Views from the World
Emerging Markets and Emerging Issues in Global Governance
Pierre Jacquet, Chief economist, French Development Agency (AFD)
(Keizai Koho, June 2008 issue)

One of the defining characteristics of the international monetary system lies with how the system manages balance-of-payment disequilibria and the recurring dilemma between external financing and adjustment. Over the last 25 years, the United States has typically financed a growing current account deficit through borrowing foreign savings. This policy has helped sustain a high rate of growth worldwide and has provided the necessary counterpart to the export-based strategy successfully led by Asian countries, most notable China. Such growth has also sustained an increasing demand for energy products. Without entering into a detailed discussion about causes and effects, this short paper argues that most of the global events that have recently come to the fore are deeply related: the US current account deficit and the fall of the dollar; the oil crisis; the Asian current account surpluses, undervalued exchange rates and reserve accumulation, the dramatically increased wealth of oil producers and of reserve-rich Asian countries, the emergence of sovereign wealth funds as global actors and of so-called state capitalism as a potentially new version of capitalism. The dynamics of wealth accumulation by State entities also partly reflects some sort of implicit nationalization of the US external financing requirements, as they are no longer met so spontaneously by international private investors. It also contributed to slowing down the fall of the US dollar.

These events herald profound changes in the world economy. At one level, we are confronted with the implications of high capital mobility and have not found how to fully cope with it yet. When savings can be allocated freely to what is perceived as the most profitable investments worldwide, there is no reason for current accounts to ever be balanced. Financing, rather than adjustment, becomes the rule; the drivers of exchange rate adjustments, possibly with long lags, have more to do with debt dynamics and sustainability than with short term current account flow considerations. Global imbalances become the standard, rather than an exception. Fixed exchange rates cannot work in a world of independent monetary authorities and high capital mobility. Yet, the current instability sheds doubts on whether a globalized world economy can strive in the long run with uncoordinated economic policies and floating exchange rates. Robert Cooper?fs early vision of a single currency for industrial countries is certainly no closer today, but increased market, capital and labor integration have strengthened his case. Meanwhile, global adjustment can be postponed for long periods, but not indefinitely, and the subprime crisis, the dollar decline and the rise in oil and food prices are all signs that the long awaited correction of unsustainable imbalances has just started.

At another level, international politics has made a forceful comeback. Even among liberal democracies, the redistribution of world wealth implied by sustainable current account imbalances does not leave governments indifferent. And not all countries are liberal democracies yet, meaning that savings decisions and worldwide wealth distribution are neither a fully private affair nor the result of solely private choices. A new form of mercantilism may well have emerged, through which oil producers and Asian exporters developing countries?f governments transform income from raw materials and energy as well as from productive domestic labor into government wealth accumulation. The rise of sovereign wealth funds has emerged as a logical and, given domestic political choices, desirable development. It is understandable that developing countries, having experienced the debt crisis and international financial instability, felt that they should accumulate international reserves as a precaution. However, in most Asian exporting countries, reserve accumulation by the Central Bank has long exceeded any volume that could be deemed appropriate on a sole precautionary motive. At the end of 2007, for example, China?fs foreign exchange reserves amounted to about $ 1.500 billion, or one third of GDP and 18 months of imports. Part of these reserves is usefully kept in the form of highly liquid and secure foreign Treasury bonds. However, this provides a limited return and in fact involves a significant exchange rate risk, as illustrated by the dollar decline. Beyond precaution, there is little rationale in keeping all reserves invested in low-return short-term assets and a powerful rationale to diversify toward longer term, riskier investments by transferring the task of managing reserves to sovereign wealth funds. This utilization of existing savings in excess of domestic investment also brings higher benefits to the world economy through better resource allocation than investing them in short term treasury bonds does. A remaining issue is of course that such excess savings are not the result of decentralized private choices but imposed through the export-led, undervalued real exchange rate government policy. Global adjustment will also mean that growth policies in Asia are reoriented toward domestic demand and terms-of-trade gains through appreciated exchange rates.

In oil producing countries, the challenge is to put the stock of depletable natural resources and energy to good use. Given a limited domestic capacity of absorption, diversification toward foreign investments is necessary. In the past, a sizeable amount of oil resources was dissipated into investments with little social return. Hence, a reasonable oil policy consists either in keeping oil in the ground, or in investing through sovereign wealth funds that accumulate higher return foreign assets. As pointed out by Helmut Reisen from the OECD Development Centre, it is in the interest of oil consumers to welcome such investments so as to encourage rational increases in production.

So far, sovereign wealth funds have been received with much ambivalence. On the one hand, they have played a stabilizing role by providing capital to financing institutions vulnerable to the ramifications of the subprime crisis. On the other hand, doubts are raised about their investment motives. Several caveats are necessary. First, these funds all have specific approaches and strategies, so that bundling them into a single actor is of course simplistic. Second, there is a tendency to oppose economic and political motives. Some observers note that, so far, there is no indication that sovereign funds?f investments have been undertaken for political reasons or for any reason other than maximizing income. However, separating economic, financial, commercial, political or even development assistance motives misses the complementary nature of these various motivations. We have been witnessing the emergence of new and powerful players in the world economy that have broadened and deepened the scope for interdependence. Sovereign funds, be they based on oil or on export based strategies, also strengthen interdependence: oil producers also depend on buyers, and creditors on debtors. The power of fund holders is ambiguous as their wealth depends on the success of what they finance.

In summary, increased capital mobility has weakened the mechanisms that used to pull current accounts back to balance, thus allowing uncoordinated policies and economic cycles to flourish and ultimately unsustainable imbalances to build. The Asian policy choice of export driven growth and an undervalued exchange rate has interacted positively with a US expansion driven by domestic and foreign borrowing. Fast world economic growth has resulted in higher demand for energy and raw materials. As a corollary of these developments, there has been an unprecedented accumulation of financial assets by emerging countries and oil producers. This has played a stabilizing role, and also means that these countries will share the burden of global adjustment. They have emerged as powerful players in the world economy, at a time when there are crucial issues calling for collective action, from traditional subjects of macroeconomic and financial regulation or of trade liberalization to the provision of global public goods such as the fight against global warming or the protection of biodiversity. However, there are serious flaws in global economic governance. Multilateral institutions were created in a different context, and although they have significantly adapted to new challenges, existing structures, power plays and practices have prevented a full-fledged adaptation. There is an urgent need to engage big emerging countries and oil producers in discussions about global governance. This dialogue only makes sense if industrial countries are also willing to share power in multilateral institutions but also to discuss rather than try to impose principles, visions and good practices. Nobody really knows what the future holds for sovereign wealth funds, as some of the reasons of their emergence are likely to fade out through global adjustment. But the rise of China, India, Brazil and other emerging countries is one of the sure and welcome features of an expanded and potentially prosperous world economy. There is a major and demanding challenge ahead in reconciling world politics and governance with these new and evolving features of the world economy.

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