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GENEVA
Chapter II
Financialization and Its
Macroeconomic Discontents
UNITED NATIONS
New York and Geneva, 2015
27
Chapter II
A. Introduction
28
29
30
31
Chart 2.1
10
1 600
1 400
8
Percentage of GNI
1 800
$ billion
1 200
1 000
800
600
7
6
5
4
3
400
200
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2013
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2013
Source: UNCTAD secretariat calculations, based on World Bank, International Debt Statistics (IDS) database.
the larger economies of this group, accumulated considerable amounts of external reserve assets during
this period (chart 2.2).9 Under these circumstances,
reserve accumulation primarily reflects an excess of
inflows over the amounts that would normally be
consistent with domestic spending and investment
patterns. By 2013, over 40 per cent of the reserves
held by DTEs were borrowed, in the sense of not
deriving from a current account surplus, but rather
set aside from capital inflows (Akyz, 2014: 11).
While policy makers often see reserve accumulation as a precautionary measure, there are limits to
this strategy. Given the levels of inflows and reserve
accumulation, an important question is whether these
patterns are consistent with financial stability and
sustained global demand.
When considering the balance of payments,
the focus is often on trade deficits and surpluses,
on the assumption that net factor incomes10 will
simply reflect a neutral pattern of capital flows. But
the determination and implications of the factor
income balance involve a few complexities. First,
factor incomes depend on the volume of assets and
32
Chart 2.2
Foreign reserve stocks in developing
and transition economies, 19702013
(Percentage of GNI)
30
25
20
15
10
5
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2013
Total for developing and transition economies
Developing and transition economies
excluding major economiesa
33
34
Chart 2.3
Composition of capital flows, selected developing
and transition economies, 20022013
(Percentage of GNI)
10
Argentina
Brazil
10
10
0
-2
-4
-6
-8
-10
10
India
6
4
2
0
-2
14
0
-2
-4
Indonesia
10
-4
0
-2
Mexico
25
20
15
10
-2
-4
-5
-6
South Africa
14
-4
14
-2
-2
2002 2004 2006 2008 2010 2012 2013
Turkey
-4
-2
2002 2004 2006 2008 2010 2012 2013
Ukraine
30
12
25
10
20
2
0
0
-2
-5
-4
-10
Other DTEs
10
10
-4
15
Thailand
6
2
Malaysia
10
-10
12
10
30
10
12
-4
China
-2
2002 2004 2006 2008 2010 2012 2013
-4
35
36
37
Chart 2.4
40
Argentina
1.5
30
1.0
20
40
Brazil
China
1.5
15
1.0
10
1.0
0.5
0.5
0.0
2002 2004 2006 2008 2010 2012 2013
0.0
2002 2004 2006 2008 2010 2012 2013
30
1.5
20
10
0.5
0
-10
15
0.0
2002 2004 2006 2008 2010 2012 2013
India
10
10
0
1.5
20
1.0
10
Indonesia
1.5
1.0
20
Malaysia
15
1.5
1.0
10
5
0.5
0.5
0.0
2002 2004 2006 2008 2010 2012 2013
-10
0.0
2002 2004 2006 2008 2010 2012 2013
15
Mexico
10
1.5
15
1.0
10
South Africa
1.5
1.0
0.5
5
0
15
0.0
2002 2004 2006 2008 2010 2012 2013
Thailand
10
1.5
1.0
5
5
0.5
0.5
0.0
2002 2004 2006 2008 2010 2012 2013
0.0
2002 2004 2006 2008 2010 2012 2013
40
Turkey
1.5
30
20
1.0
40
Ukraine
0.5
0
-5
0.0
2002 2004 2006 2008 2010 2012 2013
Other DTEs
1.5
15
1.0
10
1.0
0.5
0.5
0.0
2002 2004 2006 2008 2010 2012 2013
0.0
2002 2004 2006 2008 2010 2012 2013
30
1.5
20
10
0.5
0
-10
0.0
2002 2004 2006 2008 2010 2012 2013
10
0
Source: UNCTAD secretariat calculations, based on World Bank, IDS database; IMF, World Economic Outlook, April 2015; and IMF,
International Financial Statistics database.
