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

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

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

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Facets of external openness

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

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Trade liberalization

• Some signs of convergence in the debate on the
  social impact of trade liberalization
• Proponents of trade liberalization see their
  initial optimism disappointed and concede that
  trade liberalization alone does not create growth
  and employment.
• Critics accept that integrating countries have
  not entered a race to the bottom, but that
  non-integrating countries have continued to have
  serious problems.

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Trade liberalization

• However, trade liberalization can
• entail considerable adjustment costs and job
  churning, and
• can lead to greater wage inequality (experience
  especially in Latin America).
• Benefits of trade liberalization depend on
  initial conditions and successful management of
  process (Lall).

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Financial openness and employment

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

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The rationale behind financial liberalization

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

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Financial liberalization sincethe early 1990s
Capital account

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

Countries with Capital Controls, 1980-2001 (in
of total IMF membership)
Source IMF.
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Trends in international capital flows and
investment

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

Gross Fixed Capital Formation and FDI, 1977-2003
(World)
Source World Bank.
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Distribution of private capital flows

• Private capital flows are skewed towards
  high-income countries, and some middle-income
  countries.
• A similar trend can be observed for FDI (see
  graph).

FDI Inflows by Economic Grouping, 1980-2003 (in
billion current US)
Source UNCTAD.
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World GDP growth, 1961-2004
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Direct growth effects of financial liberalization

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

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Indirect growth effects though increased reserve
holdings

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

Reserve Holdings by Developing Countries,
1970-2004 (in of GNI)
Source World Bank.
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Volatility and financial crises

• Financial liberalization in developing countries
  is associated with higher consumption volatility
  and increased growth volatility compared to
  developed countries (Prasad et al. 2004).
• Financial openness has made countries more
  vulnerable to crises, e.g.
• Argentina 1995 and 2001-02
• Brazil and Chile 1998-99
• Indonesia, Rep. of Korea, Malaysia, Philippines
  and Thailand 1997-98
• Mexico 1994-95
• Turkey 1994, 1998-99 and 2001

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Impact of financial crises on long-run growth
Typical Growth Path after Financial Crises in
Rich and Poor Countries

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

Source Cerra and Saxena (2005 24)
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Impact of financial crises on employment

• Labour market consequences are evident from a
  number of indicators
• Higher unemployment
• increase in share of informal employment
• falling real wages and falling incomes
• higher poverty (e.g. in South-East Asia, the
  number of working poor rose from 33.7 million
  before the crisis to 50.6 million in 1998).

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Impact of financial crises on employment
(examples)

• Recovery of social indicators generally lags the
  economic recovery by several years.

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Impact of financial crises on the labour share

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

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Building a stable int. financial system for
growth employment

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

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Three broad policy areas for policy coherence

• Policies in industrialized countries
• Multilateral rules
• Policies in developing countries

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1. Policies in industrialized countries

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

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2. Multilateral rules

• Developing countries should be integrated into
  the financial system
• They are not adequately involved in reforms
• Progress is slow and limited
• New codes may make financial market access more
  difficult
• Need for equitable mechanisms of debt resolution
• Capital account liberalization should depend on a
  countrys circumstances.
• Reduce financial volatility and contagion in
  emerging markets Supply of emergency financing
  should be speeded up.

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3. Policies in developing countries The policy
trilemma

• Nationally policy space circumscribed by
  so-called policy trilemma
• Open capital account
• Stable exchange rates
• Independent monetary policy
• Something has to give?
• Or can we avoid the corner solutions?
• Or can we add more instruments?

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Avoiding corner solutions Active RER regime

• The positive effect of an active real exchange
  rate regime on employment works through three
  channels
• Higher capacity utilization in times of
  unemployment (requires combination of
  macroeconomic and fiscal policies).
• Stimulate output growth (combination with
  industrial policies).
• Contribute to increased employment elasticity
  (shift in sectors).

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

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