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Round Table Contents

An American Perspective

David Hale

At present, both the Under Secretary of the Treasury and the American Executive Director for the International Monetary Fund (IMF), are so consumed by the international monetary crisis in Mexico, that they are still formulating their positions for the Halifax G7 Summit. As a result, they will be interested in the material on sustainable development that the National Round Table on the Environment and the Economy (NRTEE) is preparing for the Prime Minister of Canada.

In setting the stage for the Halifax Summit in June, it is important to consider where the Summit fits into the sequence of international institutional evolution since World War II. It is now 51 years since the Bretton Woods Conference in New Hampshire, and 21 years since the G7 process began in the mid1970s with the first OPEC (Organization of Petroleum Exporting Countries) crisis. And it is six years since the end of the Cold War. This Summit should be viewed in the context of the world after the Cold War. And the international environment for the postCold War era is still being created. Issues are still being addressed on an ad hoc basis that were addressed much more systematically at Bretton Woods in 1944 and, to a lesser extent, in the Treaty of Versailles in 1918-1919.

Looking back on the past six years, there are three very distinctive characteristics of this postCold War era which will be setting the stage for what happens at Halifax in June. First is the relative poverty, in the 1990s, of the public sector compared to the private sector.

At the end of World War II in 1945, the public debt of Great Britain and the dominions of the British Empire was about 150-200% of GNP; in the United States it was 125%. It then fell for three decades because of economic growth and because of relative fiscal austerity of the US, Britain, the Dominions and other industrialized countries. But over the last 20 years there has been an explosion in public debt because of the growth of transfer payment programs and also, in recent years, recessions in some industrialized nations. And today, looking around the industrial world, it is clear that there are several countries ¾ Canada, Belgium, Italy, and soon Sweden ¾ where the public debt to GNP is now over 100% again. Adding on unfunded public sector liabilities for pensions and health insurance systems, the numbers rise to 300-400% of GNP. This includes the US, where the ratio of public debt to GNP is still only about 50%.

There has never been, in the history of the world, such serious public indebtedness as a constraint on other areas of public policy. The private sector, by contrast, is in much better shape. In many industrial countries private pension systems are now equal to 60 or 70% of GNP. In the case of Japan, there is a very large insurance sector with assets almost as large, and there has been tremendous growth of other forms of private savings. So there is a great divergence which has, in turn, shaped in a powerful way the contours of the world economy and the world financial system since 1989 and the end of the Cold War.

Over the last five years, the balance sheet of the World Bank has been static, and indeed it shrank a little bit in the last couple of years. The IMF has also had a static balance sheet. The last increase in its capital occurred in the early 1980s. An attempt last year to increase the capital of the IMF to reflect the new membership of countries from the former Soviet empire was voted down. And there is still continuing discussion about how to expand its resources this year.

Meanwhile, private capital flows to the developing countries, or what are called on Wall Street "the emerging market countries," have boomed. Whereas many of these countries were capital exporters in the 1980s because of debt servicing problems, there has been in the last three or four years a very explosive growth in private capital flows to them, peaking 12 months ago at about $110 billion per annum. So, it is a very different world from the world after World War II when the major focal points for capital flows were the Marshal Plan, the Dodge Plan, and the beginning of the Bretton Woods Institutions, the IMF and World Bank, that have played a continuing role for almost 50 years, but are far less dominant today than they were in the 1950s and 1960s.

The second point is that, as a consequence of these changes in the capital flows, the acceptance of liberal economic ideas in the developing countries, and the end of Communism and the spread of marketbased economic systems, this has been the first business cycle ever in the modern era, indeed in this whole century, in which the major growth engine in the early stages of the business cycle was the developing countries, not the US, not Japan, not Europe. There were, in 1992 and 1993, far higher rates of economic growth in East Asia and Latin America than in the traditional industrialized nations. Now, because of the recovery in the banking system and the financial systems of the old industrial nations, the developing countries are catching up. And the result is that last year there was a dramatic and unprecedented increase in global interest rates for the first year of a world business cycle. US interest rates doubled, and bond yields in all the industrial nations rose by several hundred basis points. Indeed, in Canada, bond yields got to the 9 to 10% range even though the inflation rate was only 1%.

This brings into dramatic focus why the issue of sustainable development and the environment will be much more important, not just in the 1990s, but into the 21st century. The arrival of so many new people into the global marketplace for goods and capital, indeed almost three billion people from formerly Marxist economic systems, will not only have a dramatic impact on the rate of output growth, but also on the demand for the commodities and raw materials. As a result, the rate of the depletion of natural resources and pollution will rise.

