participants list

Members of the Club of Madrid

Ricardo Lagos Former President o Chile. President,Club o Madrid

Sadiq Al Mahdi Former Prime Minister o Sudan Valdis Birkavs Former Prime Minister o LatviaKjell Magne Bondevik Former Prime Minister o NorwayJoaquim A. Chissano Former President o MozambiqueCesar Gaviria Former President o ColombiaLionel Jospin Former Prime Minister o FranceWim Kok Former Prime Minister o the

NetherlandsZlatko Lagumdzija Former Prime Minister o Bosnia and

Herzegovina

Hong Koo Lee Former Prime Minister o KoreaPetre Roman Former Prime Minister o RomaniaDiego Hidalgo President, Fundación para las

Relaciones Internacionales y el DiálogoExterior (FRIDE)

Anthony Jones Vice President and Executive Director,Gorbachev Foundation or North

America (GFNA)Fernando Perpiñá-Robert Secretary General, Club o Madrid

Experts and Invitees

Bjørn Klouman Bekken Higher Executive O cer, The RoyalNorwegian Ministry o Foreign A airs

Federiga Bindi Visiting Fellow, Brookings Foundationand Advisor on Global Governance tothe Italian Minister o Foreign A airs

Antoni Castells Finance and Economy Counsellor,Regional Government o Catalunya

Senén Florensa Palau General Director, Institut Europeu de laMediterrània (IEMed)

Antonio de Lecea Director o International Economic andFinancial A airs, European Commission

Carlos Gasòliba President o the Spanish Committee,

European League or Economic Co-operation Vitor Gaspar Director General, Bureau o European

Policy Advisers,European Commission

Alejandro Jara Deputy Director General, World TradeOrganization

Carlos Losada Marrodán Associate Pro essor o the Departmento Business Policy, ESADE

Leiv Lunde Senior Advisor on the Global Economyto the Minister o Foreign A airs,Government o Norway




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José Antonio Ocampo Academic Coordinator o Club o Madrid Program on the InternationalFinancial Crisis. Pro essor o Pro essional Practice in Internationaland Public A airs and Directoro the Program in Economic andPolitical Development at the Schoolo International and Public A airs,Columbia University

Al redo Pastor Pro essor o Economics, IESE BusinessSchool

Mario Pezzini OECD Deputy Director, PublicGovernance and Territorial Development

Jean Pisani-Ferry Director o the Brussels European andGlobal Economic Laboratory, Membero the European Commission’s Group o

Economic Policy Analysis (GEPA) ando the French Prime Minister’s Council o Economic Analysis

Narcis Serra President, Center or InternationalRelations and Development Studies(CIDOB)

Philip Stephens Associate Editor and SeniorCommentator, The Financial Times

Paola Subacchi Research Director o the InternationalEconomics Program, Chatham House

Philippe Egger International Labour OrganizationCarlos Westendorp y Cabeza Principal Advisor to the EU’s High-

Level Refection Group on the Future o Europe

Richard Youngs Coordinator o the DemocratisationProgram, FRIDE

Juan Zalduendo Lead Economist, O ce o the Chie Economist, Europe and Central AsiaRegion, World Bank





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Background Document or the Latin American Roundtable

‘The Impact o the Global Economic Crisison Latin America’ 20

By José Antonio Ocampo *

From 2003 to 2007, Latin America experienced an exceptional economic boomthanks to an unusual combination o world nancial prosperity, sustained growtho international trade, extraordinary raw material prices and high capital infows

rom emigrant workers. This boom was the most signi cant in over thirty years,speci cally since the region’s economic growth between the 1960s and early1970s. It was a widespread process and indeed bene ted small and medium-sized economies more than the region’s two largest ones. In contrast with thesituation since the debt crisis (and earlier in some cases), its social impact wasalso highly positive. Unemployment and poverty were considerably reduced,employment grew dynamically and was o a better quality and inequality wasdiminished in a large number o countries.

The region was not signi cantly a ected by the rst part o the internationalnancial crisis which started in August 2007 in the United States with the

subprime mortgage asco. Foreign nancing was reduced and became moreirregular. Furthermore, capital infow growth rom migrants started to decelerateas a result o ewer employment opportunities abroad, especially in the USconstruction sector. Rising raw material prices, however, sustained the boomin several countries throughout the rst hal o 2008. When this trend changedhal way through the year, there ore, it signalled the end o positive growth. Theworld crisis, enhanced by the collapse o the Lehman Brothers investment bankin the US in mid-September dramatically increased this trend.

1. Economic impact

The economic impact o the world crisis, which took some time to beacknowledged, was enormous. The orecasts o all multilateral agencies (World

Bank, ECLAC, IMF and UN) announce that the region’s GDP will be alling by1.5% (IMF) to 2.2% (the most recent estimate rom the World Bank), with ECLACand the UN predicting intermediate gures ( alls o 1.7% and 1.9%, respectively).

20. This document vas prepared as an input document or the Club o Madrid’s Roundtable on “The PoliticalDimensions o the World Economic Crisis: a Latin American Perspective” held July 13th, 2009 in Santiagode Chile.* Pro essor and co-President o the Initiative or Policy Dialogue at Columbia University. Member o theCommission o Experts o the UN General Assembly on Re orms o the International Monetary and FinancialSystem. Former Under-Secretary General o the United Nations or Economic and Social A airs and ExecutiveSecretary o the Economic Commission or Latin America and the Caribbean, and ormer Minister o Financeo Colombia.




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Some private organisations have made even more pessimistic orecasts.Furthermore, the crisis is widespread. Mexico is the most a ected economy, butmost o the region’s countries will see their economic activity reduced.

From a historical perspective, this recession is worse than those o 1990 and2002 and, according to the most pessimistic orecasts, could be worse thanthe post-war period in 1983, although possibly shorter in length (see Graph 1).

The orecasts also show that what is lost in 2009 will only just be recovered in2010, and the per capital GDP will not return to 2008 levels until 2012. In otherwords, this crisis will set development back by our years. It is not so bad asthe “hal a decade lost” in 1998-2003 and certainly better than the “wasteddecade” o the 1980s. Some scenarios are, however, more pessimistic.

The way this crisis has spread shows signi cant di erences with the past, and somesurprises. Notwithstanding some negative orecasts, the reduction in capital infow

rom migrants has been relatively moderate (5.2% and 6.7% in the last quarter o

2008 and the rst o 2009 relative to the same periods a year earlier).

The nancial channels have also been weaker than was initially expected. In contrastwith the three previous episodes (the debt crisis, the Mexican crisis o 1994-1995and the nancial crisis a ecting emerging economies that rst arose in Asia in1997), none o the region’s countries has now seen a collapse o its internal nancialsystem. Risk margins, and consequently the cost o oreign nancing, started toincrease in mid-2008 and exploded with the world nancial collapse in September,but peaked towards the end o October and has since been considerably reduced.In recent weeks, it was around 9%, some two percentage points higher than duringthe boom, but much lower than the typical rate ound rom mid-1998 to mid-2003,during the nancial crisis a ecting emerging economies. The availability o oreign

Source:ECLAC

Graph 1Economic growth in Latin America, 1950-2

-4

- 2

0

2

4

6

8

1950

Growth rate

Historic peaks





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nancing ell drastically in mid-2008 and dried up altogether in September, but hasbeen gradually improving since the beginning o 2009. In the critical weeks o the

nancial debacle, there were important losses on the derivative markets, especiallyin Brazil and Mexico, which bought pressure to bear on international reserves.However, they were only marginally reduced and remain at very high levels. Finally,although the stock markets collapsed in mid-2008, they remained at higher levelsthan in other regions and participated in the world stock market boom o April andMay 2009.

From a historic perspective, although the nancial sectors o industrialisedcountries were at the eye o the storm, in strictly nancial terms, this has beena much worse crisis or Latin America than the debt crisis and the nancialcrisis a ecting emerging economies. This is due to both external and internal

actors. In external terms, the act that the crisis arose in the industrialisedworld generated an active response rom the economic authorities, which wasnot ound in the past in crises arising in the developing world (except or the

Mexican crisis o 1994-1995). The internal reasons are associated to the actthat Latin American economies are macroeconomically stronger, as discussedin the ollowing section.

In commercial terms, the current crisis is much more pro ound. The collapsein world trade is unprecedented since World War II and is even more severethan the situation at the start o the Great Depression in the 1930s. In the rstquarter o 2009, the value o world trade was 31% less than in the same quartero 2008, because o both the drop in raw material prices and the heavy dropin the world demand or manu actured goods. Although basic product pricespartially recovered in the second quarter o 2009, a similar trend is not yet clear

or manu actured goods, as shown in the 24% reduction in Chinese exports in April and May relative to the same months o 2008. Both the IMF and the UNare expecting a 11% reduction in world trade volumes in 2009, and no growth,or at best a very partial recovery, in 2010.

Latin America has ormed part o this process. Its exports ell by 26% in the rstquarter o the year, relative to the same period in 2008. As the magnitude o thecurrent recession ound in the region cannot be explained by the nancial crisis,the present situation could better be described as a commercial crisis. In otherwords, although the region has reduced its nancial vulnerability, its commercialvulnerability is much greater than in the past.

This means that, unlike the situation in Mexico a ter the 1994-1995 crisis or inLatin America as a whole a ter the 1998-2002 emerging economy crisis, the

possibility o overcoming the recession thanks to export growth is limited. Froma broader perspective, this presents policy-makers with important questionsconcerning the development strategy that, or a quarter o a century, has beenemphasising the importance o economies orming part o world trade andinvestment trends. This issue is revisited in the last section o this document.

2. The response to the crisis

It was generally agreed in the last ew months that anti-cyclical macroeconomicpolicies were required in response to the crisis, on both a regional and globalscale. It was also recognised that developing countries have more limited




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possibilities in this respect, basically because nancial and trade fows havepro-cyclical e ects on such economies. The di erent multilateral banks havethere ore been active supporters o such policies, including the World Bank, theIADB, the ADC and the CABEI. The IMF has received unprecedented resourcesand substantially innovated its nancing strategy, particularly with the creationo the Flexible Credit Line in March, which has already been used by Colombiaand Mexico. The Federal Reserve also created lines o credit, through currencyswaps, or the central banks o Brazil and Mexico, and China has provided

Argentina with similar resources.

Furthermore, Latin America has wider margins than in the past or adopting anti-cyclical macroeconomic policies. The most important change can be ound inthe monetary and currency exchange eld. The sudden interest rate increasescharacteristic o previous crises, o ten due to attempts to prevent depreciationo national currencies, have been avoided. On this occasion, central bankshave been able to lower interest rates, provide the nancial system with

resources (reducing bank swaps, among others) and, in most large countries,they have let the exchange rate depreciate (with some intervention to preventan uncontrolled adjustment process). The countries with development bankshave also used them to support credit reactivation.

The basic reasons enabling this action to be taken were two actors which havehindered the transmission o the crisis through nancial channels: the heavyreduction in governmental oreign debt and high levels o international reserves.

As shown on Graph 2, in 2008, oreign debt net o international reserves, wasequivalent to 6% o the GDP, compared to nearly 30% prior to the previouscrisis. This was due to several actors. The rst is the development o domesticbond markets, which have become a dynamic source o public nancing inmany countries. The second is the decision o most central banks to absorbexcess oreign nancing by accumulating international reserves, as shown bythe act that the two periods o abundant oreign nancing ( rom mid-2006 tomid-2007 and the rst hal o 2008) also saw heavy accumulation o reserves.

The third was the current account surplus. With a ew exceptions (Argentina,Bolivia and Venezuela), however, this was not the most important source o accumulation o reserves. Indeed, the region’s slight current account surplusduring the recent boom is practically entirely explained by the improvement interms o trade, as i the current account is estimated with the terms o tradeprior to the boom, the decline was considerable during the period o prosperity(Graph 3).





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In the tax eld, there have been multiple announcements o anti-cyclical policies,but there is not much margin. The basic reason is that, although scal de citsremained at moderate levels and public debt levels are more avourable in nearlyall countries than prior to the previous crisis (the most signi cant exceptionsare Argentina, Colombia, Uruguay and, marginally, Brazil), these results arenot due to spending austerity during the previous boom but to exceptionalpublic income levels. Public expenditure grew aster than long-term economicgrowth and, in this respect, was pro-cyclical, with some exceptions, the mostimportant o which is Chile, but also El Salvador and Guatemala. It will not beeasy, there ore, to maintain these rates o public expenditure growth duringthe crisis. However, with acceptable growth rates, expenditure could play a

stabilising role and programmes could be launched to relieve part o the impacto this crisis on low income sectors. Indeed, such programmes have beeninstated in several countries.

3. The political implications

The political implications o this crisis will rst be ound in a decline in socialindicators. The in ormation provided in the June report on employment published

jointly by ECLAC and ILO, shows a all in the employment rate, a considerabledrop in the ormal employment growth rate (social security contributors) andan increase in unemployment in the rst quarter o 2009 relative to the same

Source: Author’s calculations based on ECLAC statistics. For Chile, this includesresources from sovereign funds

Source; Author’s estimated from ECLAC data

Graph 2

Foreign debt net of internationalreserves, at parity exchange rate of 2000

0.0 %

5.0 %

10.0 %

15.0 %

20.0 %

25.0 %

30.0 %

35.0 %

40.0 %

45.0 %

Foreigndebt Net of international

reserves

Graph 3

Latin America: current account with and withoutadjustment for terms of trade (base 2003)

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0

%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Current accountbalance Adjusted for terms of

trade

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008




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period in 2008. However, the impact is still modest and compatible with modestgrowth in employment, albeit with some important exceptions. The situation inMexico is a cause or concern, as the country could be acing one o the mostsevere labour crises in the last ew decades (among other things, due to theradical change in migratory conditions in the US), and the same applies toColombia, where the unemployment rate has increased to one o the highestin the region. With regards to poverty, the UN has projected an increase o 3.6 million people living in extreme poverty in Latin America; this e ect is alsomodest and susceptible to ocalised policies. The impact on employmentand poverty will increase, however, i the crisis lasts or long. Consistent withthese as yet modest e ects, there appear to have been no important politicalmobilisations associated to the crisis to date.

More signi cant is the switch to more active ideas o the role o the State, aspart o a worldwide process. In Latin America, however, this was occurringbe ore the crisis, as seen in several regimens clearly identi ed as le tist (with

di erent variants), although there is also more pragmatism concerning the roleo the State in central and right-wing governments. One interesting aspect isthe renewed attention paid to the role o the domestic market and developmentbanks. Brazil is a pioneer in both these issues. Anti-cyclical packages re erprecisely to how to activate domestic demand in an un avourable economicsituation. Development banks would be the most important way in which torenew interest in industrial policy (or productive development policy in general),but so ar this process is only showing strength in Brazil.

The most interesting question or the uture re ers to what will drive the region’seconomic growth. A ter more than a quarter o a century promoting a strategybased on insertion in international trade and investment currents, the collapse o world trade has generated major questions, which will become increasingly evidenti international trade takes some time to recover, which is more than likely. I thishappens, countries or regions with important domestic markets will be better o ,as they were during the Great Depression in the 30s. Like then, this may be orcedby the acts rather than by ideas, which in general continue to be open.

There are obviously other alternatives. It appears that China will be a driving orcein Asia, something that the countries closer to the US and Europe, such as Latin

American countries, do not have. It will be important to do more business withChina, but it will depend on the ability to close the huge commercial divide with the

Asian giant and diversi y exports to that destination, as or Latin America they stilldepend on a series o basic products (soy, copper, oil and iron mineral).

The “domestic” market o Latin America is its regional market. This is particularlytrue or the smallest economies. Regional political di erences, as shown in the Andean Community crisis and weakness in other processes, have become amajor obstacle. But there are also economic actors at stake. As in the previouscrises, the reduction in intra-regional trade is enhancing the crisis, and exchangerate policy di erences continue to be an important drawback preventing urtherintegration (due to dollarization, the only adjustment option or Ecuador is tolimit trade, and this a ects its regional partners).

Nonetheless, some initiatives appear to be progressing, especially those relatedto energy integration. There are also intra-regional payment proposals, includingan initiative by Argentina and Brazil aimed at enabling payment in their own





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currencies (a mechanism which could spread to all ALADI Reciprocal Paymentand Credit Agreement members) and the ALBA Sucre arrangement. Butpolitical di erences are also in play here. For instance, the Sucre initiative couldbe adopted through ALADI (Latin American Integration Association), possiblywith the collaboration o the Latin American Reserve Fund (FLAR), but theagents involved appear to pre er ALBA or political reasons. The region has thebest regional nancial cooperation mechanisms in the developing world (ADC,CABEI, the Reserve Fund and the ALADI payment convention), which couldbe enormously strengthened by the crisis. In this respect, the most importantincomplete task is to trans orm the FLAR into a true Latin American ReserveFund, as its name implies.

Regional cooperation, there ore, needs an important political e ort to makeuse o the opportunities provided by this situation to oster regional integratione orts. But this necessarily requires the region’s countries to overcome theirpolitical di erences.

The relative absence o Latin America rom major debates concerning internationalnancial re orm is also signi cant, as is that o the rest o the developing

world in generation (with the possible exception o China). Regional memberso the G20 are in an excellent position to construct an agenda which, whilerepresenting a consensus among themselves, is capable o mobilising a trulyregional proposal.





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governments in the wake o the debt crisis o the 1980s, scal balance sheetsgenerally are in better shape now than in previous periods o economic decline.Infation remains relatively low, credit is available and counter-cyclical policies arecushioning the macroeconomic blow. Initial predictions o dire consequences

or the region have proven exaggerated. Remittances, or example, have notallen as dramatically as eared, loss o reserves has been minimal, and central

banks have been able to keep interest rates low, all in contrast with the worsescenarios o the past.

Unlike previous home-grown economic crises in the countries o the region,the global recession o 2008-09 was generated outside the region, principallyin the United States. The bonanza itsel had also been caused by external

actors. Growing nancing was coupled with rapid increase in consumption inthe United States. China’s rise as an economic powerhouse drove demand orLatin America’s natural resources to unprecedented and perhaps unsustainablelevels. Rapid world growth and booming nancial and commodity markets also

led to a mutual dependency between China and the United States in which allparties, including Latin America, bene ted be ore all were hurt by the collapseo the nancial system.

“The per ect marriage between China and the United states seemed marvelous but the oundations were unsustainable.”

Jorge Quiroga,Former President o Bolivia, Member o the Club o Madrid

On the positive side, the generally sa e macroeconomic approach o the regionmay have broken the myth o Latin America as a “box o bad surprises.” [Frei p. 19]In addition, the period o bonanza delivered bene ts to everyone – consumers,businesses and governments – through lower interest rates and longer termso borrowing. As opposed to past ‘boom and bust’ episodes in which publicinstitutions took too many risks, this time around it was the private sector thatpumped up the unsustainable debt balloon.

This latest experience with the downside o globalization has added urtherweight to the view that the dominant neoliberal model o the 1990s is not onlypolitically dead, but also economically spent. The gospel o broad marketderegulation and smaller government has proven to be a recipe or nancialdisaster as banks took on more and more risk without proper controls. The

now-de amed “Washington Consensus” created unrealistic expectationso linear growth; it also relied excessively on economic rather than politicalsolutions to society’s problems. Moreover, the abrupt reversal in the region’s

ortunes on the heels o a boom period has sharpened levels o societalrustration which could lead to tensions and confict. As a result o the crisis,

political and economic conditions are ripe or a paradigm shi t toward a betterbalance between a stronger state, an e cient but regulated market, and aneducated and active citizenry.

While it is di cult to generalize across such a diverse group o countries, thereare a number o lessons the region has learned rom previous downturns. Forexample, some countries prepared themselves better than others to cope with




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possible crises even though within countries some sectors are better positionedthan others to take advantage o the enhanced trade and technological innovationthat globalization o ers. Second, pro-cyclical policies, including an increase inprotectionist measures, have been shown to back re, while counter-cyclicalpolicies are proving to be a stabilizing actor. Third, social discontent is morelikely to emerge in economic crises, making the normal unctioning o democraticinstitutions more di cult and raising the importance o expanding social sa etynets.

While states can take steps to incorporate these lessons in their response tothe current economic crisis, developments at the global level are making it evenmore di cult to organize a coherent approach. For one thing, Latin America isless relevant on the international stage than it was 30-40 years ago. Comparedto other regions, per capita income has declined. The region’s share o exportsas a percentage o the global total has dropped rom 14 to 7%. Second, thetraditional, export – led development model, based on a supposedly comparative

advantage and high concentrations o commodity exports persists, particularlyin South America, making the region more vulnerable to external shocks. Otherregions with higher rates o productivity, savings and investment in educationand in rastructure are pulling ahead. In addition, the region remains plagued bythe highest levels o inequality and public insecurity in the world. To overcomethese disadvantages, Latin American economies need to transition over the longterm to more competitive, balanced models o quality economic growth basedon macroeconomic stability, microeconomic e ciency, equity and environmentalequilibrium.

In light o these circumstances, there is a clear need not only or stronger but ormore responsible states, ones which are scally sound capable o protectingtheir citizens, delivering social services, promoting social cohesion andprotecting the environment while empowering entrepreneurs, and regulatingthe market while giving private initiative the needed space. Such responsiblestates are also needed to respond to the impending crisis o climate change, thegrowing challenges o migration and the persistent menace o drug tra ckingand organized crime.

“There are no rescue packages i we climb above two degrees Celsius o global warming (…) There is no step back.”

Ricardo Lagos,Former President o Chile, President o the Club o Madrid

Un ortunately, governments in the region have grown weaker and more ragilewith a wholly inadequate tax structure to support the aspirations o citizens ora strong state that can deliver public goods within a ramework o democraticstability.

“We want to have states like Denmark without paying high taxes”

José Miguel Insulza,Secretary General o the Organization o American States





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To make matters worse, the growing competition or scarce nancial resourceson the global stage will make it more di cult or Latin American countries toborrow on pre erential terms. For example, i the United States’ scal de citcontinues to grow, it will increasingly compete with Latin America or external

nancing. In the ace o such competition, those states with the best policiesand recognized respect or rule o law are more likely to succeed, making itvirtually impossible or today’s Latin America to secure the resources needed toreach adequate levels o growth.

Given such limited resources, states and society must make some undamentaldecisions: to what extent should we raise taxes and redistribute income ratherthan borrow rom the uture to accelerate development in the present? To whatextent can corporations sel -regulate their behavior by, or example, acting in amore socially responsible manner towards and with the communities in whichthey operate? Must the state intervene more directly in commercial a airs, eveni it means slower economic growth?

Latin America could learn rom Asia in this regard. Asian states, including China,have pursued smart policies o political economy eaturing higher rates o savings and investments in education and public goods. Latin America mustdo the same, increasing its levels o public and private investments and savingsand improving the quality o education i it is to grow economically.

“Everyone says that we have better education but i you check Latin America’s per ormance in international rankings o education we can see this is just not so”“UNASUR not only excludes Mexico, it weakens the OAS”

César Gaviria,Former President o Colombia, Member o the Club o Madrid

The impact o a major decline in oreign trade raises some particularly challengingquestions or Latin America’s export-led development model. Will the regionturn again to a more internally driven market model, not merely at the nationallevel but the regional level as well? The current blow to global trade should, intheory, be the moment or accelerating regional integration. Instead, regionalintegration is in crisis, in large measure because o internal political divisions inthe region. Tensions, or example, have grown between Colombia and Ecuador,Peru and Bolivia, Venezuela and Colombia, Peru and Chile, Uruguay and

Argentina, and so on. Brazil’s initiative to create the Union o South AmericanStates (UNASUR), which excludes Mexico, and the potential inclusion o Venezuela instead o Mexico in Mercosur, are sowing discord as well. The greatdiversity o the region – with populations ranging in size rom 300 million to only50,000 and wide disparities in wealth, resources and power – makes it evenmore di cult to achieve consensus on common interests.

The diversity o the region is also seen in the way di erent states are handling theeconomic crisis. Some have built strong scal positions, with low public sectordebts that provide some room or counter-cyclical policies, Others, however,spent heavily during the boom years and have little room or maneuver. Still othersremain heavily dependent on the U.S. economy, and have been hit hard by the




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crisis in the world’s major economy crisis. Some others have been diversi yinginto Asia and, particularly, China, and have been able to expand exports intothose markets. Despite these variations, a general consensus seems to existaround such themes as open economies, sustainable scal policies, controlo infation, and anti-poverty programs. This may be insu cient, however, toregain the momentum o the 1990s toward regional integration.

