Media Center



October 23, 2007 - Washington, DC

Secretary General Jose Miguel Insulza,
Chairman of the Council Ambassador Rodolfo Hugo Gil,

I am very happy to have the opportunity and the honor to be here today in this wonderful room, and to share with you some of my thoughts on the world economy, on issues of financial development and financial markets on the one hand, and the need for social equity and sustainable growth on the other. I do it as chair of the UNDG – the United Nations Development Group - and as head of UNDP. As you know, and as the OAS Secretary General said, the goal of UNDP is human development -development measured as broadly as possible in terms of human empowerment.

But I should say I also am particularly happy to share my experience as a former Economics Minister of my own country, Turkey, which in terms of income levels and many economic and social features shares a lot in common with many of the countries of Latin America and the Caribbean.

Just two little anecdotes here. We had invited President Ernesto Zedillo of Mexico after he had finished his presidency to give a lecture at a Turkish University. It was his first visit to Turkey. And then when he ended his trip, he said, "You know, it so much feels like Mexico." And, in many ways, it really does.

When I visited Brazil one-and-a-half years ago, I was in the plane from Sao Paulo to Brasilia and my neighbor was reading, I think it was ”O Globo,” and there was a headline, which although I don't speak Portuguese, I could understand: somebody in the opposition had said “if interest rates remain as high as this, I'm going to go and live in Turkey.” Turkey and Brazil had the common problem of the highest interest rates among emerging markets for a long time, but Turkey had managed to bring them down some. (Although today, I have to admit, Brazilian rates are lower than Turkish rates).

On the same trip I also went to Buenos Aires and visited that beautiful city. We share a lot in common with the policy makers there as we had fought a very difficult financial crisis more or less at the same time. I'm very happy to see that Argentina is now growing at an impressive, rapid rate, and has been doing so for several years. The days of the financial crisis are left behind.

Having lived through financial crises and the very difficult times that come with them when I was in the government, working at the World Bank and at the United Nations, and to-day, looking at the world economy and financial flows, I wanted to share with you some of my thoughts of where emerging markets are in the context of today’s world economy. I am going to concentrate on what are the challenges for emerging markets and what the prospects are, with a special emphasis on Latin America, but not uniquely.

I. Growing Inequalities Worldwide and Within Countries

UNDP works a lot on the poorest countries, particularly the poorest countries in Africa. There are also a few low income countries in Latin America, and it is these countries that are a priority for UNDP. At the same time, we retain a strong role in many middle-income emerging market countries. I think the key question for developing countries in general, and emerging markets in particular, is how to find the path to rapid, but also equitable and sustainable growth, what we at UNDP call 'human development.'

We are, indeed, living at a time when growth has accelerated. The first six years of this century are probably the time in world history where growth has been the most rapid ever, if we weigh income by population. But at the same time, we do see a very important increase in inequality all over the world, not just in developing countries, but also in rich countries. For example, in a recent survey of U.S. citizens, one of the questions was: "Do you see the United States economy divided between haves and have-nots?" Forty eight percent of Americans answered yes to this question. The same question was asked in 1980, but then only 26 percent answered yes. So despite a lot of dynamism in the American economy and the good times that have characterized the recent past, inequality is clearly a factor, much more than a couple of decades ago. It certainly is a factor in my country, Turkey. It certainly is a huge factor in Latin America and the Caribbean. But all over now, including in Asia, I think it has become a very critical question.

Some of the inequality statistics are, indeed, daunting. One of the most dramatic ones is that two percent of world citizens own 50 percent of world wealth. And the bottom 50 percent of all the people in the world hold only one percent of the wealth in the world. I think these statistics give one reason to pause and make one think: where are we heading?

It's very interesting that this challenge of inequality is now well accepted by the international institutions. The World Bank’s World Development Report last year focused on inequality. And the IMF, very interestingly, just published the 2007 World Economic Outlook, with the subtitle 'Globalization and Inequality.' Bob Zoellick, the new President of the World Bank, made an excellent speech at the Annual Meetings of the Bank and the Fund and also at the Washington Press Corps, where he very squarely said the challenge for the World Bank is sustainable and inclusive growth, stressing the need for including those who are left behind.

