This is not only the worse global economic downturn of the post World War era, it is also the first serious global downturn of the modern era of globalization. There is need for a global response to this global downturn. But our responses are framed at the national level, and often take insufficient account of the effect on others. The result is that there is less coordination than there should be, a smaller stimulus than would be optimal-and well less designed. Every crisis comes to an end, and this one will too. But a poorly designed stimulus means that the downturn will last longer, and the recovery will be slower, and more innocent victims will be hurt badly. Among the innocent victims of this crisis are the many developing countries-even countries that have had good regulatory and macro-economic policies-far better than those pursued by the US and some European countries-are being badly affected. While in the US, a financial crisis transformed itself into an economic crisis, in many developing countries, the economic downturn is creating a financial crisis. While the U.S. may have the resources to bail out its banks and to stimulate its economy, the developing countries cannot.
A UN meeting later this month hopes to continue a global discussion that began at the earlier G-20 meetings, and hopes to extend the discussion to what went wrong, so that we can do a better job of preventing another such crisis. The global politics of the meeting are complex. Many of the 172 countries not members of the G-20 argue that decisions affecting the lives of their citizens should not be made a self-selected club, lacking political legitimacy; some of the members of the G-20-including the new members brought into the discussion for the first time as discussions expanded from the G-8 to the G-20-like it the way it is. They would like to avoid too harsh criticism of the banks, or of the international economic institutions that not only didn’t prevent the crisis, but also pushed the deregulatory policies that contributed so much to its creation and its rapid spread around the world. Indeed, the G-20 turned to the IMF as the centerpiece of its response to the crisis for the developing countries.
I chair a UN Commission of Technical Experts whose interim report hopefully will have some influence on the discussions. Whether it will, and whether anything concrete comes out of the meeting, is too soon to tell. The international community should realize, however, that what has been done by the G-20, while a good beginning, is just that-a beginning, and much more needs to be done. Our preliminary report lists ten policies that need to be taken immediately, and ten deeper reforms in the global financial system on which work needs to be begun.
The developing countries have been important engines for economic growth in recent years, and it is hard to see a robust global recovery in which they do not play an important role. While there is a consensus that all countries should provide strong stimulus packages, many of the poorer developing countries don’t have the resources to do so. Many in the developed world are worried about the debt burdens resulting from stimulus packages, but from those still scarred by debt crises, taking on additional debt may involve an unacceptable burden. Assistance has to be provided in grants, not just loans, and without the counterproductive pro-cyclical conditionality that marked much of the assistance in earlier crises. The developed countries should set aside 1% of their stimulus packages to help the developing countries, as Germany has done.
The funds have to be distributed through a variety of channels, including regional institutions and possibly a newly created credit facility, whose governance better reflects both the new potential donors, e.g. in Asia and the Middle East, and the recipients.
The G-20 did little to extend grant money, provided loans mostly through the IMF, whose policies, while better than in the past, remain controversial-so much so that many countries are reluctant to turn to it for assistance, preferring instead to find other sources of funding. The large issuance of Special Drawing Rights that they endorsed was a positive move, but too little of that money will wind up in the hands of the poorest countries.
There is a further reason that assistance is essential. While in their meeting in November the G-20 made grand statements about the need to avoid protectionism, the World Bank notes that since, 17 of the 20 countries have undertaken protectionist measures. The developing countries have to be protected against protectionism, especially that which discriminates against them. The US included a buy America provision in its stimulus bill and this kind of protectionism-especially when there is a WTO agreement, effectively discriminates against poor countries, since most government procurement agreements are among the advanced industrial countries. We know that subsidies distort free and fair trade as much as tariffs but they are even worse than tariffs, because developing countries can ill afford them. The massive bail-outs and guarantees provided by the US, and some other countries, gives their firms an unfair competitive advantage. It is one thing for firms from poor countries to compete against well capitalized American firms; it is another thing for them to compete against Washington. Even if a developing country were to provide comparable guarantees to its banks, they would be far less credible. While it is understandable why such subsidies, bail-outs, and guarantees have been provided, the adverse impacts on developing countries has to be recognized, and some way of compensating them, to offset this unfair advantage, is needed.
International cooperation is also required if we are to devise an effective regulatory regime. There is international agreement on ten issues: (a) the crisis was caused by excesses of deregulation and deficiencies in the enforcement of existing regulations; (b) self-regulation will not suffice; (c) regulation is required because failures in a large financial institution or the financial system more generally can have "externalities," adverse effects on others (in this case, on the whole world-on workers, homeowners, taxpayers); (d) that more than transparency is required-even full disclosure of the complex derivatives and other financial products might not have allowed for an adequate risk assessment; (e) perverse incentives which encouraged excessive risk taking and short sighted behavior contributed to bad banking practices; (f) that deficiencies in corporate governance contributed to flawed incentive structures; (g) so too did the fact that many banks had grown too big to fail-which meant that if they gambled and won, they walked away with the gains, but if they lost, as they did, taxpayers pick up the losses; (h) that unless regulation is comprehensive there can be a "race to the bottom," with different countries competing to attract financial services on the basis of their lax regulation; and (i) if that happens, countries will have to take actions to protect their own economy-they cannot allow bad practices elsewhere harm their citizens; and (j) regulation also has to be comprehensive across financial institutions; as we have seen, if we regulate the banking system, but not the shadow banking system, business will migrate to where it is less well regulated and less transparent. Our banking system has shown itself to be highly innovative-not in producing products that help ordinary individuals manage the risks they face, but in regulatory and accounting arbitrage.
