Poverty & Public Policy

www.psocommons.org/ppp
Vol. 2: Iss. 2, Article 8 (2010)

The Global Economic Crisis and Developing Countries: Effects, Responses, and Options for Sustainable Recovery
Wim Naud, UN University - WIDER
Abstract Following the financial crisis that broke in the United States and other Western economies in late 2008 and led to a global economic crisis, there remains concern about its effect on developing countries. This paper discusses its unfolding during 2008-2009 and traces its initial effects on developing countries. The paper takes note of the greater resilience of many developing countries this time around (as opposed to previous global recessions) and discusses the global responses to the crisis during 2008 and 2009, concluding that the weak response of the rich world to help developing countries may contribute to a paradigm shift in international development. Keywords: financial crisis, developing countries, international development, poverty

Recommended Citation: Naud , Wim (2010) "The Global Economic Crisis and Developing Countries: Effects, Responses, and Options for Sustainable Recovery," Poverty & Public Policy: Vol. 2: Iss. 2, Article 8. DOI:10.2202/1944-2858.1050 Available at: http://www.psocommons.org/ppp/vol2/iss2/art8

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Introduction
Sales of Karl Marxs Das Kapital have been reported to have soared in the last quarter of 2008 when financial markets started to collapse like dominos and the U.S. government, traditionally a bastion of capitalism, rushed in to 1 bail out banks. Marx, on the face of it, seemed to have been particularly prescient in having expected financial crises to occur regularly in capitalist economies. There have been at least 124 systemic financial crises since 2 1970. Despite this, unlike Marx, most latter-day economic forecasters seem to have been unprepared for the present debacle. As Giles argued, there is no doubt that the credit crisis, which has morphed into recession across advanced economies, leaves most economic forecasters with ample egg on their face.3 Indeed, the crisis, that within the month of October 2008 had erased around U.S.$25 trillion from the value of stock markets, took many (but not 4 all) by surprise. This was partly because it came on the heels of a sevenyear period of high growth, and originated in the USA rather than in emerging markets as previous crises had done. Both the initial destruction of financial wealth as well as the psychological shock of seeing many elite Wall Street firms on their knees prompted numerous commentators initially to raise the spectre of the Great Depression. Although not the Great Depression, for the first time since World War II, the world economy contracted after the U.S., EU, Japan, and other high-income economies entered recession at the end of 2008. Having decimated Wall Street and then crippled Main Street, the financial crisis was soon compared to a hurricane descending on the developing world, and developing countries were called upon to to start nailing shutters on the

See, e.g., www.news.bbc.co.uk/1/hi/world/europe/7679758.stm. L. Laeven and F. Valencia, Systemic Banking Crises: A New Database, IMF Working Paper WP/08/224 (Washington, DC: The International Monetary Fund, 2008). 3 As put by Nam (2009, p. 1), As much as Wall Street and Main Street, the economics profession needs a bailout of its own. 4 See Giles (2008). In its October 2007 World Economic Outlook, for instance, the IMF, although concerned about the subprime crisis in the U.S. and its potential negative impact on slowing down growth, still assumed in its baseline forecasts that market liquidity is gradually restored in the coming months and that the interbank market reverts to more normal conditions.
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windows. By the middle of 2009 the IMF and World Bank started to refer to the crisis as a global development emergency. This paper describes the unfolding of the crisis from a developing country perspective, notes its expected and materialized impacts, and critically discusses the global responses to the crisis so far. In this, it argues that the paradigm for international development has changed irrevocably. With the example, leadership, moral authority, and capacity of the West in international development having diminished, developing countries recovery and future growth will critically hinge on their own initiatives and solutions.

Background: Causes and Unfolding

The causes of the crisis have by now been widely analyzed and dissected. Undoubtedly, many volumes and theses will no doubt appear over the coming years to explain why the crisis was actually inevitable, and why it should have been foreseen, had the world only taken note of these prior warnings. These will be accompanied by the inevitable airport blockbusters offering secrets on how individuals can prosper amidst global doom and gloom. Without mentioning new editions of Das Kapital nor wanting to rob the reader of the chance to discover these insights for her or himself, this section will be very brief. It shows that the anatomy of the crisis is rather simple: easy credit, bad loans, weak regulation and supervision of complex financial instruments, debt defaulting, insolvency of key financial institutions, a loss of credibility and trust, and financial panic and mass selling-off of stocks and a hoarding of cash by banks and individuals. With the interconnectedness of financial markets, especially among the developed countries, the panic spread rapidly, causing a widespread credit crunch and sharp declines in consumption, investment, and trade in initially the entire rich world. Although the crisis peaked in late 2008, it has its roots much further back. Following the burst of the dotcom bubble in 2000 and the 2001 terror attacks on the U.S., the U.S. and most other advanced economies
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A. Evans and S. Maxwell, Financing Development: From Monterrey to Doha, Open Democracy, 26 November 2008. 6 For recent overviews of the causes and nature of the financial crisis, see for example Barth, 2008, Felton & Reinhart, 2008, Johnson, 2009, Ritholtz, 2009, Stiglitz, 2009, Taylor, 2009.

