Governance

The financial system in the USA and much of Europe had a heart attack in September 2008.  As in the case of a real heart attack, the highest priority has gone to the emergency response and to stabilizing the patient.  Once that is done and the crisis is abating and even to some extent as it is going on, it will be important (economically and politically) for some to focus on two related issues:  What created the rising risk of an attack?  And what combination of actions post-crisis will reduce the risk of a repeat in the future. 

Aggressive and innovative monetary and financial sector policy actions in developed economies have pulled the global financial system back from the brink of an abyss. But impaired assets are not yet properly valued and neutralized. And new negative feedback loops may be forming between the financial and real sectors. In any case, even after banking circuits are eventually unclogged, confidence restored, and risk appetite revived, the financial euphoria of the recent past is unlikely to revive any time soon. The changed financial landscape has several implications for the developing economies.

Growth Commission Chair Michael Spence was a guest on CNBC's Squawk Box this past week, where he discussed the Fed's recent announcement that it will purchase $300 bn in long term U.S. Treasury Bills, adding to the $750 billion worth of agency backed mortgages it plans to purchase this year. Spence lauded this move by the Fed, and stressed that the key to recovery is to unfreeze the credit markets. Additionally, Spence emphasized the attention that must be paid to making sure that developing countries recover from this crisis.  Inevitably, he said, the western countries will recover, but due to an increased propensity to save, they will not likely drive the same levels of aggregate demand that existed before the crisis. This shortfall will only be made up if recovery in the developing world keeps pace with the industrial countries. To watch the interview, please click here.

In a sobering editorial in Tuesday’s Financial Times, Trevor Manuel, the Finance Minister in South Africa, and member of the Growth Commission, presents the very real dichotomy facing a world searching for a way out of the current financial crisis.  On the one hand, world leaders can band together and “find appropriate instruments of governance through which the propulsive power or modern finance can be harnessed to serve a development agenda”. On the other hand, a failure to do so will result in “growth and social progress” continuing to be the “bonded servants of finance capital”.

The impact of the current financial crisis on the developing countries and the slide of the major industrial countries into recession pose several interesting questions for the international community and the growth commission which released its report in 2008.

Two of these questions/issues will be singled out for attention in this brief note.  Firstly, the Commission predicated its findings on an open and expanding global economy in which developing countries could import ideas, technology and know how from the rest of the world, and, secondly, the importance of leadership, effective government and experimental policy making to facilitate poor countries in achieving high and sustainable growth rates over an extended period of time.

The Commission on Growth and Development’s Growth Report (GR) recognizes that a major problem confronting low- and middle-income countries is how to build effective governments where they do not exist.  This fundamental problem in comparative politics dates back at least to Aristotle’s categorization of city-states according to their performance in The Politics. 

Once upon a time, a commonly-held view was that many aspects of economic development—such as the spread of prosperity, mass consumption, and social mobility—and of political development (the emergence of good government) were parts of a shared process of “modernization.”

The current crisis is hurting all developing countries, but in a few years it will be past, and it will not have altered the big differences among countries on which the Growth Commission (GC) focused.  China will still be forging ahead, and Africa lagging behind.  Let us therefore do all we can to mitigate the shock, but not stop thinking about how to accelerate longer-run growth in Africa.

In an op-ed in the Financial Times’ Economists Forum on November 24th, Growth Commission Chair Michael Spence elaborates on the endogenous nature of the asset pricing problem, and its role in the current global financial crisis. The piece, entitled Balance sheets and income statements: breaking the downward spiral , highlights the uncertainty investors face in determining the intrinsic value of assets, and their consequent reluctance to enter the market.  Dr. Spence discusses the channels underpinning the decline in economic activity, and suggests that government can play a positive role in limiting the negative overshoot in assets and economic activity.  Additionally, he points to the need for a significant stimulus package and a more systematic program of purchasing assets to stem the downward spiral.

As we continue to face extreme volatility in financial markets, the dire economic prospects for the real economy are now also becoming increasingly apparent. Policymaking is rightly focusing on short-term measures to stabilize financial systems. But it is clear that financial stability alone will not be enough to avoid a dramatic global economic slowdown and recessions in many countries. The policy debate is focusing towards measures that can revive the real economy.

Some may wonder how the observations of the Growth Report, dealing with sustainable high growth patterns over long periods, can be reconciled with policy choices currently facing government decision-makers.  Clearly the food and fuel price spikes earlier in 2008, followed by the financial meltdown affecting all markets, were dramatic challenges, especially for poorer developing economies, but also for emerging market economies generally. This will inevitably be followed by a global recession in 2009, a slow-down that has already started, even in China, the world’s dominant growth engine in recent years.