So the topic is everywhere. The data in the World Economic Outlook shows that the Gini coefficient, which is of course only one measure of inequality, has been increasing steadily over the last two decades throughout much of the world. There are some exceptions in very low income countries, and also in a few middle-income countries, but broadly, throughout the world, there has been an increase in inequality. Moreover, there is also a very strong trend of income concentration in the top ten, one, or even 0.1 percent of the population. In some countries the 0.1 richest have anywhere between five and ten percent of national income. This is now something that is well-known and documented and which is clearly a challenge for the international community, as increasingly recognized by the international institutions.

But the very interesting question is how is this linked to policy, how is it linked to globalization and of course, what can we do about it? Here the answers are very difficult. The World Economic Outlook has a whole chapter of policy prescriptions, and I'll turn to it later. But I know that in the emerging market countries of Latin America, of other parts of the world, this is an absolute key challenge.

II. Unprecedented Globalization

Before coming back to this challenge of inequality in the second part of my lecture, I want to first review the phenomenon of globalization itself—because it is within this overall framework of global integration that the challenges must be met and policies must be formulated. So, let me just say a few words on globalization itself. I would like to stress that globalization is accelerating and it is not just a phase that can be easily reversed. We know that before the First World War the world had a phase of very strong global integration by trade, and also by finance. But I think that what we're living through today is something quite different, much deeper, much wider, and much more all-encompassing. Trade is a factor. The share of trade in global GDP (the sum of exports and imports) was below 20 percent in 1960; it is now above 50 percent, and growing. So clearly trade integration, which already was fairly advanced in 1960, is accelerating.

But there are two things worth stressing here. One is that the type of trade is very different from the trade we had during the first phase of globalization before World War I. Then it was trade very much along the lines of comparative advantage, with resource-rich countries exporting primary goods, and rich countries exporting manufactured goods. Today, trade is much more multidimensional. It is based on a much deeper integration of global production circuits. Integrated global firms are planning their production worldwide. A bicycle that you can buy in Washington or in California probably has 20-25 parts or components that come from all over the world. So it's not the kind of classic Ricardian type of trade that we're dealing with. We're dealing with the integration of world production systems.

And the second important point to make is that tradability is now increasingly extending to services, which is a new phenomenon. In economics, you usually had the tradable sector (mining, industrial goods, agricultural products), and the non-tradable service sector, apart from transport directly linked to trade. Now services, because of the information revolution, are increasingly becoming tradable. Not all services, of course, you're not about to have a haircut via the internet!

Alan Blinder, a very well-known American macroeconomist and former member of the Council of Economic Advisors, estimates that about 25 percent of the U.S. labor force works in occupations that can become potentially tradable. He doesn't say that all of these will be traded, but they are potentially tradable. That, of course, is a huge percentage of all jobs and includes many service jobs that are now becoming part of the international economy. Another way to look at it is to say that the labor force that is actually involved in trade, or inputs to tradable sectors, has grown tremendously with the entry of the big and formerly very closed Asian economies over the last decades, into the international trading and production system.

Now, turning from trade to financial markets, here too we see very, very strong global integration. We can quote some of the numbers. The worldwide value of equities, bonds, and bank assets are now equal to four times world GDP. If we include derivatives, the figures are even more staggering. These values are actually very hard to measure, because the derivatives are so complicated. But clearly, if you look at the stock of financial obligations in the world today, either direct or derivative type of obligations, they have become huge relative to income flows.

In terms of foreign exchange transactions, one interesting figure is that they were $2 trillion at the beginning of this century, just a few years ago; they are now more than $3 trillion a day. This is $3 trillion of foreign exchange transaction in any single day. So we see a tremendous integration also in the financial sector.

