Georgetown University From the SelectedWorks of Robert C. Shelburne November 30, 2008 The European Perspective and Experience in Promoting Regional Development Robert C. Shelburne, United Nations Economic Commission for Europe Available at: https://works.bepress.com/robert_shelburne/41/
UNITED NATIONS ECONOMIC COMMISSION FOR EUROPE Geneva, Switzerland The Follow-up International Conference on Financing for Development Side Event of the United Nations Regional Commissions on the Role of Regional Cooperation and Global Partnership in Financing for Development The European Perspective and Experience in Promoting Regional Development Remarks by Robert C. Shelburne Senior Economist, Office of the Executive Secretary UNECE Doha, Qatar 30 November, 2008
The European Perspective and Experience in Promoting Regional Development Let me begin with a few comments about the Doha document we are here to finalize and the Monterrey document that it updates and reconfirms. I think we should congratulate the co-facilitators of this process, the Ambassadors of Egypt and Norway, and in fact all the member States that have been engaged in these negotiations. Despite the tremendous diversity of ideological opinions and economic circumstances, the Doha- Monterrey documents are really substantive documents. They contain much more than just flowery language about the need for development, the necessity for aid, and the importance of exports. They contain very specific and economically sound principles on how to promote global development. If fully implemented, sustained, inclusive development is all but guaranteed. My optimism about what the Doha-Monterrey principles can achieve derives from what a similar set of principles has achieved and is currently achieving in Europe. Over the last several decades the less developed regions of Europe have grown and converged towards the more advanced regions. This occurred first with the development of southern Europe, then with that of the eastern and central European former transition economies, and the process continues now with south-east Europe and extends further eastward into parts of the Commonwealth of Independent States. Much of this has occurred within the European Union framework, but the process has been broader and more general than that. The European regional approach to economic cooperation and development has been based on what are essentially the Monterrey principles. More specifically, this process of European integration has been characterized by a rapid expansion of trade and investment flows due to the elimination of trade barriers and the opening up of financial markets. These private flows of resources have been accompanied by a significant public transfer of financial resources and technical assistance such as through the numerous EU pre-accession and post-accession aid instruments (such as the Structural and Cohesion funds). Wider assistance has been provided through such things as the EU s Neighbourhood Policy. Complementary to this expansion of trade, investment and aid flows, has been a fundamental redesign of the economic, political and legal institutions in the less advanced economies (such as fulfillment of the Copenhagen criteria and the adoption of acquis communautaire) in order to provide them with an institutional framework that is consistent with economic prosperity. It is also noteworthy that this increased economic output has been achieved not at the expense of environmental degradation but by significantly upgrading environmental standards and addressing transboundary externalities. This entire process of European economic integration and domestic reform has been undertaken under a framework of evolving intergovernmental institutions that have adapted through time to changing political and economic realities. In essence then, the fundamental pillars of the Monterrey Consensus the promotion of investment, trade, aid, and domestic reform, which are all coordinated by evolving and inclusive intergovernmental institutions are also the essential ingredients of European cooperation and integration, including the more specific and recent eastern enlargement of the European Union. These fundamental objectives enunciated in the Monterrey document are also the core of the even broader European regional initiatives such as the Stability and Association Agreements (SAA), the European Neighbourhood Policy and
Union for the Mediterranean partnership agreements. In addition, regional economic cooperative agreements in the CIS region have recently been given some additional momentum. These European regional cooperation initiatives are particularly noteworthy not only in their scope, intensity, and ambitions but in the manner in which they are formalized as comprehensive packages. Although the Monterrey Consensus represents a global partnership where the ability of each country to fulfill its responsibilities is contingent on the others fulfilling theirs, this interrelatedness is sometimes forgotten and the various commitments are incorrectly viewed as individual items instead of as a comprehensive package. The European experience suggests that this interrelatedness is important and that perhaps it should be more explicitly enunciated here in Doha. Finally it should be noted that although the objectives of the Monterrey Consensus are thought of in terms of promoting economic development, the European experience in regional partnerships suggests one more very important outcome. That message is that with prosperity comes peace. Europe today is stable and largely peaceful due to its pursuit of the Monterrey objectives of promoting trade, investment, aid and domestic institutional reform, all the while ensuring that political power in the regionalwide institutions is allowed to evolve appropriately. The central message from Europe is therefore that the objectives incorporated in the Monterrey Consensus