KUALA LUMPUR, Malaysia, Aug 14 (IPS) – When history repeats itself, first as a tragedy and then as a farce, if we do not learn from past financial crises, we risk making avoidable mistakes, often with irreversible and tragic consequences.
Between a rock and a hard place
Many people around the world suffered greatly during the 2008-2009 global financial crisis (GFC) and the Great Recession. However, the experience of most developing countries was quite different from that of the global North.
The diverse responses of developing countries reflected their context, the constraints of policymakers, and their understanding of events and options.
So the Global South reacted very differently. Most developing countries with more limited means reacted very differently from the rich countries.
The fiscal situation of developing countries, hit hard by the GFC and the subsequent Great Depression, has since been further weakened by lukewarm growth. Worse, foreign exchange reserves and fiscal balances have declined as national debt has increased.
Most emerging markets and developing countries (EMDEs) save primarily in US dollars. Some countries with large trade surpluses have long been buying US Treasury bonds. This finances US fiscal, trade and current account deficits, including war.
The vagaries of finance
Post-GFC, international investors, including pension funds, mutual funds and hedge funds, initially remained risk-averse in their exposure to emerging market economies (EMDEs).
So the GFC hit growth globally through a variety of channels. As EMDE earnings and prospects fell, so did investor interest.
But as ‘quantitative easing’ made it possible to make more money from cheap finance, money flowed into the Global South. As the US Federal Reserve raised interest rates in early 2022, money flowed out of developing countries, especially the poorest ones.
Real estate and stock markets, long supported by easy credit, collapsed. As finance became more powerful and important, the real economy suffered.
As growth slowed, export earnings from developing countries declined as capital flowed out. So instead of countercyclical aid, capital flowed out when it was needed most.
The consequences of such reversals have been quite varied. Sadly, many who should have known better have chosen to turn a blind eye to such dangers.
After globalization peaked at the turn of the century, most wealthy countries used the GFC as an excuse to reverse previous trade liberalization, so growth slowed down with the GFC—well before the COVID-19 pandemic.
Market crash
Emerging market stocks, previously fueled by easy money from the Great Easing, crashed during the GFC. The turmoil hit emerging markets much harder than rich countries.
Most wealthy and middle-class households in emerging market economies (EMDEs) own stocks, and 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. What’s worse is that banks stop lending when credit is needed most.
This forces companies to cut back on investment spending and instead use savings and profits to cover operating expenses, often resulting in layoffs.
When stock markets crash, companies and banks become overly indebted, negatively affecting their ability to pay, which triggers other problems.
Falling stock prices trigger a downward trend that slows economic growth, increases unemployment, and worsens real wages and working conditions.
When government revenues fall, the government borrows more to make up the shortfall.
Each economic zone has a different government response, and different coping strategies are applied accordingly.
Much will depend on how governments respond with countercyclical and social protection policies, but previous deregulation and reductions in means have generally eroded their capacity and capabilities.
Policy Matters
The official policy response to the GFC, supported by the US and the IMF, included measures that critics had criticized for being taken by East Asian governments during the 1997–1998 financial crisis.
These efforts included requiring banks to lend at lower interest rates, providing financial support or “bailing out” financial institutions, and restricting short selling and other practices that were previously allowed.
Many people forget that the Federal Reserve’s mission is broader than most other central banks: instead of providing financial stability by suppressing inflation, it is expected to maintain growth and full employment.
Many wealthy countries responded to the Great Depression by adopting bold monetary and fiscal policies. Low interest rates and increased public spending helped.
As the global economy has fallen into a prolonged recession since the GFC, tighter fiscal and monetary policies beyond 2022 have hit developing countries particularly hard.
Effective countercyclical policies and long-term regulatory reforms were suppressed, and instead many countries yielded to market and IMF pressures to reduce fiscal deficits and inflation.
Financial reform
Nonetheless, in times of crisis, it is common to call for more government intervention and regulation. But when the situation becomes less threatening, as in late 2009, circular policies replace counter-cyclical measures.
Quick fixes rarely provide adequate solutions. They do not prevent future crises, and they rarely replicate previous crises. Instead, measures should address current and future risks, not previous ones.
Financial reform for developing countries must address three issues: First, the long-term investments needed must be adequately financed by cheap and reliable sources of capital.
Well-functioning development banks, relying primarily on formal resources, can help finance these investments. Commercial banks should also be regulated to support the investments they want to make.
Second, financial regulation must address new conditions and challenges, but the regulatory framework must be countercyclical. As with fiscal policy, capital reserves should increase during boom times to enhance resilience to recessions.
Third, the country must have appropriate control measures to discourage undesirable capital inflows that are not conducive to economic development or financial stability.
Preventing and mitigating the destructive capital outflows that will inevitably follow financial turmoil will require precious financial resources.
IPS UN Secretariat
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© Inter Press Service (2024) — All rights reservedOriginal Source: Inter Press Service
