International policy coordination is key to help developing countries fight the crisis

Posted by Guillermo Rozenwurcel on 20 February 2009

Two major features of the current crisis probably help explain its unusual depth and extension. The first one is the dramatic and widespread downward adjustment in the net worth of families and corporations, triggered by the implosion of the real estate and other connected financial bubbles in the US and other advanced economies. The second one is the truly global nature of the crisis.


With the benefit of hindsight, it seems pretty obvious that in the previous boom the upward trend in both asset prices and overall indebtedness, supported by unduly optimistic expectations of future growth, reached unsustainable levels. By amplifying the imbalances, the unprecedented length of the global expansion only made the subsequent collapse deeper. When the crisis finally arrived, it came together with a widespread breach of financial contracts.


Massive overindebtedness implies that the contraction in economic activity is not only the result of effective demand failures. If this is true, expansionary policies inspired on traditional Keynesian views will not be enough to get out of the current impasse. Private lending and spending will not fully recover while a large number of debtors remain insolvent. Therefore, a social redistribution of the massive wealth losses caused by the crisis seems unavoidable and a direct government intervention to speed up the process might be better than waiting for the problem to be settled by standard bankruptcy procedures.


Notwithstanding the crucial importance of this still unresolved issue, the rest of these notes will focus on the second distinctive feature identified above, because of its implications for developing countries. Even if initially it was mostly a domestic affair, the financial crisis in the US, being this country the center of a truly globalized international financial system, inevitably became a global event. The proper answer to a global crisis is no doubt one where governments and central banks coordinate their national policies. In the world scenario, however, there are no multilateral institutions where such policies can be properly discussed and coordinated. It is therefore no wonder that, despite a few common but isolated (and not truly global) policy initiatives, all economies are facing the crisis mostly on their own, while international trade and financial flows are shrinking.


While the lack of international coordination weakens the impact of anti-crisis measures in the advanced economies, it certainly has more dramatic consequences in most developing countries, where the available policy resources to fight the crisis are much limited.


The issue is critical because, unlike what happens in the advanced economies, two factors tend to further impair the ability of most developing countries to cope with the crisis. One is the dramatic worsening in their external balances, because they simultaneously suffer a sharp deterioration in trade flows and massive capital outflows. The other is the adverse shift in the supply of finance faced by their public sectors. As a result, trying to avoid debt default they are forced to cut expenditures and raise interest rates, which is precisely the opposite of what is required to counter the decline in activity and employment.


The recently activated G20 group could become an appropriate forum to reach an international consensus on how to coordinate a global response to the current crisis, but it has so far adopted a quite partial and restrictive agenda.


Meanwhile, the only multilateral support offered to developing countries has been the Short- Term Liquidity Facility (SLF) created by the IMF in October 2008. Its purpose was to set in motion a quick-disbursing financing under the only conditionality of having a track record of sound policies according to the assessment of the Fund in its most recent article IV discussions.


Nevertheless, even acknowledging that the IMF is trying to adopt conditionality criteria less restrictive and more suited to the specific conditions faced by the counties seeking assistance, it is still the case that, since the establishment of the SLF no country has so far applied for the new facility. On the contrary, the several countries which did decide to ask for IMF assistance have instead chosen to resort to the old-fashioned stand-by agreements.


Moreover, even if it is true that under the current circumstances, at least according to the public statements of its main authorities, the Fund is endorsing the adoption of expansionary counter-cyclical fiscal policies, it is nonetheless a fact that no adequate funding to implement such policies has been made available to developing countries. This is so because the IMF is extremely limited by the lack of enough resources and also by the restricted features of existing facilities, which are both clearly inadequate to deal with a global systemic crisis.


For the Fund’s lending strategy to become effectively consistent with its policy advice, a major increase in its lending capacity is required. The new resources should then be devoted to two purposes: 1) to help restructure the banking systems in the countries that demand such assistance and, 2) to simultaneously finance expansionary policies in several developing countries where credit rationing affects the fiscal stance and the external balance. If negative expectations regarding growth prospects are to be reversed, interest rates should be low enough and the terms of the funding should not be too short. Provided that appropriate policies are underway in the advanced economies, such a strategy, if properly managed, could successfully coordinate a push in activity levels and an improvement in living standards in a number of developing countries, with positive spillovers for the world economy as a whole.


A coordinated effort to oppose the serious threat posed by the ongoing revival of protectionism in international trade, hopefully under the framework of the WTO, should of course complement the initiatives undertaken in the financial field. Such effort should go beyond preventing the escalation of tariff and non-tariff trade barriers. It should also help curtail two major risks of the present context: increasing economic isolationism, for instance by blocking the participation of foreign firms in the public programs and investments to be included in the anti-crisis fiscal initiatives, on the one hand, and starting a vicious circle of competitive exchange-rate devaluations on the other hand.


Finally, though less pressing in the immediate future, the global imbalances that contaminated the previous world expansion should not be left out of the picture. Without solving the exchange rate misalignments which were at the root of those imbalances, any future recovery runs the risk of facing similar problems. An agreement negotiated by the major international players, including China and perhaps some other emerging economies, could ease the required adjustment process.


Guillermo Rozenwurcel,

University of Buenos Aires, University of San Martin and Conicet (Argentina)


 Heymann, D. (2009), “On types of crises”.

 Among them, the simultaneous reduction in interest rates decided by the US, a few other advanced counties and China, in October 2008 and the swap agreements established by the Fed with the central bankers of fourteen other countries, including a few emerging ones.


Frenkel, R. (2009), “La acción internacional es imprescindible”.


The SLF offers up to 500% of a county’s quota in the Fund but only for three months, with a maximum of three draws during any 12-month period.


The reinforcement of the “buy American” clause in the US is a clear example of this trend.