Developing Nations and the New Global Order

Posted by Arvind Subramanian on 27 January 2009

On say and substance, the global financial crisis and the weakening of the US and EU are creating new opportunities for developing nations.

The hopefully permanent transmutation of the G-7 to G-20 is both an acknowledgment and a signal that the monopoly on decision-making, hitherto held by the West, is being chipped away. Developing nations are slowly acquiring greater say. Consolidating this process would require that they continue to maintain high growth rates internally; that is the first and most important order of business.

Externally, developing countries should make sure that the G-7 does not re-assert itself, and they should push strongly for governance reform of the IMF (and also the World Bank).

For starters, at the next G-20 summit in April there must be an agreement that:

(i) the heads of these institutions will be selected on merit-based and transparent procedures;

(ii) Europe will reduce its quota share in the IMF substantially (8-10 percentage points); and

(iii) decision-making will be more cooperative.

These changes matter. The IMF is, and is perceived to be, still a US-centric, and even more, a Euro-centric club which has applied different standards to different members.

In the current crisis, for example, most of the borrowers have been European countries. In the case of the IMF’s Latvia program, a country with a current account deficit of yes, 24% of GDP, the IMF asked for a devaluation of a whopping ZERO percent. Faith in “Immaculate adjustment” for the favoured few, and insistence on large devaluations with more miserly and conditionality-addled resource transfers for the many (remember the Asian financial crisis?). Is it surprising that Latin America and especially Asia are disengaged from the IMF?

On substance, developing countries should push for a larger Fund that can provide liquidity in times of crises as Dani Rodrik suggests in his Lead Commentary. But this should be accompanied by serious governance reform, and by an insistence that the Fund review its ideological/intellectual dogmas.

Here’s one way of testing and/or achieving this. Require the Fund to come up with “best practices” for managing and limiting capital inflows: what are the best instruments? how long can they be effective? What flows should be covered? Unless the Fund changes its governance and intellectual biases it is doomed either to irrelevance and illegitimacy or to surviving as a cosy club for the few.

Keeping international markets open

Keeping international markets open is probably the highest priority for developing countries in the current environment. Their sustained growth requires something close to the levels of openness seen in the last couple of decades. Dani’s view is that these openness levels can be maintained by a bargain around “policy space.” Developing countries would then use this space to figure out the best development policies. In return, industrial countries would be allowed to use this space to push for some kind of global harmonization of tax and regulatory policies that would help buy off middle class anxieties about globalization that might otherwise lead to outright protectionism.

The problem is that the crisis might (with a non-trivial probability) push the industrial countries into significantly higher levels of protection. In the US, a severe downturn and a strong dollar could feed on the pre-existing anxieties about globalization and create pressures for protection that a Democratic Congress and administration might find difficult to contain. These pressures could take the form of “Buy America” provisions in government spending or environmentally-motivated barriers (see my pieces with Aaditya Mattoo of the World Bank at http://www.petersoninstitute.org/publications/papers/FA-subramanian0109.pdf and http://www.petersoninstitute.org/publications/opeds/oped.cfm?ResearchID=1089).

How to avoid rich nation protectionism?

How can developing countries avert this outcome or minimize its probability? One possibility is that they might have to eschew protectionism and even offer to open up their markets just in order to prevent industrial countries from closing theirs. This conventional (trade-for-trade) but asymmetric (because developing nations will have to do something for industrial countries not doing other things) bargain would be very different from Dani’s symmetric “policy space” bargain. But that might be the “price” for ensuring open markets globally.

Global warming

On global warming, which along with trade is perhaps the other key issue for developing countries, I agree with Dani that developing countries shoulder some of the incremental burden of reducing greenhouse gas emissions.

The fear, however, is that the framing of the problem and identification of the solutions in industrial countries might be such as to tilt the outcome in favour of too much, rather than too little, burden being imposed on developing countries.

Legislation now in the US Congress would envisage action against those countries which do not take “comparable action” as the US. That a country – whose per capita emissions are so much greater (and have been so for decades if not centuries) than that of developing countries – could contemplate such action without eliciting outrage, even on the part of their intelligentsia, is disquieting from a developing country perspective.

Finally, will this opportunity be seized by developing countries?

There are reasons to be extremely sceptical. For one, China – the one player which can really have an impact – remains inscrutable.

What is China’s vision for the global order? Will it exercise leadership in a manner consistent with developing country and global interests?

And let us make no mistake. Developing countries will have to assert themselves to shape the new global order. For example, Europe is very generous in offering aid to developing countries but fiercely resists ceding power in the IMF. So, with apologies to Matthew Arnold, the question remains: yes, the old order is fading but do developing countries have it together now (or any time soon) to will the new order into being?

Arvind Subramanian
Senior Fellow,

Peterson Institute for International Economics and Center for Global Development