Reform is needed. Reform is in the air. We can’t afford to fail

The
task is to build a new financial architecture. If we flunk it, the
pain will strike most cruelly in the world’s poorest countries.

By
Joseph Stiglitz                                                                  Read Spanish Version  

From
The Guardian

The
financial crisis that began in America’s sub-prime mortgage market
has now become a global recession — with growth projected to be a
negative 1.5%, the worst performance since the Great Depression. Even
countries that had done everything right are seeing marked declines
in growth rates, and even deep recessions. And much of the most acute
pain will be felt by developing countries.

A
UN commission of experts on reforms of the international monetary and
financial system, which I chair, has just published its preliminary
report. It focuses especially on the impact of the crisis on
developing countries and the poor everywhere, which is likely to be
severe. An estimated 30 million more people will be unemployed in
2009 compared to 2007. The increase could even reach 50 million.
Progress in reducing poverty may be halted. The report warns that:
"Some 200 million people, mostly in developing economies, could
be pushed into poverty if rapid action is not taken to counter the
impact of the crisis."

While
this is a global crisis, responses are undertaken by national
governments, who quite naturally look after their own citizens’
interest first. Particularly invidious are protectionist measures,
such as the U.S. "buy America" provision in its stimulus
package. In fact, the World Bank reports that 17 of the group of 20
countries have engaged in protectionist measures, after making a
commitment not to do so in their meeting in Washington in November.
By focusing on national, as opposed to global impacts, the global
stimulus will be less — and the global recovery weakened.

While
there is a consensus that all countries should undertake strong
fiscal stimulus measures, many developing countries do not have the
resources, and it calls for a concerted approach for additional
funding, both for spending and liquidity support for countries and
corporations in
developing countries that are strained by the
current credit crunch. Developed countries should contribute 1% of
stimulus spending; there should be an immediate issue of special
drawing rights (SDRs), the "IMF money" that can be used
especially to help those facing difficulties, and an expansion of
regional efforts, such as the Chang Mai initiative in Asia.

It
is important that any assistance be provided without the usual
strings. Conditions such as those which force developing countries to
contract spending and raise interest rates are counterproductive: the
intent of the assistance is to help them expand their economies,
thereby assisting the global recovery. Deficiencies in current
institutional arrangements for disbursing funds — for example,
through the IMF — have long been noted, but the reforms so far are
insufficient. Countries with funds are often reluctant to give money
to institutions in which they have little voice, and which have
advocated policies that they do not support; and countries are often
reluctant to borrow, given the stigma associated with turning to
these institutions. The commission urges the creation of a new credit
facility, in which the voice of the new providers of finance and the
borrowers are both better heard.

There
are several important lessons to be learned from the crisis. One is
that there is a need for better regulation. But reforms cannot be
just cosmetic, and they have to go beyond the financial sector.
Inadequate enforcement of competition laws has allowed banks to grow
to be too big to fail. Inadequate corporate governance resulted in
incentive schemes that led to excessive risk taking and short sighted
behavior, which did not even serve shareholders well.

The
Commission recommends the establishment of a Global Economic
Coordinating Council, not only to co-ordinate economic policy, but to
assess the economic situation, identify gaps in the global
institutional arrangement, and propose solutions. For instance, there
is a need for a Global Financial Regulatory Authority — without
which there is a risk of regulatory arbitrage, undermining
regulation, and creating a race to the bottom. There is a need for a
Global Competition Authority — markets are global in scale. There is
a need for a better way of handling defaults of countries, of which
there may be several in this crisis. And there is a need for better
ways of managing the many risks that developing countries face,
especially with debt and capital account management.

The
other important commission recommendation concerns the creation of a
new global reserve system. The existing system, with the U.S. dollar
as reserve currency, is fraying. The dollar has been volatile. There
are increasing worries about future inflationary risks. At the same
time,
putting so much money aside every year to protect countries
against the risks of global instability creates a downward bias in —
aggregate demand — weakening the global economy.

Moreover,
the system has the peculiar property that poor countries are lending
trillions of dollars to the U.S., at essentially zero interest rate,
while within their country there are so many needs to which the money
could be put. The Commission argues that a new Global Reserve System
is "feasible, non-inflationary, and could be easily
implemented."

After
the East Asia crisis, there was much talk of reform, of a new global
financial architecture. But there was just talk; as the global
economy recovered, the impetus for reform faded. This is a more
severe crisis. It will last longer. Hopefully, this time, we learn
our lesson.

Joseph
E. Stiglitz is university professor at Columbia University, chairman
of the UN Commission of Experts on Reforms of the International
Monetary and Financial System and recipient of the 2001 Nobel Prize
in Economics.

http://www.guardian.co.uk/commentisfree/2009/mar/27/global-recession-reform