21 September 1999
OECD and the world economy
Committee on Economic Affairs and Development
Rapporteur: Mr John Townend, United Kingdom, European Democratic Group
I. Draft Resolution
1. The Enlarged Parliamentary Assembly, composed of delegations of OECD and Council of Europe member states, has examined the recent activities of the OECD in the light of the report prepared by the Assembly's Committee on Economic Affairs and Development and the contributions made by various committees of the Assembly. In addition to this annual opportunity to provide parliamentary input into the OECD's work, the Assembly reiterates that it would welcome a written response from the OECD to this resolution.
2. The Enlarged Assembly notes with relief that a measure of calm has returned to the world economy following the turbulence and regional economic downturns caused by the Asian financial crisis in 1997 and that in the Russian Federation in 1998. Thus, growth in the OECD area is expected to continue with an increase of slightly over 2% in 1999 and 2000. Similarly, world trade, while expected to grow by only 3.9% in 1999 as opposed to 4.5% in 1998, is projected to resume at the brisker pace of 5.6% in 2000. For such increases to be realised, however, a number of vulnerabilities in the world economy will have to be urgently addressed. To achieve the goals of more equitable and sustainable global order, the Enlarged Assembly supports vigorous collective action aimed at stabilising international financial flows, strengthening essential investment in social infrastructure, and strengthening democratic governance institutions.
3. The continued health of the US economy is of crucial importance for that of the world, as that country is now practically the world's only economic engine and 'importer of last resort'. OECD member countries must, however, prepare for the day when the US economy
will slow down, and start now to assist it in its 'locomotive' role. Increased efforts are needed to advance structural reforms in the global economy, and to promote an open and fair trading system under WTO principles, in order to achieve environmentally sustainable growth benefiting people in all regions. The Enlarged Assembly in this context recalls the importance of democracy, human rights, the rule of law, good governance, transparency and accountability for lasting economic development.
4. The Enlarged Assembly welcomes the considerable efforts undertaken by Japan to revive its economy but notes the OECD's projection of a 0.9% contraction in 1999 and zero growth for 2000. It acknowledges Japan's efforts to avert deflation, support consumer spending, and to quicken the economy that is now achieving gradual recovery. It therefore encourages the Japanese Government and Parliament to resume structural reform in all sectors of the economy, and in particular its banking system, and to open the country up even more to foreign trade and investment. The contribution such measures could make toward reviving the world's second-largest economy would be of major importance for the whole surrounding region and beyond.
5. A similar responsibility befalls OECD-Europe, especially after the introduction of a single currency among eleven EU member states. It is vital that European Union countries in particular, but also all other European OECD members, assume a world economic responsibility commensurate with their economic wealth, by engaging in long-overdue structural reform in all sectors of their economies and by strengthening the WTO's role as bulwark against protectionism
6. In Latin America the situation has improved, although risks remain. Fortunately, it was possible to contain the impact of the Brazilian financial crisis, and other countries in the region have pursued a process of fiscal discipline and structural reform. Nevertheless, the social impact of the crisis and the poverty in some parts of the region continue to cause concern.
7. The Enlarged Assembly notes the rapid economic growth reached by several countries in transition in central and eastern Europe in spite of the fall-out for the region of Russia's economic difficulties and hesitant growth in western Europe. It recognises the important contribution the OECD is making toward their continued integration into the European and world economy and stresses the significance of further liberalised trade with the OECD area and within central and eastern Europe itself.
8. The Enlarged Assembly in this context draws attention to the extensive consequences of the Kosovo conflict for the entire region of south-eastern Europe and for the need for significant assistance to all the countries affected now that peace has been restored. In addition, it urges the international society to aid recovery efforts in the aftermath of the devastating earthquakes in Turkey, Greece and Taiwan and to assist recovery in East Timor. The Enlarged Assembly welcomes the active role pledged by the OECD in the reconstruction effort, in particular as regards the development of macro-economic, structural and social policies, in helping to build the necessary legal and institutional frameworks and in promoting integration into the regional and global economy.
9. More specifically, the Enlarged Assembly awaits reliable indications regarding the prospects for lasting development capable of creating many jobs, given the high level of unemployment in south-eastern Europe, where the only alternative is migration, including illegal migration. It believes in any event that it is essential to encourage the modernisation of the ruined and obsolete industrial sector which is no longer competitive, while giving priority, however, to SMEs and agriculture. The latter must be geared towards self-sufficiency and new market demands.
10. The Enlarged Assembly is concerned that, as the new WTO Round approaches, protectionist pressure is rising that could intensify along with - and indeed worsen - any world economic downturn. It notes the OECD's findings that more open economies generally grow faster than less open ones, and that they are better able over time to overcome poverty and unemployment and improve core labour standards. It calls on all OECD countries to do their utmost to settle amicably their various disputes now before WTO arbitration, and to maintain the momentum toward more open trade necessary for a successful conclusion of the new Round.
11. As to future multilateral trade negotiations, the Enlarged Assembly supports effective participation by all WTO member countries, including the least developed, openness to democratic scrutiny, and improved co-operation on sustainable development priorities and the social dimensions of trade. To that end, the Assembly urges OECD member countries to support measures to assist the full participation of developing countries in the new WTO Round negotiations; to strengthen co-operation between the OECD and other international bodies in promoting observance of international environmental, social, labour and human rights standards within the trading system; to increase the transparency of WTO structures and processes, including through greater public involvement and input by parliamentarians.
12. Inflation in the OECD area in 1998 stood at a historical low of 3.1%. In spite of emerging inflationary pressure in the US, this trend appears to strengthen in 1999, with a projected rate of only 2.4%. For some countries, especially Japan, there is even a risk of deflation in spite of very low interest rates. The Enlarged Assembly calls for great vigilance against any deflationary spiral, and for the timely planning of counter-measures should deflation become more widespread and severe.
13. Structural reform in OECD-Europe takes on particular importance considering the intolerably high unemployment in many countries, including in Euroland where it is around 10%. Fighting unemployment must continue to be a top priority for European OECD members, especially since any downturn in the US economy would worsen an already difficult situation. They should continue to build on the OECD's follow-up work to its Jobs Strategy project, and also follow the Organisation's extensive recommendations for structural reform. These include continued efforts to keep budget deficits low; making labour and goods markets more flexible, especially by increasing incentives to work; reducing barriers to entrepreneurship; and focusing work skill enhancement efforts on - and ensuring a broad range of employment opportunities for - the most vulnerable groups in society.
14. The Enlarged Assembly therefore calls on the OECD and Council of Europe member states to prepare policies in line with the recommendations of the OECD Scientific and Technological Policy Committee's report on ”Technology, Productivity and Job Creation: Best Policy Practices”. The report is a key international analytical instrument for developing and implementing innovation and technology policies which will meet the needs of knowledge-based economies affected by globalisation.
15. The Enlarged Assembly calls for renewed efforts to pursue regulatory reform on the basis of the OECD's extensive work. Regulatory reform is particularly needed in OECD-Europe and especially in the European Union, where excessive uniformity and regulations may hinder economic growth.
16. The Enlarged Assembly welcomes the follow-up given by the OECD to its recommendation that the Organisation take a more active policy-shaping role in addressing the "Year 2000 Problem" of non-recognition by computers of the century-date change. It recognises the major investments made by OECD governments over the past few years to remedy the situation, and urges them to redouble their efforts in the remaining months of 1999. Special attention will have to be given to a nuclear power like Russia, but other transition economies in central and eastern Europe will also have to receive assistance, as will emerging economies and developing countries. The Enlarged Assembly calls on the OECD to counter 'information warfare' such as 'cyber-terrorism', using investments and experiences already acquired.
17. The Enlarged Assembly notes the OECD's new emphasis on tax reform at three levels. It welcomes the Organisation's efforts to help reform the tax system within countries in order to stimulate growth, by increasing the rewards of, and incentive to, work. As regards efforts at tax harmonisation among countries, notably the EU, it realises that EU integration and especially the EMU provide arguments in favour of such harmonisation. It cautions, however, against the observed tendency to harmonise taxes upwards, as this risks stifling economic growth further and deprive the EU of "best examples" also in this field. This notwithstanding, the Enlarged Assembly commends the OECD on its work to reduce the destabilising effects of certain 'offshore havens' lacking any transparency or control.
18. The Enlarged Assembly welcomes the signing and ratification by many countries of the Convention on Combating Bribery of Foreign Public Officials and expects all OECD and Council of Europe member states rapidly to sign and ratify this open treaty.
