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Effects of the Global Financial Crisis on Developing Countries and Emerging Markets - Policy responses to the crisis

Working paper

Written by Dirk Willem te Velde

Working paper

Three pieces of information provide interesting insights into current policy issues related to the global financial crisis.

The first is a quote of Joseph Stiglitz’s, Whither Socialism, published in 1994 (1990 Wicksell lectures), warning of the problems facing American financial institutions:

• Inadequate capital requirements, which resulted in insufficiently capitalized institutions having an incentive to take excessive risk

• Inadequate incentives for banks not to engage in risk taking

• Inadequate monitoring by regulators

Were we prepared for the 2008 global financial crisis? No. Was the crisis avoidable if the rules had been right? Most likely, yes.

The second is the crude observation in October 2008 that developed countries responded to the global financial crisis safeguarding their own banking systems to the tune of $2-4 trillion, as if only national tax payers mattered with no respect for international linkages (and no common EU position on banking or fiscal issues). Will the future hold improved global and regional economic co-operation?

The final piece of news reminds us of how slow some developing countries are to react to the greatest global recession since the 1930, thinking that they might be unaffected. President Kgalema Motlanthe of South Africa moved only last week to mitigate the effects of the financial crisis when the government decided to set up a special task team to look at how best to cope with the knock-on effects of job losses. How will each developing country cope with and respond to the crisis?

This note addresses these policy issues and suggests that:

• While some evidence is beginning to become available, individual developing countries need urgent access to updated research on country-specific economic, social and political consequences of the financial crisis.

• Each developing country needs to set up a crisis task force to consider the best possible policy responses.

• Global financial rules need to allow for new rules to reduce pro-cyclicality in international capital flows, to increase transparency, and to ensure a greater voice for developing countries.

• Developed countries should not amplify the financial mess they pass on to developing countries, and improve their disbursements on aid and development finance as the case for aid is stronger now than previously.

Dirk Willem te Velde