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embarked on a period of sustained expansionary economic policies to ward off recession. The Federal Reserve, for instance, lowered its discount rate no 7 fewer than 27 times between 2001 and 2003. Low interest rates, facilitated by the huge trade surpluses that China and other countries used to purchase U.S. Treasury Bonds, stimulated rapid growth in credit. The accompanying rise in house prices further fuelled credit growth, especially through mortgage lending. In the U.S., subprime market mortgage lending, to households without the essential means to repay loans, took on huge proportions; according to Lin, about $1.3 trillion was lent in subprime 8 mortgages. U.S. mortgage lenders, most infamously the institutions known as Fanny Mae and Freddie Mac, securitized these subprime loans, which were then sold throughout the financial system as assets. They were able to issue and securitize these bad loans due to a combination of inadequate regulation and so-called financial innovation. The latter made it difficult for other institutions to assess the risks of these securitized mortgages and 9 led to increased subprime mortgages. Thus in spite of their underlying risk, they were taken up by financial institutions. As put by Krugman: the innovations of recent yearsthe alphabet soup of C.D.O.s and S.I.V.s, R.M.B.S. and A.B.C.P.were sold on false pretences. They were promoted as ways to spread risk, making investment safer. What they did insteadaside from making their creators a lot of money, which they didnt have to repay when it all went bustwas to spread confusion, luring investors into taking on 10 more risk than they realized. Two factors in particular encouraged asset managers to throw caution to the wind: the growing global economy and their pay incentives. Riskmanagement tools were clearly inadequate properly assessing risk during for the upswing in the global economy. Rating agencies in particular seem to have been awarding high ratings much more easily under favorable growth
J. Y. Lin, The Impact of the Financial Crisis on Developing Countries. Presented at the Korea Development Institute on 31 October 2008 in Seoul. 8 Ibid., 2008. 9 J. L. Bicksler, The Subprime Mortgage Debacle and its Linkages to Corporate Governance, International Journal of Disclosure and Governance, 5(4) (2008): 295-300. 10 P. Krugman, Innovating our Way to Financial Crisis, The New York Times, 3 December 2007, available from http://www.nytimes.com/2007/12/03/opinion/03krugman.html.
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conditions. Barth shows that 45% of all new securities rated by Standard and 11 Poors in 2007 were rated AAA. As far as pay incentives are concerned, Bicksler describes the overpayment of CEOs of many financial firms as a serious breach of good corporate governance. The New York Times points out that Wall Street has been the top tier of the corporate pay range, with executives earning eight-figure salaries. Its bonus system, which rewards short-term trading profits, has been singled out as an incentive for Wall Street executives to expand their highly 12 profitable business in exotic securities and ignore the risks. By the summer of 2007, increasing defaults on mortgages and growing numbers of foreclosures in the U.S. signalled that the subprime market was in crisis. House prices and financial stock prices started to plummet. This reduced the value of household wealth in the U.S. by trillions. The solvency of Fanny Mae and Freddie Mac, as well as of a number of well-known international financial institutions was threatened by these defaults and the drops in house and stock prices. On September 7, 2008, the U.S. government nationalized Fanny Mae and Freddie Mac. Then, on September 15, 2008, the firm of Lehman Brothers filed for bankruptcy; with 13 $639 billion in assets, it was the largest in the history of the U.S. This resulted in widespread financial panic, with large-scale selling of stocks. The investment banking industry in the U.S. was wiped out. Central to the sudden reductions in availability of credit, particularly in the interbank market, which precipitated the collapse of many firms, is what Taylor 14 describes as the Queen of Spades problem. This refers to the fact that securities containing bad subprime mortgages were distributed across the financial system and institutions did not know where they were. This created a counterparty risk, which according to Taylor meant that the turmoil in the interbank market was not a liquidity problem of the kind that could be
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J. R. Barth, US Subprime Mortgage Meltdown. Presented at the 14th Dubrovnik Economic Conference on 25 June 2008, available from http://www.hnb.hr/dub-konf/14konferencija/barth.ppt. 12 See www.nytimes.com/2008/09/24/business/24pay.html. See also Bicksler (2008, pp. 295-300). 13 See www.financialpost.com/news/story.html?id=790965. 14 J. B. Taylor, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. NBER Working Paper 14631 (Cambridge, MA: National Bureau of Economic Research, 2009), p. 12.

