Tuesday, April 20, 2004

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The Copenhagen Consensus and financial instability

Back in March, the Economist, along with Denmark's Environmental Assessment Institute (which is run by environmentalist bete noire Bjorn Lomborg), announced the Copenhagen Consensus project. As their March story phrased it:

Policymakers face enormous demands on their aid budgets—and on their intellectual and political capital as well—when they try to confront the many daunting challenges of economic development and underdevelopment. Climate change, war, disease, financial instability and more all clamour for attention, and for remedies or palliatives that cost money. Given that resources are limited, the question is this: What should come first? Where, among all the projects that governments might undertake to make the world a better place, are the net returns to their efforts likely to be greatest?

You can go to the Copenhagen Consensus' main site by clicking here.

This week, the magazine reports on the report prepared by Barry Eichengreen on the costs of financial instability in the developing world. The costs are significant:

The typical financial crisis claims 9% of GDP, and the worst crises, such as those recently afflicting Argentina and Indonesia, wiped out over 20% of GDP, a loss greater even than those endured as a result of the Great Depression. According to one authoritative study, the Asian financial crisis of 1997 pushed 22m people in the region into poverty. For developing countries, currency crises are an important subset of financial crises. Mr Eichengreen, while cautioning against taking the precision of such estimates too seriously, reckons that the benefit which emerging-market countries would reap if such crises could be avoided altogether would be some $107 billion a year.

Bring on the capital controls!! Oh, wait, it's a bit more complicated:

Wherever financial markets are absent or repressed, savings go unused, productive economic opportunities go unrealised and risks go undiversified. If India's banks and stockmarkets were as well developed as Singapore's, India would grow two percentage-points a year faster, according to one study.

To grow fast, and keep growing quickly, countries need deep financial markets—and the best way to deepen financial markets, most economists agree, is to liberalise them. Does this mean that countries must open their financial markets to foreign capital, thus exposing themselves to the risk of currency crises? Or should they impose capital controls, confining the perversity of financial markets to national borders, where the central bank retains the power to offset it? Foreign direct investment aside, China's capital markets are still largely closed to outsiders. Yet it has no shortage of credit. For other countries, though, the evidence is mixed. A fair reading of the studies, and there have been many, suggests that, for most countries, opening up to foreign capital will deliver faster growth in most years—punctuated by a damaging financial crisis about every ten years. Some economists argue that periodic credit crunches are the price emerging markets must pay for faster growth.

[So you're saying we should just shrug off the $107 billion as the cost of doing business in a global economy?--ed. Absolutely not. More importantly, Eichengreen doesn't shrug it off either, and he's a real economist with some intriguing proposals up his sleeve -- though I'm not completely convinced they would work.]

You can download Eichengreen's paper here.

posted by Dan on 04.20.04 at 12:45 AM


Lotta meat here.
Gonna take a while to digest, I think.

posted by: Bithead on 04.20.04 at 12:45 AM [permalink]

Well, let's start: what does "opening up capital markets" mean in practice?

The financial crises of the 1990s pointed to significant issues related to volatility. Foreign investment is great, but investment without risk -- that is, without the danger that investors can lose some or all of their investment if the local currency weakens or the local economy slumps -- is an illusion. This risk is simply transferred to the people of countries who come to rely on foreign investment that may suddenly dry up.

So, what is the appropriate policy response to this? Drop all capital controls and just accept the transfer of risk? Or, as some developing countries led by Malaysia have done, retain some capital controls as an option? Or something else?

It is worth keeping in mind, incidentally, that opening up more economies like India's to investment will have some effect on the attractiveness of US government securities to foreign individuals and central banks. Now that we are back to running gigantic government deficits, ought this not to add some ambiguity to our thinking on pressing for open capital markets elsewhere? I'm not pressing this point, only raising it.

posted by: Zathras on 04.20.04 at 12:45 AM [permalink]

What is needed for a 2nd,or 3rd world country to advance?

Four things, Stable government, Good economics, The Right Education, and Adaquite Medical.

The cheepest way to get Good economics is to promote Globilization. ie. libiral economic polocies to entice corporations to build factories in the country. Part of the contract should requir that the factories send the workers to school (12 hour work days, 7 days a week, then 7 days off, 5 of which the employees go to school). The same schools should be used to teach the children, during the day. Since the parents are getting payed, they can pay for the schooling of their children. So, with their salary, they can also pay for medical insurance. (a system set up along the lines of the one in Chili, S.A.)

The countries that have suffered the most during the economical crashes, have been the countries with the biggest government DEBT. What is the point? Don't allow the government to borrow money. They only use it to BUY votes and sent to their Swise bank accounts.

Great Brittan is a 1st world good example of no/low government DEBT. The UK was the country least affected by the economical crashes starting in 1997. Buy the end of the Majors priministership, the UK had payed off about 60 billion Pounds of DEBT, from about 64 billion pounds. For the other side of the coin look at Argentena or Indonisia. Countries with low government DEBT had their curencies devalue the least amount, which, hopefuly lead to minimal local inflation, thus minimal drop in the standard of living of the local people.

The 2 cheepest sectors or the economiy to first promote are Agriculture and Tourism. Comparitably small capital investment. This can then be followed up with the Added Value industries, canning and processing plants.

Hongkong was a great example of a Free Trade country. They also had a Minimal Government Policy.

posted by: Jim Coomes on 04.20.04 at 12:45 AM [permalink]

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