19. The Enlarged Assembly, while encouraged by the international community's overcoming of recent financial crises, warns against any complacency. It welcomes the recommendation in the OECD's Business and Industry Advisory Committee (BIAC) for the creation, within the OECD, of a multilateral monitoring body involving the "Systematically Significant Economies" in the world, including those not belonging to the OECD. It believes that an "early attention" body of this kind could be useful for timely identification of emerging economic and financial difficulties and for post-crisis assessment in various countries or regions. In addition, the Enlarged Assembly urges OECD member governments to support multilateral initiatives, also involving non-member countries, to strengthen overall supervision of international financial markets, to alleviate and possibly prevent sudden and destabilizing outflows of capital from countries, and to relieve the debt burdens of the poorest countries.
20. It also welcomes the OECD's increasing emphasis on "good governance", in line with the Enlarged Assembly's contention in its Resolution 1167 (1998) that "democracy, human rights, the rule of law and transparency are essential for sustainable economic development". It hopes that the "Principles of Corporate Governance" presented to OECD Ministers in May 1999 will be adhered to by all OECD and Council of Europe member states. It asks the OECD to prepare a similar set of "Principles for Country Governance" in the economic and financial field - with the conviction that principles of this kind at both corporate and government level are needed to avoid a reoccurrence of the financial crises of the recent past, and to ensure lasting development.
21. The Enlarged Assembly notes that the OECD's efforts to conclude a Multilateral Agreement on Investment (MAI) were abandoned in late 1998 due to the formal withdrawal of the Government of France from the negotiations, and in light of wide differences separating member governments on key issues at a time of growing concerns expressed by citizens groups and parliamentarians over the impact of certain provisions on governments' ability to regulate in the public interest. As the OECD continues to study investment issues, it should draw appropriate lessons from the MAI experience. International protection of investor interests must not be allowed to take precedence over the exercise by countries of democratic economic, social, environmental, and cultural responsibilities. These lessons should also be taken to heart in any future multilateral negotiations on investment issues that may take place at the WTO where, it is hoped, developing countries will have a direct voice in shaping an agreement.
22. The Enlarged Assembly asks the OECD to pursue, within its International Futures Programme and elsewhere in the Organisation, the question of how new information technologies – especially the Internet, electronic commerce, computerised production and robotisation – may fundamentally alter the parameters of economic development, and also to examine the likely effects on employment, income distribution, social conditions, education and culture. The Enlarged Assembly also calls on the OECD to make further efforts to harmonise the different values and systems in the field of information technologies, so that all legitimate concerns and social considerations of countries can be taken into account.
23. Particular attention must be given to the services sector, which is an increasingly important employer of labour by virtue of work rationalisation through the growth of information technologies and robotisation.
24. The Enlarged Assembly asks the OECD and Council of Europe member states to establish new channels of communication, both domestic and international, between the scientific community, policy makers and society at large. On the domestic front, talks on possible action must be based on sufficient understanding by the general public of scientific matters, and the international dissemination of best practices in member states will facilitate the task of finding practical solutions to the major problems which exist in Europe and worldwide.
25. The Enlarged Assembly welcomes the accent of OECD educational programs on lifelong learning for all, as an important contributor to future economic prosperity, social and political cohesion and the achievement of genuinely democratic societies. It encourages the partnership between OECD and the Council of Europe in exploring issues such as the transition from initial education to working life; the role of information and communication technology in education and learning; the analysis of education and innovative strategies for social inclusion and the financing of lifelong learning. It also encourages the exchange of information and experiences in developing national educational policies and co-operation on appropriate specific projects and the promotop and .
26. The Enlarged Assembly also encourages OECD to take account of the member states' concern for a socially responsible attitude, proper standards in labour and environmental matters, and national cultural objectives.
27. The Enlarged Assembly welcomes the OECD's advanced membership negotiations with Slovakia and hopes that similar talks can soon be started with other countries that may qualify. It appreciates the Organisation's continued links with the Russian Federation in spite of that country's current economic difficulties, in the spirit of the 1994 Declaration of Co-operation. It also notes OECD's growing contacts with the People's Republic of China in view of that country's rapidly rising economic importance and the prospect of its joining the WTO. Finally, the OECD's continuing co-operation with the so-called Dynamic Emerging Non-Member Economies is a useful tool for integrating them more fully to the world economy.
28. The Enlarged Assembly encourages the OECD to carry forward, as an essential part of its mandate, the timely and promising work program it has begun on integrating sustainable development priorities into domestic and international economic strategies. Particular attention should continue to be paid to energy efficiency and innovation as a major key to the reduction of greenhouse gas emissions. In addition, the Enlarged Assembly points to the need for strengthening the capacities of countries to meet other major commitments made under multilateral environmental agreements. OECD members should also work to ensure that these commitments, and environmental sustainability principles more generally, are fully respected within future international trade and investment agreements.
II. Explanatory Memorandum by Mr Townend
II The General Economic Situation
The worst avoided but concerns remain
Can the US "bubble" hold and is it a "bubble" at all?
When can a Japanese turnaround be expected?
Is there a risk of deflation?
The situation in Euroland
"The year 2000 problem", or, the "Millennium Bug"
The financial crisis in Brazil
III Unemployment and the OECD's Job Study
IV The need for regulatory reform
V Tax reform
VI Good governance
VII Trade, investment and development
MAI in memoriam
Protectionism on the rise?
The OECD as a world economic watchdog?
VIII Concluding remarks: OECD and the future
OECD membership and outreach
1. The enlarged debate of the Parliamentary Assembly on OECD activities - entitled "OECD and the World Economy" - is scheduled to be held on 22 September 1999. This report is based on the Rapporteur's discussions with the Secretary General, Mr Donald Johnston, and his senior staff in March 1999. It also builds on the meeting of the Committee on Economic Affairs and Development at OECD on 18 June, where Canadian and Mexican delegations participated most actively. The accompanying preliminary draft Resolution was provisionally adopted on this occasion so it could be sent to delegations before the summer. The report also takes into account the OECD Ministerial meeting held on 26 and 27 May 1999. The Rapporteur and the Committee thank Mr Johnston, Mr Shigehara and their colleagues for the valuable comments they gave on these occasions. Finally, the Rapporteur thanks all his colleagues in the Committee for their valuable comments. The fact that the discussions were sometimes forceful only shows the vitality of the Committee's work on the great economic issues of our time.
2. Following the pattern of the Committee's reports over the past few years, this report will focus on a limited number of themes agreed with the OECD Secretary General. These are:
- the general economic situation
- the OECD Job's Study and the unemployment situation in the OECD area
- regulatory reform
- tax reform
- corporate governance and
- trade, investment and development.
3. Particular attention will be paid to the rapidly evolving general economic situation in the OECD area and the rest of the world. This part of the report may have to be updated in the weeks to come, should circumstances so require.
II THE GENERAL ECONOMIC SITUATION
The worst avoided, but concerns remain
4. In its "Economic Outlook" published in June 1999, the OECD took some comfort in noting that "calm and confidence" have returned to international financial markets following over a year of turbulence. Equity markets, it said, have recovered, foreign exchange markets outside Brazil have been calm and the launch of the euro went smoothly, even though the new currency's value has since fallen. And although the Kosovo conflict will have serious effects on countries in the region, its impact on financial markets has been limited.
5. In the same publication the OECD projected a slowdown in real GDP growth for the whole OECD area from 2.3% in 1998 to 2.2% in 1999 and 2.1% in 2000. Growth in the United States for 1999 was projected at 3.6% and that in the European Union at 1.9%. Growth in Japan was expected to shrink by 0.9%. Growth in world output was estimated to have come down from 4% in 1997 to 2.3% in 1998, with a resumption to 2.4% in 1999 and 2.9% in 2000. World trade growth, which in 1998 had halved from 10% to 4.5%, was projected to slow further to 3.9% in 1999, before picking up to 5.6% in 2000.
6. Three central European countries in transition are now members of the OECD: the Czech Republic, Hungary and Poland. The OECD in its June 1999 Economic Outlook projected healthy growth rates for Hungary and Poland of 4.1% and 3.5%, respectively, in 1999. The projection for the Czech Republic was for a shrinking of the economy by 0.5%, before a recovery to 2.4% in 2000. The country experienced strong growth in the early stages of transition, but it now turns out that some additional industrial restructuring remains to be done.
7. The impact of the Russian financial crisis is reduced by the rapid reorientation of the economic links of these three countries from east to west - a development which applies to many others in the region. Their future growth will to a large extent depend on the degree of trade openness of the European Union, and on how fast they can become EU members. Meanwhile, many transition countries have concluded free trade agreements with the four countries of European Free Trade Association (EFTA).