“Today we are urther apart than ever with no coordination in economic in rastructure or energy matters”

Eduardo Frei Ruiz TagleFormer President o Chile, Member o the Club o Madrid

Mexico in particular aces a number o daunting challenges. With the arrival o democracy in the 1990s, Mexico was able to reduce its external debt, doubleits reserves, cut infation and interest rates and reduce poverty. However, itsheavy dependence on the U.S. economy (90 percent o its trade is with theU.S.), particularly in the energy and auto sectors, disproportionately a ected thecountry when the U.S. economy hit bottom in 2009. The North American Free

Trade Agreement (NAFTA) is dormant. A politically contentious and immaturedebate on scal policy (Mexico’s scal income is one o the lowest per capita inthe region) prevented any signi cant re orm during the period o bonanza eventhough the government is dangerously dependent on oil as its main source o income. A confuence o negative orces – the economic crisis, the H1N1 virus,a surge in drug-related crime and violence – has exacerbated these structuralproblems. The way out demands strong democratic leadership, with thecourage and wisdom to ocus not just on economic e ciency but on humandevelopment and gender equity i it is to escape its current path o turmoil.

“Democracy has brought us a period o growth but it must be nourished and protected because surprises are always around the corner”

Vicente Fox,Former President o Mexico, Member o the Club o Madrid

Impact o Economic Crisis on Democratic Development

While Latin America’s economies are, in general, better prepared to cope withthe economic crisis than in the 1980s, the average citizen is not. The newmiddle class is highly vulnerable with ew guarantees o social security. Becausethe bonanza period was short-lived, savings rates and home ownership remainlow. Chances o a quick recovery that will directly bene t vulnerable householdsare also low. Based on the experience o prior periods o contraction, it can taketwice as long to recover levels o social progress as it does to recover economicgrowth. Similarly, productivity recovers more quickly a ter a crisis than doesemployment. On the bright side, however, some states have made importantprogress in establishing large social sa ety net programs (e.g., Bolsa Familiain Brazil, Oportunidades in Mexico). Nonetheless, the bene ciaries o public





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policies in Latin America remain segmented – education and health servicesare not the same or all, impeding social mobility. And tax policies, compared toother regions o the world, ail to redistribute income and wealth.

In the meantime, political polarization and social tensions are likely to grow,endangering the region’s advances in democratic and scal stability.

“The economic growth needed to reduce poverty will not happen in the next 4-5 years and social problems will be aggravated as a result”

Rebeca Grynspan,Regional Director or Latin America and the Caribbean,

United Nations Development Programme

The timing o the economic downturn is particularly sensitive given the impendingheavy schedule o elections throughout the region, contests that will present voterswith a choice between democratic re ormism and autocratic populism. Now that itis no longer as easy or autocrats to write checks, as they did in the not so distantpast, tendencies toward “Cesarismo” – the substitution o republican institutions withmonocratic leaders – are more pronounced and more dangerous. This phenomenonis distinctly Latin American – the classic concept o representation is substituted bya president above the constitution and the law; the parliament is replaced by directdialogue between the president and the masses; and the tools o the state are usedto serve the president, without intermediaries.

“Our Latin America still has ormidable defcits o democratic culture”

Julio María SanguinettiFormer President o Uruguay,


There is a power ul demand or internal consensus on key societal issues beyondwhat can be achieved through elections. Building such consensus, however, isproving di cult in the ace o weak and immature democratic institutions and faws inthe implementation o the rule o law. There are some notable examples o persistentstate weakness due to politicization and corruption. Argentina’s troubling experienceo manipulating o cial economic statistics and its impact on bond holders is a recent

case in point. The tendency to maneuver constitutions and elections to stay in power,promoted both by sitting presidents, political parties and special interest groups thatbene t rom privileged access to power, is particularly worrisome.

“It is vile towards democracy or a constitution to be modifed in beneft o a sitting president”

Julio María SanguinettiFormer President o Uruguay,





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This risks undermining the public’s aith in the constitution as the highest lawo the land. Meanwhile, just as parliaments held sway in the 19 th century, andthe executive in the 20 th century, judicial authorities are emerging as decisivepolitical actors. The consequence o turning to the courts to resolve politicalproblems – the ‘judicialization’ o politics – is the inevitable politicization o the

judiciary. Without su cient legal guarantees and a truly independent judiciary, itwill remain di cult to attract investors.

Another critical actor to explain Latin America’s weak democratic institutions isits de cit o citizenship, i.e., the overreliance on leaders to resolve our problemscombined with low levels o civic education and critical thinking.

The critical question, then, is what kind o state is necessary to ensure appropriateinterventions in the economy, promote social wel are and protect democracy andthe rule o law? What kind o leaders will emerge to guide the state through theseturbulent waters? Which institutions are capable o mediating the growing conficts

o ideology, redistribution o resources and demands or greater public participation? To move in a new direction, leaders need to marry the political with the social,meaning they must harness political change to legitimate social demands.

A new, much more ambitious political agenda needs to respond to the bigchallenges – corruption, violence, child labor, extreme poverty – and givethem the importance they deserve. Instead, the region is sliding back toward“caudillismo” as an escape rom weak democratic institutions and leaders. Astrong leader is particularly appealing to the poor and vulnerable, acing theabyss o chaos everyday and needing some order and stability in their lives.

“State resources beneft the politically power ul and do not help the poor.”

César GaviriaFormer President of Colombia, Member of the Club of Madrid

Tackling the very high levels o insecurity and drug tra cking prevalent in theregion – the highest in the world – must be a top priority or democratic states.

The potential collaboration among Mexican cartels, Colombian narco-guerrillas,Central American gangs and Andean cocaleros could overwhelm weak statesand pose a grave risk to our democracies. A proper and more e cient use o resources can help achieve this, as shown by the progress made in Colombiathrough improvements in the public security orces and judicial system. Mexico

can and will likewise get the drugs and crime situation under control. But noamount o e ort by Latin American states will solve these twin scourges aslong as the United States continues to criminalize drug consumption, whichhas utterly ailed to slow down demand or Latin America’s illicit drug products.

Treating addiction as a public health problem and reducing the harm associatedwith drug consumption is proving to be a better approach, as demonstratedin Europe. Legalization o small quantities should also be considered. Latin

America should move in these directions given the strong evidence againstthe e ectiveness o punitive approaches. Throwing young people in jail orconsuming small quantities o drugs will condemn them to delinquency as adults.Local demand and supply markets must be controlled through prevention andeducation through public-private partnerships.





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The political crisis in Honduras has orced the region’s governments to acesome tough questions regarding the quality o democracy in some statesas well as the capacity o the inter-American institutional architecture torespond to democratic backsliding. In the Honduran case, the politicalelite elt so threatened by the risk o a Chavez-style constitutional re ormprocess that it violated the very constitution it aimed to protect by ejectingthe democratically elected president rom the country. On the other hand, itappears certain that President Zelaya also made many mistakes, includinghis attempt to order the military to carry out the popular re erendum despite a

judicial order against it. The role o the military in acilitating the coup remindsus o the autocratic tendencies still present in Latin America, even thoughtrends o democratization – ree and air elections, continuity and alternationo elected governments, independent media and active civil society – appearpredominant. Nonetheless, the Organization o American States (OAS),despite its Inter-American Democratic Charter, appeared unable to deter ormediate the confict, leading several experts to call or its strengthening as a

diplomatic tool or de using confict. While the Honduran crisis showed thestrong regional consensus against coups deposing presidents, other brancheso the state (judiciary, legislature) cannot call upon the OAS to intervene whentheir powers are usurped. It also has no clear guidelines regarding attempts tochange the democratic rules o the game in mid-stream, a phenomenon whichmany elt was a threat to democratic stability in the region. Re-opening theDemocratic Charter under the current ractured relations in the hemisphere,however, could be more trouble than its worth and would likely ail.

Latin America’s Role in Re orming Global Governance

The global economic crisis has catalyzed the growing debate surrounding the qualityand airness o the current architecture o global governance and o the institutionscreated over the last sixty years to manage insecurity and deter conficts. Latin

America’s past experience with such institutions, both at the regional and globallevels, has in ormed this debate and moved it toward avouring proposals to di usepower and increase resources.

The initial e ort by central banks to coordinate responses to the crisis waslargely productive. The Group o 20’s decision to increase resources to theInternational Monetary Fund so that developing countries could sustain counter-cyclical policies was particularly important. The May 2009 announcement bythe World Bank, the IDB and the CAF to co- nance $100 billion dollars orthis purpose over two years is a concrete example o positive collaboration in

support o the countries o the region in the ace o the crisis. On the other hand,the capital replenishment o the Inter-American Development Bank is urgentand must be quickly resolved. The critical task o re orming bank regulationsin a way that does not create distortions between the United States and othercountries also remains incomplete. Also pending is the job o re orming theinternational monetary system, including the question o whether the U.S. dollarshould retain its role as the reserve currency, a system some elt was unstableand un air. International policies concerning debt relie and regulation o capitalfows – actors that played a major role in generating previous crises – shouldalso be added to the un nished agenda.




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“I the United States did not own the dollar, it would have to be in the ParisClub”

Jorge Quiroga,Former President o Bolivia,


Better control o credit risk agencies should also be considered, as well ascompleting the Doha Round o the trade negotiations and approval o ree tradeagreements, starting with Washington’s long-awaited assent to the accordswith Colombia and Panama.

“How do we eliminate a certain ideological dogmatism and strengthen realistic pragmatism in solving the region’s problems?”

Enrique García,President, Andean Corporation or Development

One important political issue that continues to challenge the internationalcommunity with increasing intensity is, simply put, how to organize itsel in the21 st century era o globalization.

“A new geometry is being constructed in which the uture is not just shared but negotiated and we (Latin America) have to be at that negotiating table”

Alicia Bárcena,Executive Secretary, Economic Commission

or Latin America and the Caribbean

The ad hoc institutionalization currently underway, in which the G-8 has expandedto include a more diverse set o large economies (including Mexico, Argentinaand Brazil) under the banner o the G-20, is a positive development but some

elt a more undamental restructuring is desirable. This would include placing are ormed IMF, with a more balanced share o votes among its members, at thecenter o macro-economic policy coordination. Ideally, the international nancialinstitutions should play a catalytic role in mitigating risks, a more creative role

in adapting to diverse national circumstances and a conservative role in howthey manage resources. The role o the UN on international economic mattersshould also be on the agenda.

Latin America’s leaders, especially those o the three countries that are parto the G-20, have a special role to play in insisting that such issues get on theinternational agenda.





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“Mexico, Brazil and Argentina have a responsibility to play a key leadership role in advancing Latin America’s perspectives at the G-20.”

Ricardo Lagos,Former President o Chile,

President o the Club o Madrid

In this regard, the recent encyclical o Pope Benedict XVI reminds us o thehistoric opportunity our political leaders have today to re-order the internationalagenda toward the common good and toward the ull realization o humandevelopment or all the world’s citizens, especially the poor.

At the regional level, however, Latin America’s institutional architecture in thenancial arena is in good shape. It has one o the most comprehensive set

o nancial institutions, including the Inter-American Development Bank, the

Corporación Andina de Fomento (CAF), the Central American Bank for EconomicIntegration (CEBEI), the Latin American Reserve Fund (FLAR), and the Treaty orPayments and Reciprocal Credits o the Latin American Integration Association(ALADI). Countries o the region should steer all e orts to build upon andstrengthen these institutions to adapt to and acilitate greater regional integration,but should not create new ones.

“We should strengthen the existing regional fnancial architecture instead o creating parallel institutions”

José Antonio Ocampo, Academic Coordinator, Club o Madrid Program

on the Political Dimensions o the World Economic Crisis.Pro essor o Pro essional Practice in International and Public A airs and

Director o the Program in Economic and Political Developmentat the School o International and Public A airs, Columbia University.




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Final Declaration

We, Members o Club o Madrid, met at the Economic Commission or Latin America and the Caribbean (ECLAC) in Santiago de Chile to discuss the politicaldimensions o the world economic crisis rom a Latin American perspective,agreed on the ollowing issues:

The international crisis has strongly a ected Latin America. We are particularly1.concerned with the social and the likely political consequences arising romthis crisis.

The crisis threatens to severely undermine six consecutive years o growth,2.improvements in human development and political stability, which manycountries in the region have attained with great sacri ce. The resulting losso con dence in the governments’ capacity to regain economic growth withequity could result in more polarized electoral processes which could in turn

weaken democracy and contribute to the re-emergence o authoritariantendencies. The crisis brings new political challenges to democratic leadership in the3.region. I adequate measures are not adopted, it could endanger thepolitical and social progress achieved during the last decades, generatingconditions conducive to violent social outbreaks and the exacerbation o the injustice which millions o people in the region still ace.Overcoming the crisis will be more di cult as result o the growth and4.intensi cation o drug consumption and drug tra cking and organized crimein the region. These phenomena respect no rontiers and challenge boththe quality o democracy and the rule o law, as well as intergovernmentalcooperation in security matters.

The origins o the crisis have made mani est the dangers o market5.undamentalism. We underscore the need or a strong and active State,scally responsible, capable o protecting its citizens and o promoting

prosperous economies and public policies that guarantee social cohesion. The region needs more active and higher quality States without ignoring thevalue o the market.

The adoption o anti-cyclical macroeconomic policies is crucial. We6.celebrate the reduction o interest rates by the central banks o the region,the scal packages adopted by the governments, and the renewed ocuson intra-regional trade.Latin America has the best network o regional nancial institutions – IADB,7.

ADC, CABEI, LARF and the Agreement on Payments and Reciprocal Creditso LAIA23 . We draw attention to initiatives aimed at a better use and urther

deepening o these mechanisms to improve intra-regional payments, whichexclude the need to create parallel institutions or this purpose.We emphasize the need to improve international support or anti-cyclical8.policies and to reactivate credit to developing countries. In this regard, thee ective use o multilateral development banks and their replenishment, i needed, as well as the simpli cation and modernization o conditionalitiesassociated with multilateral lending will be essential. We welcome the

23 IADB: Inter-American Development Bank; ADC: Andean Development Corporation; CABEI: Central American Bank or Economic Integration; LARF: Latin American Reserve Fund; LAIA: Latin AmericanIntegration Association





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increase in IMF resources, including the creation o a New Flexible Credit,the renewed and increased allocation o Special Drawing Rights and there orm o other IMF programs.We call or the improved voice and participation o developing countries in9.multilateral nancial institutions.We highlight measures aimed at combating the e ects o the crisis on10.the poor and most vulnerable. Experience indicates that recovering socialindicators is twice as costly as regaining economic per ormance. It isthere ore necessary to develop more ambitious social protection systems,based on the principles o universality and solidarity, including measures tomaintain and create new jobs.

The contraction o international trade has resulted in a 26% decrease in11.Latin American exports during the rst quarter o 2009. We condemn thereappearance o protectionism in its various orms. We urge the rapid andequitable conclusion o the Doha Round and call attention to the need todeepen our own processes o regional trade and economic integration,

overcoming the political tensions that have weakened them in recent yearsand taking into account that in crisis only multilateral responses can bee cient.

The presence o three Latin American countries in the G20 provides us with a12.unique opportunity to infuence the design o the new institutional architecturewhich surely must result rom the crisis. Convergence o views will beimperative and, in that sense, we highlight the need to present a coordinatedregional agenda be ore the G20 meeting in Pittsburgh in September. Thisconsensus must include issues repeatedly raised by developing countries,such as: the re orming the reserve system; correcting global paymentsimbalances; regulating capital fows; creating an adequate institutionalmechanism to resolve the problems o excessive over-indebtedness; anda greater representation o developing countries in international nancialinstitutions.




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Abstract

The nancial crisis that was originated in the United States in the middle o 2007has since September 2008 become a global systemic economic crisis. Thecurrent strong worldwide recession now threatens to become a pro ound socialcrisis with repercussions or all States. This crisis is however a ecting countriesand regions di erently, depending on their level o development and degreeo insertion in the world economy. Since there is a strong interdependencebetween the industrialized economies – where the crisis started – and theemergent and developing economies – which Latin America is part o – there isno doubt the crisis will have a deep impact in this latter region.

The socio-economic and political changes resulting rom this crisis may bevery pro ound. A ter six years o economic prosperity, with an average regionalgrowth o 5.6% – grounded in the nancial peak, a dramatic increase in

commodity prices and high levels o remittances sent by workers – the regionis now witnessing a major break in its expanding cycle.

The crisis threatens to severely undermine these years o growth, stability andimprovements in human development, which many countries in the regionhave experienced in the last ew years. The subsequent lost in con dence ingovernments being able to restore the socio-economic stability will urther berefected in a new electoral cycle in which one will have to choose betweendemocratic re ormism and autocratic populism.

As a result o this crisis, new political challenges, particularly or democraticleadership in the region, will arise. I one does not adopt the adequate measuresto con ront them soon enough, the crisis may put at serious risk the democraticadvancements booked in the last decades, as well as oment conditions o social outbreak with possible violence, and ultimately worsen the conditions o injustice in which millions o people are living in that part o the world.

In this context, the various governments o Latin America and the Caribbean,together with the relevant international organizations, must adopt the necessarymeasures to address the economic crisis, as well as the other critical issuesa ecting the region, such as poverty, global warming, the realization o humanrights and peace-building, whose management will be crucial in strengtheningdemocratic values, good governance and human development.

In addition to an e ort to design and adopt a new international and regional

nancial architecture which would help us conceive a more democratic andtransparent world order capable o responding to the political challenges o the21 st century, one will also need to set o refexion and decision-making processesthat will speci cally tackle the challenges democratic leadership is acing. Inthis context, various members o the Club o Madrid, together with prominentexperts and senior policy-makers will be gathering at this roundtable to discussthe political dimensions o this crisis rom a Latin American perspective, and to

ormulate recommendations that will help address the political issues resultingrom the crisis.

The results that will come out o both this roundtable and the other onesorganized in A rica, Asia and the Middle East will ultimately constitute the





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building blocks o the Club o Madrid Annual Con erence (12-13 November2009, Madrid) in which participants will then be designing a global politicalperspective on the current economic crisis.




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Programme

Monday, 13th July

09:30 – 18:00 Roundtable : “ The Political Dimensions o the World Economic Crisis: a Latin-American Perspective”

Moderator : Héctor Aguilar Camín , historian andpolitical analyst, MexicoRapporteurs: Ted Piccone , Advisor o the Club o Madridand Senior Fellow and Deputy Director or Foreign Policy,Brookings Institution; and Ernesto Ottone , Advisor o the Club o Madrid and Pro essor o Globalization andDemocracy, University Diego Portales.

09:30 Welcoming words (Room: Raúl Prebisch)

Ricardo Lagos, President o the Club o Madrid.Former President o Chile. Alicia Bárcena, Executive Secretary o the Economic

Commission or Latin America (ECLAC)José Antonio Ocampo , Pro essor and co-Chair o theInitiative or the Political Dialogue at Columbia University.Member o the UN General Assembly Commission o Experts on International Monetary and Financial Re orm.

Block 1: The e ects o the crisis in theregion: an inside perspectiveSpeakers: José Miguel Insulza, Secretary General o theOrganization o American States, OASJorge Quiroga, Former President o Bolivia. Membero the Club o MadridEduardo Frei Ruiz-Tagle, Senator o the Republic o Chile and Former President o Chile

12:00 Block 2: Latin America in a World in Crisis Speakers:Enrique García, President o the AndeanDevelopment Corporation (CAF)César Gaviria , Former President o Colombia.Member o the Club o Madrid

15:00 Block 3: Latin America - Crisis, Politicsand LeadershipSpeakers:Julio María Sanguinetti, Former President o Uruguay. Member o the Club o MadridPatricio Aylwin, Former President o Chile. Member o the Club o Madrid

Vicente Fox, Former President o Mexico. Member o the Club o Madrid

16:30 – 18:00 Conclusions





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PARTICIPANTS LIST

Members of the Club of Madrid

Patricio Aylwin Former President o Chile Vicente Fox Former President o MexicoEduardo Frei Ruiz-Tagle Former President o ChileCésar Gaviria Former President o ColombiaLionel Jospin Former Prime Minister o FranceRicardo Lagos Former President o Chile. President, Club

o MadridJorge Quiroga Former President o BoliviaJulio María Sanguinetti Former President o Uruguay

Advisors to the Club of Madrid

Rut Diamint Pro essor o Political Sciences, University Torcuato Di Tella

Ernesto Ottone Director o the Globalization and DemocracyProgramme o the Diego Portales University,Chile

Ted Piccone Senior Fellow and Deputy Director, Programmeo Foreign Policy, Brookings Institution

Experts and Invitees

María Elena Agüero Director o Institutional Relations and SpecialProjects, Club o Madrid

Héctor Aguilar Camín Political Analyst Alicia Bárcena Executive Secretary, ECLACEdgardo Boeninger Former Minister o State o ChileFernando Calderón Sociologist and Permanent Advisor, UNDPGeorges Cou gnal Director, Institute o Latin American High

StudiesEnrique García President, Andean Development CorporationRebeca Grynspan Regional Director o the UN Development

Programme’s Latin American and Caribbean

BureauJosé Miguel Insulza Secretary General, Organization o AmericanStates

José Antonio Ocampo Academic Coordinator o Club o MadridProgram on the International FinancialCrisis. Pro essor o Pro essional Practice inInternational and Public A airs and Directoro the Program in Economic and PoliticalDevelopment at the School o International andPublic A airs, Columbia University

Francisco Rojas Aravena Secretary General, Latin American Faculty o Social Sciences




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Final Report o the Arab World Roundtable

‘Impact o the Global Economic Crisis

in Arab Countries: A First Assessment’ i

Olivia Orozco, Socioeconomic and BusinessProgramme Coordinator at Casa Árabe

Javier Lesaca, Researcher of the SocioeconomicObservatory at Casa Árabe

INTRODUCTION

As in other parts o the planet, the Arab world is being a ected by the global

economic crisis. However, the e ects and the degree o its impact are beingdiverse depending on each country and sector.

The Arab world is not a homogenous reality; on the contrary, the economic,political, geographic, social, demographic and cultural eatures o each countrymake it a highly diverse, heterogeneous and complex region. The multi- acetednature o the way in which the crisis is a ecting the region puts into evidencethis complexity.

The initial impact o the international crash o the stock markets, which beganin September 2008, was partly elt in certain Arab countries, and to di erentdegrees depending on their openness and involvement in international nancialmarkets. However, the all in global demand which consolidated in 2009 ishaving important repercussions in certain countries and sectors. Not onlyhas this downturn been transmitted through the collapse o international

nance, with its constraints in investments and credit, but also through thedrop in the price o hydrocarbons and the reduction o exchanges at a globallevel, especially concerning exports, tourism and remittances. The InternationalMonetary Fund (IMF), in its latest report o October 2009, indicated that threemain channels by which the crisis was transmitted to the region were “thereduction o remittances, oreign investment and exports” 24 .

The region is being a ected by the crisis on di erent ronts, to di erent extentsand in di erent ways, revealing important structural and developmentalproblems yet to be resolved. The main problem is still the extreme dependence

on hydrocarbon exports and fuctuations in international markets, as a result o the still scarce industrialization and economic diversi cation in the majority o these countries. The undamental challenges posed in this sense are, on theone hand, the creation o a competitive productive system and, on the other,the re orm and improvement o the education system that would allow thesesocieties to join the new global knowledge and would create employment ortheir large youth population.

i Final Document presented to the Club o Madrid Annual Con erence, November 12, 13, 200924. Regional Economic Outlook: Middle East and Central Asia . IMF. October 2009. Page 1





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The region in a relatively positive position

Following six years o unprecedented economic growth, coined ‘the third oilboom’ 25 , the region has collectively tackled the current downturn rom a relativelyadvantageous position in terms o accumulated assets and resources. Despiteconsecutive reductions in the area’s growth orecasts, the growth indicatorscontinue to be higher than most regions on the planet. According to estimations

rom the Economist Intelligence Unit, in 2010 economies in Arab countries willbe growing at 4%, almost double the world average 26 . These coincide withthose presented by the IMF in their latest report on the region at the beginningo October 2009 27 .

Diverse e ects in di erent countries

The starting points o Arab countries are very diverse. For some the all o

hydrocarbon and ood prices has meant a certain level o respite – to a certainextent moderating the so-called “Crisis o the three Fs”, Food, Fuel & Finance ,which experienced its most critical period in the middle o 2008 – or othersit means a drastic reduction in estimated revenue. Furthermore, the globaleconomic downturn has surprised those in the middle o running ambitiouseconomic investment and diversi cation plans conceived during the boom.Other countries, however, are acing the crisis ollowing a prolonged periodo re orm and structural adjustment, as well as economic and commercialliberalization, during which signi cant reductions in social protection and limitsto the State intervention in the economy had to be carried out.

The impact and consequences o the crisis in each o these countries willdepend on both the social and economic structures and the speci c strategiesand development plans implemented during the previous period o economicgrowth.

