The financial crisis and global poverty… what’s the connection, and what can be done?

Sustained economic growth is a necessary condition for lasting poverty alleviation, and it is well known that macroeconomic stability is the bedrock of stable long-run growth.  A generation ago, low-income economies were not closely integrated with the world economy, and macroeconomic crises (high inflation, exchange rate volatility, capital flight and employment uncertainty) arose mainly from domestic policies.  Nowadays, the same economies are much more open to trade and international capital flows, and for many, the global economy is now a major – if not the major – source of macroeconomic shocks.

The world will witness this in the next few months (or even years), as the effects of the U.S. consumer spending slowdown and the subprime banking crisis work their way through global commodity and money markets.  Global growth was already slowing prior to the subprime crisis, signaling the end of a 5-year rise in demand for primary commodities and partially processed resources, the staple exports of the world’s poorest countries.  Lower export prices will create or enlarge trade deficits in many low-income economies.  On top of that, the subprime crisis has now generated a massive negative supply shock in capital markets.  This will drive up world lending rates; newly heightened risk aversion on the part of lenders will raise rates even higher in some markets—even, perhaps, those for sovereign debt—and for some more vulnerable economies, possibly cut off access to credit altogether.

The combined outcome will in all likelihood be just like the early 1980s, if not worse, when sharp slowdowns in the U.S. and other rich countries accompanied by sharply rising world real interest rates drove many developing economies into deep recession, compelling them to adopt “forced-march” adjustment policies with consequent economic and social disruptions, and in some, precipitating violent and economically debilitating contests for economic access and political power.

The economic and financial crisis of the early 1980s had predictable effects on poverty in the developing world.  Using the World Bank’s $1/day measure, from 1981 to 1987 the numbers of the poor in Latin America, the most heavily indebted developing region, rose by 27%.  In sub-Saharan Africa, the most commodity-dependent region, the rise was 29%.  Developing East and Southeast Asia, less heavily indebted and more export-diversified, saw poverty decline by 14% over the same period—and that’s excluding China, where dollar-a-day poverty fell by 43% but arguably for reasons unrelated to trends in the global economy.  Macro instability may not have been the only cause of poverty increases in Latin America’s and Africa’s “lost decade” (see GDP growth rates) but it was certainly a major contributor.  If reducing poverty is the goal of aid programs, then there is a compelling case for designing aid to prevent the recurrence of such macro meltdowns.

What can be done to forestall or minimize this shock?  Support and assistance for adjustment to trade and financial shocks—including provision of safety nets for the poor—would have been highly beneficial in the early-mid 1980s.  The Bretton Woods institutions (the World Bank and the IMF) were only of limited help at that time, and their role is even further diminished in this century.  There is, however, a well-established history of U.S. support for adjustment to major macroeconomic shocks (the postwar Marshall Plan was one; the 1989 Brady Plan was another).  Well-timed and well-designed assistance for low-income economies suffering macroeconomic shocks can be a powerful tool for preventing the burden of adjustment from landing on the poorest.  Assistance can take many forms, from timely and helpful advice to financial interventions intended to forestall balance of payments crises.  Given the size of most low-income economies, the magnitude of such interventions is likely to be quite small in relation to current estimates of the cost of bailing out America’s delinquent corporate borrowers.  (The four biggest developing-country bailouts—South Korea 1997, Indonesia 1998-99, Brazil 1998, Argentina 2001—cost the international financial system a total of just less than $250bn in 2008 prices (Foreign Policy, September 2008).  And that was the price after each country had fallen into its crisis, which must be many times greater than the cost of actions that forestall its onset.  Compared to what’s been spent in the past couple of weeks to prop up America’s (and the world’s banks, that’s chump change.)

Promoting macro stability may not be as glamorous as many more direct and targeted ODA initiatives, particularly at a time where the magnitude of total ODA itself will be under severe pressure, but it has the distinct advantage that its benefits are widely shared and long-term in nature.  Macro stability is complementary with financial deepening, and thus with the spread of formal capital markets and higher returns to investments in all forms of capital and skills that raise labor productivity.  It has a dynamic positive relationship with political stability, which is now a global public good.  And sustaining growth also means maintaining demand for imports. This is important to the U.S., whose exporters have been instrumental over the past year in preventing the collapse of domestic consumer demand from precipitating a formal recession.  These characteristics and associations mean that every dollar spent on effective means to promote stable macroeconomic conditions in low-income countries is likely to pay a high dividend in terms of gains in economic welfare.  These dividends will be measured as positive poverty outcomes in low-income economies, but will also accrue to countries, like the U.S, which have a stake in global economic and political stability.

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