8. The Canadian economy, while slowing down somewhat in 1998, has been helped by continued strong growth in the US. The Mexican economy, which grew by almost 7% in 1997 and almost 5% in 1998, is projected to increase by a more modest 3.2% in 1999 under the influence of financial instability in Latin America, before a more vigorous 3.7% may be reached in the year 2000. Korea, whose economy shrank by all of 5.8% in 1998, is expected to return to over 4% growth this year and next. (The May 1999 OECD Ministerial Meeting attributed this to "supportive macro-economic policies, more open and better-supervised banking and financial markets and other structural reforms which must be carried through". Meantime, our Korean parliamentary colleagues have informed the Rapporteur that they indeed now expect 5% growth for 1999.)
9. The Australian economy is projected to slow down from a 5.1% growth in 1998 to a projected 3.2% in 1999. The country has clearly been affected by the Asian crisis, but a depreciating Australian dollar has softened the blow by facilitating exports. Monetary conditions have also been eased, as have fiscal policies. Following rapid growth over several years, the New Zealand economy showed a –0.8% contraction in 1998 as the country suffered a severe drought, financial market volatility and a decline in business and consumer confidence. It has been severely affected by the Asian crisis. As public spending is increased and interest rates lowered, a recovery to 2.6% GDP growth is projected for 1999.
10. In the Rapporteur's talks with the OECD, the organisation showed itself cautiously optimistic about 1999. However, a number of concerns remain. These include:
- whether the US economy can be counted upon to continue on its present vigorous path;
- the lingering risk of continuing financial instability in Brazil;
- the uncertain recovery in Japan;
- the fragile state of the Russian economy;
- whether China can steer clear of the economic slowdown in Asia and avoid a devaluation of its currency;
- trade imbalances, in particular between the US and the rest of the world;
- US - EU trade tensions over bananas (now presumably solved, but for how long?), hormones in meat and genetically modified food;
- the "millenium bug" in computers and
- the situation in Kosovo and surrounding areas. (Since the Rapporteur's talks, the Kosovo crisis turned into a 10-week conflict between NATO and the Federal Republic of Yugoslavia, before hostilities could be brought to an end in June 1999.
Can the US "bubble" hold, and is it a "bubble" at all?
11. The Rapporteur was eager to hear the OECD's opinion as to whether the world's "importer of last resort" - indeed now its "importer of only resort" - will be able to continue to grow at such a brisk pace and thereby keep the rest of the world economy afloat. At the time of writing (June 1999), the Dow Jones hovers around the record value of 11,000. Jobs are plentiful. Unemployment stands at only 4.2%, less than half the EU figure. Wages are rising. Spending is everywhere. The US economy looks like a "perpetual motion machine", in which each part keeps the others moving. The rising stock market generates new household wealth, which encourages borrowing, which pays for spending, which creates jobs and higher wages, which generate confidence, which encourages people to invest in stocks, which make the market go even higher.
12. Meanwhile inflation is low, which robs the Federal Reserve of a reason to raise interest rates - something it would probably like to do to bring the economy down to a safer speed, but which could also provoke a frantic halt. Businesses both in the US and abroad produce more than Americans want to buy, so prices remain low. Raw materials are cheap as competition among producers to sell excess production holds down prices. (Also oil is still relatively cheap, even though prices have recently risen in response to a co-ordinated cutback in production by OPEC members and a resumption of economic activity in, for example, Asia.) Even low unemployment and rising wages - traditional contributors to inflation - are not enough to stoke inflation in such an environment.
13. Low inflation keeps interest rates low. This encourages people to borrow and spend, such as on homes and cars. Jobs are created, wages increase, confidence flourishes, more money is invested in the stock market, creating more wealth, against which households can borrow even more. Even the Asian crisis helps to keep inflation down, as exporters sell at discount prices in depreciated currencies. Finally, many foreign investors continue to place their money in American stocks and bonds rather than at home, causing bond and stock markets to rise additionally. In previous economic cycles, such expansions have eventually come to an end, as people begin to be pressed financially. Worrying about the future they slow their spending, causing investment to drop.
14. For the rest of the world, the answer to the question of whether the US boom can continue is of critical importance. Any sharper US slowdown would risk pushing Asia back into the crisis from which it is just emerging, just as it would choke whatever recovery there is in OECD continental Europe. It would be too much to ask that even the OECD know the answer. However, at least one interlocutor was not so worried about the US trade deficit, thinking it rather natural that the country should import much more than it exports in view of the fact that the US economy grows so much faster than those of the rest of the world.
15. Perhaps, then, the US is on another economic planet, in the sense that it is the world's largest integrated economy, has such a highly qualified and mobile work force, a low level of regulations, low social costs on business, less unionisation than most of its competitors, is so oriented towards "sun-rise", high-technology sectors including services, and has the world's ever more dominant language, English, 'for free'. Could the information and technological revolution have caused a fundamental change in the way the US economy works, and how all our economies may soon be working? The subject was addressed at an OECD Forum for the Future Conference in December 1998 on the theme: "21st Century Economic Dynamics: Anatomy of a Long Boom". The conference talked of the "possibility of a sustained long-term boom over the first decades of the next millennium. A confluence of forces -- particularly the transition to a knowledge society, the emergence of a global economy, and the pursuit of environmental sustainability -- could come together to propel huge improvements in wealth creating capacity and well-being world-wide"
16. As long as foreign investors place the bulk of their funds in the United States - because of both US economic health and the comparative weakness of much of the rest of the world - the good times may well carry on. As long as the US "debt" to the rest of the world through such placements does not rise to more than, say, 30% of GDP - it at present stands only at 15% - foreigners are not likely to shy away. However, it must also be borne in mind that the savings ratio of Americans is at a historic low, as people finance much of their borrowing against the security of rising shares. What if their values fall? For the time being, at any rate, the US economy keeps the world from falling into a recession or worse. When will the rest of the OECD-area - and in particular Europe and Japan - start pulling their weight?
When can a Japanese turnaround be expected?
17. Naturally enough, the prospects for resumed growth in Japan, the world's second largest economy, figured prominently in the Rapporteur's talks. The OECD expects a shrinking of the Japanese economy by 0.9% in 1999 and a standstill at 0% in 2000. The results of the "Total Plan" for reform launched by the Japanese government in mid-1998 have yet to show up clearly. The "Total Plan" established an infrastructure for dealing with bad loans and enhancing transparency in the economy. A Financial Supervisory Agency could order bank restructuring, as it has done repeatedly since. Public "bridge banks" would temporarily take over insolvent banks. A "Financial Revitalisation Committee" would be established to oversee the whole process.
18. At the time of writing, an expansionary budget for fiscal 1999 has just come into effect. It totals 81.86 trillion yen (15.5 billion dollars), marking a 5.4% increase from the year before. Spending on public works will rise by over 10%, and these together with tax reductions are reported to equal a stimulus of the economy of 27 trillion yen (260 billion dollars). The stock market has risen and our Japanese parliamentary colleagues report real GDP positive growth for the first two quarters of 1999, which they say would translate into an annual growth of 1.7%. Meanwhile, the yen has also started to rise against the dollar, and this could jeopardise recovery by reducing exports. However, Japanese consumers are not yet wholly convinced. They largely hold back spending that is badly needed to revive the economy - even though the interest on savings is close to 0%. Deficit spending seems to be the main weapon being used to stop spiralling deflation, but this can not go on indefinitely. As a result, the public debt has reached about 110% of GDP, a high level for any country.
19. In April 1999 the OECD published a detailed study entitled "Regulatory Reform in Japan". In it, due recognition is given to the partial liberalisation of the financial sector and to the measure of deregulation that is taking place in the retail, telecommunications and petrol distribution sectors. However, the report also points out that Japanese consumers still have to pay much more than other OECD citizens for such things as energy, transport, construction and consumer goods. Furthermore, anyone wishing to start a company needs a special authorisation from a ministry, and once in place it will find that most transactions are possible only under licence. Clearly, the country's Fair Trade Commission has a great deal left to do in order to achieve true competition and reduce the power of cartels. If the traditional Japanese system served the country well in building up its economy after the war, it is not at all adapted either to the saturated domestic market that Japan faces today, or to the new world economy. This is what more and more Japanese now realise, as also became clear in last year's Enlarged Debate, when our Japanese colleagues made very clear their commitment to reform. Meanwhile, the OECD Ministerial Meeting in May 1999 called it "essential that policies be supportive until deflationary pressures ease and a revival of domestic demand-led growth is firmly under way".