Greater exposure to nancial markets in the U.S. and United Kingdom as wellas higher levels o speculative real estate investment have produced largebudgetary cutbacks in Gul countries. The drop in oil prices has seriouslya ected exporting countries such as Algeria, Saudi Arabia and Yemen, andthe reduction o workers’ remittances abroad, exports and tourism has putcountries like Egypt, Morocco and Jordan in a di cult social and nancialposition, due to signi cantly increasing unemployment levels, particularlyamong young people, and reducing vital sources o revenue or households.In contrast, in countries like Qatar, the number one global exporter o lique ed

natural gas, the e ects o the crisis have gone undetected. In others, suchas Emirates, which habitually has an annual GDP growth o close to 15%,the economy has come to a standstill, even registering negative growth.

The scarce demographic pressure and liquidity accumulated over the boomyears has meant that the downturn has not signi cantly lowered citizens’standard o living, although this is not the case in immigrant populations rom

25. Ali AlKuwari, (2009) “The third oil boom. Preliminary reading o its causes and magnitude: the setting o the Gul Cooperation Council (GCC)”, Contemporary Arab A airs, 2:2, 304 – 318.26. Economist Intelligence Unit. Middle East and North A rica. Regional overview. September 200927. IMF. Regional Economic Outlook: Middle East and Central Asia. October 2009. Page 1.




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neighbouring countries, particularly Asian. Nevertheless, other oil-exportingcountries with higher populations, scarce levels o economic industrializationand diversi cation and less oreign investment ace a series o challengesworsened by the crisis. These include growth in unemployment and povertyrates and discrimination o certain sections o the population, all o which canbecome sources o social instability.

The cut o revenues, either due to the all in oil incomes or rom lower exports,remittances or tourism revenues, will bring about important limits to currentdevelopment processes as well as substantial social and political challengesand uncertainties. There ore, the crisis is testing out the development policies andstrategies, introduced by the States, and their stability and strength, both on anational and regional level.

The aim o this document is to provide a tool with objective data and in ormationthat helps to understand the multiple characteristics and perspectives by which

the international crisis mani ests itsel in the Arab world. It is a starting pointor carrying out a more in-depth analysis o its repercussions on the region.Likewise, it shows the main ideas and dimensions o the social and politicalchallenges that this crisis poses to the Arab countries, as it was discussedby the experts and Club o Madrid’ Members, during the roundtable “ ThePolitical Dimensions o the World Economic Crisis: an Arab World Perspective ”organized by Casa Árabe and the Club o Madrid on October 28 th , 2009 inMadrid.

I. The Impact o the fnancial crisis and the convergenceo diverse crises in Arab countries

The early years o the 21 st century witnessed a third oil ‘boom’, between 2002and 2008, and were specially positive or the income o the or Arab oil-exportingcountries, particularly, or those in the Gul . Oil and gas prices reached historic

gures and their liquidity and reserves practically increased exponentially duringthose years. The economies o these countries grew at rates o consistentlyover 6%, in real terms, and were even close to 10% in some Gul countries; asa result, the per capita income practically doubled.

As in other similar time periods, joint economic expansion spread to othercountries in the region. The rise in liquidity allowed exporting countries to tacklediverse industrialization, diversi cation and in rastructure projects, generating

a signi cant demand or employment and an increase in economic activity,which bene ted neighboring countries. Consequently, non-oil exporting Arabcountries also experienced strong growth in their GDP and per capita incomes,as recognized in the latest Arab Human Development Report 2009 28 .

28. “Producer countries gained most in that narrative, amassing untold wealth, but non-oil Arab countriesalso bene ted substantially rom oil-related services, worker remittances, intraregional investment fows,regional tourism receipts, and aid.” UNDP, Arab Human Development Report 2009: Challenges to economic

security. Page 109.





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I.1. The frst impact o the fnancial crisis: sovereign wealthunds, stock markets and banking systems

The rst symptoms o a nancial crisis appeared in the United States during thelast quarter o 2007 with the outbreak o the subprime mortgage crisis, whichquickly spread across the European nancial system, primarily in Britain. At

rst it did not appear to be a cause or alarm in the Arab world; both the WorldBank and the IMF emphasized that Arab nancial systems had “little exposure”to global nance and, consequently, to those toxic assets which triggered thecredit and banking crisis in the United States.

Nonetheless, a number o sovereign wealth unds rom Gul countries, which hadstored a large part o the liquidity accumulated in these countries during the boomyears, came to the rescue, along with other Asian unds, to recapitalize some o the U.S. banks and nancial institutions a ected by the subprime mortgage crisis.It is calculated that between 2007 and 2008 sovereign wealth unds invested

over 100 billion dollars in the United States and Europe. The Kuwait Investment Authority (KIA) and the Abu Dhabi Investment Authority, with the Singapore GICand the Saudi prince al-Waleed Bin Talal, put up 14.5 billion dollars to rescueCitigroup, while Kuwait also supplied unds to save Merrill Lynch. In Februaryand June, Qatar also invested in Barclays and Credit Suisse, who then declaredthemselves bankrupt in September 2008, inficting signi cant losses on thesovereign unds that had intended to secure them a ew months earlier.

At rst, the exposure to markets and risk assets were di cult to gauge dueto the opacity o the unds. The British newspaper The Observer estimated thatthe sovereign wealth unds in the Gul and Asia would register losses o least4 billion dollars by the end o 2008. 29 According to the latest data released bythe Economist Intelligence Unit (EIU), some unds such as those rom Abu Dabiended up losing around 27% o the invested capital.

Changes in the unds’ investment strategies

The crash su ered by a large part o these unds during the nancial crisis hascaused investment strategies to be rede ned. On the one hand, some unds areopting or more conservative strategies, such as SAMA, the Saudi SovereignWealth Fund Institute, whereas on the other, they are changing the nature anddestination o their investments. Those traditionally ocused on nancial marketsin Europe and the U.S. are turning their attentions towards other markets – in

Arab countries and emerging ones, as well as towards direct investments. Oneexample o this strategy change, announced on January 10 th 2009 by the Abu

Dhabi Investment Company, was to create our investment unds in the MiddleEast and North A rica. More precisely, the Emirate investment unds proposedthe creation o stock unds in the Gul Cooperation Council, an investment undin the United Arab Emirates, a third or the whole o the area covering the MiddleEast and North A rica, and a ourth in developing North A rican countries. ThePresident o the company’s Board o Directors indicated that it is “the idealmoment” or the Middle East and North o A rica to become the destination orthe investment o these unds. 30

29. Olivia Orozco, Casa Árabe Economic and Business Bulletin “Crisis and sovereignty”, Nº9, Dec 08–Jan 0930. Casa Árabe Economic and Business Bulletin.Nº13. August 2009, Page 11.




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This consolidated a trend which started in the last years o economic expansion,when the sovereign wealth unds started to play a more important role inintraregional development unds.

Repercussions or stock markets and the Arab fnancial system

The huge losses recorded by both sovereign wealth unds and private Arabcapital in nancial markets in the United Kingdom and the United States meantthat the stock market crash in September 2008 a ected the majority o theMiddle Eastern stock markets. A ter the insolvency o Lehman Brothers wasannounced, on September 15 th 2008, the Saudi Arabian stock market ell by6.5%, Doha 7%, Kuwait 3% and Abu Dabi 4.35% 31 . Certain markets, such asKuwait, had to close or a number o days to avoid outbreaks o panic.

Over the last year, alls in these Gul stock markets have ollowed a parallel

path to those in Europe and North America and are strongly linked. From May2008 to January 2009 practically all the Arab market values noted how indicesslumped by 50%.

In contrast, some Arab stock markets were relatively una ected by thesefuctuations, as those in Morocco, Lebanon and Jordan, with accumulated

alls rom January 2008 to March 2009 o between 13 and 28%, respectively. The behaviour o Tunisia’s stock market was particularly noteworthy, with anaccumulated growth in this period o 18% 32 .

The spread o the crisis to the banking system and credit availability

The impact o these losses, the all in investments and the ensuing lack o liquidity all had important consequences or the Gul banks. In the Emirates,as in other countries, the central banks had to intervene to guarantee creditand deposits. As a result, rom September 2008 to February 2009 cases o payment de aults multiplied; in particular, they tripled in Bahrain and doubled in

Adu Dabi, according to IMF data.

As in Europe and the U.S., various actors coincided at the same time in thebanking crisis – on the one hand, large excesses in credit concessions over aperiod o economic expansion, particularly in the real estate industry, togetherwith, on the other, the investments’ strong pre erence or secondary markets.

As the IMF remarked, when the value o these assets and company pro tsplummeted both the general nancial risk and the payment de aults increased,

weakening the banks’ balance sheet33

.

I.2. The end o the third oil boom: the all in oil prices

Oil prices started to all in the summer o 2008. However, rom September to Decemberthat year the price dropped rom 100 to 40 dollars per barrel, recovering slightly a terFebruary 2009, but ollowing a much more moderate trend rom then on.

31. Ibid., Page 11.32. IMF. Regional Economic Outlook. Middle East and Central Asia. May 2009. Page 14.33. Ibid. Page 6.





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Arab countries make up 65% o the world’s oil reserves and 45% o the gasreserves. The export o these products generates 50% o the GDP and 80% o its revenues 34 . There ore, the all in oil prices has particularly a ected exportingcountries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates(UAE), Algeria, Iraq, Libya, Sudan and Yemen – and has halted the high growthtaxes maintained in previous years.

As a result o the decline, both in exports and the price o oil, the Central Banko Yemen announced its revenues rom oil exports dropped around 75% lastJune. Likewise, the magazine 24-7 noted in July that the combination o lowprices and the decline in production could mean a revenue drop o oil exportsin the UAE o around 43% in 2009 35 .

I.3. The all o investments and the bursting o the real estate bubble

Another issue emanating rom the international crisis and a ecting Arabcountries is the all o direct oreign investment.

The crisis aced by European and American companies has slowed down recentinvestments being carried out in Arab countries. According to the World Bank,in its report o October 2009, the global fow o direct oreign investment inMENA countries could “drop notably in 2009”. The report indicates a recoveryin 2010, though still below those levels prior to the current crisis 36 .

This has particularly a ected the real estate market in many Gul and North A rican countries. On September 17 th 2009, the Kuwaiti newspaper, Al-Qabas,published that the crisis had made 675 real estate projects to be cancelled inGul countries, with 75% in Emirates, mainly in Dubai 37 . Real estate speculationhad been among the highest in recent years in Dubai – with construction andthe real estate industry representing 25% o the GDP – and, consequently, ithas also su ered one o the worst alls in house prices.

On the other hand, the IMF estimates that oreign investment in non-oil exporting Arab countries will go down by around 11 billion dollars between 2008 and2009, attributing the all to credit and nancing constraints, and the lack o domestic liquidity 38 .

In North A rica the real estate and construction industry have also su ered theconsequences o the recession. One example is Morocco, where the industryhas grown signi cantly in recent years thanks to large investments rom both

European companies and Gul investment unds.39

According to the newspaper Al-Yarida al-Ula , oreign investment in Morocco went down by 6% in 2009 40 .

34. Ibid. Page 5.35. “The crisis in Arab countries. Monitoring.” Casa Árabe Economy and Business Bulletin. Nº13, page 10.36. World Bank. 2009 MENAEconomic Developments and Prospects. October 2009. Page 30.37. Al-Qabas. September 17th 2009.38. IMF. Regional Economic Outlook. Middle East and Central Asia. May 2009. Page 19.39. In particular, the Reuters agency estimates that in recent years Gul investors have invested close to 30billion dollars in the Moroccan real estate and construction industries. “Industry trends and developments.Construction 2009”. Business Monitor 2009. March 11th 2009.40. Al-Yarida Al-Ula. August 11th 2009.




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The sharp downturn o growth in Gul countries has had a negative e ect onintraregional investment which many investment unds and companies weredeveloping in North A rica.

Besides Morocco, Algeria is also another country a ected by the all in Arabinvestments. The Emirate company Emaar, one o the largest constructioncompanies in the Gul , announced in June that it was ceasing its activity andclosing its o ce in Algeria, where it was involved with projects worth 20 billiondollars 41 . According to the newspaper Al-Hayat, the same company had lost351 billion dollars in just three months at the start o 2009 42 .

I.4. The drop in remittances and tourism

Together with the drop in oreign investment, certain Arab countries havealso su ered severe economic setbacks due to the decrease o immigrantremittances, among non-oil exporting countries, and a decrease in the number

o tourists. The last issue has had repercussions in all Arab countries, butalso particularly in the non-exporting ones who rely heavily on this source o revenue.

Signifcant drop in remittances

The drop in remittances is mainly due to those thousands o immigrants thathad to leave those employments in emerging sectors either in Europe or theGul . According to the World Bank, it is precisely Arab countries which willsu er this drop the most, ahead o other countries in Latin America, Asia orSub-Saharan A rica.

Egypt is the th highest country in the world to receive remittances rom oreignworkers, although the economic dependence on these revenues is greater incountries such as Senegal, Morocco, Jordan, Lebanon and Yemen, where theyrepresent a higher percentage o their GDP.

In the case o Morocco, as with Tunisia, almost 80% o remittances come romworkers in European countries; whereas in Egypt, like Jordan and Lebanon, themajority o them (over 50%, and 60% in Jordan) work in Gul countries. There ore,Egypt, Jordan and Lebanon are su ering indirectly, though in equal measure, theconsequences o the economic standstill in oil-exporting countries 43 .

In June, the newspaper Al-Bayan reported that, according to a report by theEgyptian Economic Observatory, Egyptian workers’ remittances abroad ell by

15%, while the number o these workers returning to the Gul increased by 7,000in March 2009 44 .

In Jordan, the Central Bank announced in June that remittances o Jordaniansworking abroad ell by 3% or the second month in a row. As in Egypt, the

41. Reuters, July 4th 2009.42. Al-Hayat, July 31, 2009.43. For instance, on September 25th the newspaper Al-Quds al-Arabi reported that 17,000 oreign workersabandoned Kuwait in the rst hal o 2009 as a direct result o the economic crisis. Al-Quds al-Arabi,September 25th 2009. Page 14.44. Al-Bayan, 22 June, 2009.





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remittances are one o the undamental sources o revenue and exceed thetotal o oreign aid the country receives. According to the newspaper Al-Dustur ,this all is due to many Jordanians losing their employments abroad, particularlyin Arab countries 45 .

Tourism drops by 18% in the Middle East while maintains itsgrowth in North A rica

In terms o tourism, using the gures rom the rst quarter o the year, thereport carried out by the World Tourism Organisation in June 2009 emphasizesthat tourism in the Middle East globally dropped the most at the beginning o 2009 – in total, Middle Eastern countries received 18% less tourists. The reportpublished by the Central Bank o Egypt on June 17 th a rmed that revenues

rom tourism decreased by 17.3% in the rst quarter o 2008. In contrast, inNorth A rican countries tourism did not decrease, in act it increased by 6% 46 .

I.5. The decline o exports

Finally, the collapse o the international markets ollowing the economic crisishas given rise to a serious decline in exports to countries rom the region. Theeconomic standstill and the drop in demand rom markets in Europe, the UnitedStates and Asia – the leading markets or exporting manu actured productsand oil in Arab countries - has brought about an additional economic reversal

or economies in the Middle East and North A rica. In some cases, exports tocountries in the European Union constitutes almost 80% o the total exports(80% or Tunisia and 78 and 76% or Libya and Morocco respectively) 47 . Thelatest data provided by The Economist in September 2009 demonstrated ageneral deterioration in current account balance sheets, which were slightlysteeper in the Gul , though they generally maintain positive balances. Inparticular, oil exporting countries in the Arab world have gone rom having apositive balance sheet o 348 billion dollars in 2008 to 62.1 billion in 2009. Thisis primarily explained in terms o the exports exceeding a trillion dollars in 2008and coming to a standstill at 685 billion in 2009.

Although Morocco’s o cial sources maintain a stance o economic optimism,there is still concern about the combined drop in exports, tourism and remittancerevenue. A report rom the Royal Institute or Strategic Studies details how, duringthe rst quarter in 2009, Moroccan exports ell by 5%, direct oreign investmentby 36%, remittances by 11% and revenue rom tourism by around 14% 48 .

II. Unemployment among young people:The main social challenge o the crisis

The economic crisis in the Arab world has not a ected everyone in the sameway. In act, the macro-economic gures do not refect the real impact the

45. Al-Dustur, 6 June 2009.46 . World Tourism Barometer 2009. United Nations World Trade Organization.47. European Commission. European Neighbourhood Policy: Economic Review o EU NeighbouringCountries. August 2008.48. Royal Institute or Strategic Studies. Le Maroc ace a la crise fnanciere et economique mondiale.




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recession has had on the citizens o Arab countries. A 10% drop in the growtho the United Arab Emirate’s GDP has not been translated into a lower standardo living or less social peace or Emirate citizens; however, a reduction o 0.1%in the growth o the Algerian economy could pose signi cant social challenges.

The World Bank has warned about this situation and the risk various Arabcountries run o the economic crisis becoming a social crisis.

Per capita incomes: disparate starting points and demographic pressure

As outlined in the introduction, not all Arab countries started o rom the sameposition when coming up against the crisis. The per capita incomes allow anestimation o citizen’s general living standards, though they do not guaranteea air distribution or balance o wealth. In some GCC countries we can seehow the per capita incomes are ound at the same level, or even higher, thanmember countries rom the OECD. There ore, although the nancial crisis

has signi cantly reduced the level o reserves, liquidity accumulated duringthe years o economic expansion, levels o in rastructures and capital, as wellas little demographic pressure has allowed them to ace the recession witha position o relative con dence. However, rom Qatar to Yemen, countriesthat have respectively the highest and lowest income per capita in the region,the position o each country is very diverse. In this sense, the countries withhigh level incomes (Bahrain, Kuwait, Qatar, Saudi Arabia and United ArabEmirates) are the least likely to su er political or social tensions, while thosewith low incomes are potentially more at risk to show social uprisings or politicalinstability, in particular in Sudan, Yemen, and Mauritania. In between these twoextremes are those countries with medium-high incomes like Libya, Lebanonand Oman, and those with medium-low incomes like Algeria, Djibouti, Egypt,Jordan, Morocco, Syria and Tunisia.

The challenge o unemployment

Unemployment rates, especially among young people, represent one o themain short and long term challenges or many Arab economies. According to the

Arab Human Development Report, youth unemployment “disproportionately”a ects Arab countries, with the unemployment average rate among youngpeople reaching around 30%. It is particularly alarming in countries such as

Algeria, which reveals a youth unemployment rate o 45%. Although slightlyless alarming, the gures are also worrying in other places such as Saudi Arabiaor Egypt, which reveal a youth unemployment rate o 25%, but that as Algeria,have higher percentages o population under 15, which could mean an increase

in uture youth unemployment rates49

.

In this way, in June 2009, the newspaper Al-Bayan revealed that unemploymentrates in Egypt could soar in 2010, an analysis shared by the Union O EgyptianWorkers Abroad, which believes the impact o the crisis on Egyptian labour willbe ully elt next year 50 .

49. UNDP. Arab Human Development Report 2009. Challenges to economic security. Page 109.50. Impact o the Global Financial Crisis on Egyptian Workers, Fi th Report. Center or Trade Union and. Impact o the Global Financial Crisis on Egyptian Workers, Fi th Report. Center or Trade Union andWorkers Services (Egypt), July 2009





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Hence, one o the greatest challenges a large number o Arab countries ace isunemployment and the need to create jobs or an increasing youth population.

This socioeconomic situation becomes even more complex in those countrieswithout revenues rom hydrocarbon exports and with strong demographicpressure. Be ore long they will have to create jobs or a predominantly youngpopulation. Morocco and Egypt are possibly the clearest example o this situation,with unemployment and illiteracy particularly posing serious problems or thepoorest sections o the population, which are, along with immigrants in theGul , those that will be most a ected by the adjustment o the crisis and the allin employment and remittances.

Other oil-exporting countries, such as Algeria and Sudan, with medium andlow revenues and high levels o young population, will also have to ace similarchallenges.

Another challenge linked to the rise in unemployment is the possible increase

o poverty. According to the Arab Human Development Report 2009 , Arabcountries, compared with other developing countries with similar levels o income and human development, should obtain higher results in povertyindicators 51 .

The economic crisis and the resulting public de cit has put development andpublic investment plans, industrialization processes, social policies and publicemployment at risk. The rise in unemployment is probably the most likely waythe economic crisis will become a social one, particularly in those countrieswith a lower income per capita and lower human development conditions.

III. Public development plans and perspectivesregarding the crisis

A ter the impact o these consecutive crises, the economic and scal situationo the Arab countries has been signi cantly debilitated. Nevertheless, it can begenerally said that, as in other countries, public investments in in rastructures,services and energy have taken over or the drop in private investment,especially oreign investment, and not just in the petroleum exporting countries.

The projects or highway expansion, ports, railways, power networks, etc. arebeing maintained and increased in Morocco, Algeria, Saudi Arabia and otherGul countries. Even though these investments will produce pressure on thepublic de cits, especially in the exporting countries that had anticipated havinghigher revenues, given the price situation in the oil market, it is expected that

the accumulated reserves avoid having to turn to exterior debt. Algeria, whichhad managed to eliminate its exterior debt, enters once again into a position o budgetary de cit (4 percent o the GDP according to The Economist, althoughthe Business Monitor International (BMI) predicted the largest budgetary de cito the last 15 years, 10 percent o the GDP). In turn, according to the EconomistIntelligence Unit (EIU), the only ones to avoid a de cit will be Kuwait, Qatar andOman, while the BMI estimated in February that Qatar and the UAE would bethe only countries in the Gul that would not return to de cit situations.

51. UNDP. Arab Human Development Report 2009. Challenges to economic security. Page 115.




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Signs o recovery, reviewing development models and some lessons rom the crisis

Certain institutions, such as the IMF in its last report o October 2009, daredto con rm certain recovery o the economy. In the case o the Middle East, thisrecuperation will take place thanks to “the recovery o nancial conditions in theregion and a rise in asset prices (especially oil) 52 ”. The International MonetaryFund has indicated that the outlook or the Middle East in the past ew weekshas improved “thanks to the stabilization o the global economy along withthe resurgence in oil prices”. They do, however, warn that the situation is still“complicated” and add that the main danger o these aint signs o recoverycould be that they are neither real nor sustained and continue to depend onpossible uture slumps in oil prices.

The World Bank is equally cautious. In a report made also public on October, itindicated that i MENA countries wish to uphold this economic recovery or the long

term, they must take advantage o the current crisis to ace imminent challenges ininstitutions and in rastructures that have hampered growth over decades.

A simply quick glance at the evolution o the GDP in Arab countries over the past20 years allows to veri y the high-level o dependency their economies have onthe evolution o oil prices – a succession o peak and troughs in a sharp curvethat refect the volatility o a non-diverse, highly dependent economy controlledby actors out o its control.

The World Bank also added that in the years prior to the crisis the growtho Middle Eastern countries was “respectable, not staggering” compared withother developing regions. This growth is identical to the 90s, and even less thanthe 80s. It is estimated that the MENA region requires 300 billion in investmentsover the coming years to cover the current need or in rastructures, which isespecially high in the countries o the Gul Cooperation Council (GCC), despitethe current e orts already implemented. It is calculated that between 1998and 2007 GCC countries invested close to 20% o the GDP in in rastructures,signi cantly lower than the 39% invested in China or the 30% in South Korea.

Certain countries in the Gul have already recognised this obstacle and haveset up measures to resolve it. In 2009, Saudi Arabia has increased publicspending in in rastructures by 36%, reaching 60 billion dollars in the process,and its medium term development plan includes 400 billion dollars worth o investment in in rastructures over the next ve years. Qatar and Bahrain havealso announced ambitious investment plans and Dubai, despite the high impact

o the crisis, looks well set or recovery.

Without these necessary in rastructures, bureaucratic improvements andindustrialization and diversi cation processes, the current signs o economicrecovery, which have been observed in Arab countries during the last ewmonths, could pass in history as another new shoot or pick up on the graph’scurve instead o constituting a positive and sustainable growth trend over time,characteristic o an emerging economy.

52. Regional Economic Outlook: Middle East and Central Asia. IMF. October 2009.





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In the current context, strengthening the re orms and development plans set upin the years o boom is more urgent than ever in order to curtail the dependency

Arab countries su er on the fuctuation o oil prices and international markets.Greater diversi cation and industrialization would be the key or creating moresustainable economies capable o generating more employment in the mediumterm.

