Africa: New Economic Crisis on the Way | by Dr Charles Soludo

by Oct 6, 2011Africa

african_financial_crisis“It is now clear that the world is slipping — or has already slipped — into a new economic downturn, and that this will have serious consequences for the developing countries. Indeed, some prominent economists have warned that this time the crisis will be more serious and more prolonged than the 2008-9 Great Recession.” – Martin Khor, South Centre. So warns the latest version of the South Centre’s Bulletin (October 3), reporting on a conference which took place in Geneva earlier this year. This AfricaFocus Bulletin contains the speech by Charles Soludo, former governor of the Central Bank of Nigeria. (Soludo is also co-author, with Thandika Mkandawire, of Our Continent, Our Future, a classic study of African development strategies.
I want to start exactly where Dr Reddy stopped. But just a few clarifications. The overall focus of this session is on developing countries. But within developing countries you have a huge spectrum. There are the LICUS countries – the Low Income Countries Under Stress. There are the Least Developed Countries. And of course there are the emerging markets. I think when we discuss them in terms of agendas or how this crisis has affected them and the way forward we need to keep this in mind – that they are different. For some of them it could be the difference between day and night.

Let me just summarize by saying that the key lesson for developing countries is to prepare for the next crisis. And therefore the discussions should really be about how do we prepare the LICUS countries, the LDCs, the emerging markets for the next crisis. And that’s why I take from what both Reddy and Akyüz said this morning. From all the scenarios on both the capital flows and the commodity prices, this boom can’t continue. It will have to end sometime. And who are the ones who are primary commodity exporters? We’ve said it before, in my country, Nigeria, when the oil price collapses, it may not collapse exactly for the same reasons that it collapsed in the 1970s or early 80s but collapse someday it may. And how do we prepare especially in light of the fact that many of these countries today experiencing boom are actually now involved in pro-cyclical fiscal policies at times of boom and that’s when they are also accumulating huge debt and then when they are also involved in expansionary policies which are unsustainable. My focus is really on how do we prepare for the next crisis for developing countries, least developed countries and so on.

If I look at the global financial turbulence and ask what is the root of it, my own summary is that it just starts from the tension that here we have an increasingly globalized world and the problems we are facing, a large chunk of these are global but the solutions have to be by national governments. And this tension will always be there. The fight for autonomy, for the sovereign nature of states versus the problems that happen to be global with cross-border consequences, contagion and so on.

The global financial crisis is simply a consequence of the uncoordinated globalization – as a result of deficiencies in the international institutional arrangements for crisis detection, prevention, management and resolution. We don’t yet have it at that level for coordination. And so global coordination failures happen to be at the heart of it. We can get into the immediate causes of the crisis, about the lax monetary policy and the lax financial regulations which are part of booming credit, leveraging and the subprime mortgages and how they spilled over into some other major economies and of course the contagion around the world from financial crisis to global economic crisis. But we have got to keep an eye on the root cause of the problem, namely that we have now a world where you have cross-border spillovers that are very significant but we don’t have a coordinated mechanism to ensure orderly transition or where a crisis erupts to ensure an orderly work-out. That’s the missing link in the whole globalization process both institutionally and otherwise.

Many of the poor countries have some very nascent capital markets that are just beginning to come up. The crisis led to massive outflows and there was a collapse of many of the stock markets in these very poor countries and they have not recovered. So the wealth effect of the crisis in many of these poor countries will be long lasting and I’m not quite sure how you get them to go back into the capital market and have development as well.

A major point to be made is that for developing countries especially for the poor ones who had absolutely nothing to do with the crisis, they just woke up one morning and faced something like a tsunami coming from somewhere. They had done all the right things they were asked to do and they were making progress. And then they wake up one morning and they see their capital market collapse, and they see the commodity prices collapse temporarily before resuming. They had the first immediate balance of payment shocks and they had to go into distress borrowing, accumulating new debt and so on. Of course they don’t have the fiscal space to have the kind of stimulus packages undertaken in much of the Western world. And therefore they have to resort to either external borrowing or going back again to central bank financing of deficits with all the consequences. So these countries are really in a very bad shape. For several of them it will take quite a while for them to get out of this.