20. Nor is the Rapporteur in any doubt that the people of Japan will in the end overcome their crisis. Japan needs to open its markets more to foreign competition, allowing market forces to govern rather than the traditional triangular power vortex of bureaucrats, politicians and business leaders. Reform is all the more urgent as the Japanese population is ageing rapidly, a fact dealt with in greater length in last year's Enlarged Assembly report on the "OECD and the World Economy". The statements made by our Japanese friends in that debate testified to their determination, and the Rapporteur looks forward to their contribution this year to report on the progress made. Indeed, they have just ensured him that in the field of financial reform, major banks have now basically completed the elimination of bad debt, while the restructuring of financial institutions is making progress. The Rapporteur is heartened by this information especially as - if reforms are indeed carried out with determination in these and other fields also in the months and years to come - it will mean a welcome departure from the experiences of the past, which unfortunately saw successive Japanese governments do too little too late.
Is there a risk of deflation?
21. Over the last few years, inflation has virtually disappeared in the large majority of OECD member states, after several decades of mixed results in fighting it. In 1998 the inflation rate for all OECD countries was 3.1%, with those in 1999 and 2000 projected at 2.4% and 2.2% respectively. (The figure includes Turkey, where inflation was over 70% in 1998). In 8 of the 29 OECD member countries inflation was less than 1%, and in 16 it was below 2%. Japan's inflation in 1998 was 0.4%, but is projected to turn into a deflation of 0.7% in 1999 and 0.6% in 2000.
22. Do figures such as these portend a beginning spiral of deflation, such as the one our parents and grandparents knew in the 1930s? Deflation has much to do with people's expectations. If they fear for their future they will not spend, as the Japanese example shows. If they believe that prices are coming down, they will delay their purchases in order to make better bargains in the future.
23. In the eyes of some observers, however, the risk of deflation is limited, as many more people are publicly employed now compared to the 1930s and thus have a relatively secure income which they would not be afraid to spend. And even if they did save more, interest rates would come down as more funds became available, thereby reviving the economy. (However, why has this not happened in Japan?) In addition, they say, governments would immediately counteract deflation by increasing budget deficits, something which did not happen in the first few years of the Depression as Keynesian principles had then still not made their breakthrough.
24. It could also be that the costly Kosovo intervention will increase inflationary pressure in OECD-North America and OECD-Europe, as happened in the United States during the Vietnam War. At the OECD's Ministerial Meeting in May 1999, Ministers not only welcomed the Stability Pact agreed for the region's benefit but also pledged an active OECD role in the reconstruction effort - a stand supported by the Committee when it met at OECD headquarters in June.
25. All things considered, however, deflation could be a bigger threat than many people believe. We shall have to be extremely vigilant. For the time being, the OECD sees the risk as particularly great in Japan, moderate in OECD-Europe and very small in the United States.
The situation in "Euroland"
26. At around the time of the Rapporteur's visit, the OECD released a major report on the EU's Economic and Monetary Union: "EMU: Facts, Challenges and Policies". The report describes the change from the euphoria of 1998 to the more sober atmosphere that has been gaining ground in the course of the euro's first four months. The study notes the slowing down of the economies in Euroland and outlines the political action now increasingly required. The call by many politicians, among them the Rapporteur, for an interest rate reduction by the Frankfurt-based European Central Bank (ECB) was at last heard, when the ECB lowered its benchmark money market rate from 3% to 2.5% in early April 1999, a rate it was still sticking to in September 1999.
27. The cut was deeper than expected. The reason was the message that the ECB wanted to send to Euroland governments: no longer would they be able to delay structural reform under the pretext that the ECB interest rate would first have to come down further; furthermore, no additional cut can be expected within the foreseeable future. A lower interest rate is of course not conducive to a stronger euro, especially as its value, even before the rate cut, had sunk from around 1.18 to the dollar at its launch in January to around 1.06 by the summer. (By mid-September it stood at around 1.04) The weaker euro also means some inflationary pressure, as imported goods, including oil denominated in dollars, become more expensive.
28. It will be interesting to see whether the cut can help to revive the sluggish economies of some of the major euro participants, such as Germany. For those with an overheated economy, such as Ireland, it was at any rate unwelcome, illustrating as it did the difficulty of applying a "one-size-for-all" interest rate throughout eleven rather different economies. The economic prospects for the EMU countries are not altogether clear. Consumer spending and confidence remains high, while industry is less optimistic. After growing by about 2.9% in 1998, the OECD now foresees growth in the EMU zone this year to slow down to only around 2% - as compared to the 2.5% projected in late 1998. The economic situation in key EMU countries such as especially France but also Italy, Spain and, to some extent, Germany, has firmed up somewhat in the summer of 1999, making it likely that the OECD forecast will have to be revised upwards in due course.
29. An ECB interest rate as low as the current one could also lead to a European variant of the so-called "yen carry trade" observed in Japan. "Yen carry trade" denotes the borrowing by investors at low interest rates in Japan, in order to place funds in countries or regions with higher interest rates. If the ECB rate were to fall so low that "euro carry trade" becomes significant, it would do little to revive Euroland economies.
30. The OECD's report on the EMU against this background enters into highly interesting discussion about the "challenges" now facing Euro governments. For instance, to what extent may we count on a closer economic policy co-ordination between Euroland governments? One already existing instrument is the EMU's so-called Stability and Growth Pact, originally conceived to incite countries to greater fiscal self-discipline through fines if they go beyond certain budget deficits. The OECD report raises the question how stabilising the Pact can be. It implies it could be destabilising. It also assesses the budget deficit level needed (and permitted) in the event of a cyclical slowdown in order to ensure that the economy can revive.
31. Suppose, for instance, that there was a real risk of deflation. The Stability and Growth Pact may well render impossible any significant increase in deficit spending that might be required to revive the economy of an individual EMU country or the euro-zone as a whole. If derogations are allowed, for instance in order to encounter a so- called "asymmetric shock", how will the Eleven be able to agree on them in view of the fact that inflationary effects will immediately spread from one country to all the others, including those who may need them least?
32. Elsewhere in the report the authors argue that the ability of various countries in Euroland to overcome "shocks" will to a large extent depend on the flexibility they can bring to bear. In the past there were at least three ways to counter shocks: currency depreciation/appreciation, raising or lowering interest rates, and labour mobility. (A fourth, wage flexibility - especially downward - has not been readily available for a long time.) With the EMU, only labour mobility remains (unless wage/salary flexibility is also revived).
33. The OECD report, however, emphasises the low mobility of labour markets in Euroland, internationally and even nationally, and it considers it as an obstacle in its own right to any rapid economic integration. Within the European Union, it is pointed out, only 1.5% of the population's live abroad. Nor does the report see any likelihood that labour market mobility will increase in the years to come.
34. In addition, it is quite possible that trade unions will demand uniform, EU-wide salary levels in view of wide income disparities between Euroland participants. This is what happened at a national level in Germany after unification, and in countries like Italy and Spain over the past several years. Wage/salary flexibility would be further reduced as a result, and the competitiveness of the countries concerned could deteriorate.
35. It is urgent that the message of the ECB be heard in Euroland and in the EU in general. The governments concerned will have to assume much greater responsibility for the overall European and world economy and not leave the bulk of the work to the United States. At the meeting of EU Finance Ministers in Dresden in April 1999, they came under heavy pressure from Mr Duisenberg to do precisely that - a message that was reiterated when the Parliamentary Assembly's Committee on Economic Affairs and Development met him the same month at ECB headquarters in Frankfurt. And the OECD, as will be clear in the chapters to follow, is the ideal partner as and when they do.
36. Furthermore, if we are to avoid a world recession and, possibly, deflation, EU markets will have to open up more to imports from struggling transition economies in central and eastern Europe, from those in the developing world and from the US. The EU is in a position to do so, since it is running a significant balance of payments surplus with the rest of the world -contrasted with the growing deficit of the United States. (The Eurozone current account surplus went up from 0.4% of GDP in 1994 to over 1 % in 1998, while the US current account deficit increased from 1.8% to 2.7% over the same period, with a further projected increase to 3.4% in 1999.)
37. Interim OECD projections for euro-zone economic growth have been revised downwards to around 2% for 1999. Its industrial production was up by only about 1% in 1998 and unemployment has almost stopped falling. Average GDP growth in Euroland averaged 1.8% between 1993 and 1998, while the US achieved 3.2% average growth. Unemployment is close to 11%, while it is falling towards 4.4% in the United States.
38. The combination of high unemployment, weakening internal demand, slowing growth and rising current account surpluses in Euroland gives the rest of the world the impression that it is not pulling its weight to keep the world economy afloat. (Japan has for several years been subjected the same criticism on the same grounds.) The duty of Euroland (and of the EU as a whole) is therefore to combat global recession more vigorously. It is also in its long-term interest to do so.