IV. The political dimensions o the crisis: policiesand measures or regional development

Even though the region’s socio-political aspects are extremely diverse, theexperts and the members o the Club o Madrid, meeting at the Casa Árabe inthe round table discussions organized in October, listed a series o priorities thatshould be worked out rom the political sphere, at a national, regional and alsointernational level, in order to promote more sustainable development models

and to recover a stable line o short-term economic growth in the region. Thesepriorities and measures are ocused on three areas in particular: developmentand governance strategies, regional integration and international cooperation.

4.1.Development and Governance Strategies at a national level

Although the economic prosperity o this last expansive period was positive,the total growth o the region was not su ciently important in relation to itspotential and to the growth experienced in other emerging countries. Moreover,the way in which the drop in oil prices and o international trade was transmittedto the Arab countries proved the strong dependence that Arab economies haveon the fuctuations o oil prices, as well as on the evolution o oreign markets.

It is necessary to implement new economic policies and new developmentstrategies in order to recover rom the crisis and to guarantee a sustainableand prosperous uture in the region in the medium and long terms. To do this,it is necessary to con ront an entire series o re orms and improvements ineconomic policies and governance in the ollowing aspects:

1. Education and employment

Unemployment (especially among young people) is probably one o thegreatest challenges in the political and economic agenda o the present Arableaders. The deterioration o the real economy and the consistent increase inunemployment, as well as the decrease in the quality o li e or the citizens can

generate situations o social reaction and protests in some States, especiallyin those weaker governments such as Palestine, Iraq, Yemen or Sudan. Thecreation o better and greater work opportunities is also an important challengein more stable countries such as Algeria, Morocco or Saudi Arabia, wheredemographic growth puts heavy pressure on the working population, with agrowing and prepared youth. In view o this situation, it is necessary to carryout economic and educational re orms designed to promote diversi cation anddevelop the industrial, services and knowledge sectors, which are needed inorder to generate a productive and competitive economy, capable o creatingat least 100 million new jobs during the next decade.




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2. State intervention in the economy and liberalizationprograms

During the last decade, the majority o the Arab countries have promotedprocesses o economic liberalization and structural programs designed toopen their economies and adapt them to the global and ree market model.However, the present nancial and economic crisis has shown some ailuresin the sel -regulated market system and has given some protagonism backto the State. In this way, the present economic crisis has deteriorated theseliberalization processes, as well as the open economic policies undertaken bythe Arab countries. The crisis must not be used as an excuse to return tointerventionist processes, or to paralyze economic policies aimed at diversi yingthe economy and opening markets. However, the States must implementmeasures that guarantee greater social coverage or the least avoured sectorso the population, especially a ter the crisis. Its role must be especially activein the creation o a clear and transparent legal and regulating ramework that

guarantees the correct unctioning o the markets.3. Economic diversifcation, industrialization and knowledge

society

The present economic crisis has revealed the existence o various structuralproblems in the Arab economies. The extreme dependence on oil revenue, aswell as the lack o economic diversi cation is presented as one o the greatestchallenges or the oil-exporting countries. Other structural problems are thoserelated with the insu cient work per ormed in promoting a knowledge society.

A key point, in this sense, is or the revenue generated by the oil exports tobe invested in generating a growth process or the real economy, so that thisgrowth is refected in the creation o job opportunities, especially among youngpeople.

It is “essential” to improve the education o uture generations in Arab countries,encourage research, as well as increase innovation and the use o newtechnologies. Promoting knowledge society is the best way to develop thegreat human capital that exists in the region. In this regard, the Arab countriesmust improve the quality o their education systems, as well as develop andstrengthen knowledge and research in emerging sectors such as renewableenergies.

4. Democracy and development through small governance

projects

Even though the present economic crisis signi es a time o trans ormation inthe Arab countries, most o the experts pointed out that the economic situationwill produce ew changes in the present government systems. In relation to thedemocratization processes in the region, the experts stated that the situationo an economic crisis may cause an increase in demand or transparency andcontrol, especially regarding the management o Sovereign Funds. However,this increase in demand or transparency does not seem to be turning into anincrease in tension and social contestation against the present governments,or altering the status quo in the region.





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Nevertheless, small changes in governance at a national level can infuencegreater development o the region’s democratization processes. These smallprojects could entail initiatives that promote transparency and good governingpractices, and ght corruption. As Pro essor Tarik Youse , Dean o the DubaiSchool o Government, stated the best way to encourage change in governanceand avour uture democratization processes in the Arab region is to promotethese small projects o government re orm (Small Governance Projects). Ona small scale, these projects can be ocussed on aspects such as promotingtransparency, governance, rule o law, or small changes in institutional management.In the medium term, these small projects can generate a great impact on theimprovement o the governing systems. Europe could be an interesting partnerin this sense when it comes to o ering support, assistance and cooperation inthe development o these small governance projects.

5. Predictability, transparency and planning in the economic policies

In order to transmit security and stability to investors and commercial partners andthus attract long-term international investment projects, it is necessary or bothplans and economic policies to be developed through a predictable and transparentprocess. Each country in the region should design its own economic plans to beimplemented and announced in an open and transparent manner. This point wasespecially stressed by the ormer Prime Minister o Spain and member o the Club deMadrid, Felipe González, who emphasized that the more oreseeable, transparent,and planed the processes or design and implementation o economic policies are,the more investment and economic growth opportunities create.

4.2. Integration and economic cooperation at a regional level

It is necessary to improve and reconsider the current political and economicrelations o the Arab countries at a regional level and encourage greaterpolitical-economic cooperation among these countries. Abdeslam Baraka,

ormer Moroccan ambassador in Spain and ex-Minister o Relations with theParliament, stressed in his intervention that the Arab countries “need to developa true neighbourhood policy, whether it be among the Arab States themselvesor between the latter and their natural geographic environment, accompaniedby a sincere desire or dialogue and cooperation and or resolving conficts dueto anachronistic rontiers inherited rom the colonial period”. Felipe Gonzálezalso pointed out the strategic importance o regional cooperation. Accordingto the ormer Spanish Prime Minister, the Sovereign Funds o the States o theGul Cooperation Council (GCC) should look towards the countries o northern

A rica and ocus their investments in that area. In this regard, Tarik Youse did

not seem excessively optimistic and stated that even though the countries inthe CCG are promoting various pan-Arab business projects, the countries o theMaghreb are basically being le t out o this dynamic mainly because economicinterests are turning towards the East, towards China and India. On the otherhand, he noted that, unlike the region o the Gul , the countries o the Maghrebare becoming with time less homogeneous and less cohesive.

Greater political and economic cooperation among Arab countries is necessary inorder to manage more e ciently the region’s natural resources and coordinate theireconomic policies. In this respect, with the exception o the integration process beingstarted among States o the Gul Cooperation Council, in the rest o Arab countriesthese policies are still a chimera. Inter-Arab trade represents just 5 percent o the




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total o commercial exchanges carried out in the Arab world. Besides, the inter-Arabtourism hardly represented a 10 percent in the whole region. In this respect, variousexperts showed their pessimism due to various actors:

1. Economic interest is turning towards the East

As Tarik Youse stated, the economic weight o countries such as India or Chinainter eres with the integration and inter-Arab economic cooperation processes.

The global economy is turning towards the East, which causes the States o the GCC also to look toward these markets with more interest than to northern

A rica. The countries in the Gul want to take advantage o , in this sense, theireconomic potential as plat orms between Europe and Asia, incrementing theirregional economic power, in contrast with other Arab countries that until nowhad a greater economic weight.

2. Sovereign Funds: new actors in regional development

During the last decade, Arab Sovereign Funds have accumulated a large parto the liquidity coming rom oil exports. As previously stated, a large part o this liquidity, instead o being reinvested in regional and local developmentprojects, has been traditionally deposited in oreign unds that have su eredgreat losses in the present nancial crisis. As a result, Arab Sovereign Fundsshould reconsider their investment strategies and ocus on creating an increaseo the real economy in the Arab region. This change in policy could turn theminto prominent actors o regional economic development.

3. A pragmatic and open regionalism designed around energy

Taking into account the di culties o a regional integration process in the Arabworld, the European integration process can be taken as an example in order todevelop regional cooperation with a pragmatic nature. A common and speci cinterest in the region, that could de ne this type o cooperation or regionalism,can be the management, consumption and distribution o energy. Also, giventhe present context and the points previously stated regarding the existence o di erent close or peripheral actors, any integration process in the region mustmaintain an open attitude in order to take into account other actors such as

Turkey, Europe or southern Asia.

4.3. The role o the Arab region in the international sphere

Currently, the Arab world lacks a single voice on the international scene. The

lack o a common voice to speak with legitimacy on behal o Arab countriesentails an important handicap when de ending the needs and interests o the Arab region in international institutions. Arab countries should urgently namea representative to represent them in organizations such as the G20 or other

orums where important economic decisions are made or the region at aninternational level. Two aspects may contribute to advancing in this direction:

1. Greater cooperation and integration with Europe andemerging countries

Greater political and economic cooperation among them, as well as a deeperrelationship with other regions, such as Europe and emerging countries, would





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help the Arab countries to gain greater infuence in the international decision-making centres.

The almost per ect complementarities between Europe and Arab countrieswere an aspect especially emphasized by Felipe González. The Arab world andEurope are two complementary regions, destined to understand each other andto cooperate. In this sense, Europe needs to commit more to the Arab region andencourage a sustainable and lasting development in the long term. The ormerMoroccan Ambassador to Spain, Abdeslam Baraka, stressed the importance o “implementing the needed dynamics so that the peoples o the Mediterraneanbuild up a new relationship based on mutual respect and on its projectiontowards the uture”. The Arab countries, on their side, must improve their policiesand their relationship with other international markets, in addition to Europe, withdeveloping and emerging regions, such as China, India, Brazil or Turkey.

2. Oil: an international policy tool

Even though the decrease in oil prices was one o the main causes that generatedthe crisis in the Arab countries, in recent months the price o oil has gone backup until reaching once again $70 a barrel. Most o the orecasts consider thatduring 2010 the price o oil will continue to rise, which will contribute to allowingthe exporting Arab countries to return to a central position in the internationalsphere. This position should be used to develop an active role in the de nitiono a more sustainable model and stable global development.

On the contrary, the recovery o prices should not be an excuse or disregardingand not acing the main economic challenges in the region, and not working toreduce their dependency on these products, as well as trying to mitigate thee ects o climate change and guarantee ood security.

References

Regional Economic Outlook. Middle East and Central Asia. FMI. May 2009

Regional Economic Outlook. Middle East and Central Asia. FMI. September 2009

2009 MENA Economic Developments and Prospects Report. World Bank. October 2009.

Middle East and North A rica. Regional overview. Economist Intelligence Unit. September 2009

“Q&A on the Global Financial Crisis and MENA.” World Bank. April 2009.

Arab Human Development Report 2009. UNDP. July 2009

The Global Competitiveness Report. World Economic Forum. September 2009.

Doing Business 2010. World Bank. September 2009

World Tourism Barometer 2009. United Nations World Trade Organization. July 2009

Impact o the Global Crisis on Neighbouring Countries o the EU. DG ECFIN, European Commission. June 2009

European Neighbourhood Policy: Economic Review o EU Neighboring Countries. DG ECFIN, EuropeanCommission. August 2008.

Casa Árabe Economy and Business Bulletin, nº 9-13, 2008-2009.

Diverse Arab newspapers and media.




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Final Declaration

The Experts gathered by Casa Árabe and the Club o Madrid at the Roundtableon “ The Political Dimensions o the World Economic Crisis: an Arab World Perspective” , held in Madrid on October 28, 2009 agreed the ollowing:

The Arab world is not a homogeneous reality. Similarly, the economic1.crisis a ecting the region has also had di erent e ects depending on thecharacteristics o each country.

The oil-exporting countries were the ones who su ered the most the2.consequences o the crisis, due to the descend o oil prices and the exposureo its nancial products in international markets, but also are the ones thathave the best prospects or recovery, mainly due to the increase in oil pricesin recent months, which is expected to persist over the medium term, and tothe growth dynamics that have been introduced since the major in rastructure

and development projects were launched.Meanwhile, importing countries were a ected by the all in global demand3.through decreases in remittances, oreign investment, tourism and exports.

Although the decline in oil prices and ood gave some temporary respite totheir trade balances, they may experience greater di culties in the uture,especially until demand and growth recover in certain markets rom whichthey are heavily dependent.

An increase in unemployment and the deterioration o the real economy4.and quality o li e o citizens could generate discontent and social protestin some states, especially those with ragile governments, as in Palestine,Iraq and Sudan.Re orms must be deepened to promote economic development, with a5.special emphasis on the real economy in order to create 100 million jobs inthe next decade or a growing youth population.

Among the proposed measures, the promotion o political and economic6.cooperation between the Arab countries in order to acilitate them togain infuence in international economic decisions and to manage in amore rational and e cient way the natural resources o the region, ishighlighted. In this sense, the di culties and challenges that exist, so thatthese projects o cooperation and integration are success ul in the shortand medium term, were also recognized. Likewise, there was advocacy

or a review o the relations between Europe and the Arab world with theaim o identi ying economic complementarities between the two regionswhich are mani old.

Arab sovereign unds, which or years have absorbed the economic boom7.

caused by high oil prices, are reconsidering, a ter losses realized on investmentsin nancial institutions, their investment strategy. The above mentioned unds canplay an important role in promoting investment and development projects whichpromote real economic growth in Arab countries instead o simply investing ininternational nancial institutions.It is essential to improve the education o uture generations o Arab countries.8.It is convenient to promote research and improve the quality o education in

Arab countries to maximize the vast human capital o the Arab countries andallow its ull integration into the knowledge society.

To attract oreign investment it is imperative that both the governments and9.the Arab economic institutions achieve a greater predictability, transparencyand planning in their economic policy.





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The current economic crisis has cast doubt on the credibility o the liberalization10.and economic openness processes in many Arab countries. It is important,however, in this sense, not to return to interventionist patterns but to quali yand resize the Arab state role and dimension in the economy according to thesituation o each country. In some cases there is still bloated state apparatus,which should be streamlined, while in others, an e ort should be made toensure the social coverage networks to cushion the e ect o the crisis incertain vulnerable sectors o the population. The role o government in allcases must be active in creating a clear a transparent legal and regulatory

ramework or the proper unctioning o the markets.Regarding possible processes o democratization in the region, the crisis11.could lead to greater demand or transparency and democracy, but it seemsunlikely that the economic slowdown may strongly erode the legitimacy o

Arab governance systems.




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Abstract

Like other parts o the world, the Arab region is being a ected by the currentglobal crisis. Its e ects and impacts have been, however, diverse depending oncountries and sectors. A ter more than six years o unprecedented economicgrowth during what has been called the “third oil boom”, the region aces thecurrent deceleration rom a relatively advantageous position in terms o assetsand resources. The crisis comes as well a ter a period o important structuralre orms and adjustments in certain countries and in the midst o ambitiousinvestment and diversi cation programs in others.

One o the key eatures that the crisis highlights is the social, political, andeconomic complexity and plurality o the Arab world. The e ect o global demandslowing down, rst elt in the drastic decrease in oil prices and, then, in otherareas o the economy, like exports, tourism, remittances, etc., depends on

both the economic structure o each country and the strategies o developmentimplemented during the period o boom.

A bigger exposure to nancial markets in the United States or UK, and a high level o speculative investments in real estate operations have produced severe cuts in thebudget o Gul countries; low prices in oil and gas have seriously a ected exportingcountries like Algeria, Saudi Arabia or Yemen; the reduction o remittances andtourism are seriously a ecting Egypt, Morocco or Jordan, increasing the already highlevels o unemployment, especially among the young. While some Gul economieslike Qatar are su ering practically no negative consequences o the recession,others like the Emirates, used to an annual GDP increase o 15%, will have to adjustto a cut o 11% in their rhythm o growth. Still, the low demographic pressure andliquidity gained during the period o boom have permitted the quality o li e o citizensin Emirates to be scarcely a ected by the crisis. In contrast, other oil-exportingcountries with larger demographic pressures, low levels o industrialization, economicdiversi cation, and oreign investment, will have to ace higher unemployment ratesand risks o social unrest. On the other hand, in spite o the important losses su eredduring last September nancial crisis, Sovereign Funds in the Gul have become akey source o liquidity and attractive investment partners both outside and inside the

Arab region.

Hence, the crisis is challenging in a variety o orms the strength and stability o economicpolicies and state development strategies, both at the national and regional level.Responses and ways out will have to adapt to each circumstance and developmentplans revised. Some orums have de ended that strengthening cooperation and

economic integration at the regional level would be the way to mitigate its impact andlimit dependency and vulnerability rom oil and global markets. This opens also newquestions or the role to be played by the region at the international sphere.

The Roundtable, organized in collaboration between Casa Árabe and Club deMadrid, will gather a unique group o Club o Madrid Members and high levelpolitical leaders and experts to analyze and debate the impacts, challenges andopportunities that the current global crisis presents in the Arab region. A ter o ering aquick snapshot o the main e ects o the crisis in the region, participants will discusspossible development models or Arab countries in light o the crisis and the newplace or the Arab region in the International scene.





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Programme

Wednesday, October 28

10:15 – 10:45 Welcoming words (Salón de Embajadores)Gema Martín Muñoz , Director General, Casa Árabe Fernando Perpiña-Robert , Secretary General, Club o Madrid

10:45 – 12:00 Block 1: The e ects o the global crisisin the region: an internal lookObjective: to give a quick snapshot o the e ects o the crisis in the region in terms o : remittances, exports,tourism, oreign direct investment, the housing sectorand the oil industry. The possible political implications

o deteriorating social conditions in some countrieswould be a key aspect or discussion.Moderator : Ra ael Conde de Saro , Director Generalo International Economic Relations, Spanish Foreign

A airs MinistryExperts :So ane Khatib , Associated director, Middle East,World Economic ForumJustin Alexander , Editor/Economist, Middle East,Economist Intelligent UnitDiscussant : Felipe González , Former Prime Minister o Spain. Member o the Club o MadridRapporteur : Fatiha Talahite , Researcher o theNational Centre or Scienti c Research (CNRS),Université Paris 13

12:30 – 14:00 Block 2: Revising the role o the Statein development modelsObjective: to revise the role o the State in enhancingnew strategies and key sectors o growth, andpromoting economic and social development throughits investment and developing programmes. A specialattention will be placed in the strengthening o humancapital and economic diversi cation.Moderator : Juan Badosa , President o CESCE

(Spanish Company o Credit Insurance or Exportation)Experts : Abdeslam Baraka , Former Minister o ParliamentaryRelations o the Government o Morocco and Former

Ambassador to SpainGhassan Finianos , Pro essor o Arab Philosophy,University o Damascus; Director o Terre desHommes-SyriaDiscussant : Abdulkareem El-Eryani , Former PrimeMinister o Yemen. Member o the Club o MadridRapporteur : Gonzalo Escribano , Applied EconomyPro essor, UNED (Spanish Distance University)




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15:30 – 17:00 Block 3: The Arab Region in a World inCrisisObjective: to analyse possibilities or promotingeconomic integration and cooperation at the regionallevel and discuss which role could and should playedthe Arab region in designing a new global architecturein a trans ormed global governance system.Moderator : Gema Martín Muñoz , Director General,Casa ÁrabeExperts :

Tarik Yousef , Dean o the Dubai School o Governmentand Co-Director o the Middle East Initiative, BrookingsInstitution.Francis Ghilès , Senior Researcher CIDOB FoundationDiscussant : Abdulkareem El-Eryani , Former PrimeMinister o Yemen. Member o the Club o Madrid

Rapporteur : Olivia Orozco , Socioeconomic andBusiness Program Coordinator, Casa Árabe

17:00 – 18:30 ConclusionsModerator : José Antonio Ocampo , Pro essor andco-chairman o the Initiative or Policy Dialogue atthe University o Columbia, ormer Ministry o PublicFinance o ColombiaRapporteur Block 1 : Fatiha TalahiteRapporteur Block 2 : Gonzalo Escribano Rapporteur Block 3 : Olivia Orozco

19:30 – 21:00 TRIBUNA CASA ÁRABE (Auditorium)Objective: Key messages and recommendations willbe shared in a session open to the public.Moderator: Gema Martín MuñozParticipants:José Antonio Ocampo

Tarik Yousef





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Participants list

María Elena Agüero Director o Institutional Relations andSpecial Projects, Club de Madrid

Justin Alexander Editor/Economist, Middle East,Economist Intelligence Unit

María Dolores Algora Weber Pro essor, Department o History, Facultyo Humanity and Communication,Universidad San Pablo-CEU

Haizam Amirah-Fernández Lead Researcher, Mediterranean and Arab World, Real Instituto Elcano

Celia de Anca Director, Center or Gender andDiversity in Global Management IEBusiness School

Abdulrab Awad Ambassador o Yemen

Ibrahim Awad Director Program o InternationalMigrations, International LaboursOrganization

Juan Badosa President, CESCE Abdeslam Baraka Former Minister o Parliamentarian

Relations and ormer Ambassador o Marrakech in Spain

Naziha Baraka Minister in charge o Social A airs,Embassy o Marrakech in Spain

Manuel Bonmatí Portillo Con ederal Secretary o InternationalPolicy, Unión General de Trabajadores(UGT)

Carla Cohi Chie , Division o MediterraneanCountries, Ministry o Industry, Tradeand Tourism

Ra ael Conde de Saro Director General o InternationalEconomic Relations, Ministry o Foreign

A airs and CooperationJ. Christer El verson Senior Diplomatic adviser, Concordia 21Ramón Enciso Bergé Coordinator-Group Spanish Committee

AverroesGonzalo Escribano Francés Pro essor, Faculty o Economy,

Universidad Nacional a Distancia(UNED)

Abdulkareem El-Eryani Former Prime Minister o Yemen,

Member o the Club o MadridJosé María Fernández López de Turiso Chief of the Department of Cooperationin the Mediterranean and Arab World,Spanish Agency o InternationalCooperation or Development

Ghassan Finianos Pro essor Domaine Arts-Lettres-Langues,Department o Eastern Studies (Árab -Hebreu) University Michel de Montaigne;Director o Terre des Hommes-Syria

José Carlos García Fajardo Pro esor, Universidad ComplutenseFrancis Ghilès Researcher, CIDOB




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Felipe González Former President o Spain, Member o the Club o Madrid

Gabriela González de Castejón Chief Editor, Afkar Ideas Studies o Foreign Policy

Nathalie Grand Dubai School o Government a liateRadi Hamudeh Director General, Trade Bank o Morocco

Yasin Khatib Economic Counsellor, Embassy o Marrakech

So ane Khatib Associated Director Middle EastWorld Economic Forum

Javier Lesaca Researcher, Socio EconomicObservatory, Casa Árabe – IEAM

Antonio López Confederal Secretary of InternationalPolicy Unión General de Trabajadores(UGT)

Zaid Al Lozi Ambassador o the Kingdom o

JordaniaGema Martín Muñoz Director General Casa Árabe – IEAM Álvaro Martínez-Echevarría Director, IEB- Instituto de Estudios

BursátilesSheri a Medina Embassy o MarrakechJosé María Mella Pro esor o Economic Structure,

Universidad Autónoma de MadridEluzai Moga Yokwe Ambassador o the Republic o SudanSalvatore Nigro Executive Director, EUROPEFEJosé Antonio Ocampo Pro essor, University o Columbia;

Former Minister o Finance in ColombiaFernando Oliván Secretary General, Hispanic-Morocco

Forum o juristsOlivia Orozco de la Torre Coordinator, Socio Economic Program,

Casa Árabe – IEAMSantos Ortega Director Institutional Relations

Mass ConsultingFernando Perpiña-Robert Secretary General, Club o MadridMohamed Ridha Kechird Ambassador o the Republic o TunisConcha Rojo García Deputy Secretary o Employment and

Migrations, Comisiones ObrerasJesús Sainz Muñoz President, PromomadridPierre Schori Director General, FRIDESheri Sharkawi Economic Counsellor, Embassy o

Marrakech

Javier Soria Quintana Chie o the Division o Middle East,General Under Direction o MiddleEast, Ministry o Foreign A aire andCooperation

Fatiha Talahite Economist, Researcher, NationalCenter o Scienti c Research (CNRS),University o París 13

Daniel Uruña Executive Director, Mass ConsultingMaría Jesús Viguera Molins Pro essor, Department o Arab and Islamic

Studies, Faculty o Philology, UniversidadComplutense de Madrid (UCM)

Tarik Youse Dean, Dubai School o Government





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Background Document or the A ricanRoundtable

‘The Political Dimensions o the WorldEconomic Crisis: an A rican Perspective’ 53

Africa Progress Panel

A year ago, A rican leaders and their partners were becoming increasinglyconcerned about the impact o the ood and uel crises and o climate change onthe continent’s people. These concerns persist, but they have been overshadowedby yet another, potentially more perilous threat. The global economic downturn

has hit A rica particularly hard, not only through the direct e ects o decreases intrade, oreign direct investment, remittances and aid levels, but also as a result o the response measures put together by the developed world. These have not onlyencouraged capital fight to the perceived sa ety o the West, but have also ailedto address the speci c situation and needs o the world’s poorest countries andpeoples. While many developed countries, including France, Germany and Japan,are already back on the road to recovery, A rican countries are acing the risk o aprolonged downturn i A rican leaders and their international partners ail to act.