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alleviated simply by central bank liquidity tools. Rather it was inherently a 15 counterparty risk issue. When the U.S. House of Representatives on September 29, 2008 first rejected a U.S.$700 billion bailout proposal for the financial firms adversely affected by the credit crunch (albeit later adopted), Wall Streets 16 Dow Index experienced its largest one-day point loss in history. Banks in Europe were soon affected due to their exposure to U.S. financial markets. In October, the U.K. government recapitalized eight of the countrys banks, followed by an agreement among the Euro-zone countries on October 15 on injecting further capital into distressed banks and providing guarantees for interbank loans, at the cost to the taxpayer of more 17 than U.S.$1.3 trillion. In early December 2008, the National Bureau of Economic Research (NBER) confirmed that the U.S. economy was in recession, and a week later, estimates were released showing that the economy of the U.K. was also contracting. Soon it became clear that other members of the EU, such as France, Germany, Ireland, and Sweden among others, and other major markets such as Japan and Singapore, were also in recession.

Effect on Developing Countries

Initially it was hoped that the developing world, given that this crisis was not of their making, and given the good progress that many countries have been making in recent years, might be spared the fallout from the crisis. But by the end of the first quarter of 2009, it became clear that these hopes had been too optimistic. For one, although not as seriously affected as in the U.S. and EU, developing countries financial markets did not escape unharmed. Most dramatically affected were developing country stock markets, which experienced a sharp outflow of investment and experienced fairly significant collapses in a short space of time. Declines in stock market prices and housing prices have contributed to reductions in the capital of banks, causing many to reduce lending in order to shore up their capital. In turn this has led to reduced investment, lower growth, and increased unemployment. Bearing in mind that government revenue depends on growth, this means less

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Taylor, p. 15. See www.etftrends.com/2008/09/dow-jones-loses-nearly-800-points-volatilesession.html. 17 See www.news.bbc.co.uk/1/hi/business/7644238.stm.

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government revenue and expanding deficits in many developing countries, with consequently means less means for governments to fight poverty. The responses of the rich world were fairly quick (albeit with an inauspicious start in the U.S.). These resulted in approximately $2 trillion being allocated toward financial sector bailouts, approximately $800 billion for fiscal expansion in the final quarter of 2008 and interest rates being cut significantlyin many cases to their lowest in 50 years. Immediate global growth prospects nevertheless continued to worsen. Simultaneously the demand for exports from developing countries dropped precipitously global trade was expected by the IMF to fall by 11% in 2009. The decline in the demand for exports of developing countries was furthered worsened by the drop in the prices of most commodities. Increases in the prices of commodities, particularly of fuel, metals, and agricultural raw materials, have been underpinning many developing countries good 18 growth since the early 2000, especially in Africa. Between January 2003 and July 2008, energy, food, and metal price indices rose by 329%, 102%, 19 and 230%, respectively. Commodity prices generally peaked between March and July 2008, just when initial concerns about further fallout from the U.S. subprime mortgage crisis were being raised. Figures 1-3 depict the sudden fall in prices of fuel (Figure 1), metals (Figure 2), and agricultural raw products (Figure 3).

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IMF, World Economic Outlook: Crisis and Recovery (Washington, DC: The International Monetary Fund, 2009a), available from http://www.imf.org/external/pubs/ft/weo/2009/01/index.htm#ch4fig.

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African countries in general (oil exporters as well as oil importers) achieved a 8.1% GDP growth rate between 2003 and 2006 (IMF, 2009a).

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Figure 1. Petroleum Spot Prices (U.S.$ per barrel), March 2006-March 2009

Source of data: IMF, 2009a. Figure 1 shows the sudden and sharp decline in the oil price between July 2008 and March 2009. Figure 2. Metal Price Index (2003=100), March 2006-March 2009

Source of data: IMF, 2009a. A number of developing countries are important exporters of minerals and metals, such as the platinum group metals (PGMs), gold,

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diamonds, copper, chromium, zinc, manganese, nickel, dimension stone, and a host of other metallic and nonmetallic minerals used mainly in manufacturing and construction. In recent years, a substantial proportion of the demand for these minerals/metals has been coming from Chinas manufacturing and construction sectors. Figure 2 shows that the average prices of these commodities have declined since mid-2008 and March 2009 by more than 150%. Figure 3. Agricultural Raw Commodities Prices Index, March 2006-March 2009

