TWN Info Service on Finance and Development (Mar09/03)
25 March 2009
Third World Network

"Made in USA" crisis now affecting developing countries – Stiglitz
Published in SUNS #6659 dated 13 March 2009

Geneva, 12 Mar (Kanaga Raja) -- The financial crisis with a "made in USA" label on it is now affecting developing countries worldwide including those that had undertaken good financial market regulation as well as good monetary macroeconomic policies, Nobel Laureate Prof. Joseph Stiglitz said on Wednesday.

"In fact, many of the developing-country central banks have policies that are much more prudent and [have] much better regulation than some of the advanced industrial countries that are currently facing a problem," Stiglitz told a media briefing at the Inter-Parliamentary Union's office here.

His personal view is that some of the advanced industrial countries should go to the developing countries and study what they did to learn what good regulation entails.

Noting that there are many distortions to the international trade regime such as tariffs and subsidies, Stiglitz said that subsidies provided by the industrial countries to their companies and financial institutions "have totally destroyed the level playing field" for years to come. It means that companies and financial firms in developed countries can undertake risks, knowing that if there is a problem, they may be bailed out.

He called for funds to be provided to the developing countries to offset this distortion in the global economic system.

Speaking briefly on the WTO Doha Round of trade negotiations, Stiglitz said that while it's not likely that the Doha Round "will reach completion quickly" particularly given the current disturbance to the free market, the developed countries can help the poorest countries by unilaterally opening up their markets to the developing countries.

Stiglitz, who is also a professor of economics at Columbia University, is in Geneva attending meetings of the Commission of Experts on Reforms of the International Monetary and Financial System, which he chairs. The Commission was formed last November by the President of the UN General Assembly Father Miguel D'Escoto Brockmann of Nicaragua.

While in Geneva, Stiglitz also made a presentation of the Commission's work at an UNCTAD meeting on Thursday. According to the UNCTAD press office, the meeting was not open to the media, but civil society groups were able to attend.

At the media briefing on Wednesday, Stiglitz explained that the Commission of Experts was set up to look at the impact of the financial crisis on developing countries in order to assess the kinds of reforms needed in the global financial system. The recommendations that the Commission is likely to come up with will serve as a preparation for the discussions that are going on that will lead to the UN high-level conference which will be held at the United Nations headquarters in New York at the beginning of June.

He said that the Commission viewed itself as having two roles -- helping to provide some of the input and thinking into that UN process, and also coming up with a longer document that hopefully will have some impact on the global debate on the restructuring the global financial system. The Commission's recommendations will also take two parts -- a set of things that need to be done right away and those that need to be done but are not necessarily going to be done overnight.

"We (the Commission) very strongly support the view that is likely to come out of the G20 process -- that there is a need for strong stimulus by all the countries in the world -- but we highlight the fact that the developing countries don't have the resources to engage in the necessary counter-cyclical policies, and therefore there is need for substantial assistance from the developed countries to the developing countries to enable them to engage in those counter-cyclical policies," said the Nobel Laureate.

(The G20 process involves some twenty leading developed and developing economies which will be holding a leaders' summit in London in early April to discuss the global financial system.)

"We point out that in the past, some of the international financial institutions have demanded pro-cyclical policies in a variety of conditionalities on countries receiving assistance, and we are likely to strongly argue [in the upcoming Commission's report] that there should not be those conditionalities, in particular the pro-cyclical conditionalities [that] are counter-productive," said Stiglitz.

Noting that it is good that the G20 has talked about there not being any protectionism, Stiglitz said that the Commission of Experts is probably likely to reaffirm that. "We know that actually in some of the stimulus measures, protectionist measures have been undertaken, and that some of the protectionist measures have the effect of discriminating against developing countries."

He said that the Commission has long recognized that there are many distortions to the international trade regime -- tariffs and subsidies. Subsidies that are being provided by the industrial countries to their companies and financial institutions "have totally destroyed the level playing field."