39. The Rapporteur sees the high unemployment and poor economic performance in Euroland as having overwhelmingly structural reasons. Labour and goods markets are inflexible and too segmented. Regulations are excessive or inappropriate. Barriers to entrepreneurship are too high and 'red tape' onerous, especially for smaller companies. Tax burdens and social costs are too high. The UK has had higher growth than many other countries in Europe and lower unemployment, due to flexible labour markets, less regulation, and lower taxes and social costs. It is now accepting via the EU more regulation, the Social Chapter, the Working Time Directive, minimum wage and paternity rights, in addition to increasing trade union rights. The Rapporteur believes this will result in convergence with Euroland - higher unemployment and taxes, lower growth, and a move away from the more competitive US model.
40. The European Central Bank, however, has no competence in these policy areas, its only responsibility being to maintain price stability. In order for the latest ECB rate cut to be non-inflationary, it must therefore be followed by structural reform, general deregulation and a reduction in taxes social costs. This will require a major change in attitudes on the part of governments. It remains to be seen whether the left-of-centre governments now in power in nearly all EU nations are prepared to take the plunge. If they do not, economic growth will stay low or go lower, and unemployment stay high or rise.
41. Euroland is upon us. We have to make the best of it. The Rapporteur persists in what has been his belief throughout, namely that the members states of the European Union including the 11 "Eurolanders" would have been well advised to delay the single currency project until there was sufficient real economic convergence between them. The United States has a single currency and it works. It also has a single government, a mobile workforce and a fiscal presence at federal level. Euroland has none of these.
"The year 2000 problem", or, the "Millennium Bug"
42. The Rapporteur is relieved that the OECD did not quite share his concern over the so-called "Year 2000 Problem" or "Millennium Bug" (also known as "Y2K"). The "Year 2000 Problem" refers to the fact many computers and other data dependent systems are programmed to identify years by a two-digit code and may recognise '00' as the year 1900 instead of the year 2000.
43. The OECD's work in this field meets the request of the Enlarged Assembly last year. In Resolution 1167 it urged the OECD to "consider, as a matter of urgency, the establishment of such a standard … and the need to ensure that member states are taking the action necessary to avoid national and international disruption, and are growing up a contingency plan to cover the key sectors of the their economies".
44. Costly investments have been made to avoid disruptions, which could range from temporary and isolated to severe and widespread. Worst case scenarios include generalised utility failures, financial crashes, bank runs, shutdown of hospital life support systems, and world recession. The most widely quoted figure for the world-wide cost of dealing with the 'millennium bug' is $300 - 600 billion. Worst case scenarios give a 70% chance of a serious global recession.
45. The OECD recognises that it is impossible to predict with any degree of certainty the impact of the "Y2K" problem. The organisation notes, however, the major human and financial investments that have been made by governments and at least the larger companies in the OECD area. Less is know about the effectiveness of measures taken in less developed countries or in certain countries in transition - including in Russia where the safety of nuclear arms facilities is also involved. The OECD trusts that hitches can be addressed quickly, however, when they come out of hiding on January 1. It also has trust in people's resilience and proven capability to adapt even to serious disruptions. At any rate, one thing is sure, the problem will never arise again.
The financial crisis in Brazil
46. At the time of writing, the financial crisis that erupted in Brazil in early 1999 still looms large. To the OECD's credit, what took place was accurately projected in the OECD's December 1998 "Economic Outlook". Brazil's problems included a worsening of the fiscal situation; a loss in the value of the real with rising interest rate in its wake; excessive federal and state spending; insufficient structural reform; an unusually high stock of short-term paper being rolled over just before elections in October 1998; and falling consumption and investment. It was only thanks to a $40 billion IMF injection of funds that a turn of events was avoided that could easily have affected other Latin American economies, the US and the rest of the world. At the time of writing, there is no guarantee that the Brazil financial crisis may not flare up again.
III. UNEMPLOYMENT AND THE OECD'S JOB STUDY
47. High and persistent unemployment is a major problem in several OECD countries. Some thirty-five million people, about 7% of the labour force, are unemployed in the OECD area. Many people, particularly in Europe, have been without a job for a long time. They and their dependants are threatened by poverty, the loss of self-esteem and contact with working life. Some have given up altogether about finding a job. However, even for those who have work, it may be precarious and poorly paid.
48. Unemployment in the United States is just over 4%. In the European Union it is about 10%. In Canada, Australia and New Zealand, it stands at about 8%, while in Japan it is lower but creeping up to 5%. Even within OECD-Europe the variations are considerable: from around 3% in Norway, Luxembourg, the Netherlands and Switzerland to close to 18% in Spain - with major countries like Germany (10%), France (11%) and Italy (12%) in between. The United Kingdom is scoring comparatively well, with around 6%. Unemployment in the OECD area as a whole stands at around 7%, down from 7.1% a year before.
49. This is where the OECD's "Job Strategy" comes in as one of many potential recipes for remedy, in that it contains a wide-ranging and balanced set of policies to deal with the problem. In 1997 the OECD presented a follow-up report - "Implementing the Job Strategy: Lessons from Member Countries' Experience" - in which it drew a number of key lessons for the upcoming Ministerial Meeting in May. It will present a further report on country experiences entitled the "OECD Job Strategy: Assessing Performance and Policies".
50. It is interesting to note that many countries that have followed the recommendations of the Jobs Strategy have also made significant indents on unemployment. The OECD recommends a combination of general policies that improve overall labour market conditions, and specific, targeted policies. Among the macro-economic conditions are price stability and reduced budget deficits that lower interest rates and give countries greater leeway to stabilise output and employment.
51. However, parallel to macro-economic stability, structural reform has to be undertaken. The OECD suggests peeling away at excessive employment protection legislation (there has been no action to implement this in Euroland); greater incentives to search for work; special attention to people at the margin of the labour force who are the first to be affected by a downturn. Emphasis must be placed on assisting young people, adult women and older workers. Education must equip these and other vulnerable groups with the skills required to enter the labour force and stay within it.
52. The OECD has found that countries with apprenticeship programmes, such as Germany, Austria, Denmark and Switzerland - have been more successful than those without. Countries that encourage part-time work - the United States, the United Kingdom, Canada and Australia - and care less about excessively high "wage floors" have more success in inserting young people than countries which frown on such practices. The same holds for countries that experiment with a more liberal use of temporary contracts.
53. The OECD urges caution, however, in the use of stopgap solutions such as reducing labour supply by encouraging early retirement or by reducing work time through legislation. Early retirement increases the burden on the national budget. Furthermore, companies will invest less in older workers if they fear they will be leaving prematurely. In addition, OECD populations are growing steadily older, a development which already increases the tax burden on the fewer younger people of working age remaining. Similarly, legislation to shorten the working hours can be a two-edged sword. True, companies may have to hire more workers to get the job done. However, if wages stay the same or increase beyond productivity gains, labour costs may cause companies to become less competitive and to hire fewer workers.
54. The OECD sees the fostering of entrepreneurial activity and more competition in all markets as vital components in any effort to reduce unemployment. The US economy is a case in point. Every person who can start up a company will gain knowledge and work experience in so doing. He or she can hire others. Already today, economic growth comes much more from small companies than from big ones, which are downsizing and outsourcing anyway. Small and medium-sized enterprises provide between 40% and 80% of all jobs, depending on the country.
55. OECD countries must learn more from each other. Especially countries with high unemployment must learn from those with better records. For example, since 1973 the US has created 38 million jobs in the private sector, while in the EU the net job creation has been zero. We politicians must muster the political courage to go through with structural reform. The fate of our children and grandchildren, indeed the very future of our societies, is at stake,
56. The situation is particularly precarious for countries with both high unemployment and a low employment rate - the latter referring to the proportion of the entire population between 16 and 24 that are actually in employment. In Spain, the employment rate is only about 50%. In Iceland it is over 85%. In the United States it is over 75%. In France it is only around 60%. Among the countries that follow policies most in line with the OECD Jobs Strategy - and which have thereby managed to keep low unemployment and high employment rates - are the United States, Norway and Portugal.
57. It is vital that the OECD does not let up on its Jobs Strategy. Peer pressure among member countries and the OECD's constant monitoring of progress are essential components. We have to make work pay better. We have to make labour markets more flexible and bring down taxation. We have to improve the school-to-work transition and ensure proper skill levels throughout working life for as many people as possible. Flexible work arrangements have been successfully used by many countries. Others must learn from them.