38
39
estate markets. Such large inflows are often magnified by the way fiscal and monetary policies adapt to
investors expectations. The consequent build-up in
financial fragility, driven by largely private speculation
and risk-taking, is often swiftly unwound by a crisis,
with substantial negative real effects and a sharp rise
in public debt. Table 2.1 lists countries and the dates
of their currency, sovereign debt or banking crises,
grouped by the four waves of financial crises identified:
various debt crises in the 1980s, the Mexican crisis in
19941995 and its so-called tequila effects, the Asian
financial crisis in 19971998, and its ripple effects
on countries outside the Asian region.28 It is not a
complete list of all of the financial crises that occurred
during these periods, but rather a representative
sample dictated by data availability and core themes.
Almost all of these crisis episodes listed (31 out
of 33) were preceded by a capital flow bonanza,
defined as an unusually large negative surge in the
current account balance.29 Similarly, domestic credit
booms preceded crisis nearly 75 per cent of the time
(24 out of the 33 episodes listed). In the table,
minimum real per capita GDP growth refers to the
minimum growth rate within four years of the start
of the crisis (including the crisis year, recorded as
the earliest year that any of the three types of crises
began, and is referred to as time T). Its intent is to
make inferences, however rough, about the output
losses resulting from these crises. The last two
columns indicate the costs of the financial crises in
terms of the growing public debt, both to domestic
and external creditors. Comparing public debt as
a share of GDP the year before the financial crisis
begins (T-1) relative to two years after (T+2) for the
entire group of crises listed, the median (average)
increase in total gross central government debt is
85.9 (124.3) per cent, while the median (average)
increase in external government debt is 42 (60.5)per
cent. Interestingly, although fiscal mismanagement is
a frequent refrain in mainstream accounts of financial crises, it is typically the public fielding of the
private bust, and all the costs associated with it (e.g.
nationalizing private debt, recapitalizing banks, and
the impact of currency devaluation on the value of
foreign currency liabilities), that run up public debt.
(a) Lessons of the 1980s
The Latin American debt crises of the 1980s
caught many investors and analysts by surprise.30
The world had not witnessed a major financial
40
Table 2.1
Periods of financial crises, capital flows and public debt
Country
Debt crises of the 1980s
Argentina
Chile
Mexico
Uruguay
Colombia
Ecuador
Paraguay
Turkey
Venezuela (Bolivarian Rep. of)
Brazil
Peru
Philippines
Argentina
Peru
Venezuela (Bolivarian Rep. of)
Brazil
Group median
Tequila crisis
Mexico
Argentina
Group median
Asian financial crisis
Indonesia
Republic of Korea
Malaysia
Philippines
Thailand
Group median
Ripple effects from
the Asian financial crisis
Colombia
Ecuador
Russian Federation
Ukraine
Brazil
Turkey
Argentina
Paraguay
Uruguay
Venezuela (Bolivarian Rep. of)
Group median
Minimum
annual real
Sovereign Banking
per capita
Currency debt crisis
crisis
Capital Domestic GDP growth
crisis
(default (starting
flow
credit
(year)
year)
year)
bonanza boom
1981
1982
1982
1983
1985
1982
1984
1982
1983
1982
1983
1984
1982
1983
1981
1983
1987
1988
1989
1982
1982
1983
1998
1998
1998
1999
1998
1998
1999
2001
2002
2002
2002
2002
1982
1983
1983
1989
1990
1995
1998
1980
1981
1981
1981
1982
1982
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
Change in
Change in
total gross gross external
public debt
public debt
as a share
as a share
ofGDP
ofGDP
(Per cent)
-7.1
-11.7
-6.1
-10.9
-1.3
-2.9
-5.9
1.2
-6.3
-5.6
-12.5
-9.8
-8.8
-14.2
-10.9
-5.9
-6.7
417.7
161.7
95.7
378.5
71.1
60.5
78.7
83.1
95.2
12.7
127.6
n.a.