And the fact that the developed countries have stood ready to provide these subsidies means that the level playing field will be destroyed for years to come because it means that companies and financial firms in developed countries can undertake risks that those in developing countries cannot, knowing that if there is a problem, they may be bailed out, Stiglitz said. The nature of a free market economy has been really undermined by what has happened, he added.

He said that the Commission is arguing that there is need for funds to be provided to the developing countries to offset this distortion in the global economic system.

"What is very clear is that this crisis that has a 'made in USA' label on it is now affecting developing countries all over the world including developing countries that had undertaken good financial market regulation, good monetary macroeconomic policies... In fact, many of the developing-country central banks have policies that were much more prudent and [have] much better regulation than some of the advanced industrial countries that are currently facing a problem."

"My personal view is that some of the advanced industrial countries should go to the developing countries and study what they did to learn what good regulation entailed... We argue that there is a very strong need for additional funding to developing countries in order for them to respond adequately..."

On short-run measures, he said, "we argue that while it's not likely that the Doha Round will reach completion quickly, particularly given the disturbance to the free market that has occurred, the developed countries can help the poorest countries by unilaterally opening up their markets to the developing countries..."

He pointed to what Europe has already done in the Everything-but-Arms initiative which, he said, needs to be extended. The United States and some other countries have not done that. "We argue that this should be done across the board."

In terms of the longer-run measures, Stiglitz said that what the Commission argues is that there are many causes of this problem, and can be analysed at many different levels -- inadequate regulation, loose monetary policy. But one also needs to dig a little deeper.

Pointing to inadequate global aggregate demand, Stiglitz recalled discussions on global imbalances that have occurred in last five years, with the United States on a number of occasions saying that "you should be thankful that we are spending beyond our income because we are supporting the global economy."

"It's a very peculiar global system where the richest country in the world would have to live beyond its means in order for the global system to work," he said. What monetary policy, and the bubble that it supported in the United States, did was to offset what otherwise would have been an insufficiency of global aggregate demand.

Stiglitz pointed to two reasons for the insufficiency of global aggregate demand. First, was the growing inequality in most countries in the world. Second, was the huge build-up of reserves in many countries, particularly developing countries, partly related to the way the last global financial crisis (the East Asian crisis) was mismanaged. Many of the affected countries in fact lost their economic sovereignty. The IMF came in and imposed strong conditionality and pro-cyclical policies, the result of which was turning an economic downturn into recessions and recessions into depression.

In the aftermath of that, according to Stiglitz, many countries said that they would never again let themselves be exposed to this kind of risk and in the absence of a global framework to deal with these risks, they built up reserves in trillions of dollars. The reserves are good for the countries but they mean that there are hundreds of billions of dollars of income every year that are not being spent. That leads to an insufficient global aggregate demand.

"So, one of [the] recommendations of our Commission is likely to be that there is a need to fix the underlying problem, and that is to create a global reserve system so that countries don't have to individually insure themselves..." He said that the dollar-based system is becoming more unstable and this will provide an alternative.

Stiglitz said that like the G20, the Commission will be talking about the need for reform of the governance of the international financial institutions. Part of the problem is that many of the developing countries feel reluctant to turn to the IMF for funds because of the stigma associated with the loss of sovereignty in the past.

These institutions have lost their legitimacy and in essence lost their ability to be effective, he said. While some of the new programmes that the institutions are talking about such as reducing conditionality are very welcome and is an important move in the right direction, the reforms in governance are "too small, too slow."

According to Stiglitz, the problem is that the sources of liquid funds in the world -- countries in Asia with large reserves, and sovereign wealth funds in the Middle East -- often have inadequate voice in international economic institutions, and often have views about good and appropriate economic policies that differ from those that have been pushed by these institutions.

"We have to remember that the IMF did not foresee the problem; [it] had in fact pushed the deregulation policies that have facilitated the contagion of the problem in the United States to the rest of the world, and that of course has undermined the credibility of the institution..."

Asked what the poor developing countries can do for themselves, Stiglitz said that one important message is that there needs to be more financing for the developing countries to have counter-cyclical policies. Other ways that developed countries could help developing countries is through opening up their (developed country) markets. New ways of finance have also been explored in the Commission's report such as new issues of Special Drawing Rights of the IMF for development purposes. In the long-run, new mechanisms have to be developed.

