A Need for Development Banks to Offer Developing Countries a Chance to Survive a Crisis - Essay Example

RUNNING HEAD: POVERTY Poverty [Name of the Writer] [Name of the Institution] Poverty Introduction There is no question that the current economic crisis originated in the developed world, and primarily in the United States. Much of the analysis of the crisis has thus focused on institutional failures within the United States and there is, rightly, tremendous concern here about high rates of domestic unemployment and underemployment. But after three decades of globalization, what happens in the United States does not stay in the United States; the actions of traders in New York City will mean hunger for children in Nairobi. (Swinnen, 2007 p. 322) We currently know what catastrophe looks like in the age of globalization and it is not sweet. This crisis is uniquely a child of the neoliberal global order. For developing countries the key elements of neoliberalism have consisted of trade liberalization and an emphasis on exports; reductions in government social welfare spending; a greater reliance on the market for determining the price of everything from the currency exchange rate to water from the tap; and, last but not least, economy-wide privatization and deregulation. In each case, the aim was also to promote cross-border flows of goods, services, and capita--and, to a far lesser degree, of people. These "reverse flows" are partly the result of attempts by developing countries to ward off balance-of-payment crises by holding large foreign exchange reserves. Within the United States, this capital helped sustain massive borrowing by households, corporations, and governments, exacerbating the debt bubble of the last eight years. Meanwhile, the global "race to the bottom" among developing-country exporters ensured that the prices of most manufactured goods and services remained low, taking the threat of inflation off the table and enabling the U.S. Federal Reserve to keep interest rates low and facilitate the housing bubble. Now that this debt bubble has finally burst, it is no surprise that the crisis has been transmitted back to the global South at record speed. A country-by-country comparison of the growth in real (i.e., inflation-adjusted) GDP from 2007 to 2008 against the average annual growth of the preceding three years (2005-2007) gives us a picture of the differential impact of the economic crisis--at least in its early stages--on various countries. Consistent data are available for 178 developed and developing countries. (Woods, 2009 p. 121-43) Overall, GDP growth for these 178 countries was down by 1.3 percentage points in 2008 compared to the average for 2005-2007. Of course, the financial crisis only hit in full force in September 2008, so the 2009 data will give us a more complete picture of the impact of the crisis. The International Monetary Fund (IMF) estimates that global GDP will turn down in 2009 for the first time after World War II. (Woods, 2009 p. 121-43) Currently, the IMF is expecting a 1.4% contraction this year. According to the International Labor Organization, global unemployment increased by 10.7 million in 2008, with a further increase of 19 million expected in 2009 by relatively conservative estimates. As an outcome, the number of people existing in poverty will increase by an estimated 46 million this year according to the World Bank. (Woods, 2009 p. 121-43) The initial impact in 2008 was greatest in Eastern Europe and Central Asia: six of the ten countries with the steepest declines in real GDP growth were from the Eastern Europe/Central Asia region. Joined by Ireland, this is a list of global high-fliers--countries with very high rates of growth (before 2008, that is) that had globalized rapidly and enthusiastically in the last decade and a half. Singapore of course was an early adopter of globalization, touted by the IMF as a model for other small countries, while Seychelles has depended heavily on international tourism. Myanmar would seem to be the exception to this pattern of intensive globalization, given its political isolation. From an economic perspective, however, this was a country whose economic growth depended heavily on the rising prices of its commodity exports (natural gas and gems). (Woods, 2009 p. 121-43) The recession in the United States and Europe has hit exports from the developing world hard. Globally, trade in goods and services did rise by 3% in 2008, but that was compared to 10% and 7% in the previous two years. Trade is expected to decline by a sharp 12% in 2009. The United States, the world's most important importer, has seen imports drop by an unprecedented 30% since July 2008. (Woods, 2009 p. 121-43) For countries ranging from Pakistan to Cameroon, this has meant lower foreign exchange earnings, slower economic growth, and higher unemployment. Meanwhile, for many developing countries, the emphasis on export promotion meant the increasing export not of goods and services but of people, who sought work in richer countries and sent part of their earnings back home. Remittance flows from temporary and permanent migrants accounted for 25% of net inflows of private capital to the global South in 2007. (Collier, 2007 p. 205) These flows are also affected by the crisis, although they have proved more resilient than other sources of private capital. The Middle Eastern countries that are important host countries for many Asian migrants have also been relatively shielded from the crisis. As a result, for the developing world as a whole, remittances actually rose in 2008. Because other private capital flows declined sharply post-crisis, remittances accounted for 46% of net private capital inflows to the developing world in 2008. (Woods, 2009 p. 121-43) In the boom years up to 2007, developing countries were encouraged to liberalize their financial sectors. (Woods, 2009 p. 121-43) This meant removing regulatory barriers to the inflow (and outflow) of foreign investors and their money. While some foreign investors did buy factories and other actual physical assets in the developing world, a substantial portion of foreign capital came in the form of portfolio capital--short-term investments in stock and real estate markets. Portfolio capital is called "hot money" for a