58. Entrepreneurship must be stimulated, not just at conferences but on the ground. New technologies must be better developed and diffused. The Rapporteur is himself a businessman-cum-politician. His son, who is in the same business as his father, constantly reminds him of the ubiquitous governmental red tape and the plethora of national and EU regulations that make his life as an entrepreneur so much more difficult. Administrative requirements alone are estimated to cost businesses in the European Union 540 billion euros per year, equal to 3-4% of total output. In the Netherlands, small firms spend 6 times as much per employee as large firms on government paperwork. In Canada, 8% of the revenue of very small firms are spent for the same purpose. People in small businesses ask for nothing more than to be able to devote their energies to their real work, and not to time- and staff-consuming form-filling. They deserve resolute and long overdue action from us politicians.
59. The Rapporteur will not conceal from the reader the reaction on the part of some socialist Committee members to expressions such as 'more flexible labour markets' and 'the need to lower taxes and social costs'. Thus, one Scandinavian colleague saw 'flexible labour markets' as portending a fundamental shift in favour of the employers, soon to render all employees part-time. They would enjoy little or no job security, nor would they keep rights acquired over a century of social struggle.
60. Similarly, 'the need to lower taxes and social costs' was voted down in the original version of the preliminary draft resolution. Little did it matter that, for instance, OECD Ministers - many of them Socialist - in their May 1999 communiqué say both that "policy must promote flexible labour markets" and that "attention should be given to … reforms of the tax and benefit systems to make work pay …" "Make work pay" must surely, in the eyes of the Rapporteur, signify lower taxes on incomes. However, differences of opinion such as these form a healthy part of the Enlarged Assembly's life, and we all look forward to the September debate when they will be fought out in earnest.
IV. THE NEED FOR REGULATORY REFORM
61. If some OECD governments are slow on regulatory reform, it is not for want of the OECD's trying to convince them that it is needed. Regulatory reform in the organisation's eyes has two components: better and fewer regulations. Even this conservative Rapporteur recognises the need for some regulations to support public policies. They can help us protect our environment, improve the safety of products, maintain competition and protect the weak and vulnerable in society.
62. However, many rules on the books just hang on even as more are added - reflecting the tendency of any authority to want to control more, and to correct things not by freeing but by binding. In the mature market economies that are those of the OECD, many regulations only serve to slow innovation, hinder job creation and reduce competitiveness both within among countries. Many are too complex and burdensome to be effective. They reduce our prosperity and wellbeing. Whether we are talking about economic regulations governing markets, social regulations or government "red tape", we must now, as politicians, look them over more critically than ever. Otherwise our economies will simply not grow enough.
63. If we make new regulations, let us make sure they are less costly and serve the public interest more effectively than they often have in the past. And wherever we deregulate, we have to find the right mix of market forces and government intervention that will permit us to reach our objectives. In both cases we must keep a constant check on the situation, given the perennial tendency of bureaucracies to want to control more rather than less. We must foster a political culture that also can say no, not just yes and amen, to regulations that will only add new complications to our already complicated lives.
64. The OECD has clear evidence showing that countries that have come further on regulatory reform also grow more quickly. As with the "Jobs Strategy", the OECD monitors while member states compare with one another and 'self-assess'. Five key sectors have been singled out: electricity, telecommunications, air transport, road haulage and retail distribution. The results suggest that the more regulated regions - Europe and Japan - could add between 3 and 6% to their GDP if they pursue reform more ambitiously. Australia, which has done so, believes it has added 5.5% to its GDP as a direct result. The European Single Market - a major step towards greater intra-EU liberalisation - is estimated to have increased EU income by an estimated 1.5% from 1987 to 1993, with the European Commission projecting additional future gains if the 'acquis' which has been reached holds and is further enlarged. It behoves us policy makers to inform the public why reform is important also to them, and to start an open, informed debate involving all concerned.
65. As far as the EU is concerned the situation continues to worsen, as new regulations continue to be issued, albeit at a lower rate. That rate is, however, faster than deregulation, which as far as the European Commission is concerned is negligible. In the UK, for example, in the last two years small business has had to cope with the working time Directive, the 48-hour week, minimum wage, the Social Chapter, paternity rights and hygiene regulations. The Fairness Work Act included trade union rights which make it more difficult to get rid of under-performing workers.
V. TAX REFORM
66. The work of the OECD necessarily reflects the concerns of its member states. In the tax domain, the organisation has for many years argued in favour of taxation levels that are not so high as to stifle growth. Many new terms were created that are now common parlance among politicians. One example is the "fiscal wedge", which denotes the difference between the cost of one hour of work for the employer and the purchasing power that this hour of work gives to an employee after his taxes and social security contributions have been deducted. This difference, the Rapporteur is told, will prevent even the highest paid surgeon in Sweden from hiring a gardener and oblige him to cut away at a hedge rather than an appendix.
67. Another OECD coinage is the "unemployment trap", which results when unemployment and related benefits are in excess of, or near, the after-tax wage/salary of a person if he or she had been employed. We all in our daily lives as politicians see especially young people lose their drive and skills as they stay long in unemployment rather than go for a job.
68. Finally, there is the "poverty trap". It applies when the combined effect of the withdrawal of social welfare benefits and the payment of income taxes and social security contributions on additional earnings means that a low wage worker has no incentive to work harder or invest in training.
69. Of late, however, the OECD is paying new attention to the co-ordination of tax systems, reflecting the concerns of many member countries, especially those with higher taxes. Tax reform may be of no particular urgency to a country like the United States, which already has low taxes, a budget surplus, rapid growth and full employment. However, it is in Europe - especially within the EU and more particularly within Euroland - that pressure for greater co-ordination of tax systems now comes. The purpose is to foster tax efficiency and discourage harmful tax competition. Already cross-border tax competition leads to capital flight. This could in time lead to a shift of the tax burden away from capital and onto labour.
70. Tax co-ordination will be particularly important among members of the EMU, as the single currency eliminates the cost of currency conversion and exchange risk. A recent resolution of ECOFIN (Ministers of Economics and Finance within the EU) targets preferential regimes in certain EU member states. The European Commission proposes a Directive to establish a 'co-existence model' for the taxation of cross-border interest flows of individuals. The Directive would oblige EU countries to withhold tax on such flows within the EU, or inform other countries of cross-border payments to individuals. There are also efforts to harmonise indirect taxes within the EU as a result of both the Single Market and the EMU. Finally, greater co-ordination of corporate tax systems is sought, since the present disparities, it is argued, hinder the functioning of the Single Market. However, the Rapporteur wishes to point out that harmonisation upwards can have adverse effects on, for example, London as a financial centre. Furthermore, the doubling of VAT on art imports will undermine London's position as a centre for the international art trade.
71. The Rapporteur's concern here is that harmonisation will cater to the high-tax countries rather than the lower-tax countries - with the former taking the, seemingly (but falsely), higher moral ground of defending the welfare state and social solidarity. Trade unions can be counted upon to serve as auxiliary troops in this battle. Successful attempts to turn economies around by lowering income taxes, corporate taxes and extra-salary costs - successfully carried out by the United Kingdom under Mrs Thatcher - may well become impossible within the clay-footed EU colossus, under the pretext that it amounts to "social dumping". The European Union would lose what little vigour it has left. With slower growth the euro would weaken, and with it Euroland's international competitiveness.
72. This is not how it works in the United States and certain other OECD countries. Federal taxes are low. Individual US states can set their own tax rates. As they do, however, they know that any tax increase may mean a flight of companies, capital and people. This guarantees that taxes are held at their best level - sufficient for the public weal but low enough not to stifle growth.
73. Lest the Rapporteur be considered by his Assembly peers as a foe of taxes per se, let it be said clearly that he has great sympathy for the OECD's efforts to come to grips with some of the world's most blatant "offshore havens". Take the Cayman Islands. Bank deposits total $500 billion, double the amount five years ago. That makes about $40 million for every Caymanese man, woman and child. Twenty thousand corporations are registered, among them 575 banks and trust companies. The islands have no tax on income, capital gains, value added, sales or inheritance. There are no tax treaties with other countries.
74. Nobody may have looked with envy at the $40 million per Caymanese, had it not been for the risk they present to international financial stability. The OECD in its December 1998 Economic Outlook repeatedly refers to the last-minute international rescue attempt of the Cayman Islands-based Long-Term Capital Management trust fund, whose sudden bankruptcy last year nearly caused a world financial collapse. The OECD therefore insists on greater tax consistency and transparency in economic life in order to avoid having a future Cayman Islands cause future Brazils.
75. This is also what the enlarged Assembly had in mind in 1998, when it called, in Resolution 1167 (1998) for "urgent measures, including clear accounting standards and transparency ... to enhance the capacity of global markets to function properly and with stability." It went on to call on OECD governments to "work co-operatively with other nations to explore practical options for curbing damaging short-term financial speculation, with the aim of restoring a more orderly global system that promotes needed long-term investment flows and mitigates the dominance of speculation of a productive enterprise".