Source of data: IMF, 2009a. Figure 3 shows that agricultural raw commodities prices also declined sharply after June 2008. However, in comparison with the steep decline in fuel and metal prices, agricultural commodity prices have not declined as significantly, with the index depicted in Figure 3 declining by about 30%. As a group, developing countries require financial inflows from the rest of the world to facilitate and accelerate economic growth, trade, and development. These flows include official development assistance (ODA), investment flows (both portfolio and foreign direct investment [FDI]), trade credits, and flows of remittances. All of these have been affected negatively during the current crisis. Cali, Massa, and Te Velde estimate the decline in

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financial resources to developing countries to be around U.S.$300 billion. 21 ActionAid gives a higher estimate of U.S.$400 billion on the decline. With regard to ODA, although most advanced countries committed themselves to the 2002 Monterrey Consensus on Financing for Development to provide at least 0.7% of GNP as aid to developing countries, it was clear at the Follow-up International Conference on Financing for Development to Review the Implementation of the Monterrey Consensus in Doha in December 2008 that few countries could meet this commitment. Indeed, the newly elected U.S. president suggested in March 2009 that his administration may not achieve its target of doubling foreign aid. Other countries such as Ireland, Italy, and Latvia decreased their aid budgets, and the value of aid from the U.K. has been substantially reducedestimated by some to be as much as $41 billion over the next seven yearsbecause of the shrinking of the U.K. economy and the depreciation of the British Pound. Given that aid has always tended to decline in the past during recessions, there may be further declines. With regard to remittances, there are many indications from countries with large numbers of migrant workers that remittance flows are declining. Countries with migrants predominantly in the U.S. or EU (e.g., Mexico and the Caribbean) and small states such as Lesotho, Haiti, and Nepal (where remittances contribute in excess of 10% to GNP) have already started to feel the pinch. Remittances in recent years have grown to be one of the most important financial flows to developing countries, exceeding 22 U.S.$240 billion in 2007, more than twice the volume of aid flows. As far as private investment flows to developing and emerging countries are concerned, we have seen these decline as more risk-averse investors move their funds to perceived safer havens. This includes both portfolio and FDI. Reduced portfolio flows are affecting government borrowingparticularly in smaller developing countries. The costs of sovereign bonds and commercial debtboth important sources of finance

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20

M. Cali and D. W. Te Velde, The Global Financial Crisis: Financial Flows to Developing Countries Set to Fall by One Quarter, ODI Report (London: Overseas Development Institute, 2008), available from http://www.odi.org.uk/resources/detailsasp?id=2523&title=global-financial-crisisfinancial-flows-developing-countries-set-fall-by-one-quarter. 21 See www.actionaid.org.uk/101543/press_release.html. 22 D. Ratha, S. Mohapatra, K. M. Vijayalakshmi, and Z. Xu, Remittance Trends 2007. Migration and Development Policy Brief 3 (Washington, DC: The World Bank, 2007).

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for developing-country governmentshave risen sharply. Similarly, FDI is declining. Although FDI to developing countries grew tremendously over the past seven years to a record high of over U.S.$500 billion by 2007, it is 24 expected that FDI flows to these countries will decrease by 10% in 2008. Cali, Massa, and Te Velde document that FDI to countries such as Turkey and India declined by 40% in 2008, greatly adding to their balance-of25 payments constraints. In many parts of Africa the decline in commodity prices is likely to compound the reduction in FDI, as most FDI to the continent is resource-motivated. Finally, a further negative impact on developing countries exports has been through contractions in trade finance. Around 90% of trade is traditionally financed by short-term credit. With the credit crunch starting to bite, trade finance has also been reduced as banks limit their risk exposure. The worldwide gap in trade finance had grown from an initial estimate of $25 billion in November 2008 to $100 billion by March 2009. As a consequence of falling export demand, reductions in credit and investment, declining remittances, and lower aid prospects, many developing country growth ratesparticularly those in Latin America and Africa came tumbling down with amazing speed after the crisis erupted in September 2008. The World Bank adjusted its expectations for emerging and developing country growth for 2009 substantially downwards to 2.1% (compared to growth of 5.8% in 2008; for regional growth collapses, see Figure 4). As a consequence, the International Labour Organization (ILO) predicted that unemployment could rise by 20 million across the world and that the number of people working for less than the U.S.$2 per day poverty 26 line will rise by 100 million. According to reports, the World Bank expects 27 40 million people to fall into poverty as a direct result of the crisis. As far as inequality is concerned, it is worrisome to note that the issue so far has been largely neglected. But the crisis has the potential to increase inequalities between countries, as the developing worlds financial
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Hostland (2008) records that average sovereign bond spreads increased from 325 base points in August 2008 to 660 by October 2008. 24 UNCTAD, World Investment Report 2009 (Geneva: United Nations, 2008), 33. 25 Cali, Massa, Te Velde, 2008. 26 See www.ilo.org/global/About_the_ILO/Media_and_public_information/Press_releases/lang -en/WCMS _099529/index.htm. 27 See www.guardian.co.uk/business/2008/nov/12/world-bank-poverty-developingnations.

