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I take the opportunity to express my profound sense of gratitude and respect to all those who helped me through the duration of the project It was a great opportunity for me to work on this project and learn about the subject. I would like to thank my project guide Mr. Rakesh Dahiya, Assistant Manager, Sharekhan Ltd., who has been a constant source of inspiration for me during the completion of this project. He gave me invaluable inputs during my endeavor to complete this project.
Tabl of content
1. Introduction 2. Causes of Credit Crisis 3.
Global Transmission of the Crisis
4. International Response 5. Impact of crisis on trade of goods and services, remittance and tourism and FDI 6. Some Facts and Figures 7. Scale of Crises and Bailouts 8. The financial crisis and wealthy countries 9. Asia and the financial crisis 10. Global Meltdown and its Impact on the Indian Economy 11. Africa and the financial crisis 12. Latin America and the financial crisis 13. .A crisis in context
y y y y
34 44 50 56 59 70
A crisis of poverty for much of humanity A global food crisis affecting the poorest the most Poor nations will get less financing for development Odious third world debt has remained for decades; Banks and military get money easily
13. A crisis that need not have happened
78 85 89
14. Dealing with recession
15. Rethinking the international financial system?
y y y y
Reforming international banking and finance? Reforming International Trade and the WTO Reforming the Bretton Woods Institutions (IMF and World Bank)? Reform and Resistance
INTRODUCTION 4 .
Some analysts consider that its intensity is equivalent to that of the Great Depression of 1929-33. was strong and there was no serious worry about financing as creditworthiness was solid. the damage caused to the world economy is enormous.Introduction A year ago. The difficulties are significant in Asia and Latin America. policies had been conducive to significant improvements in fiscal and external balances. the real economy is weakening and the prospects for a recovery can only be envisaged for late 2009 or early 2010. Commodity prices have declined by about one half from their peak. foreign demand. as they were even more dependent on credit and high export prices respectively. In different ways. with a few exceptions. Although the comparison with the Great Depression is an exaggeration unjustified by the facts. and reflected previous excesses and subsequent incompetence. Since then. Emerging Economies were initially able to absorb the initial impact of the crisis on account of the considerable progress in recent years in consolidating economic performance. and the prospects for a fast recovery are more remote by the day. and international reserves were at record levels. Policymakers felt comfortable. and wealth would grow with few restrictions. but the general perception was that Asia. Problems were hitting only the United States and a few other developed countries. the financial crisis which the world is suffering most likely has become the worst in the last fifty years. demand for manufactured goods is declining sharply all over 5 . this group of countries is experiencing mounting difficulties. Whereas the conditions in the financial markets have tended to stabilize from the unsustainable position of September-October of 2008. and Latin America. including among emerging market economies. Commodity prices were expected to continue going up. There were concerns about the effect of a shallow recession in the United States. the largest regional emerging market group. Nevertheless. The previous sense of strength and invulnerability is now gone. the second largest. That crisis was the worst of modern times. as well as other regions were doing well. The complex and wide-ranging interaction between the financial world and the real economy as a result of the present turbulence already has begun to have serious consequences for the emerging economies. In a wishful way most thought they had ³decoupled´ from the advanced economies. but more so in Eastern Europe and Russia. Surely. the prospects for Emerging Economies (EE) looked very promising.
and about 2/3 of that of developing Asia. influential and inconsiderate of others¶ viewpoints and concerns. but private enterprises held r ³toxic´ assets to an unexpectedly large extent. The problem could have been avoided. brewing for a while. This paper reviews the origins of the current crisis and the impact on emerging market economies. Governments were reasonably careful with thei policies. and Latin America in the context of the global crisis. the NICs. but focuses mainly on Developing Asia. and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems.the world. stock market valuations have declined by about one half or more. Around the world stock markets have fallen. The paper also discusses what can be realistically expected in the short and medium term. while on the other hand. according to IMF data. and common characteristics in terms of development.4 trillion. The loss of financial wealth is enormous. The global financial crisis. However. large financial institutions have collapsed or been bought out. and the consequences for the economies of the world. it is fitting to include it as the region has a GDP of US$4. as financial volatility and recessionary forces may continue to prevail for a while. a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. Furthermore per -capita income in Latin America is more than double that of Developing Asia both in current and PPP terms. On the one hand many people are concerned that those responsible for the financial problems are the ones being bailed out. No other region comes close to these two areas in terms of size. if ideologues supporting the current economics models weren¶t so vocal. with serious effects for their own financial health as well as that of their countries. as capital flows reversed seeking to find a safe heaven. 6 . which has a GDP of US$7 trillion. really started to show its effects in the middle of 2007 and into 2008. While the inclusion of Latin America may seem extemporaneous to some. somewhat larger than that of China. and currencies in many emerging countries have depreciated. there are serious economic and political stumbling blocks that may well cause the recovery to be costly and slow to consolidate. The authorities and economic agents were initially taken by surprise by the collapse. Now they are responding to the challenges caused by the rapidly deteriorating external environment. will be unfortunately commensurate.
