It has become commonplace, indeed almost obligatory, to preface statements to such eminent gatherings as this one with a call to policy makers to prepare for the new global challenges of the next millennium. There is a glibness in many of these remarks which ignores simple economic realities. The world economy has at the close of the century become a more deeply divided, unstable and insecure place with serious setbacks to development prospects. An excessive attachment to conventional policy nostrums has done little to alter this situation and, indeed, bears some responsibility for the worsening of conditions over the past two years.
The brief optimism which accompanied stronger growth in 1996 and the first half of
1997 has been dashed by the financial tidal wave which hit Thailand in the summer of 1997,
sending, in its wake, global growth sharply downwards. The crisis has not been linked to a
single country or region. After devastating East Asia and Russia, it has just prostrated Latin
America. And no one can tell whether it has run its course or will turn its destructive potential on other countries and regions. The resulting economic and social hardships and potential political damage are undisputed. What must now be honestly confronted is a crisis of
development which has arisen out of this financial turmoil. I define it as such for three main reasons.
First, the crisis not only started in a developing country, but also so far, has reserved its malignant force for the developing or transition regions of the world. The industrial countries have been largely spared from the vicious contagion. Indeed, on balance they have probably
benefited. They have gained from the unprecedented collapse in commodity prices and cheap
manufactured imports from countries forced to devalue their currencies. For the OECD area,
declines in commodity prices have resulted in some 5 per cent improvement in its terms of trade which greatly helped to maintain its income levels, reduce inflation and lower interest rates. They have also gained from the flight to safety which has followed financial turmoil in emerging markets, helping boost stock markets in the North and shoring up consumption spending.
These forces have been strongest in the United States, extending the recovery into an unprecedented eighth year. Its consumers have indeed been on a shopping spree since the crisis hit East Asia. Private consumption in the United States has risen by around $370 billion between the second quarter of 1997 and the final quarter of 1998, more than the total annual income of the low-income countries (excluding China and India).
In contrast, significant parts of the developing world have seen the fruits of decades of economic growth and poverty reduction evaporate in a matter of weeks. Practically all the developing countries have been touched. And those like China or in South Asia, which were relatively unscathed in the early stages, are already feeling the pinch of the slow-down elsewhere in the world economy.
The net result is that in 1998 growth in the developed world exceeded that in developing countries for the first time for many years, at 2.3 per cent against 1.5 per cent, including China. If China is excluded, average growth in developing countries was down to 0.4 per cent.
For the developing world prospects for 1999 are even bleaker. Welcome signs of an Asian recovery in 1999 have coincided with a deep shock to the Latin American economies following in the wake of the Brazilian currency crisis and subsequent financial problems. Recession still seems the likely outcome for the region this year. This stands in stark contrast to Latin American growth performance in 1997, the highest for a quarter of a century. The failure of transition countries in Eastern Europe to shrug off the Russian crisis had a significant impact on growth in that region in 1998 and appears to be holding down prospects even in the most successful transition economies this year.
If the hope of development lies in the possibility of growing more rapidly, thus narrowing the gap that separates rich and poor countries, this reversal of the trend represents a defeat for the entire international community. It also raises serious questions about the current global approach to development.
The second reason to call this a crisis of development is that paradoxically events have shaken some of the most advanced among the developing world. There can be little doubt that, in the commodity dependent economies, notably in sub-Saharan Africa, a short-lived revival in growth has been undermined by the very price dynamics that have helped the North. What is perhaps more surprising is the risks now faced by the more successful and resilient, the so-called emerging markets. If development is a process that steadily reduces the degree of vulnerability to external shocks, how then can one explain that some of the worst-affected have been precisely those countries that were so advanced that they were generally regarded as having graduated to OECD ranks, or being close to doing so? Are the national policies of financial regulation and supervision to blame? If so, how could one explain that contagion through trade and finance have created large current account deficits and sharply reduced growth in others with sound financial systems and macroeconomic fundamentals? Does the explanation lie in close integration with an inherently unstable global financial system? Certainly, fundamentals will
reassert themselves over the longer run, but the experience shows just how vulnerable are a large
majority of countries to the vagaries of international financial markets.
