Taking stock, taking action

Inclusive Economy09 Nov 2009Evert-jan Quak, Dirk Willem te Velde

A year on from the collapse of Lehman Brothers and talk in developed countries has moved from recession to recovery. Financial conditions in developed countries have improved, there has been a boost in business confidence, export orders are growing, industrial production is increasing and quarterly GDP in many countries is growing once more.

Bolstered by successful implementation of fiscal stimuli and collective action to support financial markets, there is a new belief in the role of the state to correct market failures. But just as the financial crisis engulfed the world, affecting those who played no part in the original causes, it is crucial that any recovery from the crisis has the same global reach.

The crisis itself stems, mainly, from poorly regulated financial markets which allowed risky and complex financial products to develop, skewing financial flows and creating unsustainable global imbalances. With world trade plummeting and industrial production falling drastically, the economic crisis has affected developing countries through declining trade, private financial flows and remittances. By the end of 2009, developing countries may have lost incomes of at least $750 billion – more than $50 billion in sub-Saharan Africa.

Growth forecasts in developing countries have been revised downward in 2009, in stark contrast to the excellent economic growth records recently. Growth in Cambodia, for example, is set to slide from more than 10% in 2007 to close to zero in 2009, and more than 63,000 garments jobs were lost by March 2009. Kenya may achieve only 3-4% growth in 2009, down from 7% in 2007.

Trade values declined. The value of garment exports from Cambodia feel from $250 million per month in 2008 to $100 million in January 2009, although Bangladeshi garment exports did not suffer the same fate. Coffee exports in Uganda fell by a third in the year to March 2009, though an increase in Uganda’s regional trade of maize and beans cushioned the impact somewhat.

Prices of copper and oil fell, affecting countries such as Sudan, Zambia, and the Democratic Republic of Congo, but have rebounded in recent months, adding to an already volatile situation. Declining oil exports have lowered government revenues threatening fiscal transfers to Southern Sudan. DRC and Zambia went to the IMF for timely support.

FDI in garments halved in Cambodia in 2008, raising fears that investors, mainly Chinese, will not return when the recovery kicks in. FDI plans in mining exploration in Tanzania were halted with potential long-term consequences. Remittances to Kenya fell by 12% in the first six months of 2009 compared to the same period in 2008.

The crisis, grim though it is, could be an opportunity to re-shape the global economic institutions and rethink growth strategies. A ‘new compact on crisis resilient growth’ between rich and poor countries is needed to ensure that recovery is sustainable, that volatility is dampened and that poor countries have a growing role in the recovery as it comes.

Ensuring a sustained rainbow recovery for all requires that current fiscal stimuli should not be withdrawn. A sizeable share should be channelled to a ‘rainbow’ stimulus in poorer counries, bringing together the best of the blue of conservatism and market forces to increase growth; the red of state interventionism directed at liquidity constrained consumers and the increasing unemployed; and the green of environmental sustainability.

Further, developed countries should be more serious in their efforts to prevent ‘beggar-thy-neighbour’ protectionism in labour, trade and financial markets, which has hardened recently as evidenced by new restrictions on temporary workers and new import duties. Developing countries need their own ‘rainbow’ policies to grow themselves out of the crisis. Too many poor countries have been in a state of denial about the crisis – a year on, this is no longer acceptable. Countries that are not competitive or have not responded are not well positioned to gain from any global recovery. Reducing global volatility requires better financial regulation and new financial rules in developed countries to increase the transparency of capital flows, curb illegal transfers, and reduce the pro-cyclicality of financial flows to developing countries, for example, by adjusting capital adequacy ratios over the business cycle, or promoting capital flows to developing countries using innovative financing mechanisms.

The vexed question of bonuses could be resolved by rewarding efforts to pursue sustainable global growth and responsible investment abroad, drawing on lessons from the use of incentives in development finance. Bankers’ bonuses should reward economic not just financial rates of return. Global imbalances fuelling volatility need to be curbed. Rather than investing surplus capital in risky financial products in rich countries, better returns could be gained when these sovereign wealth and other funds are leveraged into low-income countries

A global compact for crisis-resilient growth could help developing countries cushion the impact of crises. Dealing with global problems requires a greater provision of global public goods. Apart from governance reform, the IMF and WB need sufficient resources to help countries deal with crises. The IMF had sufficient resources to triple lending to low-income countries this year, but what about the next crisis when countries are still repaying the debts of this one? A World Bank IDA crisis facility could replace the myriad of approaches so far and reduce specific conditions and buttress growth when the next crisis hits.

A new deal on climate financing in Copenhagen can help to promote growth in developing countries which is more resilient to climate change, and ensure that developing countries gain from a drive to a low-carbon world. Aid is normally provided for development objectives, so climate finance should be additional to ensure the provision of environmental global public goods.

Developing countries themselves could help by diversifying their economic base more forcefully than before. Taken together, these measures would provide a new global compact for crisis-resilient growth, providing a better response to today’s global economic meltdown and putting developing countries in a stronger position to address unknown challenges in the future.

ODI’s research on the global financial crisis shines light on many of the issues, see for an update on a monitoring study on the effects of the global financial crisis in 11 countries with in-country teams of researcher, which is an update from a published study. We have also hosted a G-20 consultation (with DFID) on the IFIs. More ODI related studies and blogs about the global financial crisis can be find on the ODI website.