The main responsibility to do so certainly rests with the continent’s politicalleaders. They ace the challenge o articulating and asserting A rica’s needs andagenda on the global stage, drawing upon the values and standards enshrinedin the Constitutive Act o the A rican Union and other landmark agreements asthe basis or partnership and support rom both the Global South and OECDcountries. They cannot, however, do it alone. At a time when other nancialfows are dropping, donors countries have an even greater responsibility tohonour their international aid commitments and to ensure that global deals,whether on trade, climate change, intellectual property rights, illicit drugs, crimeor migration are supportive o A rica’s development needs.

Setting the context

A rica’s story remains one o uneven but remarkable progress punctuated bysetbacks and chronic problems. On the one hand, over the past decade many

countries on the continent have been able to achieve real progress, whether interms o economic growth and private sector development, primary education,women’s rights or the ght against poverty and disease. On the other hand,there are still too many countries with authoritarian and corrupt leaders, too manycontested election results and major problems persist such as the wars in Dar ur,the Democratic Republic o Congo and Somalia, the surge o piracy o the horno A rica, and recurring coups. The positive, longer-term trends towards lessconfict, more democracy and greater development are nonetheless clear.

53. This paper was prepared by the A rica Progress Panel Secretariat as an input document or the Club o Madrid’s A rica Roundtable Consultation, held 3 November 2009, in Accra, Ghana.




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These trends, however, are increasingly threatened by current dynamics. Thenancial crisis and the ensuing economic downturn have greatly compounded

the policy challenges already acing the region as they begin to erode progress,reduce per capita growth and cause severe budgetary problems. With theWorld Bank warning that 43 out o A rica’s 53 states are highly exposed andvulnerable to the e ects o the crisis, the continent aces the real danger o malignant decoupling, derailment and abandonment. E orts to achieve theMillennium Development Goals will be a ected, success stories like the“Botswana boom” may have to be rewritten, and confict resolution is becomingmore complicated. The ability o A rican countries to support basic serviceslike education and healthcare will be heavily impaired. The human, social andpolitical consequences could be enormous.

Combined with the challenges o climate change, wide-spread poverty andeconomic marginalization, the global economic crisis now threatens A rica’sdevelopment prospects and its peoples’ lives. There is, however, also a positive

aspect. The crisis could serve as a wake-up call or both A ricans and theirinternational partners. It may drive home the imperative o economic prudence andgood governance to A rica’s leaders and encourage them to use the resourceso their countries more e ectively and speed up the process o regional andcontinental integration. It may also encourage partners to recognize and makeuse o the continent’s enormous potential and the vast scope or investment inits real economy. As such, it presents an opportunity to address some o theblockages that have been constraining A rica’s growth and development ordecades thus allowing the continent to contribute to global recovery.

The impact o the global economic crisis

When the global meltdown was viewed as primarily nancial, many thought that A rica might be spared. But this ailed to recognize what globalization means, andhow the world’s economies, countries and ortunes are interconnected. A rica isnow on the ront line. Its countries are already experiencing reduced trade andeconomic activity, withdrawal o investors and an acute scarcity o credit. Touristbookings are evaporating and vital in rastructure projects are being postponedor cancelled altogether. Financial infows are dropping, including levels o remittances and possibly international assistance as the budgets o partners andthe Diaspora shrink and capital fees rom the economic periphery to perceivedsa ety in the West. In nearly all A rican countries, job losses are mounting, jobcreation is slowing and the number o working poor is increasing dramatically.

The orecasts paint an increasingly gloomy picture. As a result o the crisis, the IMFhas reduced its growth orecast or Sub-Saharan A rica rom 5.5 percent in 2008to about 1 percent in 2009. It also orecasts that a continued decline in economicactivity could result in more than 53 million people being added to those living onless than $2 a day. At its recent meeting in Istanbul, the World Bank estimated thatby the end o this year, the countries o sub-Saharan A rica will have lost expectedincomes o at least $50 billion and the Institute o International Finance predictsan 82 percent decline o net capital fows to developing countries, rom $929billion to $165 billion, with A rica’s share o this drop expected to be particularlysevere. UNCTAD predicts that as a result o the anticipated poor per ormance o

A rican economies, job creation will weaken, pushing unemployment rates higherand orcing more workers into the already large in ormal economy.





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These are more than mere statistics. Every percentage all in growth meansa reduction in budget allocations or public services and reduced householdincomes, with immediate social impacts – or example on nutrition levels,in ant mortality and school attendance. Every person pushed back into povertymeans another step away rom achieving the Millennium Development Goals.Hard won gains in poverty alleviation, health, education and ood security arenow at risk o being reversed. At the same time, the recent riots in South A ricahave shown that the risk or social unrest grows as governments becomeincreasingly unable to maintain basic public services.

Naturally, the impact o the crisis, its symptoms and the ability to cope varywidely across the continent, its countries, regions and groups o populations.While the contraction in the volume o global trade, the dramatic shi t incommodity prices and the drop in nancial infows have strong e ects acrossmost o A rica, some countries are hit harder than others. A country’s degree o vulnerability thereby relates to its dependence on export revenues and degree

o integration into world trade, its dependence on external nancial fows andtrans ers, and its capacity to react, which in turn depends on the overall qualityo governance and leadership, availability o external reserves, external debtand ability to adopt scal stimulus measures.

As with the impact o climate change, the most vulnerable countries are thoseboth least responsible or the economic crisis and least able to withstand itse ects. What is true or countries is also true or people. Many A ricans werehit hard in 2008 by rising ood and uel prices. The economic crisis has nowmade the poorest o them even more vulnerable to sudden shocks, reducedthe opportunities available to them, and rustrated their hopes. Their rustrationcould turn latent political divergences into acute stri e and political contests intocivil wars as parties ght or total power or access to resources.

Several A rican governments have already undertaken measures to minimizethe impact o the crisis which range rom setting up special monitoring units,providing scal stimulus packages, revising budget expenditures, targetingassistance on key sectors and strengthening the regulation o the banking sectorand markets to expansionary monetary policy and oreign exchange controlsto protect the exchange rate. The continent’s Ministers o Finance and CentralBank Governors have held several meetings in order to discuss the impact o the crisis and articulate possible solutions or A rican countries. Their scope oran independent monetary and scal policy response is severely limited becauseo persistent infationary pressures, strained budgets, deteriorating externalbalances, the continuing e ect o the surge in ood and energy prices in 2008,

and downward pressures on their exchange rates.

Whatever response measures A rican countries have put together, they havebeen overshadowed by unprecedented activism at the global stage ranging

rom the UN Commission o Experts on Re orms o the International Monetaryand Financial System to the G20’s gigantic $1.1 trillion stimulus plan. Whilethere have been occasional re erences to low income countries in summitdocuments and policy proposals, politicians in developed countries areunderstandably preoccupied with the protection o their own economies. As aresult, the legitimate concerns o low income countries (LICs) in general, and

A rica in particular, have not eatured prominently in the international rescuee orts. Even though the IMF and the World Bank have begun to disperse some




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o the additional money that has been earmarked or them in the G20 decisions,most o it comes in the orm o loans rather than grants and little has actuallybeen used to mitigate the impact o the crisis on the poor.

This renewed marginalization o A rica marks a notable change rom thelast ve years in which the continent has increasingly taken centre-stage atinternational policy gatherings like G8 summits. The consensus on the need

or A rica’s development which had been ostered at such meetings, whetherat Gleneagles or Monterrey, now seems to have allen victim to the second-round e ects o the economic crisis. While media coverage, and indeed thecommuniqué, o this year’s G8 summit in L’Aquila may suggest otherwise,developmental issues have lost much o their earlier prominence. Italy andIreland have already reduced their ODA budgets and several other countries,including Germany, have indicated that statutory limits on national debt levelsand domestic pressures will orce them to ollow suit once the worst o the crisisis over. This places growing pressure on A rican leaders to adapt their strategies

or recovery and reprioritize their developmental needs accordingly as well asincrease their e orts to use their countries’ resources more e ectively.

The drivers o change

Despite its enormous impact on the continent, the global economic crisis is arrom the only driver o change in A rica. Its e ects must be seen within the context

o other crises such as the continuing lack o ood and uel security as well asimportant trends such as demographic shi ts, changing climatic conditions,the spread o digital technologies, the increasing engagement o emergingeconomies such as China, Brazil and India, the growth o an entrepreneurialmiddle class and the increasing empowerment o women. Together these driversprovide the background against which the state o the continent, the impact o the global economic crisis and the respective responsibilities o A rican leadersand their international partners must be assessed.

Demographics

O ten ignored within A rica itsel , demographic trends are having a serious andundeniable impact on the economic, social and political development o thecontinent. While ar rom the only such trend o interest (others being rapid changesin the relative balance o religions, ethnicities and gender as well as acceleratingurbanization), A rica’s high rates o population growth are o particular concern.

The continent’s population has doubled over the last 28 years, and has quadrupled

over the past 55 years. Such growth rates are by ar exceeding national, regionaland continental absorptive capacities in terms o basic needs such as ood andwater, labor, shelter, sanitation, in rastructure, public health and environmentalsustainability. It is, however, not only the growth o A rica’s population, but also itsswi tly changing structure that is having an enormous impact on the continent’sdevelopmental outlook. Particularly the increasingly high percentage o youngpeople (more than 40 percent o A ricans are below 15 years o age) holds both,great risks and chances or A rica’s states. I governments ail to articulate andact on strategies to provide su cient education, employment opportunities andsecurity to their populations, the resulting discontent is bound to overwhelm

ragile societies and increase the risk o social tensions and political instability. I ,on the other hand, the potential o this youth is harnessed and used productively,





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as was the case in South East Asia during its economic boom, it may prove thebedrock o growth and development.

Climate Change

The evidence is clear. Climate change is a reality that is already a ecting thelives o millions o A ricans by reducing agricultural production and ood security,increasing water stress, acilitating the spread o diseases, increasing the risk o droughts, fooding and mass migration, as well as by eroding coastal habitatsand valuable agricultural space through rising sea levels. This reality is threateningto overwhelm ragile communities and push millions o A ricans even deeper intopoverty as it jeopardizes countries’ ability to generate sustained economic growth,create employment and achieve targets based on the Millennium DevelopmentGoals. With the Copenhagen Climate Change Summit (COP15) only weeksaway, time is running out or A rican leaders to push their common positionand negotiation strategy in order to ensure that a air deal is reached that takes

into account their special needs and circumstances with respect to nancing,technology development and trans er, as well as technical support required orclimate change mitigation and adaptation. The world’s response to climate changewill determine to what extent A rican governments can tap into new nancingsources and access improved technologies, including the Clean DevelopmentMechanism (CDM), planned mechanisms or sector approaches as well as newclimate change adaptation unds. It will also determine the level o private sectorinvestment in the continent’s vast potential or energy production rom renewablesources. Almost all Sub-Saharan countries have su cient renewable resources,exploitable with current technologies, to satis y many times their current energydemand. With the right long-term strategies and incentives, A rica could becomea model o low-carbon growth and development.

The Spread o Technologies

The spread o technologies like the internet and mobile telephony is having apro ound impact on the A rican continent. Not least due to the leap roggingo traditional xed-line telecommunications networks, the uptake o mobiletelecommunications is proceeding at a breathtaking speed. Mobile phonepenetration or example, has risen rom 2 percent in 2000 to over 30 percent by2008 and is expected to increase to over 50 percent by 2012, meaning that therewill be more than 500 million subscribers. Whether by connecting people with eachother or rural areas to the world, by spreading knowledge, improving health caredelivery or by providing a basis or small businesses, the new technologies havechanged the way A rica’s people interact and its economies unction. Farmers

are increasingly using cell phone-based trading plat orms or their agriculturalproducts and in markets were trans erring cash is expensive and exchange ratesare volatile, prepaid minutes have become a orm o currency. With the spreado new technologies bound to continue unabated, A rican leaders need to applythe developmental lessons learned by India and China who once were, and to acertain extent still are in a similar position with respect to the spread, regulationand targeted application o new technologies.

The Increasing Engagement o Emerging Economies

The importance o emerging economies like Brazil, China, Middle Easterncountries and India to A rica’s development is growing by the day. As some




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o the continent’s largest trading partners and sources o investment, theyhave been instrumental in boosting growth rates and spurring much neededin rastructure improvements in A rica or many years. Over the last years, theirinvolvement has evolved rom energy security to encompass a much broaderagenda o cooperation, including the sharing o developmental experiencesand the outsourcing o agricultural production to previously uncultivated landsin A rica. However, there is a real danger that many o the deals struck come atthe expense o large segments o A rica’s population.

The Growth o an Entrepreneurial Middle Class

A particularly promising development across the A rican continent is theemergence o an entrepreneurial middle class that is increasingly drivingeconomic growth. In some countries, such as Botswana, Rwanda and South

A rica, this middle class has been growing by double-digits per year or sometime now and has led to undamental shi ts in economic and developmental

dynamics. Middle class entrepreneurs provide innovation, help create jobs andoster the diversi cation o domestic and regional markets. However, in manyother countries on the continent structural actors and bad governance areholding back the growth o this crucial segment o the population.

Women Empowerment

The empowerment o A rica’s women has been progressing at pace over thelast ty years including some genuinely historic developments over the lasthal decade. The adoption by the A rican Union o the Solemn Declaration onGender Equality in A rica in 2004, or example, has given a new prominenceto the issue o women’s rights. This has been refected in new national lawson everything rom tackling violence against women to equal pay. The electiono Ellen Johnson Sirlea as President o Liberia one year later has also been aclear sign o how A rica is changing and a remarkable step or women acrossthe entire continent. The act, too, that Rwanda’s parliament was the rstin the world in which women took over hal the seats (56 percent includingthe speaker) is a source o pride. In many A rican countries, women are nowdriving economic growth and social progress. But as women everywhere onthe continent know, this is not the ull picture. Signi cant gender gaps persistin education, health, employment, wages and political participation. For everyheadline success, there are many more cases o women who nd their talentsand aspirations blocked by ormal and in ormal barriers. In the race to harnessthe energy and skills o women, A rica – or reasons o history and culture – isin danger o being le t behind.

The implications or A rican leaders and their partners

A rica’s challenges seem as daunting as its opportunities appear enticing. Given thedisparate nature and structure o the continent’s 53 countries and their economiesthere is no single policy panacea – one size certainly does not t all – to enable themto weather the storm, preserve the power ul momentum o recent years and usetheir potential to contribute to global recovery. There is, however, a broad consensuson the need or a combination o accountability, resources and leadership that willhelp A rican leaders to make the most out o their circumstances and allow or theoptimal support o the international community.





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Accountability

The crisis has clearly shown the need or accountability and e ective governancesystems at all political levels. At the national level, A rican countries mustconsolidate the trend towards improved political governance, including by tacklingthe key cross-cutting issues emerging rom the UNECA A rica GovernanceReport and the A rican Peer Review Mechanism (APRM) process. Leaders muststrive to improve the quality o elections, promote broad-based participation inthe development process and strengthen institutional checks and balances toincrease the accountability o the executive branch. At the same time, e ortsshould be redoubled to combat the spread o corruption. Underlying all o theabove is the importance o making governance systems more accessible andresponsive to the continent’s rapidly increasing young population.

At the regional level, A rica needs to nd cooperative ways to overcome thestructural challenge o small market size. Sub-Sahara’s total economy is

equivalent to that o metropolitan Chicago, but spread over a vast area andragmented into 48 separate countries. It will be important to accelerate threeprocesses: The rst is the rationalization o currently overlapping agreements;second is deepening the process o integration within sub-regions; and third isimproving the process o coordination across the di erent sub-regions. While

A rican governments and the A rican Union need to lead these processes, it isalso important that the policies o development partners, or instance in tradeand investment, incentivize their e orts. Un ortunately, there is a real danger thatthe ractured nature o political leadership at the continental level may preventthe harmonization o regional integration e orts.

At the global level, the nancial crisis has triggered a re-examination o a rangeo wider systemic issues such as the e ectiveness o international institutionalarrangements or policy dialogue, coordination and action. A rica’s leadersshould make good use o this opportunity to push or a new multilateralismwhich anchors the continent more rmly in international decision-makingprocesses and institutions, including the Bretton Woods Institutions and theUnited Nations. They have a strong case to argue. It is clear that A rica ispro oundly a ected by wider global developments such as climate change andthe economic crisis. It is also clear that, as a continent o nearly a billion people,it is hugely under-represented in virtually all international ora that deal with suchchallenges. Un ortunately, where A rica does have adequate representation, ito ten lacks negotiation capacity; this also needs to be recti ed.

Resources

At the same time, the current crisis will not be overcome by institutional re ormalone. Faced with enormous unding short alls, A rican countries also needincreased access to alternative resources. These include several categories,namely, emergency aid, support to sustain basic social services and economicactivity, and development assistance to und long-term growth-multiplierslike in rastructure and agriculture. They should be accompanied by systemicchanges to biased trade rules, bloated subsidy regimes, and other orms o market distortion currently restraining A rica’s economic potential.

The private sector certainly also has an important role in mobilizing additionalresources or A rica. For this reason, international institutions and the governments





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Progress in A rica depends upon partnership and mutual accountability between A rican leaders and their donor and business partners, whether governmentalor corporate. Donors must honor their commitments; trading partners andcorporations respect international human rights, environmental and transparencystandards; and A rican governments implement their own commitments to goodgovernance.

Ultimately, responsibility or driving progress rests with A rica’s leaders. Theirtask is not easy, given capacity constraints and the many challenges they ace.But only they can provide the direction that can attract and retain the investmentand support that A rica’s people need and deserve, and ensure that revenuesare used to achieve development results.




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Final Report o the A rican Roundtable

‘The Political Dimensions o the World

Economic Crisis: An A rican Perspective’

By Andie Davis

“Unless this crisis is handled urgently, the Millennium Development Goals will be unattainable, A rica will be urther removed rom development objectives and security will be worsened.”

Benjamin Mkapa

Former President o TanzaniaClub o Madrid Member

The economic crisis that gripped rich countries with increasing severitythroughout 2008 has undoubtedly engul ed A rica as well. Early orecasts o containment within Western nancial markets, or o a mitigating surge in oiland commodity prices, now seem myopic in the light o the complex range o reactions being experienced across the continent. A rican nancial institutionsthat had steered clear o toxic assets nonetheless have elt the e ects o evaporating global liquidity. Commodity-producing countries have seen theprice o oil fuctuate and those o other commodities stall or plummet belowpre-crisis levels, even as the costs o essential inputs have increased steadily.Compounding the challenges with which A rican governments were alreadycontending in shoring up ood security and responding to the e ects o climatechange, the economic crisis has come to bear down particularly hard on someo the world’s poorest and most vulnerable people, those urthest rom itsepicenter.

In development terms, the consequences are daunting. Decreases in trade, aidand investment mean ewer resources available or health, education and basicservice delivery. And contracting job markets in rich countries inevitably shrinkremittances to poorer ones – with potentially dire repercussions. A ter hal adecade o steady increase, remittances are now projected to drop by over 8percent. This short all would have a major impact on poverty alleviation in places

like Ghana and Lesotho, a country o which remittances comprise 28 percento GDP. These setbacks, in addition to hindering progress toward achieving theMillennium Development Goals and other development objectives, also carrythe potential to incite civil unrest.

On the whole, the current situation brings into sharp relie a paradox that, whileperhaps not unique to A rica, is certainly egregious in the A rican context:that deeper integration into the global economy has coincided with a relativediminution in A rican infuence over the setting o the global economic agenda.

Two decades o expanding democracy, rising incomes, resource ul responsesto pandemics, and sound policies or open and inclusive growth, trade anddevelopment have done little to alter the continent’s status as a bit player in





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the ora and institutions that govern its economic ate. Despite multiplyingdemand or its natural resources, and rates o growth unparalleled anywhere inthe developed or developing world, A rica remains a continent relegated to thesidelines o the discussion, o ten spoken or or lectured to but little heard romand less heeded.

A quantum shi t is needed in the nature o A rica’s role in the global community. There is a clear call or a new paradigm, consisting o truly democratic multilateralinstitutions that a ord A rica a strong and e ective voice and decision-makingcapacity. A rica should insist on much stronger representation and on being amore central orce in the international governance architecture.

Good governance or growth and stability

“A story is being told here. And no one but A ricans ourselves will be able to

determine its direction.”John Kufuor

Former President o GhanaClub o Madrid Member

One o the most striking lessons o the global economic crisis is the importanceo governance. The lingering repercussions o profigate deregulation and laxoversight in Western banking and nancial sectors serve as grim reminders thatresponsible governance remains both a challenge and an imperative or richand poor nations alike.

For A rican governments, that imperative has taken on a renewed urgency. Nowmore than ever, A rican leaders need to articulate and execute a clear vision

or the continent’s development. The articulation will call or lucid analysis thatprioritizes long-term sustainable progress over short-term political expediency;the execution will be a unction o the capacity to design, implement and monitorsolutions, particularly at an institutional level.

When institutions such as the judiciary, press, academia, parliament and electoralsystems are able to withstand (and even mitigate) the e ects o political andeconomic change while remaining ree o inappropriate infuence, they rise to theirhighest purpose as the tools by which ordinary people can better their lives.

The current crisis may be recon guring existing challenges in new ways, butthe strategies to address them must be grounded in a deep investment ininstitutional integrity and in the long-established basics o good governance:accountability; investment in human capital; respect or human rights andthe rule o law; preservation o security; and an unwavering commitment todemocracy and broad-based political engagement.

Even during the best o times, these undamental principles can be easier toaspire to than to achieve. In the current climate, there ore, A rican governmentsmust undertake an open and honest appraisal o their capacity to deliver, ando the political, economic and social costs involved.





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– roads, telecommunications and border controls – to encourage the fow o goods, services, in ormation and ideas throughout the region.

As A rica continues to advocate or due voice and infuence in an alteredeconomic paradigm, one hobbled in part by ine ective global governance, itsleaders on the home ront must recognize that those whom they have beentasked to serve are themselves entitled to no less.

Nurturing recovery, building resilience

“Structural adjustment… What were we adjusting?”

Olusegun ObasanjoFormer President o Nigeria

Club o Madrid Member

“I you can’t eed yoursel , how do you start talking about growth?”

Benjamin MkapaFormer President o Tanzania


In the wake o any natural disaster, the imperative is to ‘build back better’. Thismust be the response to the multilayered crisis acing the world today.

Many A rican countries are still reeling rom the e ects o scale-backs in socialinvestment imposed by the structural adjustment programmes o the BrettonWoods institutions during the 1980s and 1990s. While these policies are by nomeans the sole cause o A rica’s ills, it may be argued that their legacy has putmuch o the continent at a disadvantage in weathering extreme crisis. Basiccapacities to e ectively assess, design, implement and manage responses arelacking at all levels, rom individuals to communities to governments.

Decreases in the fow o aid, trade and investment have already sti ened theblow, with another 53 million people estimated to be at risk o alling into extremepoverty i current downward trends persist. A rica needs to build back better,and key to this e ort must be an investment in its human capital.

One distinctive eature o the region is its booming young population. A rica’s

population has doubled over the last 28 years and quadrupled over the last55; and over 40 percent o A ricans are below the age o 15. Whether thesestatistics represent a challenge or an opportunity or the continent dependschiefy on the extent to which A rica’s youth are empowered to per orm asresponsible and e ective global citizens. Their capacities must be developedand their energies channeled or social, political, and economic progress. Andthe most e ective vehicle or this is education.

Education, to be sure, has always been a pillar o human development. Whatthe current climate underscores is not that A rica needs to prioritize education,but how . Education needs to be targeted to development objectives – notonly to provide the practical skills and services demanded by rapidly evolving




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societies, but also to cultivate a cadre o leaders, thinkers and visionaries whocan propel the region orward. To keep pace with demographics, educationalopportunities must multiply in breadth (by extending the range o options in alldirections, rom technical and vocational training to ICT, sciences and languagearts) as well as in depth (by setting and en orcing adequate standards o instruction rom kindergarten through to university). The blend o creativity andinnovation coupled with practical know-how will serve the region well in ul llingits development agenda – and in combating uture crises.

