A Global Recovery for a Global Recession (Page 2)

In the past, the IMF provided assistance accompanied by "conditions." In many cases it demanded that countries raise interest rates to high (sometimes very, very high) levels and reduce deficits by cutting expenditures and/or raising taxes--just the opposite of US and European policies. This led to a weakening of national economies, when the point of IMF assistance was to strengthen them. Although those providing assistance want to be sure their money is used well, these kinds of conditions are counterproductive and make many developing countries reluctant to accept help. A condition imposed on international institutions that provide assistance to developing countries should be that they not engage in such "conditionality."

To help fund the large amount of assistance required, developed countries should set aside 1 percent of their stimulus package to help developing countries. The funds have to be distributed through a variety of channels, including regional institutions and possibly a newly created credit facility whose governance better reflects new potential donors (Asian and Middle East countries) and recipients.

The G-20 did make significant efforts to expand the IMF's lending capacity--partly, some suspect, because of the role the IMF may play in rescuing Eastern Europe rather than because of its desire to help the least developed countries. One clever way of doing so was a new issue of IMF money (to the tune of $250 billion) called "special drawing rights," a positive move, but too little of it will wind up in the hands of the poorest countries.

Although the G-20 made grand statements at its November meeting about avoiding protectionism, the World Bank notes that since then seventeen members have undertaken protectionist measures. Developing countries have to be protected from protectionism and its consequences, especially when it discriminates against them. The United States, for example, included a "buy American" provision in its stimulus bill, but many advanced industrial countries are exempt from this provision due to a WTO government procurement agreement. This means that America, in effect, discriminates against poor countries.

We know that subsidies distort free and fair trade as much as tariffs, but subsidies are even worse than tariffs, because developing countries can ill afford them. The massive bailouts and guarantees provided by the United States and other wealthy countries give their firms an unfair competitive advantage. It is one thing for firms from poor countries to compete against well-capitalized US firms; it is another to compete against Washington. Such subsidies, bailouts and guarantees are understandable, but the adverse impacts on developing countries must be recognized, and we must find some way of compensating them to offset this unfair advantage.

International cooperation is also required if we are to devise an effective regulatory regime. There is international agreement on ten issues. First, the crisis was caused by excesses of deregulation and deficiencies in the enforcement of existing regulations. Second, self-regulation will not suffice. Third, regulation is required because failures in a large financial institution or the financial system more generally can have "externalities," adverse effects on workers, homeowners, taxpayers and others worldwide. Fourth, more than transparency is required--even full disclosure of the complex derivatives and other financial products might not have allowed for an adequate risk assessment. Fifth, perverse incentives that encouraged excessive risk-taking and shortsighted behavior contributed to bad banking practices. Sixth, deficiencies in corporate governance contributed to flawed incentive structures. Seventh, so too did the fact that many banks had grown "too big to fail"--which meant that if they gambled and won, they walked away with the gains, but if they lost, taxpayers picked up the losses.

Eighth, unless regulation is comprehensive there can be a "race to the bottom," with countries with lax regulation competing to attract financial services. Ninth, if that race happens, countries will have to take action to protect their economies--they cannot allow bad practices elsewhere to harm their citizens. And tenth, regulation has to be comprehensive across financial institutions. As we have seen, if we regulate the banking system but not the shadow banking system, business will migrate to where it is less well regulated and less transparent.

Despite this broad consensus, the G-20 said little or nothing about some key issues: what to do with banks that have grown not only too big to fail but (according to the Obama administration) too big to be financially restructured? The G-20 failed to ask the hard questions: if these big banks' shareholders and bondholders are insulated from the risk of default, how can there be market discipline? What will replace that discipline? The G-20 has talked about the rapid return of "private capital," but what does this bode if private capital returns without market discipline? There was also talk of continuing to allow over-the-counter derivatives-trading with no transparency. But without transparency of each trade--to assess the nature of the counterparty risk--how can there be market discipline?

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