Joe Stiglitz, Nobel Laureate and former World Bank Chief Economist, is out again making headlines. This time because of his new book Freefall – America, Free Markets and the Sinking of the World Economy (W.W. Norton & Company, New York, 2010). I had the pleasure of hosting his presentation at the World Bank’s Infoshop a few days ago – see video conference here -, and there were several things that struck me from what he said. Freefall might be mainly about the US economy but we can draw some very important lessons relevant for our development work.
Let’s see. Stiglitz provides considerable evidence that the US and others got into trouble by ignoring standard economic and financial guidelines that we recommend to developing countries, and which –by and large—the latter have been following in recent years. Mainly, rich countries overindulged in weak financial sector regulation, the housing bubble, and ended up giving out financial sector bailout packages that are almost textbook examples of what not to do.
“As chief economist of the World Bank, I had seen gambits of this kind,” writes Stiglitz. “If this had happened in a Third World banana republic, we would know what was about to happen – a massive redistribution from the taxpayers to the banks and their friends. The World Bank would have threatened cutting off all assistance. We could not condone public money being used in this way, without the normal checks and balances.” (p. 122).
As I mentioned earlier, Stiglitz book focuses almost entirely on the US, so at this point it is pertinent to highlight to ourselves some interesting aspects of the crisis at the global level –particularly that developing countries as a group suffered a smaller fallout from the financial crisis than had been initially feared, mainly thanks to prudent macroeconomic policies.
Many countries in the Europe and Central Asia region had indeed been highly exposed because of large current account deficits financed by private capital inflows, and have had to undergo extremely severe economic adjustments. But in many other regions and countries, while growth has certainly slowed it has remained well above that in the recession-affected developed countries. This continues a trend that emerged during the 2000s where developing country growth accelerated to about 3-4 percentage points above that in developed countries, whereas in preceding decades it was about the same.
Was this merely due to temporary boom conditions? Or did it reflect better underlying policies in developing countries?
We can point to such standard factors as relatively restrained fiscal and external deficits and generally falling levels of national net indebtedness among developing countries as a group in the years leading up to the crisis. These prudent basic macro policies have undoubtedly helped these countries come through the crisis more robustly than expected. And we can also point to good policies to manage the impact of the crisis, for example, efforts to at least maintain fiscal expenditures despite temporary increases in deficits, and in some cases to even undertake counter-cyclical fiscal stimulus, generally with the support of the Bank and the Fund. Unlike the crises of the late 1990s many more countries allowed their exchange rates to devalue rather than severely tighten monetary policies in an ultimately fruitless quest to support pegged exchange rates.
So what can developing countries and development practitioners learn from the crisis and Stiglitz?
First of all, through his strong advocacy in the policy debates surrounding the emerging market crises of a decade ago, Stiglitz himself has already played a large part in changing the climate of policy opinion and the different crisis management policies adopted this time around.
And in terms of “the model,” there will clearly be a further rethinking on the cost-benefit trade-offs associated with financial globalization. Over the last 30 years there have been three huge boom-bust cycles in private capital flows to emerging markets – as we approached here. These have notably added to volatility and vulnerability but with little clear evidence of significant benefits, for example in terms of a contribution to growth. Even now, we are hardly out of the crisis, and there has already begun another major surge in flows to emerging markets, the so-called carry trade attracted by yield spreads in emerging markets. Without robust regulation and careful management in both the receiving and sending countries, another boom in flows could fuel asset bubbles, over-heating and new vulnerabilities and crises, this time in emerging markets.
We are clearly moving towards a more favorable view on whether asset price bubbles need to be a target of economic policy, and on the role of broad macro-prudential or macro-financial policies in achieving this, including rethinking the role of monetary policy and of financial regulation.
There is a major research and learning agenda on the political economy of regulation. Joe rightly stresses the important role played by weakening of regulations or the failure of regulators to properly enforce them. As it happened, in an era of prosperity it is hard for some decision-makers to appear on the side of “over-regulation.” So what sorts of institutional innovations do we need to further accountability while also protecting regulators from destabilizing pro-cyclical political pressures? Is it even possible?
Perhaps this will be a good topic for Joe’s next book!
Originally published at Growth and Crisis Blog of the World Bank Institute and reproduced here with the author’s permission.