Thursday 19 Jul 2018 | 00:42 | SYDNEY
Thursday 19 Jul 2018 | 00:42 | SYDNEY

The financial crisis and the developing world

25 March 2009 13:02

Laurence Chandy is a Research Associate at the Wolfensohn Center for Development at Brookings. His Lowy Institute Analysis, 'Linking Growth and Poverty Reduction in PNG', will be published in May.

A curious feature of the global financial crisis has been the speed with which events have unfolded, leaving analysts and policymakers struggling to keep pace. Prime Minister Putin gloated that Russia would buy up Wall Street, before discovering that his economy was among the worst affected. Here in the US, the one-month old stimulus package was built around a set of assumptions regarding the contraction’s severity that already seem dated.

This same pattern is now playing out in developing countries. Only in the last few weeks has the signal been raised about the implications of the crisis for the world’s poor, when the writing was on the wall months ago. Unfortunately, the solutions being put forward lack foresight. 

The International Monetary Fund is cautious about developing countries attempting fiscal stimulus packages of their own, suggesting instead for them to wait patiently for more aid which, without a miracle at next week’s meeting in London, is unlikely to be forthcoming. The World Bank is keen to establish another new funding mechanism which would take months to get up and running, rather than concentrating on fast-tracking pre-committed disbursements (a point emphasised by my colleague, Homi Kharas).  

Donors were unprepared, just as they were for last year’s food crisis. This time, however, donors find themselves unintentionally part of the problem. Aid flows are expected to decrease, just as other forms of capital on which developing economies depend, such as trade credit and FDI, are running dry (the pro-cyclicality of aid deserves a place in the aid effectiveness agenda).

What is the cost of a delayed or half-baked response to the crisis in developing countries?

It is intuitive that external shocks can cause the most harm in countries where people are already vulnerable. Moreover, we know from research that these effects can be long-lasting. Evidence from Africa shows that child and infant mortality are substantially higher during growth decelerations than in normal times, but do not always improve during growth accelerations or recoveries. Stepping in to prevent growth collapses is therefore essential to the achievement of the Millennium Development Goals by 2015.

Reduced public expenditure — an inevitable consequence of lower export revenues — has long term effects on the cost of service delivery. For example, routine maintenance of PNG's roads costs between K3,000 and K15,000 per km (divide by two for value in Australian dollars). Withhold funding for two to three years and roads must then be rehabilitated at a cost of K400,000/km. Neglect for another couple of years and complete reconstruction is required, costing K900,000/km.

One issue now on the horizon but where the commentary is already lagging is the link between the crisis and political upheaval or conflict. We have already seen two governments fall – Iceland and Latvia — as a direct result of the crisis and a third beginning to waver. The concern is that some developing countries that appear to have turned the page on governance may, under pressure, revert back to populist policies which have failed their economies so miserably in the past.

Of greater concern, Paul Collier estimates that for low-income countries, a 1% reduction in GDP translates into a 1% increase in the likelihood of civil war within a five-year period. For a conflict-prone area like the Pacific where the risk of conflict is already high, this should serve as a wake-up call.

Photo by Flickr user glennharper, used under a Creative Commons license.