Handling Financial Crises in the South

By Jomo Kwame Sundaram

KUALA LUMPUR, Malaysia, Aug 14 2024 (IPS) - When history repeats itself, the first time is a tragedy; the next is a farce. If we fail to learn from past financial crises, we risk making avoidable errors, often with irreversible, even tragic consequences.

Between rock and hard place

Many people worldwide suffered greatly during the 2008-2009 global financial crisis (GFC) and the Great Recession. However, the experiences of most developing nations were significantly different from those of the global North.

Developing nations’ varied responses reflected their circumstances, the constraints of their policymakers, and their understanding of events and options.

Hence, the global South reacted very differently. With more limited means, most developing countries responded quite dissimilarly to rich nations.

Hard hit by the GFC and the ensuing Great Recession, developing countries’ financial positions have been further weakened by tepid growth since. Worse, their foreign reserves and fiscal balances declined as sovereign debt rose.

Most emerging market and developing economies (EMDEs) mainly save US dollars. The few countries with large trade surpluses have long bought US Treasury bonds. This finances US fiscal, trade, and current account deficits, including for war.

Vagaries of finance

After the GFC, international investors – including pension funds, mutual funds, and hedge funds – initially continued to be risk-averse in their exposure to EMDEs.

Thus, the GFC hit growth worldwide through various channels at different times. As EMDE earnings and prospects fell, investor interest declined.

But with more profits to be made from cheap finance, thanks to ‘quantitative easing’, funds flowed to the Global South. As the US Fed raised interest rates in early 2022, funds fled developing nations, especially the poorest.

Long propped up by easy credit, real estate and stock markets collapsed. With finance becoming more powerful and consequential, the real economy suffered.

As growth slowed, developing countries’ export earnings fell as funds flowed out. Thus, instead of helping counter-cyclically, capital flowed out when most needed.

The consequences of such reversals have varied considerably. Sadly, many who should have known better chose to remain blind to such dangers.

After globalisation peaked around the turn of the century, most wealthy nations reversed earlier trade liberalisation, invoking the GFC as the pretext. Thus, growth slowed with the GFC, i.e., well before the COVID-19 pandemic.

Markets collapse

Previously supported by the Great Moderation’s easy money, stock markets in EMDEs plunged in the GFC. The turmoil arguably hurt EMDEs much more than rich nations.

Most rich and many middle-income households in EMDEs own equities, while many pension funds have increasingly invested in financial markets in recent decades.

Financial turmoil directly impacts many incomes, assets and the real economy. Worse, banks stop lending when their credit is most needed.

This forces firms to cut investment spending and instead use their savings and earnings to cover operating costs, often causing them to lay off workers.

As stock markets plummet, solvency is adversely impacted as firms and banks become overleveraged, precipitating other problems.

Falling stock prices trigger downward spirals, slowing the economy, increasing unemployment, and worsening real wages and working conditions.

As government revenues decline, they borrow more to make up the shortfall.

Various economies cope differently with such impacts as government responses vary.

Much depends on how governments respond with countercyclical and social protection policies. However, earlier deregulation and reduced means have typically eroded their capacities and capabilities.

Policy matters

Official policy response measures to the GFC endorsed by the US and IMF included those they had criticised East Asian governments for pursuing during their 1997-1998 financial crises.

Such efforts included requiring banks to lend at low interest rates, financing or ‘bailing out’ financial institutions and restricting short selling and other previously permissible practices.

Many forget that the US Fed’s mandate is broader than 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 increased public spending helped.

With the world economy in a protracted slowdown since the GFC, tighter fiscal and monetary policies since 2022 have especially hurt developing countries.

Effective counter-cyclical policies and long-term regulatory reforms were discouraged. Instead, many complied with market and IMF pressures to cut fiscal deficits and inflation.

Reform finance

Nevertheless, appeals for more government intervention and regulation are common during crises. However, procyclical policies replace counter-cyclical measures once a situation is less threatening, as in late 2009.

Quick fixes rarely offer adequate solutions. They do not prevent future crises, which rarely replay previous crises. Instead, measures should address current and likely future risks, not earlier ones.

Financial reforms for developing countries should address three matters. First, needed long-term investments should be adequately funded with affordable and reliable financing.

Well-run development banks, relying mainly on official resources, can help fund such investments. Commercial banks should also be regulated to support desired investments.

Second, financial regulation should address new conditions and challenges, but regulatory frameworks should be countercyclical. As with fiscal policy, capital reserves should grow in good times to strengthen resilience to downturns.

Third, countries should have appropriate controls to deter undesirable capital inflows which do not enhance economic development or financial stability.

Precious financial resources will be needed to stem the disruptive outflows that invariably follow financial turmoil and to mitigate their consequences.