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resources are diverted to the rich worlds financial system (the poor bailing out the rich). Within countries it is still unclear whether the net effect of the crisis will be to increase or decrease inequality. It could decrease wealth inequality to the extent that owners of assets are more adversely affected. But it may possibly also worsen inequality within countries because of the fact that not all people within countries will be affected in the same manner. Ravallion, for instance, argues that not all of the poor will be affected. Indeed, some will be protected by the same things that have kept them poor in the first placegeographical isolation and poor connectivity with national 28 and global markets. One implication is that the urban poor in developing countries may be disproportionately affected. A further channel of impact on inequality is discussed by Naud and MacGee, who raise the concern that given that the financial crisis has a differential impact on the ability of households to become entrepreneurial, either across countries or within different levels of income within countries, it will have an impact on the 29 future distribution of wealth.

M. Ravallion, Bailing Out the Worlds Poorest. WB Policy Research Working 4763 (Washington, DC: The World Bank, 2008). 29 W. A. Naud and J. C. MacGee, Wealth Distribution, the Financial Crisis and Entrepreneurship, WIDER Angle Newsletter, March 2009, available from http://ideas.repec.org/p/unu/wpaper/angle-feb-2009-a.html.

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Figure 4. Growth Collapses in Developing and Emerging Countries

Source of data: World Bank Global Economic Prospects, Update 30 March 2009. From the above, it can be seen that the crisis has affected developing countries through all of the expected channels, namely financial sector difficulties and reductions in domestic lending, reductions in export earnings, and reductions in financial flows (including aid).

Responses
Country-Level Responses There is no commonly accepted theory of financial crisis to provide failproof advice on the correct policies that each particular country should adopt 30 in the wake of the crisis. As a consequence, we have seen a multitude of approaches to the current crisis on a country level. Generally, these can be categorized into immediate, short-term (stabilization) and long-term (structural) policy responses. As will be argued in the next subsection, much more is still needed in terms of long-run structural policy responses, and in
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L. Jonung, Lessons from Financial Liberalization in Scandinavia, Comparative Economic Studies, 50 (2008): 564-98.

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this regard there is little that countries can do on their own to address some of the most fundamental causes of the crisis. Countries largely engaged in immediate and short-term policy responses to ensure that the crisis is contained and that confidence in financial systems is restored and to mimimize the effect on the real economy. In doing so they have either drawn down on forex reserves and/or raised short-term borrowing. Table 1 summarizes measures that various developing countries have been seen taking over the past year. Table 1. Summary of Generic Developing Country Responses to the Global Economic Crisis
Timeframe Objective Immediate Policy options

Containment of financial panic

Guaranteeing of bank deposits Guaranteeing of interbank loans Provision of liquidity to banks Forbearance on regulations Recapitalization of banks Reduction in the costs of borrowing Raising of inflation targets Increasing the spending on social safety nets, including conditional and unconditional grants and public works, provision of fertilizers and seeds Lowering and raising protective measures Maintaining competitive exchange rates Reducing the supply of commodities Support measures to local industry Public works programmes supporting industry

Short term

Resolution measures Monetary expansion Fiscal expansion

Trade expansion/protection

Industrial policies

Source: Compiled by the Author.

It is too early, and country circumstances and measures are too diverse, to provide an appropriate evaluation of the effectiveness of these responses within the scope of this paper. Future comparative research will however be very useful in this regard. For the present it can be noted that developing countries did act, and some remarkably well, in the wake of the crisis. As will be shown in the next section, this is in contrast to the assistance that they have so far received on a global level.