III. Capital Flows and Emerging Markets

Consider now private capital flows to the developing countries. This is of particular interest to Latin America and to the emerging markets, because so many of the crises of the past were linked to sudden stops, or reversals, after big surges of private capital flows. The same was true, for example, in Turkey. In 2000 there had been huge inflows. At that year’s Annual Meetings of the World Bank and the IMF everybody was still very interested in putting money into Turkey and this lasted until the end of 2000. There was a mini-crisis in November, but by year-end after a renewed IMF program, the situation seemed normalized. And then all of a sudden in February 2001, there was a complete stop, reversal, massive capital outflows, with all of this happening within months. Nothing really fundamental had changed, but somehow market expectations had shifted, Turkey had ongoing vulnerabilities in its fiscal position and in the Banking system, but these had been there before. Capital reversed course and thus generated a tremendous crisis in Turkey, leading to huge unemployment and a GDP contraction of nine-and-a-half percent. So this is just one example, but many Latin America countries, and some Asian countries in the late 1990s, experienced the same kind of phenomenon.

Looking at the history of capital flows and macroeconomic cycles in Latin America, many ask the question today: "Is there a chance for a repeat of the types of crisis we lived through in the 1990s and in the first two years of the new century? What kind of capital flows are we seeing? How are the macroeconomic developments worldwide and particularly the financial sector problems that we're now witnessing in some of the advanced economies, how is this all going to affect the emerging markets"?

Capital flows to emerging markets dipped after the Asian crisis. They then took off again, but the financial sector problems around 2001, as well as the 9/11 tragedy, negatively affected some of these flows. They have picked up again since, quite rapidly, and now they are very large – larger than ever in 2006 and 2007. But some things are very different from the past. First, there are now large outflows as well as large private inflows into developing countries and emerging markets. The figures projected for this year are of total private capital inflows of $1,330 billion, to the emerging markets, and $840 billion of outflows. And I'm just talking here of private capital flows, not official reserves or official flows.

So what we are seeing now is a change in the nature of private capital flows and much more two-way investment going on, a transformation which we have seen in the nature of foreign trade flows before. In the old classical period, developing countries were exporting labor-intensive or land-intensive products in exchange for capital-intensive goods from the North. But in fact, when we look at trade after the Second World War, we see a lot of trade happening in the same sector with similar countries, France trading a lot with Germany, despite the fact that their economic structures are quite similar. We are now beginning to see a trend where emerging markets are not just importers of private capital, but they are also exporters of private capital. That reflects the diversification trend in the global economy. It is another feature of globalization, which includes a lot of two-way traffic and two-way interaction between countries. So if one asks whether the 1990s type reversals are likely to be repeated, I think we have to keep in mind that today the nature of capital flows has changed.

Another important feature is the role of direct foreign investment. The share of direct foreign investment relative to portfolio investment, and to bank loans has grown continuously. Direct long-term investments in productive sectors are playing a much bigger role in capital flows than in the past. That also is a major difference from the 1990s. Foreign direct investment flows tend to be much more stable than portfolio flows, without the kind of quick reversals that you experience with portfolio flows – and this would suggest greater stability in the whole nature of capital flows.

Finally, from the point of view of the macroeconomic framework, we have seen a tremendous strengthening of fiscal policy, of overall macroeconomic stability and macro frameworks with the budget situation in most countries, not all of course, but in many countries, much stronger than in the 1990s. And looking at the balance of payments side, we also see that these strong capital flows, gross flows, and in some cases net flows, are in many places, accompanied by actual current account surpluses, not deficits. In Asia these surpluses have become huge. But even in Latin America there have been surpluses in the current accounts, most notably in Brazil, the largest economy in the region, which has had a recent surplus in the current account, rather than a deficit. So that also would suggest quite a different macroeconomic and capital flow situation than in the past.

I should add that the one notable exception to these current accounts either being close to zero or in surplus, is Eastern Europe. Eastern European countries are actually running quite large current account deficits which are financed by capital inflows. That sets them apart from the Asian countries, from the Middle East, and from the Latin American emerging markets. Turkey is also running a big current account deficit, and in that sense, at least, has joined, if not the European Union, the European economic space. Turkey exhibits the same kind of current account behavior than Romania or Bulgaria or some of the new members of the European Union.