Related IPS Articles

·                   US Fed- Induced World Stagnation Deepens Debt Distress

·                   Developing Countries’ Government Debt Crises Loom Larger

·                   Needed Global Financial Reforms Foregone yet Again

·                   Developing Countries Need Monetary Financing

·                   Inflation Phobia Hastens Recessions, Debt Crises

·                   Finance Drives World to Stagflation

·                   Financialization at Heart of Economic Malaise

·                   Urgently Needed Deficit Financing No Excuse for More Fiscal Abuse

Available online here: https://www.ipsnews.net/2024/08/handling-financial-crises-south/

More Poverty for the Poor

By Jomo Kwame Sundaram

KUALA LUMPUR, Malaysia, Jul 24 2024 (IPS) - Many low-income countries (LICs) continue to slip further behind the rest of the world. Meanwhile, people in extreme poverty have been increasing again after decades of decline.

Falling further behind

World output more than doubled from $36 trillion in 1990 to $87 trillion by 2021 (in constant US dollars), but this growth has not been evenly distributed, causing most LICs to fall further behind.

Many of the world’s poorest economies have had meagre growth since the 1960s. As most developing countries have made progress, income gaps among nations have declined.

World economic stagnation adversely affects most countries and people, especially developing countries relying on commodity demand and prices. As much of the world grew, most LICs fell further behind.

Hundreds of millions are stuck in extreme poverty, with incomes per capita in many post-colonial countries barely changing. A World Bank paper argues the poor are especially worse off.

Many poor nations have not caught up, let alone diversified their colonial-type economies. Meanwhile, many poor nations remain mired in conflict, deepening their stagnation.

Poverty has risen due to poor progress as populations grew. Another World Bank report found lower growth correlated with conflict deaths and institutional fragility. Unsurprisingly, these countries often had the world’s highest poverty rates.

Worse, global warming disproportionately harms poor tropical nations and their populations much more. Climate change is expected to push well over a hundred million into extreme poverty by 2030.

Left behind

Paper co-author Paul Collier identified 58 countries in Africa, Asia and Latin America, with about 1.4 billion people in 2021, as the ‘Bottom Billion’. Collier argues most still face problems and have failed to progress since.

These nations have long suffered from persistent poverty, low growth, and failure to develop. Their plight has been exacerbated by civil conflict, geographic constraints, and, often, the inability to use their natural resources to accelerate economic development.

Since the 1980s – not the 1960s and 1970s, as the Bank paper claims – the Bottom Billion countries have failed to grow, falling behind instead. By contrast, the few former LICs that sustained high growth now enjoy per capita outputs at least thrice that of other Bottom Billion countries.

Except for these few notable exceptions, most of the 58 Bottom Billion countries remain LICs or have become lower-middle-income countries. Only six have achieved upper-middle-income country status in the past decade, mainly due to rapid growth thanks to oil and gas.

Although the Bottom Billion countries exist in all regions, about two-thirds (38 of 58) are in SSA. They account for 77% of the Bottom Billion population. Over half have abundant natural resources, but most have not used their mineral wealth to sustain economic progress.

In 2012, the IMF classified 34 of the 58 Bottom Billion countries as ‘resource-rich’, with non-renewable resource exports and revenue often exceeding 20% of their total exports and government revenue, respectively. But most still experience lacklustre growth, if any.

Since 1990, Sub-Saharan Africa (SSA) averaged barely 0.8% annual per capita income growth. Meanwhile, global growth rates doubled as regions like East Asia registered more than 6% yearly per capita growth rates.

Anaemic growth meant that the average incomes of Africans and other slow-growing LICs slipped further behind the rest of the world. Using the World Bank’s global poverty line, the number of poor Africans grew by tens of millions.

If current growth and poverty trends persist, many slow-growing or stagnant LICs, mainly in Africa, will be unable to end extreme poverty, let alone catch up with the rest of the world.

Poorest worst off

Conventional growth models imply that countries lagging behind should grow faster than those already ahead. East Asian industrialisation – supposedly emulating earlier European growth – supports this notion.

Growth in many LICs has slowed since the turn of the century. The paper finds that “The Bottom Billion fared worst of all”, as per capita output barely rose.

The poorest Bottom Billion did not experience convergence by catching up with the others. While some studies suggest overall income convergence, the world’s poorest are relatively worse off.

Now, the Bottom Billion are ‘falling behind’ while those in extreme poverty may be rising again. Incomes of the world’s poorest countries and people are likely to fall behind, even if only relatively, despite some convergence among countries.

The situation has worsened since 2022. In addition to the commodity-price collapse since 2015, the COVID-19 pandemic, the Ukraine and Gaza wars, and geopolitically driven unilateral sanctions have ensured protracted stagnation.

Bottom Billion countries lack the policy and fiscal space to cope with, let alone address, the impending debt crises. The situation has been exacerbated by tighter credit with high interest rates set by the US Fed.

Despite decades of recognising LIC characteristics, the World Bank has yet to develop strategies, policies and means to overcome their poverty. It is unclear why the Bank has endorsed the Bottom Billion designation, although it has not enhanced our understanding of poverty.

