The financial crisis that began in America's sub-prime mortgage market has now become a global recession – with growth projected to be a negative 1.5%, the worst performance since the Great Depression. Even countries that had done everything right are seeing marked declines in growth rates, and even deep recessions. And much of the most acute pain will be felt by developing countries.
A UN commission of experts on reforms of the international monetary and financial system, which I chair, has just published its preliminary report. It focuses especially on the impact of the crisis on developing countries and the poor everywhere, which is likely to be severe. An estimated 30 million more people will be unemployed in 2009 compared to 2007. The increase could even reach 50 million. Progress in reducing poverty may be halted. The report warns that: "Some 200 million people, mostly in developing economies, could be pushed into poverty if rapid action is not taken to counter the impact of the crisis."
While this is a global crisis, responses are undertaken by national governments, who quite naturally look after their own citizens' interest first. Particularly invidious are protectionist measures, such as the US "buy America" provision in its stimulus package. In fact, the World Bank reports that 17 of the group of 20 countries have engaged in protectionist measures, after making a commitment not to do so in their meeting in Washington in November. By focusing on national, as opposed to global impacts, the global stimulus will be less – and the global recovery weakened.
While there is a consensus that all countries should undertake strong fiscal stimulus measures, many developing countries do not have the resources, and it calls for a concerted approach for additional funding, both for spending and liquidity support for countries and corporations in developing countries that are strained by the current credit crunch.
Developed countries should contribute 1% of stimulus spending; there should be an immediate issue of special drawing rights (SDRs), the "IMF money" that can be used especially to help those facing difficulties, and an expansion of regional efforts, such as the Chang Mai initiative in Asia.
It is important that any assistance be provided without the usual strings. Conditions such as those which force developing countries to contract spending and raise interest rates are counterproductive: the intent of the assistance is to help them expand their economies, thereby assisting the global recovery. Deficiencies in current institutional arrangements for disbursing funds – for example, through the IMF – have long been noted, but the reforms so far are insufficient. Countries with funds are often reluctant to give money to institutions in which they have little voice, and which have advocated policies that they do not support; and countries are often reluctant to borrow, given the stigma associated with turning to these institutions. The commission urges the creation of a new credit facility, in which the voice of the new providers of finance and the borrowers are both better heard.
There are several important lessons to be learned from the crisis. One is that there is a need for better regulation. But reforms cannot be just cosmetic, and they have to go beyond the financial sector. Inadequate enforcement of competition laws has allowed banks to grow to be too big to fail. Inadequate corporate governance resulted in incentive schemes that led to excessive risk taking and short sighted behavior, which did not even serve shareholders well.
The Commission recommends the establishment of a Global Economic Coordinating Council, not only to co-ordinate economic policy, but to assess the economic situation, identify gaps in the global institutional arrangement, and propose solutions. For instance, there is a need for a Global Financial Regulatory Authority – without which there is a risk of regulatory arbitrage, undermining regulation, and creating a race to the bottom. There is a need for a Global Competition Authority – markets are global in scale. There is a need for a better way of handling defaults of countries, of which there may be several in this crisis. And there is a need for better ways of managing the many risks that developing countries face, especially with debt and capital account management.
The other important commission recommendation concerns the creation of a new global reserve system. The existing system, with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time, putting so much money aside every year to protect countries against the risks of global instability creates a downward bias in – aggregate demand – weakening the global economy. Moreover, the system has the peculiar property that poor countries are lending trillions of dollars to the US, at essentially zero interest rate, while within their country there are so many needs to which the money could be put. The Commission argues that a new Global Reserve System is "feasible, non-inflationary, and could be easily implemented".
After the East Asia crisis, there was much talk of reform, of a new global financial architecture. But there was just talk; as the global economy recovered, the impetus for reform faded. This is a more severe crisis. It will last longer. Hopefully, this time, we learn our lesson.
Joseph Stiglitz, university professor at Columbia University, chairman of the UN Commission of Experts on Reforms of the International Monetary and Financial System and recipient of the 2001 Nobel Prize in Economics.