The limited initial impact of the financial crisis gave rise to a false sense of security that has now disappeared. not all countries acted in a similarly prudent fashion.Recent evolution of the world economic environment Over the last decade. the fiscal accounts and monetary policy showed great strength. Economic growth in 2009 may decline by half among developing and emerging economies (Table 1). The adverse terms of trade effect will aggravate the situation. Latin America made a very strong recovery. and high volatility that extended through the 1990s. and much lower growth rates. Helped by the consistent growth of China. after a period of low economic growth. Within this overall positive picture. 7 . and to an increasing extent India. the Asia region witnessed a stellar performance. It is likely to be well below 1% in Latin America. policy makers will need to find a balance between the needs of economic stimulus and of financial stability. and the external accounts were much sounder than they had been in decades. as the impact on the balance of payments and on domestic activity becomes very serious. international trade boomed. a recession among the newly Industrialized countries of Asia (NICs). compounded by a massive loss in financial wealth. this is shocking for all the regions that had experienced very strong growth from 2002 onward. Con currently. Asian countries were able to emerge from the serious crisis that had brought many of them down in the late 90s. and to a lesser extent India. The crisis is now in the open. Of course. Under these conditions. mainly on account of the resiliency of China. even though still in the order of 5% in Emerging Asia. persistent crises. Inflation declined. poverty declined.
as described in further detail below. embarked in consumption binge and a growing fiscal deficit. experienced growing external current account deficits. These were financed by the surpluses of oil producing countr es. inadequate regulation and supervision of national financial systems and fragmentation of global regulation. China. its highest sustained rate since the early 1970s. but markets did not respond significantly before 2007. As stated very precisely by Jack Boorman. entailed a new economic paradigm.Genesis of the Present Financial and Economic Crisis The reasons for the current crisis are complex. The value of financial and real assets was growing without a perceptible limit. these trends were further complicated by an increasingly integrated global trading and financial system which magnified and accelerated the transmission process. even if with some upward pressures. weak surveillance by the IMF and other multilateral organizations. i Japan. Inflation remained generally contained. About three -fourths of this growth was attributable to a broad-based surge in the emerging and developing economies. and aggravated by weak and uncoordinated policy responses to the initial signs of trouble in the financial system ± responses that. the US dollar started to weaken in international markets and there were growing signs of impending problems. For four years through the summer of 2007. and to a lesser extent Europe and Latin America. However. in many instances did more to shake confidence than to instill a sense that policy was up to the task of dealing with the banking system crisis and the impact on the real economy. the value of financial assets rose sharply. the global economy boomed. The US. The most important factor behind the increasing imbalances was the emergence of growing imbalances among the main economies of the world. and commodities had reached new and sustainable heights. after a period of extraordinary growth but fraught with dangers that were not anticipated by most even a few months ago. with low rates of savings. Global GDP rose at an average of about 5 percent a year. Prosperous stage that using an abused word. and are linked to the financial market deterioration of the last 20 months or so. 9 . as noted below. Concurrently. These imbalances grew rapidly.
CAUSES OF CREDIT CRISES 11 .
This is simply not true and more importantly serves to grossly oversimplify a problem whose roots run deep and involve myriad actors and issues. non-partisan oversight.Causes of the Credit Crisis In the midst of the most serious financial crisis in a generation. Fannie Mae and Freddie Mac fall into this category. an over-reliance on inaccurate risk assessment and a fractured regulatory system. Key players and institutions include Members of Congress. well-respected members of Republican and Democratic administrations. and pointing to just one person or organization does a disservice to the American people. the Department of Housing and Urban Development (HUD). rather it was multiple decisions and issues involving many actors over time that led us to where we are today. This minority staff analysis attempts to objectively explore the causes of the financial crisis we are in and how companies like Lehman Brothers and AIG contributed to this crisis. the major private sector credit rating agencies. In a time of crisis. this cancer spread throughout the financial industry. They were the central cancer of the mortgage market. Fannie Mae. banks. The simple truth is that many share the blame. mortgage brokers. they need and deserve real. we can point to organizations that contributed greatly to the problem and how their role was the catalyst for others to become involved and eventually fail. A few key elements are critical in understanding how we got to where we are today. the Securities and Exchange Commission (SEC). However. The current credit crisis is a complex phenomenon with its roots in a number of places involving a myriad of people and institutions. some claim that deregulation is entirely to blame. Freddie Mac. We need a series of hearings that will focus on the root causes and how we can fix a system in order to avoid financial meltdowns in the future. which has now metastasized into the current financial crisis. 12 . the Federal Reserve Board. There is no single issue or decision one can trace as a cause of the current financial crisis. the American people cannot afford the same old partisan finger pointing. With the help of a loose monetary policy at the Federal Reserve. and consumers.