A few numbers on the level of urbanization in the world economy make this very clear. At the outset of the British Industrial Revolution 200 years ago, only 3% of the world's people lived in cities. By 1950, that number was 30%; now it's about 40%. By the year 2025 it will be 60%. And that percentage will be calculated on a world population of 11 billion or 12 billion people, compared to 6 billion currently. It is a truly dramatic change. The fact is that twothirds of mankind is still going through the change that industrialized societies experienced 150 years ago. And this change will, in turn, lead to a dramatic increase in emissions of carbon and to various other kinds of pollution.

The third feature of the new postCold War economy has been a resurgence of ethnic warfare the likes of which had been frozen for a long time by the Communist regimes in Asia and eastern Europe. As well, there has been the spread of anarchy to many developing countries which, during the Cold War, would have been subjected to far more aggressive intervention by the major industrialized nations or even by the Soviet Union. Countries like Somalia, Liberia, Zaire, and Sierra Leone are now characterized by a form of anarchy that simply would not have been tolerated in the 1970s or even in the 1980s. There is nothing that can be done in the short term about this phenomenon because there is no consensus yet about what kind of international intervention is appropriate, not only regarding nonfunctional nation states in Africa, but also where there has been a resurgence of ethnic conflicts that began 500 years ago, such as the combat now occurring in the former Yugoslavia and the hostilities which will probably develop on the fringes of what was the Soviet Union. It is certain that within a 10 or 15 year view, there must be agreement to create some kind of new form of trusteeship which will restore core human services in these countries. And with that will come discussions about economic development, the environment, and so on.

Throughout 1994, there were numerous conferences held about the 50th anniversary of Bretton Woods, to discuss the role of the Bretton Woods Institutions and how they should be updated. The general consensus was that great progress was being made in building the postCold War economic order, primarily through private sector initiatives. It was further agreed that there would be a role for the public sector on certain issues. For example, it might deal with the backward regions, in particular the African continent, that are lagging because of the breakdown of their political and economic institutions. There will also be a need for the public sector, through the IMF, the World Bank, and other organizations, to play a major role with what economists would call "externalities", the environment, greater investment in various forms of human capital, and other areas. But since December 1994, there has been a dramatic financial crisis in Mexico which will cause a major rethink about the role of the Bretton Woods organizations in the new postCold War economic order and about international organizations in general.

Because the Mexican crisis is still evolving, no final and definitive conclusions can yet be drawn. But there appear to be three clear implications on which to focus. First, the fact that Mexico has experienced a major liquidity crisis, despite the fact that most of its economic policies were fundamentally sound, does demonstrate that there is more fragility in this new world financial system than most people would have thought six or 12 months ago. Certainly, in November 1994, there appeared to be a case for a moderate devaluation of the Mexican peso, but the scale of the capital flight that actually occurred once the adjustment was begun ¾ the wholesale collapse of the currency, interest rates going from 15 to 50% ¾ was wholly unpredictable. And now, there exists the serious threat that the Mexican economy may be plunged into a very serious and deep recession that could even destabilize its political system.

To put this into perspective, Mexico needs to have a million jobs a year to absorb school leavers. Last year, because of the constraints on the economy caused by political uncertainty, it produced only half a million jobs. This year it may lose half a million jobs or more. There is no way that the country, now in transition to a multiparty democracy for the first time in its history, can make that transition smoothly with that kind of economic disruption. So, by the summer of 1995, there will likely be a consensus that there is a role for the IMF as a lender of last resort, not just to the poor countries of Africa or central Asia, but also to middle income developing countries that have had, in recent years, much more access to private capital. Even after the Mexican loan, the IMF still has $60 billion of underutilized resources. But if there is an expanded role for the IMF to play in other developing countries, not to mention what could happen if the former Soviet Union had effective policies for attracting foreign capital, there will be a case for expanding its resources.

Second, the severity of the Mexican recession now getting under way will create strains and tensions in the North American Free Trade Agreement (NAFTA) over issues like the environment. Mexico was becoming sensitive to environmental issues simply because of the enormity of the pollution problem in Mexico City, and because rising income and rising affluence makes people more environmentally sensitive. The risk now is that, given the severity of this recession and the danger of many bank failures and corporate bankruptcies, Mexicans will tend to deemphasize the environment because of the need to focus on economic survival. This will attract the attention of American protectionists in the US Congress, many of whom abused the recent debate about the Mexican aid program to attack NAFTA. So it is critical that the North American Commission on Environmental Cooperation (NACEC) in Montreal, and the Canadian government, play a positive and benign leadership role to try to make sure that the three countries do not regress on issues of the environment. Certainly it must not be left as an open door for American protectionists because, if they play the leadership role, they will, of course, try to destroy the whole institution, not try to improve it and make it more effective.