"The developing countries have to be given more scope to pursue counter-cyclical policies. In the past, that scope has been circumscribed by some of the international institutions," said the Nobel Laureate.

While developing countries can do as much as they can, their resources are limited. It is in the interest of the developed countries to give that assistance, because if they don't, the fall-back can be very serious, said Stiglitz, adding that this is being seen now in Europe, in the collapse of Eastern Europe which may weaken financial institutions in Europe, and in turn may weaken financial institutions in the rest of the world.

Asked to comment on the debate in the United States on the stimulus package (of some $787 billion recently passed into law by President Barack Obama) being either too small or too big, he said that his personal view is that what is important is that there be not only a large stimuli but that it be well-designed as well. The concern about the US stimulus, in his personal view, is that it is not only too small, but also not well designed. He noted that one-third of it goes to tax cuts, and there is a high likelihood of people saving this money.

Stiglitz also said that in assessing the US stimulus, one has to remember that the United States has a federal system in which about a third of all expenditure occurs at the state and local level. While the federal government is expanding, at the state level it is contracting. "It (the stimulus) will be much better than nothing, but much less than we need," he said.

Asked as to what President Obama should do, he said that from his own perspective, what President Obama has done "is so much better than would happen in the previous year. What's been done will make a big difference but I think we also ought to be realistic and realize that it wasn't enough."

As to what should be done, he said that there is need for a larger and better designed stimulus. What the president has done with respect to mortgages is a major step forward (a $75 billion plan to aid mortgage holders on the brink of foreclosure). "The foreclosures and real estate problems have been at the root of what we have been doing. We've been pouring money into the banking system without fixing the underlying problem with mortgages."

He however noted that there is a broad consensus that it is not enough. He also said that hundreds of billions have been poured into banks to restructure them, but it has not rekindled lending. There is a great deal of anger in the United States over the way the bank restructuring has been done.

Pointing out that the deficit in the social security system in the United States was $560 billion, he said, "With $560 billion, we could have put our old-age pension programme on sound financial grounds for at least 75 years, and guaranteed the retirement benefits for all Americans for 75 years. That is less than the $700 billion that we spent in bailing out the banks. We provided money for the ailing banks but we may ask ordinary Americans to sacrifice their retirement benefits."

In response to another question as to whether the Commission will be looking at the issue of offshore financial centres, Stiglitz said that the Commission will be talking about the tax and regulatory havens. "You cannot have a comprehensive regulatory reform without dealing with a comprehensive framework, otherwise you would have what we call 'regulatory arbitrage'..."

He noted that it is not just offshore financial centres; a lot of this is onshore in major financial centres. He said the secrecy (in banking) exists because it is in the financial interest of some people for them to exist.

Asked whether there will be a convergence between the G20 process and the Commission's work, he said that on some of these things, there will be a parallel. "But we are more likely, on some of these issues, to take a much more developing country focus." He said that the G20 is going to be talking about offshore financial centres and "we are going to point out that it's not just offshore."

"Some people are going to be trying to sell the view that there have only been minor problems... and fix a little bit of a plumbing leak and everything is fine... Our view is that the problems are deeper, more fundamental and if we don't fix that, it will be difficult to restore the global economy to a robust balanced growth."

Asked if the World Bank and the IMF should disappear as a result of the crisis and new institutions should be created, Stiglitz was of the view that this is a "Bretton Woods II" moment. "I strongly believe this crisis illustrates the importance and need of good global institutions."

He noted that there will be changes but like any political process, different people will have different views. On the issue of financial regulation, in the United States, everybody will use the language "we need more regulation". But what some people will mean is we need "cosmetic reform". There is a strong movement for cosmetic reform, especially from those who were involved in the earlier deregulation movement.

Other people are saying "no" in that the system is really imposing enormous costs on society. There will be a debate in the United States. In Europe, the outcome of that debate is already clear. People there believe that there is need for stronger regulation. "In the United States, that debate is still going on very intensely," said Stiglitz. +