There’s no shortage of proposals on what to do. Everyone has their own litany of “if only we did this the world would become a great place” — the G20, the UN, the multilaterals, the NGOs, every institution has got a set of proposals on what needs to be done. And especially in the areas of financial sector regulation and for developing countries the whole question of whether to design or not counter-cyclical macroprudential regulation or guidelines. For developing countries, I urge them to carefully study many of these ideas and see which ones make sense, which ones can be implemented and which ones you can’t within the political boundaries.

I said the whole crisis was triggered because of either incomplete or imperfect coordination failures at a global level. I think it’s very serious. If the coordination does not take place, we are in for another crisis. Maybe the world needs to go through even a more severe recession to a depression for us to be forced to the new realities that we’re in to be able to think out of the box, and to act on them.

I see three scenarios in terms of the next crisis — what may eventually evolve. One scenario is that the world will either voluntarily or be forced into a more aggressive coordination — an economic governance coordination — of the type proposed in the Stiglitz report for a Global Economic Coordination Council or a WTO-type binding commitments and rules in respect of international banking, capital flows and macroeconomic coordination. This will require more active governance of the international system, to coordinate the provision of international public goods including economic and financial stability. This may be a WTO-type mechanism to regulate global finance and applying sanctions when necessary. Within this you can also have the sovereign debt tribunal or independent panel. Without the enforceable sanctions for bad behavior, how can you coordinate and enforce compliance of the systemically important countries?

Number two is to leave things as they are. There may be a listing of international best practices and standards. We just tell them what is good and then let each country take which one it likes and does and leave things as they are. Perhaps again there may be international regulation only for systemically important global financial institutions with cross-border effects. Control and regulate only ones that have cross-border effects, and things will be OK. In addition, some of us believe, that in addition to this if this is the interim step, to design a compensatory contingency financing to be funded by what we call a globalization tax. There ought to be a pool of funds, at the IMF or whatever the institution is, even if we would have created a new one where this pool will be. And this pool will make mandatory transfers for the LDCs and LICUS countries in particular in a form like a Marshall Plan. To pull them up and participate in a world of unequal economic powers but where everyone is required to compete under the same rules. The globalization tax might be taxing capital flows but the tax revenue doesn’t get to the individual countries. It gets into a centralized pool. And that is to make globalization work or fairer.

It could also provide international liquidity to countries with sound economic and financial management but are hit by unanticipated external shocks. We can have some thoughts about what this kind of fund or pool would do but I think the world needs a pool that is mandatory in terms of transfers but that does not necessarily depend on the benevolence or kind-heartedness of somebody sitting there in a world where the laxity in the US could bring so much rain in Nigeria or Chad or in Eritrea in one morning, and with no consequences and they just bail themselves out and those other ones can perish. I think we need something — a mechanism that ought to be in place and that fund would have to be it.

The third scenario is to just continue to muddle through. There will be more talk about reforms and see whatever comes out of it, which is what is going on now mostly. There is a dominant mindset that somehow things will fall in place. I don’t know. Maybe they will fall in place or maybe they will fall in pieces.

But if we just adopt Option 3, I think we will be facing a race to the bottom because each country then as a sovereign nation would start preparing for the next crisis by itself and one of the ways they do it is to self-insure. Most developing countries would start accumulating reserves. Because we know what happened the last time in Nigeria, we lost $15 billion in about a month in outflows. When the crisis hit, the hot money had to leave quickly from the capital market – $15 billion in one month. Of course that crashed the exchange rate, that led to liquidity crises in several banks, so on and so forth. So to self-insure, countries accumulate reserves, and this will lead to a race to the bottom as it were. We’ll be tightening regulation, mainstream risk management while emphasizing development, rethink the abandonment of development banking, how to make it work, to channel long-term funds, pension funds and so on to development projects. We will mainstream regional cooperation. We have a lot to learn from each other, especially through South-South exchanges. I want to commend the work that the South Centre is doing and I think we need more of this kind of cooperation and of course also skills transfer especially to our policy makers. Build skills, network better because in the end I believe for the LICUS, LDCs and the emerging markets, they have to stand in a united way.

Three Scenarios As South Faces the Next Global Crisis
Dr Charles Soludo, former Governor of the Central Bank of Nigeria and a member of the South Centre Board, told the Conference that developing countries must prepare now for the next financial crisis. He also gave three scenarios of how policy makers will respond to the crisis.

By Charles Soludo
South Bulletin, October 3, 2011 / direct URL:

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