In the present crisis, the most pressing concern or A rica has been oodsecurity. Tumbling commodity prices and abrupt increases in ertilizer, uel andother costs combined with severe drought in some o A rica’s breadbaskets tocause a worrying shortage o ood staples. Here again, the scale and severityo the crisis has exposed a shortcoming in the region’s growth strategies: atendency to deprioritize agriculture in avour o other sectors, and a narrow

ocus on urban development without complementary schemes or rural

development. Thus, while a signi cant percentage o the region’s populationremains agrarian and rural, national development plans place disproportionateemphasis on urban development and on non-agrarian service sectors. At thesame time, too little has been done to accommodate heavy rural migration tourban centres. The resulting high unemployment and strain on in rastructureand public services create a volatile mix that in times o acute crisis canheighten the potential or civil unrest. Now is the time or agriculture to resumea central role in A rican development – through investment in technologyand research, as well as through the judicious use o agricultural subsidiesto improve ood security and to enable producers to compete in national,regional and global markets.

Investments in youth and in agriculture will yield their greatest impact by targetingwomen. As principal drivers o A rica’s economic growth and social progress,women need to be empowered to their ull potential. Eliminating gender gapsin health, education, income, employment and political participation will notmerely level the playing eld; it will strengthen A rican resilience and exponentiallyadvance its development.

A population that is healthy, adequately ed and educated, with equal access toopportunities becomes its own engine o progress. It is the role o governmentto uel this engine by ocusing public policy and expenditure on providing thein rastructure and services to oster growth. Support to small and mediumenterprises is critical across the region, especially in countries where a ast-emerging middle class is increasingly driving economic prosperity, such as

Botswana, Kenya, Nigeria, Tanzania and South A rica. O these, commodity-based economies like Botswana and South A rica are nding themselvesparticularly susceptible to the crisis, with rising unemployment and alteringbusinesses threatening to roll back the ranks o the entrepreneurial middleclass. Government must create an enabling environment to generate a robustprivate sector with which it can partner to expand economic progress andsustain growth.

A rica needs more than quick- x solutions; it needs resilience. Governmentsmust invest in strengthening social and economic oundations so that thebuilding blocks o development can better withstand global crises.





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True Democracy

“Where is the democracy in the management o the global economic system?It’s dismally absent.”

Percival N. J. PattersonFormer Prime Minister o Jamaica


Organizations like the Bretton Woods institutions and the United Nationshave largely maintained the hidebound governance structures set up at theirinception, structures increasingly at odds with modern geopolitical realities. Asa result, A rica, like much o the developing world, continues to be marginalizedwhere global economic decisions are made.

Part o the blame or this marginalization rests with A rica itsel . The slow pace o regional integration – particularly the urgent imperative o economic integrationin terms o ree trade, establishment o customs unions and harmonization o policies – has undercut A rican negotiating power and kept many countries

rom accessing the ull bene ts o participation in a global economy. Moreover,the ailure to e ectively mobilize domestic resources and stimulate privatesector development has meant an overreliance on extra-regional support (in the

A rican Union, or example, over 80 percent o nancing comes rom externalpartners) that ampli es external infuence and clouds the region’s ability to tailordevelopment solutions solely to its own objectives.

Nevertheless, the act remains that A rican countries too o ten bear the brunt o situations that are neither o their own making nor within their power to prevent.Given the disastrous consequences or the continent o global phenomenasuch as climate change and the current crisis, it is clear that the structure o theinternational policy-making apparatus is ripe or reassessment.

A rica remains woe ully underrepresented in international ora and, whererepresented, its capacity to infuence or negotiate tends to be poor. A newmultilateralism is urgently needed, one that refects the dynamics o today’sglobal economy and places A rica at the centre o international decision-makingprocesses and institutions.

The bene ts o such a paradigm could be signi cant. A stronger voice at theWorld Trade Organization could yield pre erential market access or A rican

products that must now compete not only with heavily subsidized Westernproducers, but with high-volume producers rom China and India as well. Realclout at the Bretton Woods table could help adjust de nitions governing LDCstatus, making more emergency aid available to solid but struggling economicper ormers like Ghana and Kenya. With higher negotiating capacity, A rica couldendeavour to do more than merely shame the G8 and G20 into honouringtheir commitments on aid, partnerships and operational transparency. And amultilateral body that actively refected and de ended the security interests o theworld at large – not just those o rich countries or o historic colonial powers –could contemporize the balance o power among nations, and serve as a trulye ective and dynamic orce or peace.




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Now more than ever, these possibilities lie within reach. What is needed isa shared and active commitment to the very democratic ideals on whichthe international institutions have been based. As the world reappraises itseconomic governance mechanisms in the midst o this crisis, A rica shouldseize the opportunity to insist on true democracy, voice and infuence in theinstitutions and structures that determine its well-being.

Few o the observations presented in this report are new. A rica’s challenges werewell known be ore the crisis, and many o the prescriptions o ered here refectthose proposed in the past. But there is now a new urgency to implementingthem, and to nding new ways to shore up resilience to shocks present and

uture. More e ective governance at national, regional and global levels; strongersupport or the drivers o sustainable growth; and genuine infuence over globaleconomic decisions are the way orward not only or A rica, but or an evermore integrated world in which the strength and stability o the part determinesthe social, economic and nancial prospects o the whole.




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deployed and managed (including, where appropriate, though partnerships with theprivate sector) to acilitate inclusive growth.

At the same time, A rica needs a more strategic integration into regional7.and global markets. It needs to make itsel an attractive hub or investors byproviding a high-opportunity, high-return business environment. This can beachieved through regulatory re orm, strengthening o institutional capacity,and the rede ning o eligibility criteria or EU and WTO pre erences.Regional scal and trade policies need to be made more coherent. Regional8.and sub-regional bodies such as the A rican Union and the regional economiccommunities need to coordinate more e ectively to stimulate growth anddevelopment. Customs unions, common markets, ree trade areas, allsupported by joint investments in improved national and regional in rastructurewill empower A rica to realize its ull potential.

A rica needs partners, not mere donors. It needs greater capacity strategically9.to negotiate its own best interests with external partners, whether traditionalor emerging. A rican countries need a clear sense o what they can achieve

on their own and what can be achieved only in collaboration with regional andglobal partners. Mutual accountability and respect or democratic principleswill be key.

A quantum shi t is needed in the nature o A rica’s role in the global community.10. There is a clear call or a new paradigm, consisting o truly democraticmultilateral institutions that a ord A rica a strong and e ective voice anddecision-making capacity. A rica as a region should insist on much strongerrepresentation and on being a more central orce in international institutionsand within bodies like the G20.

In light o the above, we call or a more inclusive, more democratic and ultimatelymore e ective multilateral paradigm that will help us to overcome today’schallenges and make the most o tomorrow’s opportunities.





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Abstract

The world nancial crisis that hit the world in 2007 has now become a systemicglobal economic crisis which will a ect socially, economically and politically, allthe countries and regions di erently depending on their level o development andgrade o insertion in the world economy. Since there is a strong interdependencebetween the rich economies – where the crisis was generated – and the emergentand developing economies, to which the A rican continent pertains, there is nodoubt that the crisis will have a deep impact in this region.

Over the last decade the region has gone through major breakthroughs in termso economic growth, poverty reduction and access to basic social services, butin spite o that, 36.2% o the A rican population lives on less than one dollar perday. The current economic crisis has evidenced that this progress to date couldbe washed away and that much needs to be done to achieve the Millennium

Development Goals in the region. The socio-economic and political impact arising rom this crisis may be verypro ound. The changes in the region could be refected on the one hand,by the signi cant reductions o export earnings, growth targets, remittances

rom the A rican Diaspora, direct oreign investments and development aidand on the other hand, by the increase o unemployment and the possiblerise o social and political tensions.

I the adequate measures are not adopted soon enough, the crisis may alsoput at serious risk the democratic development achieved in the last decades,as well as creating conditions o social outbreak with possible violence, andworsen the conditions o injustice in which a signi cant part o the A ricanpopulation lives.

In their response to the economic crisis, A rican governments, along withinternational organizations, will have to address the challenges resulting romthe current economic crisis in conjunction with nding solutions to othercritical issues A rica has been severely hit by, e.g. poverty, ood security,global warming, human rights and peace-building, whose management willbe crucial in strengthening democratic values, good governance and humandevelopment.

Finally, in addition to an e ort to design and adopt a new world order capable o responding to the political challenges o the 21 st century, arising rom the current

world economic crisis, as well as e ectively sustaining democratic values at aglobal, regional and national level, one will also need to set o refexion anddecision-making processes that will tackle the challenges democratic leadershipis acing.

In this sense, Members o the Club o Madrid, Members o the A rica ProgressPanel and other prominent experts and decision-makers, will be gatheringat this A rican roundtable to discuss the political impact o the crisis rom an

A rican perspective and to ormulate practical recommendations to the politicalinstitutions and policy-makers in charge o responding to the political challengesarising rom the crisis, at a global, regional and national level.




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The results that will come out o both this roundtable and the other onesorganized in Europe, Latin America, Asia, the Arab World and the BRICs(Brazil, Russia, India and China), will become the building blocks o the Clubo Madrid’s Annual Con erence ocused on “ The Political Dimensions o theWorld Economic Crisis: National Interests, Stability and Global Governance ”in which participants will be ormulating a global political perspective o thecurrent crisis.





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Programme

Monday, 2 nd November

20:30 – 22:00 Welcome Dinner o ered by the Government o Ghana

Tuesday, 3rd November

9:30 – 18:00 Roundtable: “The Political Dimensions o the World Economic Crisis: An A rican Perspective ”

Moderator: Michael Keating , Director A rica ProgressPanelRapporteur: Andrea Davis , Strategic Communicationsand Policy Consultant, and Roundtable ContentCoordinator

9:30 – 10:00 Welcoming wordsMaría Elena Agüero , Director o Special Projects andInstitutional Relations, Club o MadridO osu-Amaah Paatii , Special Adviser to the President,

A rican Development Bank Ricardo Martínez Vázquez , Director General, Casa Á rica

10:00 – 11:30 Block 1: The e ects o the crisis in theregion: an internal look

Key issues to be discussed:

What are the social and political implications o the•

crisis in the region? Which A rican countries have been the hardest hit•

by the crisis? Why? The economic crisis added up to other crises•

( ood security, uel, climate change, violation o human rights) and its implications. What are the implications or A rican leaders and

A rican leadership?

Experts :

Andrea Davis , Strategic Communications and PolicyConsultant, and Roundtable Content CoordinatorErnest Aryeetey , Director Department o Economics -University o Ghana, and Director o the A rica GrowthInitiative, Brookings Institution

Discussants:Benjamin Mkapa , Former President o Tanzania.Member o the Club o MadridOlusegun Obasanjo , Former President o Nigeria.Member o the Club o Madrid




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12:00 – 13:30 Block 2: Drivers o change

Key drivers to be discussed:

Youth o the population•

Gender empowerment•

New A rican entrepreneurial middle class•

New relation between the A rican region and new•

world players interested in resources A rica o ersImpact o new technologies and communications•

Experts :O osu-Amaah Paatii , Special Adviser to the President, A rican Development BankGuillaume Grosso , Chie Operating O cer and Policy

Counsellor, OECD Development Center (A ricanEconomic Outlook)

Discussants:John Kufuor , Former President o Ghana. Member o the Club o Madrid.Festus Mogae , Former President o Botswana.Member o the Club o Madrid

13:30 – 15:00 Lunch

15:00 – 16:30 Block 3: Regional integration and theinsertion o A rica in the internationalscene

Key issues to be discussed:

The Economic Crisis: an opportunity or a threat to•

regional integration? Relationships within A rica: how to strengthen•

regional cooperationPlace o A rica in global governance•

Experts :

Maxwell M. Mkwezalamba , Commissioner orEconomic A airs, The A rican Union

John Page , Former Chie Economist or A rica andDirector o Poverty Reduction, World Bank and currentSenior Fellow, Global Economy and Development,Brookings Institution

Discussant:Percival Noel James Patterson , Former Prime Ministero Jamaica. Member o the Club o Madrid





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16:30 – 18:00 Conclusions

Andrea Davis , Strategic Communications and PolicyConsultant, and Roundtable Content Coordinator




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Participants list

Members of the Club of MadridJohn Ku uor Former President o GhanaBenjamin Mkapa Former President o TanzaniaOlusegun Obasanjo Former President o NigeriaPercival Noel James Patterson Former Prime Minister o Jamaica

Experts and Invitees Adam Abdul-Rahaman European Bureau, Ministry o Foreign

A airs Yan Adjei Director o Europe Bureau, Ministry o

Foreign A airs, Government o GhanaKathy Addy Dissemination Coordinator, Center or

Democratic DevelopmentMaría Elena Agüero Director o Special Projects andInstitutional Relations, Club o Madrid

Emmanuel Anyambod Anya Board Chairperson, West A ricanNetwork or Peacebuilding

Ernest Aryeetey Director Department o Economics -University o Ghana, and Director o the A rica Growth Initiative, BrookingsInstitution

George Ayittey Pro essor, American University Andie Davis Regional Coordinator o the A rican

RoundtableMaría Coriseo González Izquierdo Economic Counsellor, Embassy o

Spain in Ghana Theophilus Dowetin Programme Manager, West A rica,

International IDEA Ainhoa Fábrega Programes Director, Casa Á ricaBenedikt Franke Programme O cer, A rica Progress

PanelGuillaume Grosso Chie Operating O cer and Policy

Counsellor, OECD Development CenterMichael Keating Director, A rica Progress PanelRicardo Martínez Vázquez Director General, Casa Á ricaMaxwell M. Mkwezalamba Commissioner or Economic A airs,

A rican Union

Musilio Obanikoro Nigeria High Commissioner to GhanaJohn Page Former Chie Economist or A rica andDirector o Poverty Reduction, WorldBank

O osu-Amaah Paatii Special Adviser to the President, A ricanDevelopment Bank

Abiah Sunday Udoh Economist, Economic Policies andResearch Division, Economic A airsDepartment, A rican Union Commission





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‘Adjustments to the Global Economic Crisisby India and China’

By Sanjay Peters 54

Purpose o the Study

The re-emergence and growing infuence o India and China as economicpowers is now widely accepted. The global business revolution that has beenun olding in India and China over the past 15 years is currently also having, andwill continue to have a major impact on the economies o the US, the EU, andon other parts o Western Europe, A rica, Latin America and South Asia overthe next two to ve decades; albeit in varying degrees. However, the di erence

in per ormance on measures o human development as well as adjustments tothe present crisis could shape the uture progress o both countries.

This discussion paper aims to address a number o pertinent issues in relationto the possible outcomes and adjustments being made by India and Chinain response to the current global economic crisis. The range o questions

or which answers will be sought, include, or example, to what extent thecrisis is derailing the development achievements in China and India? In whatways are the development malaise mani ested (i.e. rising poverty levels,inequality and deterioration rural development programs, education, healthand unemployment)? What have been, and are likely to be the outcomes o the stimulus packages in both countries? Is the current global economic crisislikely to increase political instability in Asia and the threat o war? I so, whatmight provoke such an outcome? What are the international implications o China and India becoming more infuential in terms o their rising percentageshare o global GDP growth? Is the Renminbi likely to become a regionalcurrency without being foated as an o cial global reserve currency? Can thetwo countries compensate or declining demand in export markets throughconsumption driven growth given the enormity o their internal markets? Are

oreign investments likely to be discouraged by both India and China as a resulto the crisis and a more inward oriented ocus? I yes, will this not lead toretaliation and protectionism? Will the current crisis contribute towards greatercohesion and support o ASEAN by India and China or will it lead to decouplingin Asia, led by China and India? What use ul trends (empirical data rom theWorld Bank, the IMF and OECD) do we have to guide us to better understand

the magnitude o the tasks that lay ahead or Asia’s emerging giants?

The structure o the paper is as ollows. The rst section ocuses on theimpact o the crisis on Asia’s emerging giants and exposes some the directrami cations that it is having on the lives o the general population in both Indiaand China. The second section sets out to highlight the type o re orms andchanges in government policy that India and China will need to implement inorder to overcome the current global economic downturn. The third section

54. Associate Pro essor. Department o Economics, Director: Center or Emerging Markets, IESE BusinessSchool, University o Navarra.




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draws attention to the present, as well possible uture challenges in internationalrelations that China and India are likely to con ront. Finally, section our o erssome concluding observations and remarks.

1. The crisis

Collateral Damage on Emerging Asia rom Failure o WesternFinancial Markets

While several Chinese sovereign wealth unds have lost US$ billions by investingin US banks such as Morgan Stanley and Lehman Brothers, on the whole, thesub-prime crisis and toxic assets in the US and in Europe have not directlya ected the Chinese economy. The speculative bubble in the luxury housingmarket in major urban areas o China has also burst, but given that over 12million migrants gravitate annually to di erent Chinese cities, the demand or

a di erent type o housing will at least partially absorb decline in demand inthe high end housing market. On the other hand, the sharp drop in demandrom the US, China’s key export market, is clearly having a detrimental indirect

impact on employment. China is ortunate to have a number o internal solutionsto combat the crisis including, domestic demand and scal balance. Privateconsumption is still less than 50% o GDP. Hence the government is takingmeasures to increase consumption. The government’s scal package increasesspending on education, health and pensions to 5% o GDP. A US$ 586bncentral government initiative in new in rastructure projects will also ensure thateconomic growth is not derailed. China is a net oil importer and bene ts romthe drop in oil prices. Lower infation permitting the central bank to lower interestrates and the reserve requirement ratio may also contribute to growth. Thedecrease in exports does pose a risk to China, but possibly not a very high onegiven that the nature o production involves majority o inputs being imported

rom neighboring Asian countries. There ore, the allout o the crisis will greatlyharm China’s suppliers o inputs (La Caixa Monthly Report, 2009). Moreover,according to Jonathan Anderson, at UBS bank (The Economist, January. 3ed2008), China’s growth is not as highly dependent on exports as commonlythought, than it is to productivity gains. Labor productivity is around 7-8% andaverage annual growth total actor productivity has been in the region o 4% (by

ar the highest in the world) over the last two decades (see Chart 1).

While the major Indian IT companies such as In osys, Wipro and Tata ConsultingServices have been hit hard by the nancial crisis, due to the act that manyo the loss making US nancial institutions were their key clients, on a national

scale, India is protected rom the decrease in global trade, as exports orm arelatively smaller part o GDP. The drop in oil prices will also bene t the countryand reduction o subsidies on uel contributes to the government’s ability ormaneuver. Nevertheless, India and also China should expect to receive lessinvestment fows, resulting in less liquidity in the nancial system, but, the dropin infation has led to the government’s ability to reduce the interest rate andreserve requirement ratio. Moreover in China, the government has released astimulus package amounting to more than 16% o GDP (1,5% in India) to bespent in 2009 and 2010.

In sum, these policies should enhance the national economic development goalsor both countries, but instability and uncertainty around the e ectiveness o the





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stimulus package, coupled with the act that emerging markets in the regionare plagued with liquidity problems raises serious concerns. The risk o risinginfation and demands or currency appreciation adds yet more pressures.

The Impact o the Global Financial Crisis on Poverty Control and Employment

An Estimated 470 million and 827 million people earn less than $2 a day in Chinaand India, which represents the median poverty line or all developing countries.

A decline in growth prompted by the recent global economic crisis in Chinaand India, even i in relative terms substantially lower than in OECD countrieswill surely have a damaging e ect on poverty alleviation, unless concretepolicies are employed (such as those carried out in China’s rural areas mainly tosupport consumption in non durables), to curtail the knock on e ects o grossindulgence by the very wealthy on the lives o the very poor (Bajoria, 2008). Therising prices o basic ood items could exacerbate poverty in both China and

India. Hence a subsidization program to ensure that essential ood items reachthe neediest groups should be seen by policy makers as paramount to avoidsocial and political backlash. In both India and China, a major destabilizingaspect o the global economic crisis is the rise in unemployment. Hundredso thousands o migrant workers rom rural India have had to return back tothe countryside due to loss o work produced by declining demand in exportmarkets. Research by Vashist and Pathak (2009) reveal that merchandiseexports dropped by 17% rom October 2008 to May 2009. Meanwhile monthly

gures in December 2009 show that the drop in exports rom its peak in July2008 are still high 23.3% (but lower than 43.6% registered in April 2008). InChina, rom the onset o the crisis in September to the end o 2008, more than20 million migrant laborers had lost their jobs due to a decline in demand inexport markets. It is estimated that around 25 percent o China’s 6.1 millionnew college students in will be unable nd work when they graduate in 2009(Pei, 2009). The political legitimacy o the Chinese Communist Party, as MinxinPei right ully points out, rests on ensuring that economic needs o the massesare satis ed, and more concretely, on controlling the decline o job losses andcreating new employment opportunities so that millions o rural migrants arenot discontented and ready to carry out protests and demonstrations. I highgrowth rates are sustained in China in spite o the crisis and the growth rates o developed economies remain bleak or the next three to ve years, the likelihoodo protests against restricted political reedoms, social and individual libertiesare likely to be slim even amongst the Chinese youth. In such case, overheatingand currency pressure will be the greatest danger. However, in the event that thestimulus package is withdrawn too soon and growth rates decline substantially

in China, neighboring India and the international community in general shouldexpect internal instability in China, and subsequently also within the region.Human rights violations would grow ten old as millions o protesters battle itout with security orces o the state. The greatest danger in such a scenario isthat China may become too ocused on controlling domestic unrest and internalpolitical objectives at the expense o absolving its growing responsibility in theregion and to the international community, particularly when global demand is

or China to play a more active role on issues such as climate change, monetarypolicy and reducing macroeconomic imbalances (Pei, 2009).

A major drop in exports brought about by the current nancial crisis andcontraction in western markets has led to the closing down o 67,000 actories




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across China during the rst hal o 2008, producing nationwide street protestsby laid o workers. ( Bajoria, 2008).The Impact on the industrial sector in Indiahas been less severe, as much o India’s growth over the past decade hascome rom the service sector. Nonetheless, both countries are experiencinga massive exodus to rural areas by millions o migrant workers, with no clearsigns or the vast majority o returning to urban centers anytime in the near

uture to earn a more stable living. Poverty levels in China and India have beenbrought down substantially over the past two and a hal decades. No othercountry in the history o human civilization has been as success ul has Chinain pulling out over 600 million rom extreme poverty (those earning less than$1 a day) in such a short span o time (since 1981). This was achieved largelythrough sustaining 10 percent growth rates since the beginning o the 1980’s.India with a 6.2 percent average annual growth over the same period has alsosucceeded in upli ting 30 million people out o abject poverty. Nevertheless,the World Bank maintains that approximately 100 million Chinese and over 250million Indians remained under the extreme poverty line in 2005. Kumara and

Jayaskera (2009) report that,“While the Indian and world corporate elite have made much o the 9 percentannual growth India experienced or our successive years beginning in2004-5, the reality is that the gains o India’s boom fowed almost entirelyto big business and more privileged sections o the middle class. RuralIndia, meanwhile, has been ravaged by the fip side o the pro-investorpolicies pursued by successive Indian governments. State investment inagriculture has been slashed, so governments can lower taxes and pursuethe megaprojects required by big business to make India a cheap-laborproducer or the world market. Agricultural price supports and subsidies or

ertilizer and other inputs have been pared back or eliminated.”

A reorientation o ocus is hence urgently needed in practice by the incumbentgovernment o Manmohan Singh to ameliorate the growing inequality betweenurban and rural India and to reduce poverty levels.

2. Re orms

Political Challenges Facing China

China and India are enjoying sustained economic growth in spite o the currentglobal economic crisis. There are o course serious problems acing bothcountries in terms o the distribution o wealth. Government policies in areas

such as public education, health and social wel are need urgent attention.Otherwise the widening disparities in living standards, in per capita income andwell-being in regions within these two countries, between rural and urban areasand within urban areas could result in disastrous consequences which couldthreaten social and political stability.

China’s ruling Communist Party, led by President Hu Jintao, wants continuingeconomic liberalization and sustainable economic growth alongside enduringpolitical control. The biggest domestic challenge the Communist Party acesare the tens o millions who have lost out since economic re orms began inthe 1970s. Economic prosperity has been uneven; many rural areas, outskirtso cities and inland regions have been “le t out” rom the development gains,





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creating huge populations o unemployed and disadvantaged citizens whoconstitute a political liability. Wang (The Chinese Academy o Sciences’ andInstitute o Psychology) estimates, China had more than 80,000 riots anddemonstrations in 2007, a huge increase rom 10,000 in 1993. In September2004, a survey o Chinese scholars and think tank analysts reported that Chinawould likely experience serious social unrest as a result o a combination o social challenges including environmental problems, corruption, a weak nancialsystem, poverty and unemployment. “Accordingly, the balance o economicdevelopment is being tipped towards social priorities” (Political Forces, 2005).