VI. GOOD GOVERNANCE
76. The enlarged Assembly has for several years encouraged the OECD in its struggle against economic crime and corruption. In Resolution 1167 (1998), it welcomed the first signatures of the OECD's Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. (This Convention which came into force on 15 February 1999 has, in the meantime, been signed by 34 countries and ratified by 15.1)
77. This year the Rapporteur wishes, however, to concentrate on a new priority of the OECD in this general field, namely corporate governance. It is the increased turbulence in world financial markets which has heightened our awareness of the importance of transparency and accountability in companies - or "good corporate governance". Our economies, and by prolongation the world economy, derive their strength from healthy firms. Firms create jobs, raise capital, earn profits, pay taxes and divide the 'value added' among both shareholders and the wider group of 'stakeholders' - employees, creditors and suppliers.
78. The OECD sees a strong relationship between economic development and good corporate governance. Companies that are run in an open and honest way will add to the vigour of an economy, enhance its international competitiveness and ability to attract international capital markets, and further its social progress.
79. Clearly, however, standards such as these were not met in the majority of countries affected by the Asian crisis in 1997, nor were they there in Russia in 1998 or in Brazil in early 1999. Hence the OECD's urgency in drawing up a set up Principles of Corporate Governance - officially intended for its own circle of member countries but in reality also for many others in the world. The principles are general rather than specific, reflecting the wide differences in legislation and practice in the several countries. They are sufficiently flexible to be alterable over time. However, generality does not mean that they are watered down to some least common denominator. Rather, they go to the heart of corporate governance,
80. In the crisis countries, effective monitoring mechanisms were not in place, nor was management encouraged or obliged to use resources efficiently. There were serious defects in disclosure regimes. Firms pursued objectives other than profitability, often instead aiming exclusively at expanded market shares or conglomerate-building. Banks in the crisis countries did not engage in proper credit analysis and did not try to restrain the corporate sector as its expansion became excessive. There were serious flaws in the prudential supervision of banks and other financial institutions. Finally, there was little in the way of market competition which, had it existed, would have forced greater discipline and efficiency.
81. The Principles, approved by the OECD Ministerial meeting at the end of May 1999, come under five broad headings:
- The rights of shareholders to be able to influence the behaviour of the corporation;
- The equitable treatment of shareholders, for instance as between national and foreign shareholders;
- The role of 'stakeholders' - employees, creditors and suppliers but also society as a whole - for instance as regards environment protection;
- Disclosure and transparency of all information of interest to investors, for instance through an annual, independent audit;
- The role of the board, especially its duty to treat various groups of shareholders and stakeholders fairly and to ensure that the company abides by the laws.
82. The principles are primarily aimed at governments. But they should also be of value to stock exchanges, investors, private corporations and national commissions on corporate governance that wish to establish rules of their own. Their success will depend vitally, however, on whether the larger economic environment in which firms operate is healthy. Good macroeconomic policies, a rising national income and strong competition will encourage observance of the principles, just as the opposite will contribute to a more generalised erosion of standards in companies. In that sense, they form part of the OECD's overall mission and merit the support of the Enlarged Assembly.
VII. TRADE, INVESTMENT AND DEVELOPMENT
MAI in memoriam
83. If the OECD's Corporate Principles had been universally observed within a sound macroeconomic framework, the year of 1998 and early 1999 might not have seen such a low growth in world trade, such a dip in investment in emerging economies, and such frustrated hopes for development on the part of so many countries.
84. Perhaps - heretic thought - the world might even have fared better if the OECD's efforts to conclude a Multilateral Agreement on Investment (MAI) had not been abandoned in late 1998 under the combined pressures of a number of member countries, trade unions and assorted NGOs. The provisions in the then still provisional MAI indeed supported accountability, transparency and non-discrimination - the very values that the Corporate Principles seek to encourage. Had MAI been around, investor choices might have been better informed, investor confidence stronger and built on more solid ground, and the risk of sudden, widespread, capital flight reduced.
85. The enlarged Assembly last year made a number of requirements on any future MAI, such as that it should take into account the views of parliaments and citizens' groups, cultural differences, environment and labour standards, and the need to regulate short-term capital movements. The MAI had, in brief, taken on such an omnibus, albatross character that it had become too difficult to be negotiated, and perhaps too heavy to fly.
86. The Rapporteur believes that there will inevitably be an MAI-type agreement in the future, since the international economic system will need it. Now we have over a thousand bilateral agreements instead, plus whatever is enshrined in regional agreements such as the EU, EFTA, NAFTA or Mercosur. Meanwhile, many countries outside the OECD area aspire to meet internationally agreed expectations in an attempt to attract foreign investors. The OECD has a critical role in helping shape international consensus around such aspirations. It is the Rapporteur's hope that it will again in some future be entrusted with this task, for it is not likely that the much more heterogeneous WTO will be able to take it over.
Protectionism on the rise?
87. In the meantime, the OECD tries to make its contribution to a forthcoming WTO Millennium Round, by examining the responsibilities of each country for its own and the world's economic development. It finds rich evidence that economies with open trade and investment policies grow significantly faster than closed economies. Growth is also found in general to lead to a reduction in poverty and to improved core labour standards. Finally, the OECD finds evidence that investment in human capital has the greatest positive influence on economic growth within open economies. In other words, you may invest in education, but it is only if the people that are educated can deal with the rest of the world that they will maximise added wealth. Many OECD countries would do well in realising that their obligations vis-à-vis the young do not stop at giving them a good education, but that they must also create a society in which they young can find jobs when they graduate.
88. The OECD's conclusions also serve to underline the Rapporteur's belief that "trade is better than aid". The economic progress reached by, for instance, South Africa since the fall of apartheid is a point in case. South Africa now radiates stability to the rest of southern Africa, with which it trades heavily and relatively freely.
89. This leads us to the state of trade relations in the world. Last year's enlarged Assembly urged that "any protectionist tendencies should be withstood in order to allow recovery to be resumed in the countries most affected by the crisis [in Asia]". Since then we have witnessed a resurgence of the banana conflict, pitting the US against the EU. The matter was settled by WTO Arbitration in April 1999 obliging the EU to reform its banana import regime and pay fines to the US. More EU-US trade conflicts are looming, however, such as over hormones in meat and over genetically modified food. The importance of the arbitration authority of the WTO cannot be over-estimated, but this is also a high-risk game in that it presupposes that the parties to a dispute will abide by the WTO's rulings. OECD Ministers in May 1999 therefore pleaded with member countries to "continue to settle trade disputes in accordance with WTO rules" and drew attention to the "responsibility resting on governments in this regard". The Rapporteur agrees. Countries will have to reflect carefully before rendering the WTO dispute settlement system inoperative. The result could be trade lawlessness, which would be the same as trade chaos. The same spirit of compromise will have to be shown as regards the new WTO Director General, who at the time of writing (June 1999) has not yet been appointed due to conflicting preferences among the member countries.
90. Protectionist pressure is rising in the US. The country's negative trade balance (goods and services) went up by 53% in 1998 ($ 168.6 billion) compared to 1997 ($ 110.2 billion). In the US Congress, import quotas are being considered for steel, and the Administration has not been given "fast-track" authority for forthcoming WTO negotiations. The US now has a considerable deficit not only with Asian countries including Japan, but also with the EU and even its NAFTA partners Canada and Mexico.
91. The EU is already protectionist. If this is perilous with regard to the US, it can be disastrous for economic growth in central and eastern Europe, and hence for the harmonious pan-European development we all seek. True, the EU is divided between countries with more free-trading inclinations and those with more protectionist instincts. So far, unfortunately, the latter group seems to have had the greatest influence. As the EU falls victim to its own habits, there is a risk that the more free-trade oriented countries will start taking after the others. One example is the just quoted case of South Africa. The EU pledged, five years ago when a multi-racial democracy was established, to throw open its doors to trade with South Africa. Despite 20 rounds of negotiation no agreement has been finalised, due to problems with EU Mediterranean members. Furthermore, the EU has refused to allow South Africa into the Lomé Agreement (with 70 African, Caribbean and Pacific states).
The OECD as a world economic watchdog?
92. The Enlarged Assembly in 1998 said that "there is an urgent need to establish additional mechanisms to safeguard against sudden movements of speculative short-term funds". This raises the issue of whether the world needs a new 'watchdog' or 'early attention' institution, that will bark early enough at countries that neglect "good governance", be it at governmental or corporate level. The 1998 Enlarged Assembly emphasised that "democracy, human rights, the rule of law and transparency are not 'luxuries' which countries may or may not 'afford', but essential for sustainable economic development".