Before I proceed to my next point, I would like to stress the obvious fact that countries with a current account surplus are necessarily financing other country's deficits. The public sector in many of the emerging markets, and particularly of course, in the Asian countries, has become a net financer of deficits in some of the advanced economies, most notably the U.S. current account deficit, but also deficits in countries such as Spain and Italy. So while many emerging markets are importing private capital, they are then turning around and exporting public capital which is a very different situation from what we had ten or 15 years ago.

So when I look at the overall nature of the emerging market economies, their macro frameworks and the world economy, I am tempted to take the risk of making a prediction, which is always very dangerous for economists, but I would say that we are unlikely to see the same kinds of problems the emerging market economies experienced in the 1990s. The nature of capital flows has changed; their structure and their composition have changed. The official sector in many developing countries has become much stronger and holds vast reserve assets. So overall, with maybe some exceptions here and there, I do not see a likely sudden stop, or reversal of flows type of crisis, affecting the emerging market economies. I don't think that problem is the biggest problem that is ahead of us. In history it is usually the case that new problems arise, it is not really the old problems that come back. It is quite possible that there will be problems in global financial markets due to the complexity of the new structured financial products, which rely on complex securitization, and we see some of this happening right now in the United States and elsewhere. But that is a different type of problem than the capital flows reversal problem that emerging market economies experienced in the past. So I am not saying that there will not be financial sector problems. There most likely will be financial sector problems – but of a different nature.

I think their source, their root, will be in these complex financial products and delays of the regulatory agencies in setting up the strong regulatory and supervisory frameworks that are needed, given the rapid innovation in the financial sector. So there is a danger there. It is true that monetary authorities are in a much better position these days to react and mitigate the effect of financial distress on the real economy, because inflation being so low worldwide, monetary expansion, lowering the interest rate (as the U.S. Fed did for example recently), is much more feasible when you have low inflation. So the capacity of the monetary authorities to react to problems in the financial sector is quite good. But I do not want to venture too far into that kind of prediction. All I am saying is that the kind of classical reversal of private capital flow type of situation leading to a major crisis in the emerging markets seems much less likely than it was for a long time.

IV. Globalization and the Political Economy of Inequality

Having said that, I don’t think we can be greatly optimistic and say that everything is fine in emerging market economies because as I mentioned at the beginning of my remarks, the real problem now facing emerging market economies stems from the large and most often rising inequalities in many countries, and the challenges these inequalities constitute for political economy and policymaking. I think that is where the real problem is for emerging markets.

In Latin America, the rise has actually been less than elsewhere. In fact, in some countries there has been a decline in inequality, such as in Brazil, where the Gini coefficient actually declined over recent years. But there are such high levels that a Gini coefficient declining from .62 to .58, even though it is welcome development, it is not something one can be too satisfied about. Moreover in other countries, in many Asian economies, inequality is increasing very rapidly. In the Middle Eastern economies it is increasing, and, of course, in the advanced economies, in the United States, but also in Europe and Japan now, there is a discernible trend of increasing inequality.

That is why I chose the title of my remarks today as, “Equitable Growth and Democracy”. I don't believe that such rising inequality is fundamentally compatible with social stability and the democratic process, with the kind of constructive and peaceful political participation we all desire. There is a real problem, even in the rich countries. There is a dilemma. On the one hand, globalization has accelerated growth; the fact that technology, foreign investment is spreading, that the opportunities for trade are worldwide means that there is tremendous scope for large markets, for export growth, for diversification, and all this is fueling growth. But, on the other hand, the very same processes are also dis-equalizing, or un-equalizing.

When one reads the analyses and studies the data, one cannot blame it on trade per se. And certainly one also cannot blame it on foreign capital per se. Bringing in foreign capital to areas where capital is needed and where there is unemployment should be a good thing and should lift wages and should in fact help the distribution of income. But one explanation for what is happening is that the technology embedded in the foreign direct investment and in the trade flows is of a sort that puts a high premium on highly skilled labor and not on relatively unskilled labor, and actually contributes to increases in inequality, more than compensating for other factors at play.

