The hardest hit

Waterloo Region Record

April 27, 2009

Economic turmoil in the developed economies is jeopardizing the recent hard won progress in developing countries. The Asian economies have accelerated their growth in the last five years. Countries in Latin America and Africa made substantial progress as these economies grew more than five per cent a year, a welcome change from the malaise that afflicted them in the 1980s and 1990s.

The recent decline in demand in the developed economies has caused large drops in the export earnings of developing countries. Also, funds have been withdrawn from stock markets in developing countries as institutional investors from developed countries sought to rebuild their balance sheets. As a result, stock indexes have fallen by over 50 per cent in some cases and the currencies of many developing countries have depreciated by 25 per cent or more.

The decline in trade has impacted the entire economy of developing countries, particularly in East Asia and Africa, which are heavily dependent on exports. The decline in exports, together with the fall in inflow of foreign capital, could seriously damage investment in many developing economies. Investment in many countries in Latin America and Africa, despite recent increases, still lags behind levels achieved in the late 1960s and early 1970s. A decline would seriously damage future growth prospects.

Recovery of the developed economies is still uncertain and depressed economic conditions are likely to continue for a prolonged period, even if the bottom has now been reached. Prospects for exports of primary commodities are particularly bleak as commodity prices are the last to recover. Furthermore, the large budget deficits arising from the implementation of stimulus packages by the governments of the developed countries will pre-empt a substantial part of the world's savings to the detriment of the developing world. The increased resources promised to the World Bank and the International Monetary Fund (IMF) come nowhere near replacing the amounts pre-empted by the developed countries. Furthermore, it is unclear when the additional funds will be made available.

Protectionism in the developed countries has increased. Developing countries fear that this might cripple their export earnings and make it difficult for them to service their debts. Fortunately, the multilateral trade agreements signed by governments in the past will prevent a recurrence of the level of protectionism seen in the 1930s and the external accounts of most developing countries are, as yet, healthy.

Developing countries could compensate for lower growth in the developed markets with policies that further South-South co-operation. Already, regional South-South trade and financial flows have been growing rapidly, and are now significant for many developing countries. However, more efforts are needed to further increase these, particularly to encourage trade between different regions.

Governments of developing economies often are limited in the expansionary fiscal and monetary policies they can adopt by their budgetary and balance of payments positions. Countries, such as China, with large foreign reserves and a sound budgetary position are in the best position to adopt expansionary policies. Unfortunately, commodity exporters may be inhibited from adopting expansionary policies as the decline in commodity prices have weakened their budgetary and balance of payments positions. Assistance from the international community may be necessary before governments in these countries can adopt expansionary policies.

Part of the problem with the international economy has been the imbalance with some countries usually in the developing world having large surpluses and the U.S. in particular having a large deficit. Increased savings by U.S. consumers will not resolve the problem because there would then be an excess of savings leading to recession in the world economy.

Developing countries have built up reserves as insurance against having to approach the IMF for loans when they have a balance of payments deficit. The governments of these countries intensely dislike the conditions imposed by the IMF when it grants loans. The problem will not go away until IMF policies and, perhaps, the governance structure changes.

There is an additional problem. The U.S. dollar has been the world's currency since the end of the Second World War. Now, other currencies may rise to the status of an international currency. It is essential to reform the international monetary system so that there is an orderly evolution. Otherwise, we could have destabilizing speculation with large shifts of funds between the different currencies.

Substantial changes in international economic governance may be necessary for developing countries to continue growing rapidly.

Manmohan Agarwal is a senior visiting fellow at the Centre for International Governance Innovation (CIGI) in Waterloo.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

About the Author