111.4
146.8
43.9
191.1
95.7
53.4
106.9
117.9
302.9
35.2
16.0
35.5
32.7
62.1
39.7
73.4
34.2
87.7
68.7
8.8
32.1
46.6
1994
1995
x
x
x
x
-7.6
-4.1
-5.9
26.4
14.5
20.5
47.0
41.3
44.2
1997
1997
1997
1997
1997
x
x
x
x
x
x
x
x
x
x
-14.4
-6.4
-9.6
-2.7
-11.5
-9.6
246.0
278.8
7.1
10.4
597.7
246.0
100.9
65.3
38.1
42.5
28.0
42.5
1999
1998
1998
1998
1998
1998
1998
x
x
-5.8
-6.6
-5.1
2001
2000
2001
x
x
x
x
x
x
x
2002
2002
x
x
x
x
117.5
49.9
39.5
70.0
-15.2
144.4
208.1
-3.3
88.6
22.5
60.0
20.8
28.9
96.4
n.a.
46.1
35.1
149.9
18.5
60.7
10.1
35.1
1999
1998
x
x
-1.2
-7.1
-11.7
-2.0
-7.8
-10.5
-6.2
Note: Country and crisis listings: Countries are listed in order of earliest crisis year of the three types of crises listed, referred to as time T, and then
alphabetically; source for dates of the currency, debt and banking crises is Laeven and Valencia, 2008.
Capital flow bonanza: An x indicates that a capital flow bonanza occurred within any one of three years preceding the earliest crisis date; source:
Reinhart and Reinhart, 2008.
Domestic credit boom: An x indicates that a domestic credit boom was identified preceding time T in one of three sources: Arean et al., 2015;
Elekdog and Wu, 2011, or Takts and Uper, 2013.
Minimum real per capita GDP growth: This refers to the lowest annual growth rate within four years of the beginning of the crisis (i.e. the range
is time T to (T+3)); source: World Bank, World Development Indicators database.
Public debt: Total gross central government debt includes both domestic and external debt. Total gross external government debt includes all
external debt owed to both the public and private sectors. Percentage changes are based on UNCTAD secretariat calculations; source: Reinhart
and Rogoff, 2010a, except for data on Ukraine, which is from de Bolle et al., 2006, and percentage changes are based on UNCTAD secretariat
calculations of the change between (T-1) and (T+2).
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43
The experiences of Argentina and Brazil illustrate these dynamics and their links with vulnerabilities established in prior crises. Brazils system
of public financing was severely weakened by its
efforts to weather the tequila crisis, where in addition
to raising interest rates, a banking sector restructuring loaded the Government with lots of additional
debt. The economic slowdown and very high interest payments caused Brazils internal fiscal debt to
soar between 1994 and 1998, with interest on public
domestic debt amounting to 3.4 per cent of GDP in
1994 and 7.3 per cent of GDP in 1998 (TDR 1999;
Sainz and Calcagno, 1999).35 Defending the currency
peg in light of the sudden stop in capital inflows and
insufficient reserves became quickly untenable, and
currency crisis and devaluation ensued in early 1999.
In Argentina, with unsustainable exchange rates,
any economic growth increased its trade deficit, but
the lack of growth led to a fiscal deficit: neither of
these deficits was consistent with the convertibility
regime. This contradiction could be circumvented as
long as external financing kept flowing. However,
when that stopped, tough fiscal austerity and IMF
assistance could not prevent an economic implosion,
a run on deposits and a partial default on public debt
(Calcagno, 2003; Calvo and Talvi, 2005; Damill et al.
2013; Grabel, 2006). Real average annual per capita
GDP growth in Argentina sank to -4.2 per cent during the lost half-decade, while the average for Latin
America as a whole was 0.2 per cent.36
(d) Public sector finances in the context of
financial liberalization and systemic risk
This brief review clearly suggests that the likelihood of financial crises increased as DTEs liberalized
their capital accounts and domestic financial markets,
which led initially to surges in capital inflows and
then to the sudden stops or reversals that almost
always ensue.37 And although capital flow bonanzas
increased in tandem with free market policy stances
in developing countries, they continued to be significantly driven by circumstances external to the
economies that hosted them, such as changes in global commodity prices or in United States interest rates,
or by the psychological and economic contagion
effects of crises elsewhere. These external forces
interact with domestic macro policy and structure in
ways that raise overall fragility and risk. But domestic
factors are only significant when they exist within
a larger global financial system characterized by
44
Table 2.2
Financial crisis and public debt in Mexico, the Russian Federation and Argentina
(Per cent)
Total gross public debt
as a share of GDP
Country (crisis date)
Mexico (1994)
Russian Federation (1998)
Argentina (2001)
Reference
level
Pre-crisis
growth
Post-crisis
growth
Reference
level
Pre-crisis
growth
Post-crisis
growth
42.6
30.2
37.6
-29.2
34.1
19.8
26.4
39.5
208.1
37.3
31.0
47.9
-10.7
4.0
6.2
47.0
96.4
149.9
Source: UNCTAD secretariat calculations, based on data from Reinhart and Rogoff, 2010a.
