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Spending their way out of crisis: Should international transfers fund fiscal stimulus packages in poor countries?

Written by Kate Bird

Many believe that the global financial crisis is the fault of risk-taking by bankers in America, the UK and other rich nations, and poor regulation by their governments. The impact of the crisis has rippled across the world and there is no doubt that its direct and indirect effects are intensifying the hardship of some very poor people in some of the world’s poorest countries. Job losses and reduced profits also are pushing some previously wealthy people in these countries into poverty. The crisis is also slowing or reversing both development and economic growth.

Given that the rich nations made the mess, shouldn’t they also clear it up? Some people think so. Others claim that charity begins at home – and with government revenues down in many rich countries, aid budgets have been under pressure.

Furthermore, there is no consensus on what southern governments should do, or what rich countries should do to help southern governments. Some people think that southern governments should undertake fiscal stimulus, as we have in the UK – to spend their way out of crisis. Others think that this is irresponsible – and will leave poor countries in a worse situation. These polar opposite positions were taken by Carlos Braga (World Bank) and Giovanni Andrea Cornia (University of Florence) at a debate at the PEGNet conference last week (3-4 September 2009) (on Policies for Reducing Inequality in the Developing World). Braga was strongly against fiscal stimulus programmes in poor countries, Cornia in favour. The audience voted as the debate progressed and by the end a narrow lead had emerged in support of not only fiscal stimulus in poor countries but the rich countries digging deep to fund such an approach. The clincher? Perhaps when Cornia spoke with passion about the impact recession and structural adjustment had on poor people in Latin America in the 1980s, and stated eloquently that it was the responsibility of rich countries to prevent such suffering now.

Clearly there is a certain fairness in supporting a transfer of resources from rich countries to poor countries. It might go some way to compensate for the damage done. Such transfers (or aid) might be channelled through government budgets and into fiscal stimulus packages. Work by the ODI shows that the capacity of low income developing countries to absorb a sudden increase in aid is varied. Other work by the ODI shows that not all poor countries are experiencing recession as a result of the crisis: the impact depends on the structure of the country’s economy and some countries are actually experiencing inflation, meaning that a fiscal stimulus package could drive inflation up further, harming poor consumers. This suggests that not only must the response by rich countries be tailored, but that the policy package of poor countries will need to address both current and future needs.

Reducing the suffering of poor people now needs to be done hand in hand with helping the economy recover.

At the conference, I argued that we know some of the things that will help. Another discussion at the conference suggested investments in early childhood development, conditional cash transfers, infrastructure and policies to enable employment rich growth. However, it is tricky to balance both current and future needs and economic efficiency and social equity. ‘Building back better’ requires a rapid, determined and sustained response which makes society more equal and fair while increasing the chances for future economic growth and development. Evidence suggests that if we fail to spend courageously to limit the damage from this crisis we may well increase inequality and sow the seeds for worse to come.