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Global Responses There is agreement that the crisis has been caused by more than just greed and inadequate banking regulations. It is due to fundamental inequities in the structure and governance of the global economic and financial system. Consequently, fiscal stimulus packages can only be short-term responses to declining demand. More drastic interventions are required for sustainable 31 growth in global demand. As Professor Joseph Stiglitz, speaking at a United Nations University Lecture early in 2009, put it: Some people have acted as though this is a problem in our financial system. A problem you might say, in the plumbing. So we fix the plumbing and we can go on. But the problems are much deeper and are problems of the modern version of capitalism, at least of the American style. I think we are coming to a realisation that the institutions that were created sixty years ago are not up to the task, and we need to begin re-thinking these institutions. We are also realising that some of the ideologies that prevailed over the last quarter century are greatly flawed. So I think that the next few years will be a really exciting time as we begin to discuss a new global architecture What Stiglitz is referring to here is the need to reform the global economic system, including the IMF and World Bank, which were created around 60 years ago. There is now widespread agreement that global economic reform should at least include (1) addressing global imbalances in savings and consumption,32 (2) moving away from the U.S. dollar as the major reserve currency, (3) reforming the Bretton Woods institutions and in particular giveing more voice to developing countries, and (4) reforming the international aid architecture. Calls have also been made for a rethink of global trade agreements.

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Watch Professor Joseph Stiglitzs UNU lecture online at

http://www.ony.unu.edu/events-forums/events/2009/emerging-thinking-seriesexpla.html. 32As pointed out by UN-DESA (2009 28): Developing countries as a group are net creditors to the rest of the world, and their savings will quite likely provide, directly or indirectly a major source of funding to cover the costs of the multi-trillion dollar bailouts of financial institutions in the United States and Europe.

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In light of the need for such reform, the global responses over the past year to the crisis acknowledged the need for reform, but neglected to make much progress. The two major global responses took place around the G-20 meeting in London in April, and the United Nations Conference on the World Financial and Economic Crisis in New York in June. The G-20 meeting in London certainly recognized the plight and challenges of the developing countries. However, it failed in many fundamental respects. It did not seriously set in process the reform of the IMF and World Bank, and did not address the reserve currency issue, nor of related global imbalances in trade, savings, and consumption. At the G-20, the main thrust was on short-term measures, including bank bailouts, to stabilize the U.S. and European battered banking systems. These measures are not popular, and have been described as financial protectionism, whereby the U.S., as issuer of the worlds reserve currency, can pump sufficient money into its banking sector to guarantee its stability, thereby attracting funds from other countries without this ability. Furthermore, only about $50 billion of the G-20s commitments has been directly allocated for the poorest developing countries. This amount should be seen in context. Many have already remarked on the fact that huge amounts of money have been found at short notice to bail out banks, but that money to bail out the worlds bottom billion is always in short supply. Contrast the $50 billion with the estimated $8.4 trillion allocated in total so far for bailing out banks. As Oxfam has pointed out, the latter amount is 33 sufficient to end extreme poverty worldwide for 50 years. One fundamental dimension in which the G-8 and now the G-20 continue to come up short is representation and legitimacy. Even before the G-20 summit recommendations were made that the G-20, if it continues to harbor ambitions to drive the international economic agenda, be itself reformed. For instance, the German Development Institute issued a 34 statement pointing out that the legitimacy of the G-20 will particularly depend on its interaction with the United Nations because the G-20 suffers from the fact that over 170 nation states are not represented, and proposing that the secretariat of a future G-20 be hosted by an important UN agency. Earlier proposals of an Economic Security Council at the UN were also called on, and Kofi Annan, writing in the foreword to the Africa Progress

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See http://www.oxfam.org.uk/applications/blogs/pressoffice/?p=4078&media. See http://www.die-gdi.de/CMS-Homepage/openwebcms3_e.nsf/(ynDK_content ByKey)/MRUR-7NCH5C?OpenDocument&nav=active:Home\MRUR-7NCH5C; expand:Home.

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Panels recommendations issued before the G-20 summit, stated that longerterm reform of the global economy needs to be underpinned by institutions with universal reach such as the UN whose legitimacy is beyond question. In retrospect, one might not be blamed for seeing in the G-20s response the limited repertoire of the U.S. government in dealing with economic crises on a superficial level, without addressing the deep, fundamental causes of these crises. For instance, after the Asian crisis of 19971998 the response was then, as now, to increase funding to the IMF; after the 20002001 dotcom bubble burst, the response was then, as now, expansionary monetary and fiscal policy. Of great potential concern is that once the euphoria of the summit has died down, it may be found that the response to the crisis may have further weakened prospects for more long35 term, equitable development. The UN Conference of June 2009 was a much different affair. It was largely marginalized by the rich countries. The world media for all intents and purposes ignored it. What was reflected in the media made it appear as it was another hat-in-the-hand forum for poor countries made to demand aid from rich countries. Unlike the G-20, the UN Conference did not directly commit monetary assistance for developing countries. Although it stressed the plight of developing countries and recognized the need for short-term stabilization measures, liquidity, and for strengthening financial regulation and longer-term structural changes in the global economic system, it did not come up with novel or immediate solutions to the immediate challenges facing developing countries. But in many respects, which will be elaborated below, the Conference reflects a paradigm shift toward international development. Although not explicitly described as such in the Conferences outcome document (which was endorsed by the General Assembly in resolution 63/303 of July 9, 2009), the document seems keenly aware of the precariousness of putting too much hope on aid, on expecting aid commitments to be kept or protectionism to be avoided, and seems to recognize that changing the global economic system will take a long time (it proposes working groups and ad hoc panels to explore possibilities further, perhaps indicative that no consensus on reform is as yet near). It is therefore meaningful that the Conference sees a major and enhanced role for the United Nations development system in recovery from the crisis. Therefore, as the way forward, the Conference documents main recommendations, adopted by the General Assembly, were to
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(a) Strengthen the capacity, effectiveness and efficiency of the United Nations; enhance the coherence and coordination of policies and actions between the United Nations, international financial institutions and relevant regional organizations; (b) Further develop the United Nations development systems comprehensive crisis support of national development strategies through a coordinated approach. The United Nations support and coordination may indeed be an important dimension of the emerging new paradigm for recovery of the poorest countries.

