Yilmaz Akyuz

As seen over and again during recurrent financial crises in both developing and advanced economies (DEs and AEs), financial instability and boom-bust cycles undermine all three ingredients of sustainable development – economic development, social development and environmental protection.

Financial bubbles generate excessive investment, which remains unutilized for an extended period even after full recovery from the ensuing financial crisis. This includes investment in industry, as in Japan in the late 1980s and early 1990s, as well as in property, as seen during the current crisis in the US and Europe. This is the main reason why recoveries from financial crises see little investment.

When productive capacity is left unutilized, natural resources used in generating such capacity are wasted. This means that even weak sustainability conditions would not be met, since natural capital that is depleted would not be compensated by produced capital. There are now eight hundred and twenty thousand newly constructed, unsold, empty houses in Spain, and they are unlikely to be occupied for many years to come even without new investment in housing.

More jobs are destroyed during financial crises (busts) than jobs created during booms driven by asset and credit bubbles. Even when income levels are fully restored following a financial crisis, it takes several years for lost jobs to be replaced. For instance, in its third year of recovery, the US has not even replaced half of jobs lost during 2008-09. At the current pace, it will take 10 years to replace all jobs lost compared to 4 years in two previous recessions (1981-82 and 1990-91).

Fairness and equity, as basic ingredients of sustainability, are increasingly violated by the predominance of finance and finance-driven globalization. This has been a major factor in growing inequality in wealth and income distribution. Almost everywhere, income earned on financial assets and property has been rising relative to labour income. There has been a major shift in the global balance between labour and capital. Wages often lag behind productivity growth because of increased competition among the global labour force and financial incomes are lightly taxed because of the threat of footloose capital.

Income and wealth distribution is further distorted by financial boom-bust cycles. The benefits of credit and asset bubbles are generally reaped by private individuals but the costs of crises impinge on all segments of the society – very much like costs and benefits of exploitation of natural capital. The distributional consequences of crises are aggravated by financial bailout operations. In the US, crisis interventions have increased financial concentration; systemically dangerous, “too big to fail institutions” are now even bigger, and executive bonuses have been restored while labour incomes remain de- pressed.

Financial markets, rating agencies and inter- national financial institutions ignore inter- and intra -generational equity and environmental sustainabil- ity and focus almost entirely on debt and balance-of -payments sustainability in their ratings and lending decisions. The emphasis on financial sustainability is a source of increased inequality. It also tends to undermine environmental sustainability by leading to acceleration of exploitation of natural resources to fill income and foreign exchange gaps.

These finance-related disruptions imply that any programme of action designed to promote sustainable development should contain, as its integral part, regulation of financial markets and institutions and fundamental changes in the international monetary and financial system to secure greater stability and reduce the likelihood of crises. A broad agreement on this appeared to have been formed in the early days of the global economic and financial crisis, which culminated in the 2009 UN conference on “The World Financial and Economic Crisis and Its Impact on Development.”

However, a stock taking of the initiatives and actions taken since June 2009 shows that “efforts to reform and strengthen the international financial system and architecture” have fallen short of expectations and “long-standing systemic fragilities and imbalances” underlying the global economic and financial crisis remain unaddressed.

This is a serious matter of concern for DEs. Contrary to widely held view, they are not decoupled from AEs. After spreading from the US to Europe, the crisis is feared to hit the developing world next. Indeed, almost all major DEs are now seeing deceleration of growth. They face significant downside risks from AEs, including dampened export prospects and increased instability of capital flows and commodity prices. As noted by the IMF, “even absent another European crisis, most advanced economies still face major breaks on growth. And the risk of another crisis is still very much present and could well affect both advanced and emerging economies.”

What is to be done? So far incremental approaches to establishing an international monetary and financial system in support of sustainable development has not yielded tangible results. There is a need for a complete overhaul, based on a broader view consistent with the principles of sustainable de velopment, instead of narrow Treasury and financial perspectives that have so far dominated the debate on the reform in mainstream international financial institutions .

An intergovernmental task force should be created in the UN to examine the shortcomings in the international monetary and financial systems and propose solutions in such areas as the mandates and governance of international financial institutions; regulation of systemically important financial institutions and markets, including markets for commodity derivatives; regulation of international capital movements; orderly sovereign debt workout mechanisms; financing for sustainable development; the international reserves systems; the exchange rate system; and the multilateral policy surveillance. This undertaking should culminate in a UN conference to bring about fundamental changes in the way the international monetary and financial system opearates. This is no doubt a bigger project than the Bretton Woods Conference, because objectives, interests and concerns are now much more diverse and the issues involved are much more complex.

This policy brief is based on the author’s presentation at the Sustainable Development Dialogue on Sustainable Development as an Answer to Economic and Financial Crises which was held as part of the UN Conference on Sustainable Development (UNCSD) 2012/Rio Plus 20 in Rio de Janeiro on 16 June 2012.

It was originally published in its entirety at www.southcentre.com.

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