KUALA LUMPUR, Malaysia, Aug 14 (IPS) – When history repeats itself, the first time is a tragedy; the next time is a farce. If we fail to learn from past financial crises, we risk making avoidable mistakes, often with irreversible, even tragic, consequences.
Many people around the world suffered greatly from the 2008-2009 global financial crisis (GFC) and the Great Recession. However, the experiences of most developing countries were markedly different from those of the Global North.
The different responses of developing countries depended on their circumstances, the constraints of their policymakers, and their understanding of events and options.
Therefore, the global South responded very differently. With more limited resources, most developing countries responded very differently than rich countries.
The financial position of developing countries was hit hard by the GFC and the subsequent Great Recession, and has been further weakened by tepid growth since then. Worse, their foreign reserves and fiscal balances have declined as government debt has risen.
Most emerging market and developing countries (EMDEs) save primarily US dollars. The few countries with large trade surpluses have long bought US Treasuries. This finances US budget, trade and current account deficits, including for war.
The vagaries of finance
After the Great Financial Crisis, international investors – including pension funds, mutual funds and hedge funds – initially remained risk averse in their exposure to EMDEs.
The GFC thus hit global growth through different channels at different times. As EMDE’s profits and outlook declined, investor interest waned.
But with more profits to be made from cheap financing, thanks to ‘quantitative easing’, funds have flowed to the Global South. When the US Fed raised rates in early 2022, funds fled developing countries, especially the poorest.
The real estate and stock markets, long propped up by easy credit, collapsed. As finance became more powerful and important, the real economy suffered.
As growth slowed, developing countries’ export earnings fell while money flowed out. So instead of helping countercyclically, capital flowed out when it was needed most.
The consequences of such reversals have varied considerably. Unfortunately, many who should have known better chose to remain blind to such dangers.
After globalization peaked around the turn of the century, most rich countries reversed previous trade liberalization, using the GFC as a pretext. Growth thus slowed with the GFC, that is, well before the COVID-19 pandemic.
Markets crash
Previously buoyed by the easy money of the Great Moderation, EMDE stock markets collapsed during the GFC. The turmoil has probably hurt EMDEs far more than rich countries.
Most wealthy households and many middle-income households in emerging markets own stocks, while many pension funds have increasingly invested in financial markets in recent decades.
Financial turmoil has a direct impact on many incomes, assets and the real economy. Worse still, banks stop lending when their credit is needed most.
This forces companies to reduce their capital expenditures and instead use their savings and profits to cover operating costs, often requiring them to lay off workers.
When stock markets crash, it has a negative impact on solvency, as companies and banks have too much debt, which in turn leads to other problems.
Falling stock prices create a downward spiral, slowing the economy, increasing unemployment and worsening real wages and working conditions.
As government revenues fall, they borrow more to make up the deficit.
Different economies deal with such consequences differently, as government responses differ.
Much depends on how governments respond with countercyclical and social protection policies. However, past deregulation and reduced resources have generally eroded their capacities and opportunities.
Policy matters
The official policy measures endorsed by the US and the IMF in response to the Great Financial Crisis included the same measures they had criticized East Asian governments for implementing during the 1997–98 financial crisis.
Such measures include requiring banks to lend at low interest rates, financing or “bailing out” financial institutions, and restricting short selling and other previously permitted practices.
Many forget that the US Fed’s mandate is broader than that of most other central banks. Instead of providing financial stability by containing inflation, it is also expected to sustain growth and full employment.
Many wealthy countries adopted bold monetary and fiscal policies in response to the Great Recession. Lower interest rates and higher government spending helped.
With the global economy in recession for an extended period since the Great Financial Crisis, tighter fiscal and monetary measures since 2022 have been particularly damaging to developing countries.
Effective countercyclical policies and long-term regulatory reforms were discouraged. Instead, many responded to market and IMF pressures to reduce budget deficits and inflation.
Reform of finances
Nevertheless, calls for more government intervention and regulation are common during crises. However, procyclical policies replace countercyclical measures when a situation is less threatening, as in late 2009.
Quick fixes rarely provide adequate solutions. They do not prevent future crises, which rarely repeat past crises. Instead, action should address current and likely future risks, not past ones.
Financial reforms for developing countries should address three issues. First, needed long-term investments should be adequately financed with affordable and reliable financing.
Well-run development banks, which rely primarily on official funds, can help finance such investments. Commercial banks should also be regulated to support desirable investments.
Second, financial regulation must address new circumstances and challenges, but regulatory frameworks must be countercyclical. As with fiscal policy, capital reserves must grow in good times to strengthen resilience to recessions.
Third, countries must have appropriate controls in place to prevent unwanted capital flows that are not conducive to economic development or financial stability.
Valuable financial resources are needed to stem the disruptive capital outflows that inevitably accompany financial turmoil and mitigate their effects.
IPS UN Office
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© Inter Press Service (2024) — All rights reservedOriginal source: Inter Press Service