I would also advance, perhaps somewhat less conventionally, a second argument. The first argument is something that economists very much accept, even very mainstream economists, and indeed, the World Economic Outlook of the IMF has a lot of analysis of how globalization actually leads to increased inequalities by the very market mechanisms and competitive mechanisms that it promotes. In addition to the traditional analysis, however, bargaining power is actually important in the labor market. Or, to put it differently, wage bargaining has to be analyzed in a global context. If some part at least of wage determination is linked to bargaining power, the fact that you can potentially outsource, or potentially relocate production is by itself a factor that works against labor, and in favor of capital, broadly speaking. You do not actually have to relocate a factory from Ohio or in Northern France, or for that matter, from Brazil or Turkey, or Argentina, to a much lower wage economy to have greater bargaining power vis-à-vis labor at the local level.

And I do believe that this potential outsourcing, or potential relocation, may be one of the explanations for the bigger share of capital, as well as for the weak position of labor in the whole bargaining process regarding factor shares. It is a worldwide phenomenon. We have better data for some countries, particularly the U.S, which has very good data on median wages. And we see that the median wage in the U.S. - despite a very dynamic economy, a lot of productivity growth (the U.S. has had one of the best periods of productivity growth ever between the mid '90s and about 2005) - the median wage has hardly grown at all. And it is hard to explain this fully within the domestic competitive markets, marginal productivity paradigm without taking into account relative bargaining strengths in a global context.

So I think this increasing inequality is going to be a challenge. It is a challenge for globalization; it is a political challenge for democracy. Because if markets do not produce inclusive results, if large parts of the population (not necessarily the majority, but substantial parts) are left out of progress, I think that we will see tensions, protectionism, and strong populist reactions. And I think we should pay attention to what is happening throughout the world in terms of rising inequality, also when analyzing political behaviour.

Now, I think there are two possibilities, two scenarios here. If growth is rapid enough that it truly lifts all boats, impacting even the poorest segments of the population, then these tensions are manageable. That is what we are probably seeing in East Asia. When you grow at ten percent, or eight percent, while the process may be very un-equalizing, and while the upper income and highly skilled and capital-owning segments of the population may be gaining much more, the poor also gain significantly. Indeed, in China, more people are being lifted out of poverty than ever before in human history. And in India, too, there's a lot of inequality and poverty, but the poorest segments are also benefiting from that quite rapid growth, even if they do not benefit as much as the rich.

So once you have that impact on the poor through very rapid growth, this is a factor that stabilizes the political mechanisms, and, I think, it leads to a degree of political support for open markets and global engagement. And indeed, when you look at the survey data, when you ask in East Asia for support for globalization, it is quite high. However, for that to happen in a system where at the same time income and inequality is increasing, growth has to be truly rapid; four or five percent is not enough. What you really need for this political “buy in” is eight or nine percent, and that is, of course, very hard to achieve.

A related point in terms of political economy, is that when a country is in the top growth league worldwide, there is a lot of national pride. Citizens are very proud of their country's growth performance, and that too becomes a very stabilizing factor. I remember being in India three years ago, and the Indian economists were debating at that time whether they would be growing at six/seven percent, and some were saying, "No, no, we have to make eight percent," although it was a minority and most people felt that eight percent was not achievable. India is now growing close to eight percent, and now the debate is whether it should be ten. And of course, this is accompanied with a huge amount of national pride, a sense of achievement, which has a tremendously positive impact on social cohesion.

That is one scenario. But I think for many middle income countries, particularly in Latin America, it is much more difficult to achieve that pace of growth on a sustained basis. Partly there is less of a catch-up effort in middle-income countries. In the lower income countries, where wages are extremely competitive, some of the growth reflects a certain catch-up. After all, the average income in the Latin America countries is still quite a lot higher than in East Asia. Growth may be less rapid, but the average incomes are quite a bit higher.

The second problem is that some of the social cultural structural features that lead to very high savings rates are extremely difficult to achieve in many of the middle income countries. I do not see Turkey saving 30 35 percent of its income, and neither do I see Latin American countries achieving that kind of saving rate. So I do believe that what is achievable in many of the emerging market economies, middle income emerging market economies, particularly in Latin America, is something not quite as dramatic as East Asia. But it still could be quite good. Five, six percent growth, I think on a sustained basis, is quite possible. But I do believe that to achieve that, a much stronger effort is needed to deal with inequality, the inclusiveness issue, and the social dimensions of growth. Otherwise, that kind of growth rate will not be sufficient to really absorb the social tensions and discontent generated by inequality, and therefore, to make that growth sustainable. In many middle-income countries, a much more frontal attack against poverty and inequality is needed.

