Building a More Inclusive Global Financial System

GG 2020 - 7th May 2010

By Swati Mylavarapu

The global recession has had remarkably local effects. As hardship hits our own pocketbooks and destabilizes our local communities, people’s attention naturally focuses on the recession’s impact on them. In America, the recession has been a story of elite Wall Street greed that has cost Main Street Americans their jobs and their homes.  In Europe, there has been the added complexity of determining “who will save who,” as Rainer’s post detailed.
This myopia has meant that little attention is being paid to the recession’s effects on developing countries. Over 85% of the world’s population lives in these countries. We’re talking about what the recession has meant for over 4 out of every 5 people in the world.

If we turn our attention to this part of the world, a problematic trend becomes apparent. The global recession has produced two divergent experiences in the developing nations.

In some BRIC states, the largest economic powers among developing countries, (often rapid) growth continues – if slightly tempered. But the difference between 10% and 7.6% growth rates, experienced in India pre and post-recession, is marginal given that most countries’ economies have been shrinking. And to answer Rainer’s question of “who’s buying the next round,” Brazil, China and Russia are among the top 15 lenders to the US.

China is leading this trend. Thanks in part to a domestic stimulus package equivalent to 6% of GDP ($660B) that bolstered China’s booming manufacturing industry, the country is on track to become the world’s second largest economy by year end. China faces the relative luxury of managing inflation from rapid growth in a time when most of the world faces deflation. Underlying its growth is comforting liquidity; the central bank has raised reserve requirements for lenders to a whopping 14.5-16.5% (compared to virtually eliminated requirements in the US) in an attempt to slow down lending.

But for many in the lower socioeconomic brackets within the BRICs, as well as billions in other poorer countries, poverty has increased and the damage may last a while. Growth has slowed or stopped in many of these countries. The World Bank estimated that GDP in developing countries would slow to 2.1% in 2009, much lower than the 5.8% average seen in 2008. Even worse, the pool of development financing that was available before the recession has shrunk. The Bank estimates that at least 84 of 109 developing countries across Europe, Central Asian Latin America and Sub-Saharan Africa will face financing gaps.

The recession also threatens longer-term recovery and inclusive growth prospects in these countries. In poorer states, when growth declines by a few percentage points, populations living on the cusp of the poverty line plunge decidedly below it. The number of people living in extreme poverty in these countries has risen. That means, for example, that the proportion of African workers earning less than $2 a day rose nearly 3% to 86.6% in 2009.

Millions of individuals have lost what limited ability they may have had to invest in longer term productive assets, such as business equipment, houses – or a child’s education. Basic services such as nutrition and health care have become inaccessible. Even when the recession ends, these individuals will not have the means to bounce back with the rest of the economy.

During this recession, the mistakes of a wealthy few have caused devastation for a poor majority who can least afford it. If ever there was a case for a more inclusive global financial regime, this is it. So what might such a system include?  

Expanding the financial governance system from the G8 to include 12 other nations was a starting point. Now that forum must be used to create effective sector-wide regulation. Liberalization of the global financial system and accompanying banking deregulation in the 1990s ensured the recession’s global spread. As much as developed countries are loathe to admit it, they championed these flawed policies.

Protectionism, which increases during recessions, must be resisted. The US’s “buy American” provisions in its economic stimulus package, for instance, exempt other advanced industrial nations and so effectively discriminate against poor ones. If such measures will continue, we at least need mechanisms to offset the unfair advantage it gives to firms in developed countries.

To create a more equitable and stable system, today’s dollar-based reserve system must become a more global one. A UN Commission of Experts has called for such a measure. The current system places a large burden on developing countries, which must set aside huge dollar reserves. 

Development aid should be guaranteed in future financial crises. This is perhaps the most controversial proposal. Still, Joseph Stiglitz goes so far as to argue that 1% of developed country stimulus packages should be mandatorily set aside to help developing countries. In times of hardship, aid is needed even more to avert devastating consequences for the most vulnerable populations.

The era of globalization will not end with this recession. If anything, the rapid spread and globally devastating effects of this crisis underscores just how interdependent the world financial system has become. A global financial system that prevents future crises will only emerge if reforms cater to the needs of a too-often-sidelined majority living in developing countries.

Swati Mylavarapu is a Consultant with Dalberg Global Development Advisors in San Francisco.