have a proven track record. There is no reason to expect that the outcome of fully implementing the Monterrey principles should be anything less than what has been achieved in Europe, that being a much more peaceful and prosperous world. In my remaining time I would like to discuss some new developmental issues of regional significance for the European emerging markets that have become more important since Monterrey. First is the importance of remittances. For many of the poorer European emerging markets these are the largest financial flow and the way in which they are used can significantly affect development. Secondly, is the need to integrate climate change into development policy at the earliest stages. And finally I would like to discuss the current financial crisis and its implications for the European development model and the international financial architecture more generally. Remittances are a very significant financial inflow for the European emerging markets, especially the former transition economies. Figure 1 shows remittance levels in the wider European region as a percentage of gross national product (GDP). The darker the blue, the larger is the percentage. For the world as a whole, remittances are less than one per cent of GDP and for emerging and developing economies they average less than two per cent. For the former transition economies, however, they are quite often over five per cent of GDP and in many cases are in double digits; for some economies they are over 20 per cent and in a few, over 30 per cent of GDP. These are really large numbers and provide an incredible resource for financing development. Most of the accompanying migration flows are intra-regional with those in central and south-east Europe going to western Europe and those in the CIS going to Russia. 2
Figure 1 Remittances in Europe as a Percentage of GDP In figure 2, these remittance inflows are plotted with the other two primary financial inflows, aid (or ODA) and foreign direct investment for the eleven poorest countries in our region over the last decade. Remittances (in the green) have dominated these other flows throughout this period and are now larger than the two other flows combined. As you look at figure 2, I would like to point out that the word remittances appears in the Monterrey Consensus document one time in one sentence while aid is discussed for three pages or one-sixth of the entire document. In the latest draft document for Doha, aid is now up to four pages while remittances now have their own small paragraph. Although the situation is slightly improving, the importance of remittances as providing a source of funds for development is not being given the weight they deserve. In the spring of this year (2008), the Economic Commission for Europe held, as did the other regional commissions, regional consultation meetings regarding the Financing for Development agenda in preparation for this conference. The document of conclusions that came out of that meeting, which is now on the UN s Financing for Development website, contained a number of specific recommendations about policy actions that could increase the impact of remittances on development. We discussed the importance of having worker flows occur within a formal migration framework, the need to provide workers legal protections, initiatives that reduce transfer costs, and the importance of keeping the monetary flows within the formal financial sector if the funds are to be used for investment. Because of time constraints, I do not have time today to go into the details of these proposals, but they are available in this regional consultation document. Nevertheless, the point that I wish to make is that remittances are of increasing importance as a source of external finance, and properly using them can contribute a lot to promoting development; the current Doha and Monterrey documents probably do not give them the attention they deserve. 3
Figure 2 Remittances Compared to Aid and FDI for Europe s 11 Poorest Economies 30.00 Percentage of GDP 25.00 20.00 15.00 10.00 5.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 Aid FDI Inflows Remittances Another issue that has increased in importance since Monterrey is that of climate change. Dealing with this issue will completely alter how the world produces and uses energy. The need to address climate change will fundamentally alter the development process and needs to be integrated into it at the earliest stages. There is sometimes the suggestion that by ignoring this issue, developing countries can take a short cut to development. However, the experience of the European transition economies suggests that it is not economically efficient to develop first and then address environmental problems. It is much cheaper in the long-run to do it right the first time. This does not mean that developing countries have to have the highest standards or those of the advanced economies, but it does mean that they need to fully consider this issue in formulating development plans. By being out front on this, countries can: 1) minimize resource use by using the latest technologies, 2) increase their export opportunities and integrate themselves more easily into production sharing networks, 3) can avoid high rehabilitation costs in future years, and 4) can better plan infrastructure needs and design land-use policies. Climate change, like remittances, does not seem to have been given sufficient attention in the Doha and Monterrey documents, but since this issue remains on the global agenda hopefully it will get the attention it warrants in terms of developmental policy. As others have cautioned this weekend, the financial crisis must not be used as an excuse to delay addressing this issue. The need for a global fiscal stimulus coincides with the need for government expenditures in addressing this issue, and thus climate change expenditures can kill two birds with one stone. In my remaining time I would like to address the current financial crisis and discuss its implications for the region, for development policy, and for the design of the international monetary system. The crisis started in the United States with its mortgagebacked securities based upon subprime loans and spread quickly to Europe where the banks owned a surprisingly large amount of these instruments. Clearly new regulations 4