Related IPS Articles

·                   Land Grabs Squeeze Rural Poor Worldwide

·                   Chronicle of a Catastrophe Foretold

·                   Global South Stagnating under Heavier Debt Burden

·                   Onerous Debt Making Poorest Poorer

·                   Rich Nations, IMF Deepen World Stagnation

·                   Out of Africa: Rich Continent, Poor People

·                   IMF, World Bank Must Urgently Help Finance Developing Countries

·                   Neoliberal Finance Undermines Poor Countries’ Recovery

·                   Poor Lives Matter, but Less

·                   Social Protection Necessary to Quickly End Poverty, Hunger

Available online here: More Poverty for the Poor

Government Debt Is Symptom, Not Cause

By Ndongo Samba Sylla and Jomo Kwame Sundaram

DAKAR and KUALA LUMPUR, Jun 20 2024 (IPS) - Developing country governments are being blamed for irresponsibly borrowing too much. The resulting debt stress has blocked investments and growth in this unequal and unfair world economic order.

Money as debt

Myths about public debt are legion. The most pernicious see governments as households. Hence, a ‘responsible’ government must try to run a surplus like an exemplary household head or balance its budget.

This analogy is simplistic, unfounded and misleading. It ignores the fact that governments and households are not equivalent monetary entities. Unlike households, most national governments issue their currencies.

As currency is widely used for economic transactions, government debt and liabilities influence households’ and businesses’ earnings and wealth accumulation.

The standard analogy also ignores principles of double-entry bookkeeping, as one entity’s expenditure is another’s income, one entity’s debit is another’s credit, and so on. The government deficit equals the surplus of the non-government sector, which includes households, businesses, and the ‘rest of the world’.

Thus, when a government budget is in deficit – spending exceeds revenue – the government has created net financial wealth for the non-government sector. Government deficits, therefore, increase private savings and the money supply.

Since only the government issues the national currency, its spending does not ‘crowd out’ private-sector spending but complements it. As the currency is debt issued by the state, no money would be left in an economy if the government paid off all its debt!

Hence, media hysteria about public debt is unjustified. Instead, attention should be paid to the macroeconomic and distributive impacts of public spending. For example, will it generate inflation or negatively impact the balance of payments? Who would benefit or lose?

Debt-to-GDP ratio useless

Another widespread myth maintains that public debt beyond a certain level is not sustainable or negatively impacts economic growth. Allegedly supportive studies have been discredited many times, including by IMF research. Yet, the myth persists.

Mimicking eurozone criteria, many West African governments have set policy targets, including public deficits of less than 3% of GDP and debt-to-GDP ratios of less than 70%.

The debt-to-GDP ratio undoubtedly shows relative levels of indebtedness. But otherwise, this ratio has no analytical utility. After all, public debt is a ‘stock’, whereas GDP or output is a ‘flow’.

Suppose a country has an annual income of $100 and zero debt. Suppose its government issues debt of $50 over 25 years, with annual repayments of $2. Its public debt-to-GDP ratio will suddenly increase by 50%.

This poses no problem as GDP will likely increase thanks to increased investments while repaying the $50 debt. With an annual economic growth rate averaging 3%, GDP will more than double over this period.

Second, public debt is always sustainable when issued and held in domestic currency, and the central bank controls interest rates.

With a debt-to-GDP ratio of 254%, the Japanese government will never lack the means to pay off its debt. Unlike developing countries that take on foreign currency debt at rates they do not control, it will always be solvent. Thus, Peru defaulted in 2022 with a debt-to-GDP ratio of 33.9%!

Monetary ‘Berlin Wall’

Thus, there is a significant difference between the governments of the North – mainly indebted in their own currencies – and those in the South, whose debt is at least partly denominated in foreign currencies.

But governments in the South are not indebted in foreign currencies due to inadequate savings.

They can always finance any spending requiring local resources, including labour, land, equipment, etc. Objectively, no country issuing currency can lack ‘financing’ for what it has the technical and material capacity to do.

The chronic indebtedness of most developing countries and the ensuing crises are thus manifestations of the international economic and financial system’s unequal and unfair nature.

Global South countries have been required to accumulate ‘hard currencies’ – typically dollars – to transact internationally. This monetary ‘Berlin Wall’ separates two types of developing countries.

First, net exporting countries that accumulate ‘enough’ dollars usually invest in low-yielding US Treasury bonds, allowing the US to import goods and services virtually free.

Second, those which do not earn ‘enough’ hard currencies resort to transnational finance, typically increasing their foreign indebtedness. Most eventually have to turn to the IMF for emergency relief, inadvertently deepening their predicament.

However, as they have to cope with prohibitive terms and conditions for access to emergency foreign financing, it is difficult to escape these external debt traps.

Paradoxically, countries of the South with chronic dollar deficits are often rich in natural resources. Bretton Woods institutions typically demand protracted fiscal austerity and economic denationalisation, undermining developing countries’ chances of getting fair returns for their resources and labour.

Abuses and mismanagement may aggravate Global South governments’ indebtedness in foreign currencies, but these should always be understood in the context of the unequal world economic and financial order.

Related IPS Articles

·                   Developing Countries’ Government Debt Crises Loom Larger

·                   Global South Stagnating under Heavier Debt Burden

·                   Onerous Debt Making Poorest Poorer

·                   Debt-Pushing as Financial Inclusion

·                   Inflation Phobia Hastens Recessions, Debt Crises

Available onilne here: Government Debt Is Symptom, Not Cause