A New Paradigm for Developing Country Recovery?

Global responses to the crisis over the past year have brought home the realization that developing countries should not expect too much assistance from the rich world. The West is facing an unprecedented economic crisis of its own. Monies thrown at bailing out banks and other firms and in fiscal stimulus initiatives will require spending cuts in future as these countries deal with their high debt and try to steer away from a new debt crisis. We see this already in the fact that the rich countries have actually so far done very little for developing countries in this crisis. Commitments for monetary assistances seem inadequate and doubtful. Aid budgets are being cut and aid is declining despite commitments. And despite the commitments of the G-20, murky (and not-so-murky) forms of trade protection continue to be implemented. And despite promises very little concrete steps have been taken to reform the IMF and World Bank. The consequence is that if developing countries want to recover, and do so sustainably, they would need to do so without Western aid, assistance, growth, and leadership. This may sound like a tall order and may sound like many previous calls, but perhaps it is not so impossible as it would at first seem. Indeed, many now see an opportunity amidst the crisis that the dependence of the developing world on the assistance, example, and leadership of the West may be reduced, and the UNs role enhanced. In support of this conclusion, we have already witnessed over the past year brave and even imaginative efforts by many developing countries to cope. Moreover, we have seen a diversity of approaches, and more unfolding over time. A detailed discussion of these falls outside the scope of the present paper. It can, however, be mentioned as an example that in the larger and

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more stronger developing economies, such as China, India, and Brazil, encouraging early signs of recovery are visible after these countries implemented timely counter-cyclical policies. In many African countries, governments have been showing encouraging signs of pro-actively attempting to protect their economies. Some governments (e.g. Botswana, Mauritius, South Africa) have expanded their expenditure. Ghana, facing a large budget deficit, is negotiating assistance from the IMF and, while doing so, has been taking steps to continue the momentum it has gathered in attracting growing FDI inflows. Kenya and Tanzania are carefully monitoring their economies, and the latter has set clear exit requirements for state support to industries. South Africa has embarked on a substantial public investment drive. The African Development Bank has reacted quickly by identifying the most vulnerable countries and has made emergency finance available. Many long-term investment projects in Africa, many in critical infrastructure, seem to remain in place. The fact that many developing countries can now act in this fashion is quite in contrast to previous times when they faced global recessions, such as those in the early 1980s, 1990s, and 1998. Then, developing countries, especially those in Africa, were much less well managed. Deficits were high, and reserves were low. Consequently, when global growth declined, these economies shrunk substantially. This time around, with a few exceptions, developing countries have on average more leeway: deficits are lower and reserve holding much better. For Africa, as an example, this is shown in Figure 5, which compares its macro-economic situation before the present crisis with that which has preceded major global recessions in the past.

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Figure 5. Comparison of SSA Macro-economic Position to that Before Previous Synchronized Global Recessions (2007 Compared to 1982 and 1991)