will be needed in a number of areas in their financial sectors. The banking problems that arose in Europe exposed the inadequacy of its cross-border financial supervision and crisis management capabilities; new regional initiatives will be needed to address the shortcomings that have been revealed. More generally, a new balance will be needed between the market and the state in the financial sector. In addition to the structural issues, a coordinated macroeconomic policy is now needed to address the current downturn. However, given that this is a conference on development, let me focus on the implications for the emerging economies in eastern, central and south-east Europe. These economies will be especially hard-hit given that their development model has relied on extensive net external borrowing to finance their investment. The source of this external funding is now drying up and the resulting adjustments will be costly. If I could step back for a minute, I would like to discuss the desirability of relying on net capital inflows for financing a country s investment. One of the key objectives of the Monterrey Consensus was to create an international environment where developing countries could obtain additional net resources for development which would supplement domestic savings. These would allow a country to invest and consume at a higher level than would be possible otherwise. These additional resources are something extra on top of the benefits of getting foreign direct investment inflows but having to export capital through international reserve accumulation (as collateral) as China or Russia have been doing; this latter process, although beneficial results in no net transfer of resources. The ability to get additional net resources through capital inflows is a powerful development tool. Most would agree that an efficient international monetary system should be able to transfer savings from the capital-abundant advanced economies to the capital-scarce developing countries. However, despite the advantages of financing one s investment from private external capital inflows, many developing countries have decided that with the current design of the international monetary system that this is too risky. This belief was based upon the experiences of Latin America in the 1980s and south-east Asia in the 1990s. The European emerging markets, however, were almost unique amongst emerging/developing economies in attempting to take advantage of this development option over the last decade. To see this, look at figure 3; this provides the estimated current account deficits for the world s economies in 2008; a current account represents net capital inflows. The green represents deficits and the dark green reflects deficits of over 5 per cent of GDP. The European emerging markets of southern, eastern and southeastern Europe are a sea of green. Ignoring the really advanced economies, the only other area with significant dark green is in central Africa. But in Europe the size of the deficits in percentages is much larger, the dollar amounts are much larger because their economies are larger, and the deficits have been large for a long period of time. Thus, when one talks about financing development from private external sources, one is talking about emerging Europe. Let me illustrate a few of these points. 5
Figure 3 World Estimated Current Account Deficits 2008 In figure 4, is a close-up of current account deficits in Europe. The darker the green the larger is the deficit. Not only are the deficits over 5 per cent of GDP, but many are in double digits and several are close to or over 20 per cent. Figure 4 Projected Current Account Deficits in Emerging Europe In addition, these deficits have been persistent over time. Figure 5 provides the current accounts for the major sub-regions of European emerging markets over the last decade and although they are a more recent phenomena in the CIS, overall they have varied between almost 5 per cent and almost 9 per cent of GDP. This means of course that these countries have been able to invest and consume between 5 to 9 per cent more than they would have been able to without external private capital inflows. 6
Figure 5 Current Accounts in the Major Sub-regions of Emerging Europe Note: SEU: Southern EU, NMS-12: EU new member States, SEE-7: south-east Europe, CIS-5: European CIS (excluding Russia), EEM: All European emerging markets In addition, let me point out that not only were the capital inflows from private sources but they were used by private agents. These were not current account deficits that financed government deficits. Much of the capital inflows were equity inflows, but even the debt created was private sector debt. Figure 6 shows that there was very little new public debt created between 1995 and 2007. Figure 6 Long-term Debt in Emerging Europe 7
