The Financial Crisis is Devastating Developing Countries: Let them be part of the solution.

The World Bank’s most recent forecast shows that the crisis is starting to hit less developed countries. It has revised downwards by 2 percentage points is growth forecast for 2009. This marks the end of a remarkable catch-up story for developing countries as a whole which grow by an average rate of 7% during the last 5 years and brought 300 million persons out of poverty during the last 10 years.

World Bank estimates, however, show that each percentage point loss in growth amounts to 20 million persons more falling under the poverty threshold. Thus, as fall in the growth rate for 2009 from 6.5% to 4.5% will cause an additional 40 million persons to fall under the poverty threshold – a real tragedy.

It is always the same story: the most vulnerable and weakest groups are hit most strongly by catastrophes and other negative events. And – as is also quite usual – less developed countries had no part in the making of this crisis, but will be affected most strongly. Their external financing sources have dried up, their export markets are in recession, but their debt service remains, while their exchange rates have come under pressure – in effect increasing the real burden of their external debts. In addition, the crisis in more developed countries will also reduce the amount of remittances being sent to families in developing countries. Social crises will increase, political instability rise – and the probability of violent conflict over even scarcer resources increase. The exorbitant increase in food and energy prices during the last year has already endangered the survival probabilities of many. While energy prices have come down, food prices are still up.

The international development institutions are the last hope of these countries to obtain finance. But their “firing power”, the amount of finance they can muster, is limited – and can certainly not replace the private sector’s financial flows. The World Bank has just announced to nearly triple their loans during the next 3 years, EBRD is signalling its continued support, and the African, Asian and Inter-American Development Banks are working on emergency assistance programs. It is right that International Financing Institutions (IFI) are acting in a counter-cyclical way and take more risks onto their books in times of crisis. It is also positive that – finally – IFI are cooperating, as the recent examples of Ukraine and Georgia packages have shown.

The upcoming G-20 Summit in Washington has created a lot of expectations about a way out of the crisis, a new economic world order, a reigning-in of the excesses of financial markets which have caused the most recent crisis. The world puts its hopes into the same politicians whose deregulatory activities of the last 10 years – and whose adulations of the captains of financial markets and champions of excessive compensation – have caused the crisis. But maybe, just maybe these politicians can repeat a dictum of John Maynard Keynes: “When facts change, I am willing to change my opinions”.

Still, there should be caution:

a)     any rush to “solutions” of the crisis is likely to produce hyper-activism and wrong solutions (viz. the several turn-arounds of the US treasury secretary Paulson about the structure and purpose of the 700 bill. US bailout fund); the original Bretton-Woods negotiations took several months and tough negotiations, they were not done over a weekend

b)     the G-20 composition of the group is not inclusive enough: better than just G-7, but where are the poorest countries? If new rules are devised, all types of countries must be represented around the table. The poorest will feel the effects of the crisis most strongly, they have a legitimate and vested interest in a new setting.

c)     The most sensible outcome would be a “road map” and a mandate for specific working groups of experts to be negotiated by politicians next spring

d)     If the IMF is planned on taking on a major role in a new “global financial architecture”, it first must re-build confidence that it will open itself to a wider portfolio of policy solutions for countries under distress. Its prescriptions during the Asian crises of 10 years ago have turned many countries in Asia and Latin America away. Its solutions and prescriptions must go beyond the orthodox prescriptions of cutting social expenditures and dismantling subsidies. This is why the presence of poorest-country representatives in the summit is essential.


In this context, it is disappointing that the new Chief Economist of the World Bank, Justin Yifu Lin (the first person from a developing country in such a position), in a recent speech about the impact of the financial crisis on developing countries in Korea, does not – as was hoped – come up with innovative policy solutions. He rather sticks to the same old tenets, where developing countries should follow the orthodox policy prescriptions for industrial countries. He could be an IMF economist: only countries that behaved well before the crisis will have the “fiscal space” to invest in infrastructure, education and social services. He does not talk about the ones who did not build up reserves. Who will help them – under what conditionality? To the outside observer it seems that Lin is attempting to obtain the praise of traditional neoclassical economists by “out-liberalizing” them – an opportunity missed.

The task of containing the crisis is taunting. Since it has spread from developed to emerging to least developed countries, halting further and deepening contagion is the first task. This is where IFI can play an important role, together with the governments and Central Banks of industrial and emerging countries. But for the least developed countries – and thus the most vulnerable population groups – IFI-led programs must be devised to prevent them from defaulting or closing their important investment fiscal space by crippling debt service. These are extraordinary times: they require extraordinary solutions. The toolkits of the past are inadequate. New and innovative thinking, outside the orthodox box, is required.



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Filed under Crisis Response, Global Governance, Socio-Economic Development

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