reason: it tends to be incredibly mobile, and its mobility has been enhanced by the systematic dismantling of various government restrictions ("capital controls") that formerly prevented this money from entering or leaving countries at the volume and speed it can today. Around the time of the collapse of Bear Stearns in the United States in early 2008, various global financial powerhouses began pulling their money out of developing-country markets. (Woods, 2009 p. 121-43) The pace of the pullout only accelerated after the crash that September. One consequence for developing countries was a fall in their stock market indices, which in turn depressed growth. Another was that as foreign investors converted their krona, rupees, or rubles into dollars in order to leave, the value of the local currency got pushed down. The IMF has long touted the virtues of allowing freely floating exchange rates, where market forces determine the value of each currency. In the aftermath of the financial crisis, this meant a sharp depreciation in the value of many local currencies relative to the dollar. This in turn meant that every gallon of oil priced in dollars would cost that many more, say, rupees. Similarly, any dollar-denominated debt a country held became harder to repay. The dollar cost of imports and debt servicing went up, just as exports and remittances--the ability to earn those dollars--were falling. Predictably, countries with floating (i.e., market-determined) exchange rates were harder hit in 2008. (Gough et.al, 2009 p. 124-54) Falling flows of FDI and development aid. Meanwhile, one other source of foreign exchange, foreign investment in actual physical assets such as factories (known as foreign direct investment, or FDI), is stagnant and likely to fall as companies across the world shelve expansion plans. The signs of vulnerability are evident in the fact that countries most dependent upon FDI inflows (as a percentage of GDP) between 2005 and 2007 suffered greater relative GDP declines in 2008. (Gough et.al, 2009 p. 124-54) Developed countries are also cutting back on foreign aid budgets, citing the cost of domestic stimulus programs and reduced tax revenues. Such cuts particularly affect the poorest countries. With the economic slowdown their governments are losing domestic tax and other revenues, so falling aid flows are likely to hurt even more. The importance of continued aid flows can be seen in the fact that higher levels of aid per capita from 2005 to 2007 were actually associated with more mild drops in GDP growth in 2008. (Gough et.al, 2009 p. 124-54) This may be partly due to the fact that these countries already had low or negative rates of GDP growth so that 2008 declines appear smaller relative to that baseline. (Gough et.al, 2009 p. 124-54) Nevertheless, aid flows appear to have protected the most vulnerable countries from even greater economic disaster. In fact the so-called HIPC group (highly indebted poor countries) actually saw an increase of one percentage point in GDP growth rates when compared to the 2005-2007 average. (Gough et.al, 2009 p. 124-54) The simultaneous transmission of the crisis through these three channels has left developing countries reeling. What makes the situation even worse is that unlike developed countries, developing countries are unlikely to be able to afford generous stimulus packages (China is an important exception). Meanwhile, the IMF and its allies, rather than supporting developing-country governments in their quest to stimulate domestic demand and investment, are hindering the process by insisting on the same old policy mix of deficit reductions and interest rate hikes. In an illustration of how ruinous this policy mix can be, countries that had followed IMF advice and adopted "inflation targeting" before the crisis suffered greater relative GDP declines once the crisis hit. (Collier, 2007 p. 205) The tragedy, of course, is that while the remnants of the welfare state still protect citizens of the developed world from the very worst effects of the crisis, developing countries have been urged for two decades to abandon the food and fuel subsidies and public sector provision of essential services that are the only things that come close to resembling a floor for living standards. They were told they didn't need that safety net that it only got in the way; now, of course, they are free to fall. Conclusion For those unwilling to let this tragedy unfold, this is the time to apply pressure on developed-country governments to maintain aid flows. Even more importantly, this is the time to apply pressure on the IMF and the other multilateral development banks, and on their supporters in the halls of power, so that they offer developing countries a genuine chance to survive this crisis and begin to rebuild for the future. It is worth recalling that the end of the previous "age of globalization," signaled by the Great Depression, led to a renewed role for the public sector the world over and an attempt to achieve growth alongside self-reliance. In the years after World War II, led by Latin America, newly independent developing countries attempted to prioritize building a domestic producer and consumer base. In the long run, perhaps this crisis will result in a similar rethinking of the currently dominant model of development. In the short run, however, the world seems ready to stand by and watch while the poor and vulnerable in developing countries, truly innocent bystanders, suffer. References Collier, Paul. The Bottom Billion: Why the Poorest Countries are failing and what can be done About It.NewYork: Oxford University Press, 2007, 205 pp. Gough, John McCormick, Peter Pedersen, Jose Ugaz, and Stephen Zimmermann. 2009. The Fight against Corruption: International Organizations at a Crossroads. Journal of Financial Crime 15(2): 124–54. Marquette, Heather. 2003. Corruption, Politics and Development: The Role of the World Bank. New York: Palgrave Macmillan. Swinnen, J. F. M., Editor. Global Supply Chains, Standards and the Poor: How the Globalization of Food Systems and Standards Affects Rural Development and Poverty. Cambridge, MA: CABI, 2007, 322 pp Woods, Ngaire. 2009. The Globalizers: The IMF, the World Bank, and Their Borrowers. Ithaca, NY: Cornell University Press. Read More