The third reason for this being a crisis of development derives from the fact that, far from
being an exception, the "stop-go" performance of developing countries is becoming more
frequent and widespread. The current problems have nothing to do with the downward phase
of a business cycle that regularly befalls market economies, usually generating short-lived
recessions followed by upswings. They are, in fact, more similar to the structural crisis that
deeply destabilized the world economy in the inter-war period when years of recession or
depression were as frequent as those of recovery and growth.
Historical parallels are never perfect, but the similarities do offer a reminder of what can
go wrong. What is certainly true is that complacency that the crisis is over could, under the
present conditions, generate a backlash in the North as well as the South which would push
global economic prospects back a very long way.
Neither a return to stability in the buffeted Asian economies, nor the apparent
containment of the Brazilian crisis to its Latin American neighbours should hide the immediate
downside risks facing the global economy in 1999. Such risks are as much produced by policy
actions as they are the inevitable consequences of global economic forces. Conventional opinion
has advocated a series of measures to offset declining capital flows in many developing countries
which may actually make matters worse. High interest rates, for instance, designed to offset
increased risk premia and sustain foreign investment also reduce economic activity, worsen the
fiscal position and weaken corporate and bank balance sheets.
However, it is not only the developing countries that are still at risk. A sharp correction
in equity prices, a consumer retrenchment to restore savings rates, fallouts from trade frictions,
exchange rate gyrations arising from investor concerns about the large and rising current-account
deficits of the United States, and worsening economic and financial difficulties in Japan can all
be possible catalysts for a further round of volatility on global financial markets and additional
downward pressure on economic growth.
The responsibility and possibility to act lies with policy makers in the North. Monetary
policy could play a role but this would be quite limited in most cases. However, unlike in
previous downturns, there would be substantial leeway to allow public spending to play its
traditional role as a stabilizer for aggregate demand.
Given the reality of those downside risks, it is perhaps time to give serious consideration
to bolder options. Since there is limited scope in developing countries to pursue expansionary
policies, a possible response in the face of a stronger than anticipated downturn in growth could
be a direct injection of liquidity into developing countries through official channels to raise
demand, imports and growth. Given the developing countries´ propensity to spend and import,
such schemes could have a strongly positive impact on global economic demand and growth.
Japan and the EU are in the strongest position to play an important role in this respect
by recycling their trade surpluses. The Miyazawa Plan offers one such model. But other means
of producing a direct increase in liquidity should be explored. One possibility would be to
remove the debt overhang of highly indebted poor countries through a rapid write-off of their
unpayable official and multilateral debt. An independent body to assess this matter, as suggested
in last year´s Trade and Development Report on Africa, could offer significant progress along
these lines. Similarly, a substantial new SDR allocation to developing countries could provide
support not only to those countries facing a threat of contagion, but equally to current account
and trade financing, at a time when not even middle income developing countries have access
to private finance at reasonable costs.
At our last meetings in September, the severity of the Asian crisis and its rapid spread
to economies inside and outside the region with strong fundamentals seemed set to galvanise the
international community into concerted actions. For a few weeks it appeared that the need for
a new financial architecture would translate into concrete proposals, that a looming catastrophe
would finally conquer inertia. This was wishful thinking. The bounce back on Wall Street in
late 1998 has meant a return to business as usual.
So far the efforts to redesign the financial architecture have given rise to a proliferation
of meetings, inflation of communiqués, multiplication of groups and fora. However, just when
developing countries are becoming increasingly vulnerable to external financial pressures, there
has been a reluctance to accommodate their concerns and interests. This is perhaps because what
we have falls short of an optimum crisis- that is, a crisis grave enough to force the mighty to
finally do something without being so serious as to render any action ineffective.
Delay and denial have thus come to dominate the issue. Some participants in this debate,
perhaps heartened by the perverse selectivity of the crisis, do not shy away from stating that
there is nothing wrong with the architecture. At most, there may be a small matter of improving
the plumbing. However, if the crisis comes back with a greater force, a possibility which we do
not exclude, the advocates of denial may find themselves absorbed, like the crew of the Titanic,
in rearranging the furniture on the deck of a sinking ship or playing the Transparency Waltz for
passengers drowning for lack of life boats.