V. A Developmental State for Inclusive Globalization

There are many programs against poverty in many countries, so I am not at all implying that governments have not paid any attention to this. But I think the fundamental processes in the globalizing economy are so strongly un-equalizing that, unless public policy makes it a real priority to fight against inequality, these processes will continue and will overwhelm many of the ongoing redistributive efforts.

The global market gives us this tremendous opportunity for growth, this tremendous opportunity for progress. Certainly international trade is a tremendous engine of growth and financial markets can be extremely useful in channeling savings to the most productive uses and the most productive investments. However, if left alone, if just left to themselves without a strong developmental state that is market friendly and market supportive (as opposed to some of the states we've had in the now increasingly distant past that tried to squash the market); a state that wants to support the market, but at the same time a state that shows very strong resolve to fight inequality and poverty, I think we will reach limits of the current growth model in emerging market economies.

We have to think much more seriously about building that new type of state, the developmental state appropriate to our new century. We have to focus on what functions it must fulfill and what areas it has to concentrate on. I think we have to be much more than marginal in our policies and concerns dealing with inequality.

The recommendations that are often available in the international institution's reports are okay, but insufficient. I think education, building human skills is very important because part of the inequality is driven by the skills gap. But we cannot leave this to decades long efforts in the education sector. What is needed is a much, much stronger focus on skill formation in a very egalitarian strategy that really tries to reach the poorest, and equip them with the skills they need in a much more immediate way, in a much more dramatic way than I think is being done so far. The education of young adults which “missed’ that opportunity when they were adolescents must be part of the strategy. I think infrastructure going to neglected areas and reaching for the disadvantaged, the building of the infrastructure that links places that are remote from the global economy, is another area where a much more voluntarist model is needed. Pascal Lamy has called for a meeting on “Aid for Trade” in Geneva on 20th November. I think he's right in addressing this problem. No amount of liberalization of markets and of pro-market policies can allow you to really participate in the global economy unless you have the infrastructure and the means to achieve that participation. And I do not mean just for the richest regions of a country, but also for some of the more disadvantaged regions.

The tax system is another area, particularly in Latin America, which really needs drastic reform. It needs reform to give the ”State” the means for this developmental role. At the same time the tax system also has to be a redistributive mechanism which has as an explicit goal the correction of the inequalities that globalized markets and unsupported markets lead to. Tinkering on the margin here will not work. A very deep approach to tax reform, with fighting inequality as well as extra-legality as a major objective, has to be part of the overall strategy. This is not easy to achieve, because all of this has to be done, of course, within a framework of fiscal responsibility. We cannot go back to the bad old days of spending without regard for fiscal balance. But I do believe there is tremendous opportunity of restructuring both within the revenue side of governments, and within the expenditure system, of dealing with the whole role of government in society in a very different way, and of giving the state the means to fight inequality and exclusion. It should not be a role that works against markets; on the contrary, if the states are successful in that role, it will help markets work better.

The new developmental state should not work against globalization; on the contrary, it will make globalization much more sustainable and much more acceptable by the populations and by the citizens. But markets alone will not do it. A partnership is needed between private sector initiatives, entrepreneurship, the energy and efficiency of markets, and a voluntarist developmental state. It is that kind of partnership that can really face up to the huge challenges ahead of us as we look forward towards managing a process of globalization that is creating a lot more inequality than in the past. What we must find and develop is a set of complementary policies that go much beyond the timid attempts to fight inequality working only on the margin, but policies that also avoid irresponsible populism that will always result in economic collapse, even if pursued with good intentions.

We have not yet found this path that truly regulates markets without destroying them, that redistributes without weakening incentives for entrepreneurship and hard work, that fully uses the market and the opportunities of the global economy, without letting society be ruled by those with market power.

I believe finding this path is the true challenge we face at the beginning of the 21st century.

Thank you very much.