Note: Time T refers to the crisis year in parentheses. The columns refer to the following:
Reference level is debt as a share of GDP at (T-3);
Pre-crisis growth refers to the percentage change between (T-3) and (T-1);
Post-crisis growth refers to the percentage change between (T-1) and (T+3).
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developing countries can attract international investors to domestic securities markets. And even when
they do, there is the additional risk that larger shares
of debt, regardless of currency denomination, will
be held by more internationally mobile investors.
Recent evidence bears out this warning: greater
foreign participation in domestic currency sovereign
bond markets has been associated with heightened
volatility as a result of increased exposure to global
financial shocks (Ebeke and Kyobe, 2015).
A similarly mixed result is seen in the growth
of international reserves among DTEs. The build-up
of reserves is in principle mostly precautionary, in
the sense that it is expected to guard against a host of
ills introduced by large and speculative international
capital inflows and the negative economic and social
consequences of their sometimes sudden or substantial departure. Precautionary reserve buffers also
hedge against the loss of policy autonomy that often
accompanies IMF-type bailouts or against pressures
to provide the macro policy conditions preferred by
international financial investors (Grabel, 2006). But
even if reserve accumulation does offer some protection, providing some policy space to countries whose
currencies are under attack, there is an opportunity
cost to tying up development resources in this manner. Furthermore, when policymakers try to counter
capital flow reversals through the use of reserves, they
often end up resorting to complementary measures,
such as interest rate increases, as the stock of reserves
declines. These policy responses ultimately weaken
the economy and erode confidence even further. As
noted above, such trade-offs pose a challenge to
central bank policy.
In considering policy options, central banks
in DTEs should carefully evaluate the implications
of narrowly applied inflation-targeting regimes.
Pressing too hard to achieve inflation rates deemed
desirable more often in developed-country contexts
could easily lead to high interest rates and appreciation of the real exchange rate, both of which
discourage productive investment and hence development. Still, the widespread (formal and informal)
adoption of inflation targeting by some developing
countries central banks reflects real apprehension
over any hint of inflation, given their histories of
high inflation. But probably more important is the
widespread belief that inflation targeting regimes give
more credibility to the central banks that implement
them, lowering expectations of inflation and enabling
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Notes
7
8
10
11
1 2
1 3
1 4
15
16
1 7
1 8
1 9
2 0
2 1
22
23
24
25
26
27
28
29
30
31
32
49
50
3 3
34
35
36
37
38
39
40
41
42
the leakages (tax, savings and import propensities, respectively). This equation establishes that
growth of GDP depends on the growth of the three
variables, G/t, I/s and X/m; defined as fiscal stance,
private stance and external sector stance, respectively, amplified by the strength of the respective
multipliers, given the mentioned weights, in the
macroeconomic context. To avoid complicating
the presentation with derivation of the steady state
conditions, it is sufficient to note that these stances
reflect financial conditions as well, where a larger
numerator than the denominator points towards a net
borrowing position. Thus, a steady path of sustained
growth and financial stability requires that none of
these stances grow at a proportionally faster pace
than the others for a prolonged period of time.
The external account became the leading driver in
40 per cent of these cases, and became significantly
more important in another 27 per cent of cases.
See Frenkel and Taylor (2006) for a discussion of
the varying circumstances and challenges that are
associated with managing the exhange rate to support
development.
Data from the World Bank (2013) indicate that at
the end of 2012 the share of non-resident holdings
in local DTE debt markets was 26.6 per cent, and
that it was as high as 40 per cent in some economies
(cited in Akyz, 2014: 20).
See TDR 2013, annex to chap. I, where a global
model simulation provides empirical illustration
of the fact that policies based on improved labour
income and supportive fiscal policy yield weaker
results, even if still positive, when partner countries
take an opposite stance and profit in a typical freerider manner.
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