In spite of this broad consensus, the G-20 said little or nothing about some of the key issues: what to do with banks that have grown not only too big to fail, but (according to the Obama Administration) even to big to be financially restructured. They did not ask the hard questions: if shareholders and bondholders of these big banks are insulated against the risk of default, how can there be effective market discipline? But what will replace market discipline? They have talked about the rapid return of "private capital," but what does this bode-if it is private capital without market discipline? So too, there is talk about allowing the continuation of over the counter trading in derivatives without transparency. But without transparency of the individual trades-so one can assess the nature of the counterparty risk-how can there be market discipline?
The G-20 did take long overdue action on the non-transparent off-shore banking centers. The large amount of banking that occurs in some of these is not because the weather is particularly suited to banking. In many cases, it is not because these countries have developed a comparative advantage in the provision of banking services. It is because of the role that they have played in avoiding and evading taxes and regulations. But it should be clear: these problems, while they are important, played little if any role in the current crisis. That so much effort was spent on these extraneous issues rather than on those more directly related to the crisis is telling.
From the perspective of the developing countries, though, what was done was still not enough. They are often criticized for the corruption that occurs within their countries, but secret bank accounts facilitate this corruption-they provide the safe haven for the funds that have been stolen. The developing countries want the money return, and they want access to information that will allow them to detect the accounts. The developing countries’ problems are not just with the offshore islands, but also with the onshore banking centers.
Financial and capital market liberalization-as well as banking deregulation-contributed to the contagion of the crisis from the US to the developing countries. The advanced industrial countries are reluctant to admit that these policies, which they pushed so hard on developing countries, are part of the problem, and that we need to rethink these policies. No wonder then that the G 20 did not argue for a reconsideration of these longstanding policies.
It should be clear that the world has but two choices: either we move to a better global regulatory system or we lose some of the important benefits that have resulted from globalization. As globalization has been managed, too many countries have had to pay too high a price.
This crisis highlights the inadequacy and deficiencies in existing international institutions. As I noted, they obviously did not prevent the crisis; in some cases, they pushed policies that are now recognized to be among its root causes. And changing the name of the Financial Stability Forum-the institution created in the aftermath of the last global financial crisis, that of 1997-1998 to prevent another recurrence– to the Financial Stability Board won’t ensure that it will do any better job going forward than it has done in the past.
Moreover, it is important to move from ad hoc arrangements to more inclusive and representative institutional frameworks. There is a need for a global economic coordinating council, within the UN, not only to coordinate economic policies (e.g. in the size of the stimulus and in regulatory structures), but also to identify, and move to rectify, gaps in the global economic institutional structure. For instance, this crisis will almost surely be marked by some sovereign debt defaults; but in spite of extensive discussion at the time of Argentine’s default, there was no progress in creating a sovereign debt restructuring mechanism. And the IMF-dominated by the creditor countries-cannot play a central role in designing such a mechanism (anymore than we in the United States would or should turn to our banks to design a good bankruptcy law.) One of the alleged reasons for not "playing by the rules" and forcing the international banks that were in trouble to go through financial restructuring (bailing them out instead) was that it would give rise to huge cross-border complications. Iceland’s banking problems illustrate the potential seriousness of the problems. And yet, again, nothing is being done to address these problems.
Most importantly, the Commission calls attention to the need for reform in the current dollar based global reserve system; it calls for the creation of a global reserve system. Not only is the current reserve system fraying, but also the current system contributes to an insufficiency of global aggregate demand and to global instability. Every year, developing countries set aside hundreds of billions of dollars to protect themselves against the costs of such instability, made so evident in the East Asia crisis. The UN Commission has argued persuasively that this problem must be addressed if we are to have a robust global recovery. Recent statements from China, expressing their concerns about the dollar reserve system, have added immediacy to the Commission’s recommendation. This is an old idea-Keynes argued strongly for the creation of a global reserve currency more than 75 years ago-but it is an idea whose time has come.
America’s financial markets have failed to do what they should have done-manage risk and allocate capital well-and these failures have had a major impact on others all over the world. These failures force a re-examination of premises concerning the role of markets and the State. Even without the massive bail-outs, governments have the right and responsibility to protect their citizens, and that will require regulations. But the argument is even more compelling given the amount of public money that has been put at risk.
Globalization too has not worked the way that it was supposed to. It facilitated the spreading of the consequences of the failures in the American financial markets around the world. 9/11/2001 taught us that globalization has meant that not only do good things go more easily across borders, but so too do bad things. 9/15/2008 has reinforced that lesson. The G-20 response was a beginning-but just a beginning. It neither did enough to address the short run problems nor the long term restructuring that is necessary to prevent another crisis.
Those who would like us to go back to the world as it was before the crisis will find some of the questions being asked at the UN Summit uncomfortable. They would be happier with a few harsh words for the off-shore islands, a few cosmetic reforms to banking regulation, a few lectures about hedge funds (which, like the offshore banking centers, were not really at the center of this crisis), a new name and a couple new members for the Financial Stability Forum-and for us then to move on. Many of the developing countries will be less content to accept these "reforms" as going to the heart of the matter.
As the developed countries struggle to ensure a quick recovery, they need think of the effects of their actions on developing countries. It is time to begin the restructuring of our global economic and financial system, in ways that ensure that the fruits of prosperity are more widely shared and that the system is more stable. This is a task that will not be accomplished overnight, but it is a task that must be begun now.