The rural poor are receiving much more attention, particularly through taxreduction, and cleaning up government corruption is another priority.

Required Educational Re orms in China and India

China’s education system is the biggest in the world, but only a very smallpercentage o the vast number o university graduates possess the necessary

skills and knowledge to be employed or rms specializing in export markets(Farrel, Grant; 2005). China’s educational system is overly biased towardstheory, with too ew graduates having the necessary practical skills to work in amultinational environment. Poor English and lack o team work experience areother reasons contributing to the perceived weakness o Chinese tertiary levelgraduates. This shortage o homegrown talent will place limitations on both theability o domestic rms to globalize and also potentially restrict China’s ability todevelop world class service sector companies. An additional problem that Chinaneeds to address is the lack o accessibility to primary and secondary educationbeing granted to amilies o rural migrant workers in major cities. Though thelaws on mobility has been upli ted or people to move reely throughout thecountry to look or stable employment, the rights o individuals are restricted topublic services o ered by the city i they are not registered residents. Migrantworkers rom rural China are not automatically eligible to become residents inmajor cities. This policy oments rather than reduce inequality between citizenso rural and urban China.

While India has a core o highly skilled and educated workers, it too needsto signi cantly improve many aspects o its education system. An educatedand skilled labor orce is a critical part o a developing economy, but evenmore so or India as it aims to exploit its knowledge economy. While India hasmade substantial progress in literacy and school enrolment rates, it still hasthe largest number o illiterate people in the world and the participation o girlsin elementary education is low. Other areas that India needs to invest in orderto educate a large pool o agile and skilled workers is to encourage more on

creative learning, rather than on schooling, and ocus more on practical skillsrather than theory, which has created a “mismatch between education and thelabor market.” (World Bank, 2005). The record on education in India howeveris even more worrisome in many respects than that o China. The high dropout rates at a primary and secondary school level mean that approximatelyonly 10% enter into higher education. Moreover, around 70% o those who doenter higher education end up pursuing studies in law, literature, history andother liberal arts subjects, thus making them less prepared or the job market intechnical elds which India is so well reputed in (Kumar et al, 2007). The genderdisparity in India in the area o education is lagging considerably behind that o China. More than 70% o the emale population o highly populous states, suchas Bihar, with over 100 million inhabitants, is illiterate. Such trends clearly harm




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India’s hopes or balanced uture growth and development. Approximately 44%o the country’s over one billion population resides in seven o the poorest statessuch as Bihar, Uttar Pradesh, Jharkhand, Orissa, Assam, Madhya Pradesh andRajasthan. One o India’s major problems is that it places an excessive amounto priority on the service sector. This sector cannot absorb the surplus supplyo labor in agriculture. Manu acturing sector development there ore has to besought to balance the spread o employment creation in India. Both countrieswill also have to nd ways to avoid the loss o brain drain caused by theirmost gi ted scientists relocating to Europe and the US to carry out advanceddegrees. Innovation can only be achieved through an expansion o investmentin higher education and in R&D. Both countries will need to nd ways to providethe right incentives to keep their brightest minds rom immigrating to industriallyadvanced countries.

The crisis will play an important role here. Only sectors with high productivitywill maintain strong demand or labor. On the one hand, this may o er strong

incentives or the State and private entrepreneurs to promote such sectors andsubsequently the skills and know-how, and there ore economic growth. Onthe other hand i the educational gap persists and incentives are not guidedproperly, the greatest part o the population could be le t behind.

China’s Goal o Political Harmony through Focus on Social Wel are Protection

As a result o the total collapse in GDP o western economies brought about bythe most recent nancial crisis, it is increasingly clear that the growth prospectso the global economy over the next 25 years depend heavily on Asian growth,and especially so on China and India’s growth. In both these countries, thegrowth story will increasingly be about consumption, though India has been

ocusing on such a strategy since it began economic re orms in 1991. Between2003 and 2007 the majority o the increase in consumption came rom the G3economies, the US, Euro zone and Japan. Consumption growth in the G3 overthe next ew years will be anemic at best (though recent trends in the US castsome doubts on this line o reasoning), leaving emerging Asia to pick up theslack, and China de nitely has the potential to ll this vacuum. An additional vepercentage point increase, or example, o private consumption in China wouldhave meant China o setting the poor consumption trends o the G3 during thecurrent crisis. There are several reasons to believe that consumption, particularlyin China is going to increase, not least because it could hardly get much lower.

At a mere 37% o private domestic share o GDP in 2008, consumption in Chinais the lowest o any large economy (see Chart 2). The gure or the US and

Mexico is 71% and 73%, while in Brazil and India, the share o consumption inGDP is 65% and 57% respectively over the same period (García-Herrero andPeters 2010, orthcoming).

Two major underlying actors should accelerate this re-balancing trend inChina towards a more consumption driven economy over the next ew years.

Those actors will come emanate rom the Central Government because whatChina understood rom the Asian nancial crisis was that liberalization is notas important as prudence or guiding the market is. China’s response to thecrisis is going to be continued presence o state owned enterprises and activepublic sector, as has been the case or the past three decades. Concrete policymeasures are being taken by the central government to improve the social





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sa ety net and to reduce corporate savings, and such steps will no doubt actas major instruments to oment consumption. One o the main reasons or lowconsumption in China is that Chinese households tend to save a lion shareo their earnings. Gross household savings have averaged in the region o 20% o GDP over the last ew years. Thus ar, the lack o a social sa ety netcombined with the one-child policy has meant that most people have resortedto precautionary savings in order to support themselves during retirementage. Due to the low penetration o even basic nancial products such as li einsurance, most households end up saving in excess. The Chinese governmenthas designed several policy measures to increase the social sa ety since theonset o the recent nancial crisis. For example, it has pledged to providemedical insurance to 90% o the population over the next three years (using1/5 o scal stimulus package o $586 billion). A three-pillar pension systemhas also been introduced in urban areas and a plan is now being worked out toprovide pensions or rural residents Plans are starting to be developed to makeeducation nancially more accessible to all students, thus reducing the need

or parents to save or their children’s college education. A ordable housinghas become a top priority or the government (over 5% o the scal packagehas been devoted to it) not only to support growth but also to help develop amiddle class in China. An increase in home ownership rates could thus lead toincreasing consumption, not just through the “wealth-e ect” o owning a home,but also through increased spending on home improvement (García-Herreroand Peters, 2010, orthcoming).

In the developed Asian economies (Taiwan, Korea, and Japan) consumption asa share o GDP increased gradually as per capita GDP increased. China’s GDPper capita has long been nearly at subsistence level, which is generally associatedwith a low share o consumption to GDP. As GDP per capita increases in Chinaover the next ew years, it is likely to ollow the same well-trodden path as its

Asian peers, and consumption as a share o GDP will gradually increase.

Most o the increase in Chinese savings has also come rom the corporatesector. The notable increase in corporate savings, rom 2002-2007 is mainlydue to the rising pro tability o state owned enterprises (SOE’s), which havenot distributed their excess pro ts back to the government. This has started tochange since 2007, where 10% o pro ts have to be paid out as dividends tothe government. More steps in this direction over the next ew years will helpease government pressures (García-Herrero and Peters, 2010, orthcoming).

The strong consumption oriented ocus by both China and India suggest thatthese two large emerging markets can no longer be relied up on simply as

destinations or outsourcing o low cost manu acturing and service sectorwork. Western companies will need to learn how to sell products and servicesto these large economies rather than to just export products and services romthese countries.

Key Drivers o the New Consumption Driven Growth in China

Though the economic re orms ushered in by Deng Xiao Peng in 1978 hasundoubtedly acilitated greater privatization o the national economy, it is stillhard to determine in any sort o clear way as to what extent Chinese privateentrepreneurs have witnessed visible improvements in their ability to set up andrun success ul businesses. Although productivity gains have been important,




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according to Zha Daojiong, Pro essor o Political Economy at the InternationalUniversity o Beijing, the productivity rate o , or example, an auto worker inChina is still only 20 percent o that o his counterpart in Japan (Zorilla, 2006,p. 53). Low productivity in China is attributed by Zha to the excessive roleplayed by the state in keys sectors o the economy. The Chinese economycontinues to remain highly interventionist in the rst decade o the 21 st century,in spite o the act that the general perception is to the contrary. To substantiatethis claim, Zha points out that the state has monopoly control in a number o key areas such as, alcohol, tobacco, telecommunications, railways, aviation,petroleum and other strategic industries (ibid, 2006. p. 53), or example, suchas in banking. The visible and excessively inter ering hand o the state caneven be seen such small scale businesses as the taxi industry in Beijing. Thetaxi business in China is cited as one o the most regulated and controlledin the world. How so? Firstly, the cost o obtaining a taxi license is said tobe exorbitant. Secondly, taxi drivers are required to hire their vehicles rom aspeci c company that the state obliges them to work with. Thirdly, authorization

is required by operators rom state regulators to replace an existing taxi witha new one. Fourthly, the make and model o the car to be used as taxis isdecided by the state. The taxi driver has no say whatsoever with the brandhe would like to have or his car (ibid; p. 53). Zha insists that the core o theproblem with low productivity in China is directly linked to the lack o institutionalre orm in the political arena. He asserts that, individuals who normally takedecisions on policy matters related to business strategy in China are between50 and 60 years old. This means that they were either educated in the ormerSoviet Union or they received their training during the Cultural Revolution. I it were the latter, which is the case or most decision makers in China today,it is unlikely that they got much o an education according to Zha, becausestudying anything other than Maoist ideology was outlawed in China between1966 and 1977. From the Communist Party o China’s standpoint, the abilityto read and write is all that was required to become amiliar with Mao’s ideasand to learn rom his wisdom. Coupled with the act that most o the currentdecision makers in China come rom humble social class backgrounds without anytradition in education, it is unsurprising to Zha that the end result o policy makingis nothing short o corruption and ignorance. He argues that the communistparty is the spinal column o China. Even at a technical level, one has to belongto the communist party in order to take important decisions. Zha maintainsthat leadership within the Communist Party o the People’s Republic o Chinais not based on meritocracy. In order to ascend within the party, seniority (oldage) and loyalty to the party oligarchy is much more important than merit. Asa result, it is very hard to see any signs o real innovation within Chinese rms.China may be able to send rockets to space, but they are unable to solve

problems associated with water leaks in household and public latrines (ibid;2006, pg 53-54). Any real hope or China to modernize, become innovativeand develop its own competitive industries in a continually globalizing world,according to Zha, will only take place a ter the XVIII Party Congress in 2012,when those such as Hu Jintao, the current President o China and memberso his generation who were educated during the Cultural Revolution will haveretired rom politics. Current encouraging signs however can be seen in the

act that prominent members o the Chinese business community are nowbeing allowed to orm part o the central government apparatus (ibid; 2006, p.61). One o the important outcomes o the current nancial crisis is that it haslegitimized the role o the Chinese State in e ectively managing the economy.Hence, what we are likely to witness over the next three years at least, until the





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change o guard in 2012 and the replacement o Hu Jintao, is an increase inthe role o the state, with a greater ocus on sel -reliance as opposed to exportled growth and dependence on oreign direct investment. This policy o heavystate control may become more accentuated depending on who takes over.(Summers, 2009).

Xi Jinping and Li Keqiang, are seen as the leading candidates to succeedHu Jintao and Wen Jiabao respectively in 2012. President Hu’s goal or theremainder o his term in o ce will be to uphold the necessary political cloutso that the transition will be smooth and ree o uncertainty and instability. Hiseconomic aims are likely to be short term in nature. For the various aspiringcandidates however, the process o transition might o er a unique opportunityto radically re orm the existing system through ushering in major political andsocial re orms. Such a contrasting stance could severely undermine the authorityo the state and inadvertently provoke urther political instability. (Pei, 2009).

Important lessons could be learned by China rom looking to its neighbour India,on how to promote private entrepreneurship amongst the local population ratherthan to be overly dependent on oreign direct investments. India meanwhilecould also learn rom China on how to develop its manu acturing sector moreand to encourage oreign investment, but without becoming overly dependenton this source as major driver or GDP growth, as the service sector boom isnot going to be su cient to absorb India’s surplus labour orce.

Environmental Challenges

China’s economic development, based on manu acturing sector growth, overthe past two decades has produced serious environmental problems, whichin turn are creating a range o other social, political and economic challenges.Skyrocketing rates o air and water pollution, severe land degradation, andincreasing resource scarcity are all creating huge pressures. China’s relianceon coal or three quarters o its energy has made its air quality among theworst in the world. In 2001, the World Bank reported that 16 o the 20 mostpolluted cities in the world were in China. Acid rain, resulting rom sul urdioxide emissions rom coal burning, a ects over one- ourth o China’s land.Unregulated economic development has also contributed to the devastation o China’s orests. However, “China’s dramatic growth in automobile use poses thegreatest uture threat to China’s air quality. China today has over 20 million cars,trucks, and buses; 20 million agricultural vehicles, and 50 million motorcycles.By 2020, conservative estimates suggest that China will have 110 million cars.”(Elizabeth, 2004).

However, the most serious environmental challenge China con ronts is accessto water, which stems rom both growing demand and rapidly increasing levelso pollution. Approximately 700 million people drink contaminated water ona daily basis. More than three-quarters o the water in China’s urban areas isconsidered unsuitable or drinking or shing. China’s water pollution problemswere demonstrated in November 2005 by an industrial accident whichcontaminated a river and le t our million residents in Harbin (a major city in thenortheast) without water or several days.

China’s leadership has recently realized that its environmental practices arehaving a signi cant negative impact on the economy. The World Bank reports




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that the cost o environmental pollution and degradation in China is equivalent to8-12% o GDP annually. Lost days o work, contaminated crops and sheries,and industry closures due to lack o water all contribute to such costs. Theprospect o social unrest is causing the government to pay closer attentionto the environment. As early as the mid 1990s, the Central Committee o theChinese Communist Party published a report acknowledging that environmentaldegradation and pollution was one o the our leading causes o social unrest inthe country. Moves towards more sustainable development is also supportedby academic studies. The “Environmental Kuznets Curve” suggests that as aneconomy grows and wealth increases, governments allocate more resources toenvironmental protection. “Rising per capita income spurs consumer demand

or luxury goods, including environment protection. Consumers will spur ashi t in production away rom environmentally very stress ul heavy industrialproduction to the production o environmentally less stress ul consumer goodsand services.” (Peters, 2005) The early signs o this trend are already underwayin China.

3. International relations

Status o Bilateral Relations between China and India

There is a notable increase in the body o literature in scholarly journals aboutChina and India and the supposed rise in competition between these twocountries along with speculations about the likely winner o the race in themedium to long term (Gibb and Li, 2003; Majumdar 2004; Arora and Athreye,2002; Contractor and Kundu, 2004; and Srinivisan 2004). O ten, erroneousassumptions are made suggesting that China and India are bitter adversaries.Whilst it would be inaccurate to suggest that they do not ear each other at all ata military level, particularly given the relatively recent history o border disputes,the most salient one being the war in 1962, it would be a gross mistake todraw the conclusion that a military threat rom each other once again is themain concern that occupies policy makers. This somewhat narrow debateovershadows other relevant issues, such as the growing trade between them.

Though there is a healthy amount o competition between China and India toaspire to be the leading player in Asia, most analysts tend to completely overlookthat there is also a considerable rise in cooperation and trade between thesetwo countries. For example, the bilateral trade gures between India and Chinaamounted to $43 billion in 2009. This is a notable rise rom the year 2001, whenbilateral trade gures amounted to a meager $1.2 billion. China or example,surpassed the US and the EU to be India’s main trading partner since 2007.

The debate over the so called rising competition between China and India alsodownplays important lessons that both countries could learn rom one another,about the bene ts o bilateral cooperation as means to reduce the possibilityo geopolitical conficts (ie. such as over access to global energy supplies) andabout the positive or adverse impact their re-emergence as global economicpowers could have on other countries both within Asia, the EU, the US, Latin

America and A rica. To urther illustrate the growing closeness between Chinaand India, it may be worth highlighting that as recent as 2002, there were nodirect fights between China and India. As o 2007, there are 22 weekly directfights between major cities in China such as Beijing and Shanghai to Delhi andMumbai. There are also over 90 Indian companies rom various sectors such aspharmaceuticals, IT and automobile components that have registered o ces





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in China as o 2005. As a result o the rise in global demand or IT specialists,more than 25,000 Chinese so tware engineers have received their training romNIIT, one o India’s major so tware engineer training companies, that has 170training centers across major cities in China. The FDI’s have not been strictlyunidirectional in the recent cooperation and growth in bilateral trade betweenthese two Asian countries. Leading Chinese companies such as Huawei

Technologies and TCL, specialising in telecommunications and householdelectronic components have also invested approximately $250 million in settingup production acilities and R&D centres to serve as suppliers to the risingmiddle class in India and to remain internationally competitive (Peters, 2005).

Impact o China and India’s Rise on Industrialized and other Emerging Economies

Irrespective o the current global economic crisis, the adverse or positive a ecto India and China as global players varies across countries. For example,

Eastern European countries such as Poland, Hungary and Slovakia who haverecently gained accession to the EU are likely to su er more than say, FranceItaly or Britain, that are producers o technologically advanced goods such asluxury cars, commercial aeroplanes and household electrical components. Thementioned East European countries su er more because o the export o jobsdue to the comparatively lower cost and abundant supply o skilled labour inChina and India in manu acturing and services. Boeing, Airbus, Volkswagen,GM and Siemens are the type o multinational rms rom industrially advancedcountries that are bene ting rom China and India’s economic rise. The potential

or accessing the large internal markets within these two Asian countries,in addition to producing and exporting to other markets in Asia and Europealso mean that East European and other Asian countries which specialise intraditional industries such as textiles and ootwear have also su ered ratherthan bene ted rom the rise o China particularly. On the other hand, the rise o China and India as major global players has also resulted in higher GDP growthrates in commodity exporting countries rom A rica and Latin America that are

eeding the industrial growth, particularly in China. For example, or Brazil, Chinahas become the leading export market or minerals, steel and other commoditygoods during the past decade.

The rise in commodity prices during the decade o the 2000´s has been directlylinked to increase in imports by China and India. This has been a blessing or

A rica as a continent, at least over the short term. For example, Sudan, Angola,Burkina Faso, and the Congo are important exporters o cotton to China.

Angola and Sudan mainly export oil to China. In addition to cotton, Cameroon

also exports wood and oil to China. Over the past 30 years, there has been a90% demand in growth or oil in developed countries. In Asia, the increase indemand has reached a staggering 400% (Santiso, OECD, 2006). One o thedownsides to rising commodity prices and to the commodity goods exporttrend however is that it encourages developing countries rom Latin Americaas well as A rica to continue to specialise in primary goods exports rather thanto diversi y into other higher end activities in manu acturing where returns arelikely to be greater over the medium to long term. Secondly, the dependencyon China or oil, coal, cotton, steel and other primary goods exports couldmean that i there is overheating in the Chinese market and consumption iscorrespondingly reduced, then demand or these commodity goods wouldsubside. Such a scenario would there ore expose these commodity exporting




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countries to severe un oreseen shocks. In addition, China’s ootprints in A ricaare becoming a great concern or human rights organisations and corruptionobservers as or unions and political actors. As an example, in Namibia 2009,China companies were accused o bribing authorities, in Sudan authoritiesaccused mining Chinese companies o ignoring local labour orce.

Developing countries rom Latin America and A rica are not the only oneswho have to adapt to developments in China and India. The outward fight o major multinational companies like Samsung and Philips rom a one time lowcost labour destination such as Spain, to China and India has also resulted inemployment loss in certain areas. The phenomenon commonly re erred to as“deslocalizacion”, which re ers to the process o relocation o multinational rmsto more competitive overseas markets, has also created new opportunities oragile Spanish rms to increase their international competition by outsourcingR&D and manu acturing activities to these large Asian markets. Given thatSpain’s main area o comparative advantage is in banking, telecoms, the

energy sector, logistics, construction and tourism, areas which ortunatelyor Spain also happen to be high demand areas or China and India, newbusiness opportunities will present themselves to compensate or losses inother manu acturing areas. The key however will be to identi y these challengesand to adapt to the speci c conditions and needs o both these Asian markets.Spain, or example, can also play an important intermediary role between Chinaand India in Latin America. Apart rom the advantages that certain key sectorssuch as banking, telecoms and in rastructure have, rms across a broad rangeo sectors rom Spain can bene t rom the opportunities presented to themby China and India. The clear bene ciaries o the rise o China particularly, areconsumers in the EU and the US. Consumers in both these regions are ableto bene t rom lower cost goods such as computers, sport shoes, televisionsets, washing machines and electric blenders produced in China by oreign

rms. The quality o these goods is also no longer compromised by lack o technological inputs.

China and India are clearly aiming to become global powers in the 21 st century,through exploiting the potential o their huge populations to take their right ul placeon the world stage. In terms o the demographic changes that are expected totake place by the year 2030, India is orecasted to have a much younger workingpopulation in relation to China, with 28% o the working population betweenthe ages o 15-29 compared to 19% or China. More alarmingly is that 23%o China’s population is expected to be in the 50-64 year old group comparedto only 9% or India (Financial Times, 2004). These projected demographicadvantages do not guarantee that India will be able to achieve higher growth

rates than China. Unless the primarily and secondary educational system isimproved as well as made more accessible and malnutrition and poverty levelsare brought under control, advantages o being younger will not amount tomuch. In sum, both countries ace di erent economic, political, social andenvironmental challenges in their ambition to become global leaders and todeal with sudden shocks as the current global economic crisis.

Re orm in the Global Monetary System and the Rise o theRenminbi

The British Pound was the main reserve currency throughout a large portion o the 19 th century and when the British Empire declined the US dollar replaced it





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in the 20 th century. Early signals in the 21 st century suggest a change o guard inthe international monetary system with China’s Renminbi threatening to replacethe US dollar. However, serious doubts remain whether the Renminbi posesa real challenge to the dollar any time be ore the next decade, as history hasshown that it generally takes time or con dence to be acquired by agents tocarry out trade transactions and to accumulate oreign exchange reserves in anew currency.

Con icts o Interest

Considerable resistance would be met by China to have an alternative reservecurrency replace the dollar, as this would substantially reduce the ability o the US to inexpensively nance its budget and trade de cits. The burden o responsibility prompted by the all in value o the dollar has so ar been shoulderedby its creditors, who lend in the same currency. Commodities priced in dollarshave also meant that imports to the US do not become more expensive when

there is drop in the value o the dollar. Borrowing hence, would become moreexpensive or the US i countries were to diversi y their reserve currencies. Atpresent 67% o global oreign exchange reserves are in US dollars. There areseveral other actors which restrict the viability o the Renminbi becoming analternative regional currency in Asia. For example, China would have to removerestrictions on money entering and leaving its borders, make the currency ullyconvertible or trade transactions and make its bond market more liquid andtransparent. The act that China means serious business on the other hand,can be seen in the setting up o currency swaps with Argentina, Belarus andIndonesia and permitting nancial institutions in Hong Kong to issue bonddenominated in Renminbi. This is an important step in creating a signi cantdomestic and international market or its currency. I the Renminbi to were toreplace the dollar in the medium term, or the US it would mean that the highcost o borrowing would lead to a decline in consumption, investment andgrowth. For Asia, transacting in Renminbi’s would oment an increase in regionaltrade. For China, on the other hand, it would mean adopting on a role very similarto that o Germany in the EU, by subsidizing the economically weaker countriesin the region. In sum, it would mean shi ting the ocus to regional security asopposed to solely protecting its national interests. Other substantial challenges

acing China up until now has been the political barrier in collaborating withJapan (the only country in the region with international banking experience), itshistorical adversary in the development o an Asian Currency Unit. The ragility o the existing international monetary structure brought about the current nancialcrisis has now once again reopened the debate.

