Coupled economies, decoupled debates

Posted by Arvind Subramanian on 29 April 2009

In the industrial countries, and the United States in particular, the current financial crisis has raised fundamental questions about capitalism and the so-called Anglo-Saxon version of it that had elevated the status and role of finance. The London-based Financial Times ran a series on the future of capitalism over several months and many of the world’s leading economists and other intellectuals weighed in on this topic. The global conference/seminar circuits are teeming with crisis-induced introspection and prognostication. Radical reform of the international monetary and financial system has been set in motion. All in all, it is difficult to escape the sense that the crisis represents a rupture, a discontinuity that will make the future less recognisable from the past.


Surprisingly, in the emerging markets, including India, there has been no such existential angst about capitalism, no serious questioning of the role of the market. It is not that these countries have not been affected by the crisis. Indeed, all countries—rich and poor—have found themselves in the same financial maelstrom, if not in the same boat, and the effects have been substantial. There has also been serious discussion and action on the appropriate short-term responses to the crisis. But, there have been no serious calls or indeed actions to roll back capitalism, to erect protectionist barriers, or to re-nationalise the economy. Most surprising, there has not even been a pitch to restrict inflows of fickle foreign capital that were arguably at the centre of this crisis for many emerging markets. The crisis may have exposed the claim of a decoupled world economy, but it seems to have emphasised the decoupling in policy debate and long-term policy choices.


What explains this decoupling? First, the crisis originated in the US and to a lesser extent in Europe. The rest of the world has been affected, and in some cases, seriously. But it remains true that the original sin was committed in the “core” not in the periphery, which has therefore had less reason to turn inward. And many emerging market countries, especially in Asia and parts of Latin America (Brazil and Chile, for example), as a consequence of prudent economic management, have been less affected by the crisis (see my calculations of the relative growth impact of the crisis based on the IMF’s latest forecasts at and managed to mitigate its worst impacts. So, what should we be introspecting about, they are entitled to ask?


Second, one contentious aspect of the debate has been new to the United States but less so for developing countries. The crisis has been a kind of intellectual wake-up call or a revelation for the United States in one sense: it has been forced to recognise that sordid political economy applies not just to those poor countries out there but also back at home.


Until this crisis hit, the discourse surrounding finance, as it witnessed securitisation and the creation of new and incomprehensible instruments such as collateralised debt obligations and other exotic mutants, had always been more technical than political. But recent contributions have changed that.


Simon Johnson of MIT has written of a financial oligarchy stymieing the implementation of sensible solutions in this crisis. This echoes the concerns expressed by Jagdish Bhagwati a decade ago that the so-called Wall Street-Treasury complex was pushing for capital account liberalisation in developing countries. Dani Rodrik of Harvard University has questioned the role of intellectuals in creating a system of beliefs that oversold the role of finance. Devesh Kapur of the University of Pennsylvania has pushed this further, arguing that academics are themselves compromised by their links with the financial sector. All these contributions are pushing popular opinion in the United States to accept that this crisis was not just a case of honest but unavoidable mistakes on the part of policymakers.


There is a gradual realisation that the diagnostic spotlight must shine on the revolving door between Wall Street and government, on the power and influence of the financial sector, and on the imperfect workings of a much-vaunted democracy that is unable to do what evidently needs to be done to fix its financial sector. Developing countries have, for long, lived with crony capitalism as a fact of life, almost as a defining condition of their under-development. Might the US too, in this respect, be a developing country is a question that can no longer be dismissed as outrageous.


The third decoupling relates to another big question thrown up by the crisis in the core countries: the role of the state and the appropriate demarcation between state and markets, especially in the financial sector. In the emerging markets, particularly in the more successful ones such as China and India, this is simply not an issue. The line still favours state over markets and in the financial sector heavily so: in both these countries, most of the banking system assets and liabilities are still controlled by the government. The issue is not how to claw back the role of the state so much as how to continue reducing its role in the gradual and pragmatic manner that these countries have been doing over the last two decades. In India, for example, the only bank threatened by the crisis was a private one that chose to deal in the toxic assets that wreaked havoc in western financial markets, resulting in a flight of deposits to the safety of public sector banks. Yet, it is remarkable that the debate on finance in India has not lurched in the direction of triumphalism about the public sector model of finance and the need to ensure its permanence.


Perhaps the most important reason for the decoupled debate phenomenon is that the big development challenge in the developing world is not the state-market boundary but the more mundane yet fiendishly difficult question of how to improve the state and its basic capacity to deliver law and order, security and other essential services such as health, water, sanitation and education. That was so before the crisis. That will remain true in its aftermath.


Arvind Subramanian,
Peterson Institute for International Economics, Center for Global Development, and Johns Hopkins University