Note: Average Subsequent growth for 2007 is the average of IMFs forecasts for 2009 and 2010 growth. Source of data: IMF, 2009a and World Bank Development Indicators Online. In Asia, valuable lessons were learned after the 1998 financial crisis, which has resulted in their economies now being less vulnerable to financial shocks. Many countries here, like China and South Korea, accumulated large foreign exchange reserves in order to insure themselves against such crises. While this reflects poorly on an international financial system that it is not trusted by developing countries, it does show that developing countries can and will act in their own best interest. It also needs to be pointed out that the improvement in macroeconomic management in many developing countries reflects improvements 36 in governanceincluding improvements in many African countries. These improvements, including more robust democracies, more frequent elections, and, initiatives to reduce corruption and end conflicts and to empower women, are largely homegrown. It would be very difficult for anyone to
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argue that they were the outcome of Western aid or pressure. This means that better governance, which leads to better resilience in the case of financial and economic shocks, has most often been achieved without, or even in spite of, Western aid. If the crisis can ever have a positive outcome, it may be found in showing developing countries that they can and should manage by themselves and in collaboration with regional institutions and the UNs development system. They still areand this is another lesson from the crisisvery dependent on global economic growth, but unlike previous times the extent of the Wests dependence on developing countries has been made clear. Consumer demand in the West will be low and sluggish for years to come. Global growth depends now more than ever on the growing demand of developing countries. The days of the U.S. as consumer of last 37 resort, as Stiglitz put it, is over.

Options for the Road Ahead and Concluding Remarks

The first challenge for the road ahead is that the rich world should do no further harm. This means that rich countries should continue to restore order in their financial systems (even if it takes the form of bank bailouts) and that they should put in place proper regulation to prevent excessive risk taking and other factors which contributed to financial bubble. It is often said that it is rapid financial innovation which caused the bubble and encouraged excessive risk taking. One should object, since the term innovation should have a more positive connotation. What we have seen in the subprime meltdown has been greed, predatory lending, skewed incentives, and fraud by no stretch of the imagination should this be confused with innovation. Now, the world indeed needs real financial innovation in order to restore trust in banks and create strong financial systems that do effectively what financial systems are supposed to do. Moreover, an important lesson from the current crisis is that finance matters for growth; millions of people in the developing world are daily subject to a credit crunch. Financial innovation is needed to extend financial resources across the world, particularly to the poorest households, to support consumption smoothing by households, business creation by entrepreneurs, and source of funding for governments

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investment in infrastructure. Rich countries can play an important role in such a true financial innovation. Can rich countries go beyond do no more harm to positively assisting poorer countries through the crisis? As it is clear that developing countries cannot pin their hope on more or faster aid, all that would seem to remain for rich countries to do is to stimulate their own economies and get their own growth going again. This will benefit developing countries through a recovery of global demand. The good news is that there is already some indication one year after the crisis started that counter-cyclical policies are kicking in. Business confidence in many EU countries has improved, and forecasts for growth in the OECD have picked up. The downside is that there is still much concern whether these green shoots will welter, and about the nature of the recovery. Some fear that recovery will be slow with deflation, whereas others fear sluggish growth with inflation-stagflation. Rising food and energy prices with low growth in rich countries will pose a deadly combination for poor countries development prospects. If these expectations were to materialize, it is not clear how the rich world will get their short-term recovery going. Ultimately, high growth requires the deep-seated structural changes in the global economic system described earlier. But as was remarked, these reforms would take many years if not decades to be sorted out. In the meantime, developing countries must find a way forwardwithout substantial Western aid, without strong Western growth, and within a very imperfect global economic system. What are their options? There is no single magic formula, nor any one size fits all approach for countries to foster recovery. But while many countries have been trying to find their own means to cope with the immediate impacts of the crisis as mentioned, there has so far been little consideration of what the approach to the crisis should be in the light of the longer-term scenario sketched here. For instance, making use of their better fiscal space is a policy option used by many (but not all) developing countries. The problem is that fiscal stimuli are only feasible for a short period. And a retreat behind tariff protection and direct state intervention in business may be detrimental over the longer term for all but the very poorest countries. The many short-term measures that developing countries are now employing may soon run out of steam or become counter-productive. The way forward for most developing countries outside of China, India, and perhaps Brazil (countries with large domestic markets) may hinge on whether or not exports can continue to be relied on as an engine of growth. Some believe that this is no longer possible. That countries should now, with sluggish prospects for Western growth and rising protectionism,

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stop relying on exports. Calls for countries to stimulate import replacement production, and to reduce for instance production of commodities for exporting, are widely heard. But others are less pessimistic about the potential of exporting to continue to be a viable development strategy. Some see greater importance and need for South-South trade and for progress in regional integration and coordination. Here, an enhanced role of the UN, in collaboration with regional development agencies and regional integration initiatives, may have an important impact even though the UN itself may not have the resources to fund development. Rather, the mechanisms and tools that the UN and regional-level assistance can provide may be indispensable to support differentiated country-level responses to the challenges of global development, which now includes not only the financial crisis, but also food, energy, and climate change crises as well. A historical challenge now faced by the UNs Economic and Social Council is addressing the requests made to it in these respects by the General Assembly as contained in Resolution 63/303 of July 9, 2009.

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