The inability of the American president to secure congressional support for the Mexican aid package quickly and effectively provides a stark and important reminder of the constraints on American leadership in this new postCold War era. This Congress probably would have voted down the Marshal Plan in 1948, not just the Mexican aid program. Now it is quite possible that, given several more weeks of debate and discussion, the educational process would have gone far enough and Congress would have approved the aid package. But the fact is there was a financial crisis ¾ a liquidity crisis ¾ and the US had to move quickly. And even though President Clinton enjoyed leadership support from House Speaker Newt Gingrich and Republican Senate majority leader, Bob Dole, he could not carry the backbenchers of the American Congress. Indeed, there was active opposition from Congressman Richard Gephardt, the leader of the Democrats in the House of Representatives.

There are some background circumstances of relevance here. President Clinton himself is engulfed by some very unique scandals. He was the Governor of a state that could be classified as an emerging market, and many of his opponents in the Congress are convinced that he cannot seek reelection; hence, they do not want to squander political capital on helping him. However, the isolationism of the US Congress is disturbing, as is the hostility to Mexico and the general aversion to any active international role for the US. And indeed, half of the members of Congress were elected after 1990, after the end of the Cold War. Canada is accustomed to dramatic rotation in the parliamentary system as witnessed in 1993. But because of the nature of the Canadian Parliament, the leadership process, and the role of the Cabinet, the Privy Council, and the Prime Minister, the changes have not had as constraining an influence on Canadian foreign policy as have the tremendous upheavals that have occurred in the US Congress over the last four years.

In summary, Canada has some very unique opportunities and some unique challenges in hosting the Halifax Summit, as well as in playing a role in other organizations to promote better discussion and more awareness of sustainable development. First and foremost, Canada has a history, as a middle power in the modern period, of using international organizations to leverage Canadian views. Canada has played an active role in the past in the United Nations, the British Commonwealth, and other organizations; and that kind of middle power leveraging should also serve as a precedent for what happens in the lead up to the Summit, and beyond.

However, the G7 is not the optimal organization through which to address many of these issues. It is a wonderful "bully pulpit" for four or five days to dramatize and focus public awareness on issues; but the G7 has no secretariat, hence it is very difficult to have continuing discussion with study groups and so on. After using the G7 as a bully pulpit, Canada should direct its attention to using other organizations as more effective forums for focusing on the sustainable development problem. NAFTA already stands out because the organization now exists, and there will be, almost immediately, a discussion about Mexico violating NAFTA rules as a consequence of the severity of the recession beginning there.

Second, there is an important future role for the Asia Pacific Economic Cooperation (APEC) forum. APEC is still evolving, but it has great potential, for a variety of reasons. First, the major growth in the world's potential pollution problems, such as the growth of carbon emissions in the next quarter century, will be in East Asia, China, Korea and Taiwan, and later on India. It will not be in Africa and Latin America, it will be in Asia, because of the size of the populations there, and because of the head start they have in enjoying high rates of economic growth. Canada is a member of APEC, and so are other countries which are becoming more sensitive to environmental issues. Because of rising affluence in countries such as Korea, Taiwan, Malaysia, and Thailand, there exists much more environmental awareness in those countries today than there would have been five or ten years ago. For example, the Central Bank Governor of Taiwan says that the major constraint on growth in Taiwan is not the labour supply or other economic issues, but the supply of oxygen. Taiwan is a country where the air pollution index is at 400. In Los Angeles, schools are closed at 200. APEC also includes Australia and New Zealand, two of Canada's Commonwealth cousins which have political cultures very similar to Canada's in terms of awareness of the environment. Canada could easily build in the APEC group a coalition of countries that would promote, through a Secretariat in Singapore or elsewhere, much more effective action in the region to address issues like pollution and protecting the seas.

Third, the existing organizations can also play a role. The G10 with the IMF, the World Bank, the United Nations, and now the World Trade Organization, can also play a role. Canada's leverage will not be as great there as it will be in the other organizations, but it has a role to play.

Finally, the time is right to continue effective action in this area for the very simple reason that there is going to be a long and broadly based global business cycle in the mid and late 1990s. Despite the Mexican crisis, there will be continuing growth of capital and trade flows with the emerging market countries. The Mexican crisis has some very unique features and there is no reason to fear that similar crises will be reproduced elsewhere. As a result, looking toward 1997 and 1998, there will be a growing awareness in the private sector, not just in the public sector, about the issue of excessive consumption of resources, about the dangers of pollution, and about the hazards to health and to economic growth of having levels of economic development or forms of economic development that are unsustainable.

This focus might not be as intense as it was in the early 1970s when the Club of Rome Report was fashionable. But, the scope, breadth, and magnitude of this global economic expansion will be so great that by 1997 and 1998 there might be a level of commodity prices so high that there will be more and more concern about the environmental side effects of a global business cycle in which five billion people, not just oneandahalf or two billion people, have marketoriented economic systems and rates of economic growth two or three times as high on a global basis as they have had at any other time in the modern era.

David Hale is Senior VicePresident and Chief Economist, Kemper Financial Companies Inc.

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