To summarize this point, the European emerging markets have over the last decade financed their development significantly from externally obtained capital. Thus these countries were almost alone in attempting to reap the promise of globalized capital markets and the hope contained in the Monterrey Consensus that emerging/developing countries could jump start their economies by obtaining more private resources from abroad. This was done in a fairly prudent manner in that little of this was borrowed money to finance government deficits. With the global financial crisis, however, this development model is no longer viable; already six of these economies have had to turn to the IMF for assistance and a number of others will probably have to do so in the coming months. How well these countries can weather this storm will have important implications for what is viewed to be a suitable development model as well as for the degree to which the international monetary system will need to be reformed. If they get through this with only a moderate downturn, it will suggest that relying on net external capital is a reasonable development model and that the international monetary system may need only measured reform in its architecture. However, if they should suffer major crises, such as those in east-asia in the 1990s, it will suggest that relying on net external capital is foolhardy given the current system. In such a situation, it will be clear that when so many different countries, under so many different economic circumstances experience crises from relying on private capital inflows, that there is a fundamental systemic problem in the current design of the international monetary system. As a result, there will likely be calls for a major reform in the current design of the world s monetary system on par with what happened in Bretton Woods in the 1940s. Let me make two other quick observations about this topic. The first concerns the specific institutional mechanism that channeled this capital into eastern Europe. The banking systems there are primarily foreign-owned; west European banks either obtained these banks when they were privatized during the transition or made greenfield investments. The degree of foreign ownership is provided in figure 7. Essentially the west European parents loaned money to their eastern European subsidiaries which then financed investments in these economies. Since the funds provided by the parents were usually in euros, the east European banks often lent in euros to avoid any currency risks. This created an additional source of vulnerability for these economies. Czech Republic Estonia Slovakia Croatia Romania Lithuania Hungary B ulgaria Serbia Georgia Poland Latvia M acedonia Figure 7 Foreign Bank Ownership in Eastern Europe Percentag e of Foreig n Ownership of Banks' Assets 2007 0 20 40 60 80 100 120 8
These relationships are presented graphically in figure 8 (obtained from EBRD). Each line represents the establishment of a significant affiliate in a given eastern European economy from a given west European economy. The current question is whether these lines represent channels of contagion where the financial crisis that has affected banking solvency in western Europe moves eastward; or whether, given the inability to borrow on frozen international capital markets, these lines represent a lifeline of liquidity. How this plays out over the next year will determine the perceived desirability of liberalizing banking systems and allowing foreign ownership for decades to come. Figure 8 Foreign Bank Ownership: Lines of Stability or Contagion? Source: EBRD My second observation concerns the most recently provided IMF assistance to the eastern European region. The Monterrey conference occurred with the memories of the Asian crisis fresh in the minds of many. Concerns about the perceived poor performance of the IMF in addressing that crisis is reflected both in the spirit of the conference and in the content of the Consensus document. In many ways the current situation in east Europe is similar to that in east Asia in the 1990s in terms of the nature of the vulnerability that exists. However, this time the IMF seems to be placing far more emphasis on providing counter-cyclical liquidity for maintaining growth than on insisting on the rapid correction of what they considered then (and perhaps incorrectly) to be structurally unsustainable imbalances. This time, the loans have come faster, are large, and have quite limited conditionality attached. Although the IMF is certainly an institution that has proven capable of learning from its past mistakes, undoubtedly the agreed principles in the Monterrey document were instrumental in bringing about this change in emphasis. Conferences, like this one in Doha, do achieve things. If the approach to sudden stops in international private capital inflows is going to be to attempt to maintain liquidity until private capital markets recover, more public resources will be required. This includes increased funding for the IMF, more bilateral currency swap agreements, and more regional assistance like that recently provided by 9
the EU-ECB to Hungary. Regional monetary authorities may need to be created such as that proposed in the Chiang Mai Initiative. And as the previous speakers have emphasized, the regional development banks need to practice counter-cyclical financing by increasing their loans during periods when private lending dries up. In the European region, the EBRD (European Bank for Reconstruction and Development) has in fact recently increased its activity accordingly. More generally, aid flows should also be counter-cyclical and not pro-cyclical as they have been in the past. In summary then, the Monterrey and Doha documents are substantive guidelines for promoting sustainable and inclusive development. The European approach to cooperation, integration, and development is based upon a similar set of principles and it has been and is proving to be a successful formula. Applied globally it should be equally successful. For the European emerging markets, there are some new developmental issues that have increased in importance since Monterrey and need better recognition; these include remittances and climate change. The current financial crisis will particularly impact European emerging markets and the degree to which they can weather this crisis will have important consequences for the future design of development policies and reform of the international monetary architecture. 10