Page last updated at 14:21 GMT, Wednesday, 28 January 2009

Dire warnings about protectionism

By Tim Weber
Business editor, BBC News website, in Davos

Stephen Roach, chairman, Asia, Morgan Stanley
One cannot overestimate the dangers the world economy faces in 2009
Stephen Roach, chairman, Morgan Stanley Asia

The global economy is set for a year of recession and then low growth until 2012, economists at the World Economic Forum in Davos have said.

They also warned that the downturn could persuade politicians to introduce trade barriers and steer investments only into their own economies.

This would harm developing countries the most, said South Africa's finance minister Trevor Manuel.

Meanwhile, there are growing calls for better financial sector regulation.

Speaking at a panel taking stock of the state of the economy, Stephen Roach - chairman of Morgan Stanley Asia and long-time prophet of the economic downturn - said one could not "overestimate the dangers the world economy faces in 2009".

Justin Yifu Lin, senior vice-president and chief economist, World Bank

The current projection is a protracted recession and we have not reached the bottom yet

Justin Yifu Lin, World Bank

The global economy was likely to shrink this year for the first time since World War II, he said, and nobody on the panel or in the audience was prepared to contradict him.

The general gloom was echoed by the International Monetary Fund, which has predicted that world economic growth will fall to just 0.5% this year, its lowest rate for 60 years.

Justin Yifu Lin, senior vice president at the World Bank, said there were "lots of downside risks; the current projection is a protracted recession and we have not reached the bottom yet".

Mr Roach added that demand from US consumers, for many years the main driver of global growth, was in steep decline, while on the supply-side China had seen its economy shrink during the last quarter of 2008.

The economies of the rest of Asia had become China-centric, Mr Roach said, and now that China's economy had "hit a wall", exports were plummeting - down 42% in Taiwan and 35% in Japan.

Mr Roach said that after 2009, global growth would be anaemic at around 2.5% in the three years to 2012, which prompted one well-known economic commentator, Martin Wolf of the Financial Times, to accuse him - probably only half-jokingly - of "optimism" and "getting soft in his old age".

Indeed, wherever one goes in the congress centre in Davos, pessimism pervades all conversation - although one participant counselled that "irrational exuberance has been replaced by irrational despair".

The return of protectionism?

The biggest concern of all panellists, however, was the risk that the downturn could herald a return to protectionism.

If it walks like a bank and quacks like a bank, then it should be regulated like a bank
Davos participant
This being Davos, the majority of participants are proponents of free trade, but it was striking that the representatives from developing and emerging economies were particularly worried about rising trade barriers.

Africa was "at risk of decoupling, derailment and abandonment together," said South Africa's finance minister Trevor Manuel.

Protectionism could close Western markets and then flood emerging markets with cheap subsidised products.

Panellists warned not just about the threat to free trade, but also the danger that Western governments could steer their nationalised or recapitalised banks towards investing only at home.

Already, foreign direct investment in emerging economies had dropped more than 80%, said Ferit Sahenk, chairman of Turkish conglomerate Dogus Group.

And Mr Li cautioned that developing countries did not have the "fiscal space" to launch economic stimulus packages of their own. They would need the help of richer nations to kick-start their own economies.

Most importantly, all panellists agreed, only concerted multilateral action would allow the economy to get out of the current crisis.

How to regulate the financial sector?

However, government spending alone was not enough to solve the problem, warned Heizo Takenaka of Keio University, pointing to the experience of Japan's "lost decade" of economic slump.

Monetary policy and a co-ordinated global regulatory framework were key to getting the global economy back on track, they agreed.

Less than an hour later, a closed session tried to tackle this very issue. To encourage frank debate, participants and panellists in these sessions cannot be quoted by name, but the thrust of the debate was fairly unanimous: More and better regulation, and especially enforcement of regulation is coming.

The financial system had evolved over the past 30 years, and financial institutions that used to be on the fringes of the system had grown to become a central but only lightly regulated part of it.

"If it walks like a bank and quacks like a bank, then it should be regulated like a bank," said one participant, who also mused that in five or 10 years some hedge funds might find themselves under much closer scrutiny by regulators.

More importantly, regulators had simply failed to see what was going on: "Things that they thought would reduce risk actually introduced extra risk into the system."

International framework

But there was disagreement as well. Bankers and investors still made the case for a lighter touch and better self-regulation, warning that a tougher approach could kill off entrepreneurs and prevent the creation of wealth that had lifted millions out of poverty.

"How large should the French garden of a well-regulated financial sector be, and where should we allow it go grow into a wilderness," asked one participant. As the panellists warmed to the metaphor, they also agreed that any regulation would have to be based on some internationally agreed framework.

Anything else would result in "regulation arbitrage" where financial firms go where regulators have the lightest touch.

And while it is fashionable in Davos right now to pillory the bankers, one of them asked the pointed question: "Are the regulators themselves accountable? You were so tough, but when the crisis happened, you guys disappeared.

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