93. It is interesting to see what the OECD's Business and Industry Advisory Committee (BIAC) has to say on this in a report on the global financial situation. It raises the proposal to create an ad-hoc group of 22 countries - termed the "Systematically Significant Economies" - to work on issues of transparency and on ways to strengthen international financial institutions. By the "Systematically Significant Economies" is meant the major OECD member countries as well as some non-members such as China, Indonesia and Brazil. The BIAC recommends that existing OECD resources should be used for this project. It would include periodic peer reviews, leading to "multilateral surveillance" and greater policy co-ordination.
94. The Rapporteur has considerable sympathy for this proposal, which gave rise to an interesting discussion at the Committee's June meeting of OECD, especially as regards precisely which economies should be considered "systematically significant". The important thing is that the 'early attention' body will bark loudly as soon as a country leaves the 'straight and narrow' of democracy, transparency, the rule of law and "good governance" in governmental and corporate affairs. The Rapporteur believes the OECD could do the job, perhaps drawing on its long experience in elaborating its renowned Country Studies of its own members and others. True, these are drawn up in co-operation with the countries studied, and compromises on wordings become necessary as a result. The organisation is, however, among the very few to possess the necessary experience and expertise for such an 'early attention' role - naturally enough extended to all the "Systematically Significant Economies" and exercised in close co-operation with the IMF and the World Bank.
95. Furthermore, in May 1999 the IMF's Interim Committee decided to open up a new credit line as a tool to encourage crisis-hit economies implement reform and prevent a repeat of contagion from financial turmoil. An 'early attention' body within the OECD together with an extra credit possibility of this nature could allow the international community to deal more efficiently with such problems in the future.
96. At any rate, the matter is of great importance for the economic health of OECD countries. In its December 1998 Economic Outlook, the OECD included statistics on bank lending to emerging markets. Banks in the European Union have outstanding loans of over $600 billion to emerging markets, more than double those of Japan ($265 billion) and over five times those of the United States ($116 billion). For EU banks, this represents over 90% of their capital. The exposure of Canadian banks is almost as high (87%), much higher than that of US banks (31%). Worst off are Japanese banks with an exposure 44% above their capital.
97. At the Committee's 18 June meeting, an interesting discussion took place on debt relief for, in particular, the so-called "Heavily Indebted Poor Countries" (HIPCs). Such relief, subsequently agreed at the June 1999 G-8 Summit in Cologne, is considered by the OECD as helpful both to HIPCs and the world economy. It is important, however, that it does not encourage 'moral hazard' on the part of either lenders and borrowers, i.e. that it makes them overly careless in giving or taking loans in the future. Nor should it be allowed to cause a 'dependency culture' to develop. Finally, it must be accompanied by 'good governance' to ensure that funds are put to proper use.
98. Financial crises and 'early attention' regardless, globalisation is upon us, driven ever faster by new technology. If properly managed, if accompanied by concern for the poor and the vulnerable, globalisation can bring millions of more people - now toiling in marginal local economies - into a more fully integrated world market place, with all the scope for contacts, specialisation, division of labour and give-and take that that entails. An immense new global middle class with vast purchasing power is being created in more and more countries around the world. They will compete with richer nations, but also buy eagerly from them. It is into this new world, this new century, that the OECD is there to accompany us.
VIII. CONCLUDING REMARKS: OECD AND THE FUTURE
OECD membership and outreach
99. The membership of the OECD still stands at 29 countries, unchanged since 1996. Advanced negotiations are under way with the Slovak Republic, and there are increasing contacts with countries like Chile, Argentina and Brazil. The Baltic countries have announced a strong interest in joining.
100. Meanwhile, co-operation with Russia - never abandoned even at the height of last year's financial crisis - proceeds apace in the spirit of the "Declaration of Co-operation" of 1994. Russia has applied to become a member, but no formal membership application process has been started. No doubt, OECD membership will require considerable efforts as regards domestic economic reform, regulatory transparency, the environment and the security markets.
101. The OECD attaches great importance to its co-operation with China. China is already a major world economic and political power and its role will only grow in the future. The OECD's role in fostering the country's economic integration with the rest of the world remains significant, especially at a time when China is knocking at the door of the WTO.
102. Finally, there is continuing co-operation also with countries like India, Brazil and Indonesia - the latter two, of course, in particular need of advice in their current difficult situation. Co-operation is also close with the so-called Dynamic Emerging Non-Member economies (DENMs) such as Malaysia, Singapore and Taiwan, not least through the OECD's Emerging Market Economy Forum, in which over a dozen other countries participate.
103. The OECD does not foresee any imminent enlargement of its membership. But this stance brings with it a dilemma. On the one hand, the organisation would need more members to increase its global role. On the other hand, the more members there are, the more heterogeneous the OECD will become, rendering an already cumbersome consensus decision-making process even more so. Enlargement might also not mean more money, as existing members see a chance to reduce their own contributions against those of new members.
104. The OECD is already stretched to the limit after cutting its budget by around 10% over the last three years. The first fruits of reform can already be discerned. The type of over-arching studies repeatedly referred to in this report point to an important OECD role in the coming years, namely that of permitting us to see better into the future by drawing on the best minds in the organisation's various fields of interest. The International Futures Programme has had precisely this role for a long time, but many other OECD departments now provide similar cross-fertilisation among disciplines. The OECD Secretary General also said he that he wished to have greater freedom to move budgetary resources from one sector to another in the light of upcoming needs.
105. The OECD is likely to concentrate in the future on developing relations with, on the one hand, major non-member economies and on the other, fast-growing smaller countries. It is also likely to seek even greater co-ordination with other international organisations such as the WTO, the World Bank and the IMF.
106. The OECD does not offer a single model for development, but rather a framework for countries to shape their institutions and policies in support of three principles: pluralistic democracy, respect for human rights and open-market economies. The Rapporteur believes that the OECD continues to have an important mission to fulfil and that it has to be given adequate resources to do so.
107. World economic development must in part be unguided and spontaneous to retain its dynamism. However, as the recent financial crises have shown us, economic development cannot be left entirely to its own devices. The OECD itself reasons in terms of a 'triangle', whose different sides - economic development, social equity and political stability - are mutually supportive and equally necessary. The world does not yet have a government, and this Rapporteur for one does not feel it should have one. However, what the world does need is to have countries come together to compare experiences, confront ideas and agree on the likely determinants of the future. Asking the right questions together is already part of the answer. The OECD is a forum for such a debate and it must be permitted, with our support and permanent comment, to continue in this role.
Reporting committee: Committee on Economic Affairs and Development
Budgetary implications for the Assembly: None
Reference to committee: Standing mandate
Draft resolution unanimously adopted by the enlarged committee on 21 September 1999.
Members of the committee: Degn (Chairperson), Valleix, Bloetzer, Elo (Vice-Chairmen), Akgonenc, Aliko, Andreoli (Alternate: Felici), Attard Montalto (Alternate: Agius), Billing, Blattmann, Bojars, Bonet Casas, Braun, Brunhart, Calner, Lord Clinton-Davis (Alternate: Lord Judd), Cunliffe, Cusimano (Alternate: Turini), Durrieu, Eyskens, Frey, Freyberg, Galvao Lucas, Gonzalez Laxe, Grass, Gül, Gusenbauer, Gylys, Hempelmann, Hoffmann, Kacin,, Kirilov, Kittis, Kuznetsov, Lazarenko (Alternate: Kosakivsky), Leers, Liapis, Linzer, Lotz, Mateju, Mitterrand, Niculescu, Nothomb, Obuljen, Pereira Coelho, Popescu, Popovski, Prokes, Puche (Alternate: Ramirez Pery), Rigo (Alternate: Pozza Tasca), Rutskoy, Sarishvili-Chanturia, Schmitz, Shuba, Sorocean, Squarcialupi, Stepova, Stoyanova, Tallo, Townend, Vasile, Verbeek, Verivakis (Alternate: Pottakis), Wielowieyski
Canada : Mr Caccia, Senator De Bané, Senator Rivest, Mrs Lalonde, Mr Mahoney,
Japan: Mr Nakayama, Mr Sasaki, Mr Yamaguchi, Ms Hata
Korea: Mr Lee, Mr Paek, Mr Ham, Mrs Kwon
Mexico: Senator Solana
Committee secretaries: MM. Torbiörn, Mezei and Ms Ramanauskaite.
1 Ratified as of 7 June 1999 by: Austria, Mexico, Sweden, Iceland, Japan, Germany, Hungary, United States, Finland, United Kingdom, Canada, Norway, Bulgaria, Korea, Greece. Signed by: (29 OECD member countries): Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States, (and five non-members): Argentina, Brazil, Bulgaria, Chile and the Slovak Republic.