Contradiction and Problems with the Existing International Monetary System

The US has gone rom being a net lender since WWII to becoming a netborrower, whereas in the 21 st century, China has turned into a creditor countrywith strong growth, low debt in proportion to GDP and large current accountsurpluses. In the late 1980’s, China’s oreign exchange reserves were estimatedto be around $167 million. At present, China’s oreign reserves are in the regiono $2 trillion, and approximately $1.5 trillion o it is invested in dollar assets,mainly US treasury bonds and quasi-sovereign securities issued by Fannie Maeand Freddie Mac. With the onslaught o the 2008 global nancial crisis, worldattention is heavily ocused on China’s massive stock pile o US dollars in oreign




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exchange reserves. The Chinese government is understandably very concernedabout the sa ety o its investments in the United States. However, even with anongoing global recession there seems to be no sign o decline by China toaccumulate US dollars, as the Euro is perceived as even less stable than theUS dollar due to ears over the uture o European Monetary Union. To o setthe vulnerability created by the projected decline in value o the dollar, policymakers in Beijing are pushing or a greater role in international trade through theuse o special drawing rights (a currency devised by the International MonetaryFund in 1969), while being well aware that the US can veto an IMF decision.Hence China’s position can be taken as a warning signal to the United Statesrather than as any sort o immediate threat or demand or global monetarypolicy re orm. During G20 meeting held in April 2009, China and other emergingeconomies acquired greater infuence within the IMF. The crisis, which resultedin greater harm on the economies o many developed countries, has enabledemerging economies to become more aware o how the world is trans ormingin terms o power relations and how their own power and infuence is rising.

China will soon want to have the Renminbi included in the new internationalcurrency, which China’s central bank governor, Zhou Xiaochuan, describes as a“super-sovereign” reserve currency that doesn’t belong to any particular nation,and made up o SDR’s (a basket o dollars, Euros, pounds and yen), or use asa means o payment in bilateral trade. In the short run, the existing monetarystructure is unlikely to change, but cracks in the system are more visible and itis only a matter o time be ore the US dollar’s infuence as the dominant oreignexchange reserve is o set by re-emerging China (Peters, and García-Herrero,2010, orthcoming).

4. Conclusion

Concluding Observations and Remarks

The principle aim o this discussion paper has been to draw attention to thebroader social and political implications o the current global economic crisis orboth India and China rather than to ocus purely on its direct economic outcomeon both countries. The paper highlights the signi cant changes that are takingplace in the bilateral relations between China and India and the impact thatthese two countries are having on industrially advanced and other emergingeconomies. The paper also identi es the main challenges to governance acedby China and India that stem rom the current crisis, which are linked to risingunemployment, controlling poverty, providing universal access to and improvingthe quality o education, environmental degradation, global imbalances and

monetary policy shi ts. An additional critical actor that is likely to place serioussocial and political stress on both countries is regional instability brought aboutby a decline in economic growth in neighboring countries. Rather remaintoo ocused on meeting national goals both India and China will have to playa more important role at a regional level as well as on a global scale. Thischallenge will be particularly acute or India, with politically unstable neighborssuch as, Pakistan, Nepal, Bangladesh, Myanmar and Sri Lanka. Though Indiahas been largely spared o the direct harm ul economic consequences o theglobal economic crisis, its neighbors certainly have not. Moreover, the austeritymeasures being carried out by industrially advanced economies suggest thatdevelopment aid to these mentioned countries in South Asia will likely bescaled back substantially or cancelled altogether. India will hence need to play





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a much more active role to ensure economic stability in the region instead o ocusing purely on national interests. It is in India’s long term national interest,or example to have a stable Pakistan as its neighbor. The long standing confict

over Kashmir could become accentuated i Pakistan’s economy alls urtherinto a state o disarray and social unrest increases. India runs the risk o havingto ace large scale immigration into the country rom bordering nations andother social tensions connected to Pan-Islamic undamentalism i it ocusestoo much on sel preservation and solely promoting national interests. The ghtagainst global terrorism may become a secondary priority or countries suchas the US and or the EU, in order to address challenging domestic pressures,and India will need to ll this vacuum through international dialogue and greatereconomic commitment. Regional cooperation in South Asia has one o thepoorest records thus ar. The countries in the region share public commonssuch as environmental degradation, water resource management, securityand terrorism which cannot be e ectively managed by any single country. Thesigning o the India-ASEAN ree trade agreement in April 2009 was a positive

step towards sharing the burden o responsibility in economic development inthe region.

Both India and China are undergoing a major demographic trans ormation,with a shi t to urbanization o more than hal the population in both countries,amounting to one billion people. This process is taking place at exponentialspeed and both countries will need to adjust to the social and environmentalimpact o resource use and the availability o services to absorb such a rapidlygrowing population rom rural areas. Inclusive growth will have to be givenhigher priority in both countries, to avert social unrest. Thus ar, the level o inequality in living standards, per capita income and general well being in ruralversus urban populations in both countries is one o the most major sources o political and social instability.

The current global economic crisis is di erent rom previous nancial crises,which have either been restricted to a country or to a speci c region. Thedilemma o addressing global imbalances thus goes ar beyond the responsibilityo one or two countries such as China and the US, or a speci c region o the world. Developed nations o the world will need to cooperate and workclosely with economically power ul emerging economies such as China andIndia rather than to perceive their growing infuence as somehow threateningto their own economic stability. It is only through viewing the challenges acedby India and China in sustaining high economic growth to address povertyreduction, minimize inequality, control environmental degradation and achievesocio-political progress as a collective problem that we can collectively nd

solutions that ace an ever globalized and integrated world economy. Thisharsh realization, ortunately or the wel are o humanity at least in the shortterm seems to be gaining steady ground over national interests.




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Annex

Chart 1. Total Factor Productivity, average annual growth 1990-2008, %

Source: The Economist “Secret Sauce” 12 th Nov 2009.

Chart 2. China’s Household Consumption as Percent o GDP, 1978-2005

Source: China: Rebalancing Economic Growth. N. R. Lardy 2007

ChinaIndiaSingapore

ThailandSouth KoreaIndonesiaJapanBritainGermanyUnited StatesFranceSouth A ricaMexicoBrazilRussia

0 1 2 3 4 5

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‘The Road to Sustainable Growth: An East Asian Perspective’ 55

Yun-han Chu 56

The Resilient East Asia

Asian economies were not insulated against the impacts o the global nancialcrisis. Their dependence on trade through global production networks andexport-led growth strategies made them vulnerable to the sharp contractiono demand rom the North American and European economies. However, theregion has proven to be more resilient than the rest o the world and is poisedto lead the global economic recovery.

By late September o 2009, the Asian Development Bank has upgraded

economic growth orecast in East Asia to 4.4 per cent rom 3.6 per cent. Chinaalone is now expected to grow by 8.2 per cent in 2009 and 8.9 per cent in2010, up rom the March orecast o 7 per cent and 8 per cent, respectively. Theprospects or South Asia have also improved with growth expected to hit 5.6per cent this year, up rom the initial orecast o 4.8 per cent. Emerging signs o a recovery in private business con dence and a continued large scal stimulusannounced in the July 2009 budget helped bolster India’s projected economicexpansion to 6 per cent this year, upgraded rom 5 per cent. The aggregategrowth in South-East Asia was projected to slow to 0.1 per cent in 2009, stillslightly better than the initial orecasts o a negative 0.7 per-cent growth. Risinggrowth in Indonesia and Vietnam has partially overcome drops in other South-East Asian economies most exposed to international trade, such as Malaysia,Singapore and Thailand.

Four actors contributed to the region’s stronger than expected economicrebound. First, the region was relatively well insulated rom the global nancialmeltdown as it had inherited a relatively healthy state o nancial systems priorto the sub-prime loan crisis and built up a huge oreign reserve as a hedgeagainst a replay o the 1997 regional nancial crisis. Asset bubbles were eithernot alarmingly threatening or they had been contained well be ore the currentcrisis as in the case o China. Second, most East Asian economies have shownconsiderable resilience, thanks in part to high household savings during goodtimes on which they could all back upon during lean times without havingto make drastic cutbacks in private consumption. Third, the macro-economic

55. This paper was prepared as an input document or the discussion that took place during the Club o Madrid’s Annual Con erence56. Yun-han Chu is Distinguished Research Fellow o the Institute o Political Science at Academia Sinicaand Pro essor o Political Science at National Taiwan University. He also serves concurrently as Presidento Chiang Ching-Kuo Foundation or International Scholarly Exchange. Pro essor Chu joined the aculty o National Taiwan University in 1987. He was a visiting associate pro essor at Columbia University in 1990-1991 and has held a visiting pro essorship at Peking University since 2007. Pro essor Chu specializes inpolitics o Greater China, East Asian political economy, international political economy, and democratization.He is the Coordinator o Asian Barometer Survey, a regional network o survey on democracy, governanceand development covering more than seventeen Asian countries. He currently serves on the editorial boardo Pacifc A airs, International Studies Perspective, China Review, Journal o Contemporary China, Journal o East Asian Studies and Journal o Democracy.




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undamentals were quite healthy in most East Asian economies. Except orJapan, most governments were not heavily indebted and they still enjoyedspare scal capacity to borrow and spend. So most East Asian governmentsand central banks responded to the global nancial crisis with decisive and rm

scal and monetary actions. Last, but not least, the region’s resilience should beattributed to the rapid turnaround in the region’s larger, less export-dependenteconomies. Although adversely a ected, China and India are not in recession:their huge domestic sectors helped cushion the impact. Exports constitute just35 per cent o China’s GDP and 22 per cent o India’s.

The Root Causes o the Crisis

Most East Asian policy makers and economic thinkers take issues with theview that a savings glut rom Asian surplus nations was the main culprit o the global crisis. It is true that a ter the Asian nancial crisis o the late 1990s,

most developing countries in the region insured themselves through managingexchange rates and building huge currency reserves. So that they could beprotected against the tempests o currency speculation and never again wouldhave to call on the emergency lending windows o the IMF.

While some o these insurance measures contributed to imbalances and tensionsin the global economy, they were the symptoms, rather than the root causes,o the inherent vulnerabilities and systemic risks in the existing internationalmonetary system. The requency and increasing intensity o nancial crises

ollowing the collapse o the Bretton Woods system suggests that the cost o the current system has exceeded its bene t. The dollar, as the predominantinternational reserve currency, is not anchored to a stable benchmark andissued according to a clear set o rules. Furthermore, the supply o dollars is notdisconnected with economic conditions and sovereign interests o the UnitedStates. As a result, an orderly issuing o reserve currencies or securing global

nancial stability and acilitating world economic growth has become an evermore illusive goal.

More broadly speaking, the current system o global economic governanceorged in the middle o the 20th Century has been overtaken by the undamental

economic shi t taking place in the last twenty years. The breakdown o theplanned economies in the Soviet Union and Central and Eastern Europe,the economic re orms in China and India, and the export-driven growthstrategies o East Asia contributed to an enlargement o world market economyat breath-taking speed. The size o active participants in this enlarged globalized

economy has grown rom about 1 billion to more than 4 billion people. Boththe legitimacy and e ectiveness o G8, the IMF and the World Bank, has beenmuch undermined as their rules o representation and decision-making couldnot refect the weights and new responsibilities o these emerging economicpowers.

This outdated global system o economic governance was also intellectuallyfawed as it was designed around a dubious intellectual underpinning, namely“rational market” theory. The gospel o nancial deregulation has given rise toan explosion o unregulated shadow banking activities by non-bank nancialinstitutions and hedge unds. The complexity o their o -balance-sheettransactions and hedging strategies and the systemic risks they have created





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were simply beyond the grasp o national and international regulators andsupervisors.

Most East Asian thinkers agree with the diagnosis o Simon Johnson, the ormerchie economist at the IMF, who pointed out that the mismanagement in U.S.

nancial system was not a series o random accidents. Rather it was the resulto loose government regulation and perverse incentives that tied executives’compensation with short-term per ormance. In the nal analysis, they werethe outcome o a political process through which regulators were capturedintellectually by the Wall Street.

Many East Asian policy makers also shared the view that central banks in thedeveloped world have been complacent about the gigantic risks that asset pricebubbles posed to the real economy o jobs, production, savings, and consumption.

The U.S. Fed’s repeated e orts to contain the damage o the burst o bubble to thereal economy through aggressive easing o interest rates have merely delayed

the necessary structural adjustment and market correction and produced biggerasset price bubbles later on and aggravated the problem o “moral hazard”.

In a nutshell, both the existing system o global economic governance andits intellectual tools have not been grounded on the “reality” or too long. Thisoutdated system calls or not just some patched-up changes but a timelyoverhaul.

Road to Sustainable Growth

With perhaps the exception o Japan, all East Asian countries welcome BarackObama’s announcement at the Pittsburgh Summit that in the uture G20 willreplace G8 as the world’s premier coordinating body or economic issues andpossibly other global challenges as well. Although revamping this premier globaleconomic orum was introduced on an ad hoc basis to manage the nancialcrisis, it ushered in a new era o global economic governance. The G20 could playan important role in acilitating and inducing East Asia to pursue crucial structuralre orms to rebalance the global economy. It could also acilitate discussion anddeliberation to develop a set o new principles and guidelines or the adaptationo global economic institutions and arrangements to the new challenges.

Most Asian countries strongly elt that a sweeping re orm o the internationalnancial institutions, in particular the IMF, was long overdue. Many Asian leaders

have consistently urged that the voice and representation o the developing

countries be realigned to refect their contributions to global outputs. They havealso advocated an overhaul o the Fund’s lending and conditionality ramework.In that context, Asian countries generally support the introduction o “FlexibleCredit Line (FCL)” as a new crisis prevention mechanism or countries withstrong undamental, policies, and track records o policy implementation. Theyalso support IMF to enhance its cooperation with the Financial Stability Forum(FSF) and to complement each other’s role in promoting nancial stability, andstrengthening the regulatory authorities’ responsiveness to risks, includingworks on an early warning system.

Most East Asian leaders also endorsed a sweeping re orm o national andsupranational regimes o nancial regulation. It is essential to revamp the regulatory




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regime so as to cope with global conglomerates with too big to ail nature and posesystemic risks to the nancial system. It is imperative to expand the scope andmandate o the existing regulators so that they are equipped to reign in non- nancial

rms that have grown out o traditional border boundaries and created new rontiero risks. It is also imperative that nancial regulatory standards within and acrossnational borders should be updated to e ectively supervise new nancial productsand innovations. However, they don’t have high expectation or a sweeping changebecause so ar there is very little real re orm under way or on the table.

Most Asian economic thinkers are inclined to endorse the recommendationto the United Nations General Assembly by the Commission o Experts onRe orm o International Finance and Economic Structures. As Joseph Stiglitz,the chairman o the Commission, suggested, the crisis provided the impetus

or pushing or a comprehensive regulatory system ocused more intensely onlarge, “systemically signi cant” institutions and countries. The new regulationscould be propped up by incentives encouraging good risk behavior and policies

that would keep banks rom becoming too big to ail. The commission’s report also promoted the ideas that countries and marketsmay also experiment with nancings denominated in Special Drawing Rights(SDR), which refect a port olio o major currencies. Eventually SDRs couldbe upgraded to unction as a type o global reserve currency. Moreover, anincrease in SDR allocation would help the IMF address its resources problemand the di culties in the voice and representation re orm.

The Commission’s recommendation rein orced the persuasive power o an earlierproposal put orward by Zhou Xiao-chuan, the Governor o the People’s Bank o China. Zhou openly advocated with exceptional candor the creation o a super-sovereign reserve currency or the replacement o the United States dollar as theworld’s standard reserve currency. He argued that doing so will not only eliminatethe inherent risks o credit-based sovereign currency, but also make it possible tomanage global liquidity. A super-sovereign reserve currency managed by a globalinstitution could be used to both create and control the global liquidity. And whena country’s currency is no longer used as the yardstick or global trade and as thebenchmark or other currencies, the exchange rate policy o the country would be

ar more e ective in adjusting economic imbalances. This will signi cantly reduce therisks o a uture crisis and enhance crisis management capability.

More speci cally, Zhou proposed that special consideration should be given togiving the SDR a greater role. The SDR has the eatures and potential to actas a super-sovereign reserve currency. There ore, SDR allocation should be

increased steadily and the scope o its use should be broadened. As a rst step,a settlement system between the SDR and other currencies need to be set up. This will make the SDR, which is now only used between governments andinternational institutions, a widely accepted means o payment in internationaltrade and nancial transactions. Another measure to increase its appeal is tocreate nancial assets denominated in the SDR. In addition, the use o the SDRin international trade, commodities pricing, investment and corporate book-keeping should be actively promoted. These steps will eventually enable SDRto ully satis y the member countries’ demand or a reserve currency.

However, most East Asian policy makers don’t think a transition rom thecurrent system to the new system designed around a super-sovereign reserve





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currency is imminent. Nor do they think that the transition, i it ever comes topass, will be smooth. So a undamental x to the inherent vulnerability andsystemic risks o the existing global monetary regime is not in sight or the timebeing. The United States simply would not orego her seigniorage bene ts o reserve creation in the oreseeable uture. As a consequence, most East Asianeconomies still eel the need to build up their own shock-absorbing capacitythrough managing exchange rate and stockpiling oreign reserve to protectthemselves rom the tempest o nancial turmoil. The implication, however, isstraight orward. I the dollar remains the predominant reserve asset, speci callyi the growth in reserves continues to consist principally o dollars, then East

Asian economies’ reserve objectives can be satis ed only i global imbalancespersist. A new (but di erent) crisis will eventuate be ore long, this time mostlikely caused by an unacceptable level o indebtedness o the United States.

With that dire prospect in mind, East Asian countries are motivated to seek mutualassistance through bilateral or regional arrangements with greater vigor. First, major

East Asian economies have expanded their bilateral currency swaps mechanismswith their major trading partners to make a larger share o their bilateral trade tobe settled in local currencies rather than U.S. dollars. Next, under the auspices o

ASEAN Plus Three (APT), two regional nancial cooperation initiatives, the ChiangMai Initiative Multilateralisation (CMIM) and the Asian Bond Markets Initiative (ABMI),are well underway. The CMIM established a ramework o mutual assistance among

APT countries to address each others’ short-term liquidity di culties. The ABMIinitiative was designed to promote the local currency bond markets and enhancethe recycling o regional savings towards developing regional bond markets.

At a special meeting held in Phuket in February 2009, APT members have agreedto increase the size o the CMIM by 50 percent rom US$ 80 billion to US$ 120billion, and to develop a more robust and e ective surveillance mechanism tosupport the operations o the CMIM. In their May 2009 meeting in Bali the nanceministers o APT have reached agreement on all the main components o theCMIM, including the individual country’s contribution, borrowing accessibility,and the surveillance mechanism, and decided to implement the scheme be orethe end o the year. At the Bali meeting, the nance ministers also reiteratedtheir pledge or expanding the role and unction o Asian Development Bank(ADB). A planned capital enhancement will augment ADB’s capital base to anappropriate level. A Credit Guarantee and Investment Mechanism (CGIM) willbe established as a trust und o the ADB to support the issuance o localcurrency-denominated corporate bond in our region.

In private, most Asian sovereign holders o U.S. treasuries are deeply concerned that

the U.S.’s spending and planned record scal de cit will eventually lead to infationand a loss o con dence in the dollar. The de cit is projected to reach $1.75 trillionin the year ending Sept. 30 rom last year’s $455 billion short all, according to theCongressional Budget O ce. However, publicly most Asian countries do not wantto push this issue too hard. I they sound too alarmist and contribute substantially toa dollar and Treasuries sell o , they are going to eel more pain than the rest o theworld at least in the short run. Collectively East Asian economies hold more than twothird o the $3.428 trillion oreign-owned Treasuries as o July 2009, with China andJapan respectively holding $800.5 billion and $724.5 billion.

Nevertheless, Asian countries will open their eyes or other options to the dollar.Disparaging demographics and growth prospects make Japanese Yen an




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increasingly unlikely candidate. In the near terms, the Euro’s acceptability couldgrow. Over the horizon, Renminbi poses the biggest challenge to dollar’s statusas the predominate reserve currency, especially in Asia. Most notably, China ismoving toward gradual internationalization o its currency. China has introduceda series bilateral currency clearance centers along its borders with Central Asia,

Vietnam, Laos, Thailand and Myanmar, to make it easier or trading partnersto do business in Renminbi. China recently announced that oreign companieswill be able to list their stocks in China, a step toward making Shanghai aninternational nancial center. Also, as a substitute or ull currency convertibilityo its currency, in September 2009 Beijing issued or the rst time Renminbi-denominated government bonds to o shore investors through Hong Kong. Thisis widely regarded as a strategic move or advancing its long-term objective o developing a ully-fedged o shore Renminbi bond market with enough depthand liquidity.

In the past, Asian economies have bene ted immensely rom trade liberalization

and the process o economic globalization in general. They are ully committedto the principle o open regionalism and rmly uphold the WTO-centered rule-based system. They embraced the anti-protectionism and pro-Doha Round

joint statements o the G20 London Summit. However, they are concerned withthe recent political trends in the developed world. Virtually all OECD countrieshave violated in some degree their pledges not to take protectionist measureswhen they ormulated their anti-recession policies and measures, or choose totarget their nancial support or speci c industries, and the inhibitions on theirdoing so may erode with time.

They are equally concerned that the United States will not be able to provideinternational leadership needed in the trade arena or some time. The recenttwo American national elections, particularly the 2008 Congressional elections,brought large numbers o new, mostly Democratic members o Congress whoare highly skeptical o reer trade agreements. Obama’s campaign rhetoric,particularly his call or renegotiating NAFTA during the primary season, althoughskirting outright protectionism gave the appearance o a protectionist approach.Domestic U.S. industries may be urther encouraged to seek protection as aresult o a more sympathetic political environment or protectionism in the UnitedStates. This was widely regarded as one o the main dangers o the decision toaward Section 421 sa eguard protection against Chinese tires in September2009.

Policy makers in the region also share a worry that the Doha Development Roundhas been the longest-running negotiation in the history o the modern trade

negotiating system, and it threatens to be the rst to ail. Delays have alreadyprevented the harvesting o trade liberalization measures that have already beenpromised. This has already precipitated the proli eration o bilateral and mini-lateral agreements. South Korea has been the ront runner in seeking bilateralpre erential arrangements. It signed the FTA with the United States in 2007 andstruck a similar deal with EU in October 2009. More Asian economies will ollowSouth Korea’s path.

In the a termath o the crisis, all East Asian policy makers recognized that theold export model o growth won’t be sustainable in a more “balanced” globaleconomy in which the U.S. consumers will have to save more and spend less. Anecessary strategic adjustment entails rebalancing the dependence on export-led





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growth with more regional and domestic demand. Most East Asian emergingeconomies look to exploit the vast potential demand in China and India and theregion’s savings glut. This suggests that more o the region’s savings shouldbe intermediated within the region and that intra-regional production networkscould be deepened by investing in regional in rastructure to speed up intra-regional shipments, by promoting trade in green technologies and by greaterreliance on trade in services. The o cial launch o the ASEAN-China FTA in2010 will be a crucial step in advancing this common vision.

All East Asian leaders also ully recognized that their economies are now enteringa post-crisis, low-carbon world. They quickly adopted “low-carbon greengrowth” as their new paradigm o sustainable growth which uses less energyand is more compatible with environmental sustainability. Japan has alreadysped ahead o the rest o the world in hybrid-car technology. China is emergingas a leader in electric cars, solar power and wind power. The South Koreangovernment is spending $31 billion to und research in 27 green technologies,

including non-silicon-based solar cells, biomass uels and carbon collection,storage and processing. Green projects account or 81% o South Korea’seconomic-stimulus programs and 38% o China’s. At the latest Northeast AsiaSummit held in Beijing in October, In particular, the leaders o China, Japanand South Korea share a bold vision to push or East Asia’s bid or economicleadership in the low-carbon age. They have hammered out not only a united

ront or the Copenhagen climate con erence in December 2009 but also a joint plan to pool their resources and expertise to develop and commercializeemerging green technologies. Many observers believe that it is a hardheaded,shrewd initiative to marry Japanese and South Korean high technology withChina’s manu acturing prowess, massive domestic market and bulging oreign-currency reserves.

Asia’s Place in the World

Many prominent Asian thinkers see the region at a crossroads. Asia is poisedto occupy a unique place in the world. By 2030 three o the world’s our largesteconomies will be located there and the world’s two largest populations live sideby side. By 2020 China will produce 44 per cent o Asia’s economic output andIndia and Japan will account or 17 and 15 per cent, respectively, as estimatedby the Asian Development Bank in its 2008 study Emerging Asian Regionalism.

Together the three will be 20 per cent larger than the US economy. As Chinaand India emerge as economic powerhouses they will compete with Japanand each other or infuence and leadership o the region – unless a serious

commitment to community building creates common goals and channels orcloser cooperation.

The absence o an acknowledged leader, however, constrains the scope andspeed o deeper integration in East Asia. Without an accepted champion toprovide ocus and set priorities governments have to be content with incrementalchange. For some time ASEAN has been regarded as the core, particularly byChina which assumes any initiative it might take would be highly suspect by thesmaller countries. Cooperative regional institutions serve China’s objective o developing closer riendly relationships in the neighborhood and its desire tocounter-balance US infuence but the impetus must be provided by others.

At present, evolving regional institutions have ASEAN at the core and other




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