The politicization of Fannie Mae and Freddie Mac over the last decade seriously undermined the credibility of the organizations and prevented their restructuring and reform. These liabilities were equal to 32. 14 . Greed and corruption were unfortunately part of the equation as well. Fannie Mae and Freddie Mac grew more than 944% to $1.S. The size and growth of Fannie Mae and Freddie Mac leading up to their collapse were nothing short of astonishing. and from 2000 to 2008 their employees contributed nearly $15 million to the campaigns of dozens of Members of Congress on key committees responsible for oversight of Fannie and Freddie.8% of the total publicly-held debt of the U. The transformation of Fannie Mae and Freddie Mac into the Affordable Housing Center was a laudable goal. which in 2005 stood at $4.51 trillion.By 2005. and their outstanding liabilities grew 980% to $1. Between 1998 and 2008. Federal Reserve Chairman Alan Greenspan was so concerned that he characterized the concentration of systemic risk inherent in the ever-growing portfolios of Fannie and Freddie as. Recent events have unfortunately proved him right. placing the total financial system of the future at a substantial risk. Fannie and Freddie combined spent nearly $175 million lobbying Congress. Those who opposed the restructuring of Fannie Mae and Freddie Mac were unwittingly helping to build a house of cards on risky mortgage backed securities. From 1990 to 2005. with Democrats viewing any attempt at curtailing their behavior as an attempt at curtailing affordable housing.64 trillion.6 trillion. Government. but to push predatory subprime lending to unspeakable heights and to encourage questionable lending practices believing housing prices would continue to soar was beyond reason. The motivations for Fannie Mae and Freddie Mac to gamble with taxpayer money on bad nonprime mortgage bets was not entirely a matter of good intentions gone awry.
AIG is somewhat different. then we can understand how it metastasized to Lehman Brothers. AIG and the Challenges of Statistical Risk Modelling Lehman Brothers didn¶t cause this mess but it certainly jumped head first into trying to make money on securitizing mortgage-backed instruments. Countrywide. They followed on the heels of Fannie Mae and Freddie Mac and for precisely the same reasons. If we understand the initial cause of the cancer at Fannie and Freddie. 16 . Yet underlying its bad decisions was the same mistaken reliance on sophisticated but inaccurate computer models. bad management decisions were made in thinking that the mortgage-backed securities and derivatives could be insured. trusting the rating agencies were accurate and that Fannie Mae and Freddie Mac couldn¶t possibly fail.Lehman Brothers. Wachovia. and beyond.
Deregulation is not the problem. They are political cant used to describe complex policy discussions that defy simplistic categorization. nor are they meaningful policy prescriptions. The words regulation and deregulation are not absolute goods and evils. mortgage brokers. The key to successfully regulating markets is not to either create more or less regulation in an unthinking way. investment institutions. and insurance companies all being overseen by different and often competing federal and state agencies.Regulation and the Credit Crisis Democrats are wrong in insisting that de-regulation is the primary cause of the financial crisis. The problem is a lack of coherent regulatory oversight that has led mortgage brokers and lending institutions to write questionable loans and investment institutions to play fast and loose with other peoples money in purchasing bad mortgage-backed assets. Government needs to design smart regulations that align the incentives of consumers. rather it is the fractured regulatory system that has banks. 17 . lenders and borrowers to achieve stable and healthy markets.
picking and choosing among each of the three credit rating agencies in order to find the one willing to give their assets the most favorable rating. Unfortunately. 18 .the downgrading of assets that incorporate risky. on the grounds this constituted an anti-competitive practice. the Republican Congress was swayed by this argument and codified it in law.Credit Rating Agencies and the Practice of Rating Shopping Some firms that bundled subprime mortgages into securities were engaging in rating shopping .by their competitors. Rating agencies willing to inflate their ratings on subprime mortgage-backed securities lobbied Congress to prohibit notching . unrated assets .
For example. and online lenders.or 19 . thrifts. subprime and near-prime mortgages increased dramatically as a proportion of the total mortgage market. mortgage companies. low.Mortgage Markets: A Primer Prospective homebuyers apply for mortgages from primary market lenders such as banks. in addition to being below the standard risk threshold lenders traditionally deemed creditworthy for mortgages. credit unions. were increasingly taking advantage of socalled alternative mortgages that further increased the risk of default. Starting in 2001. These mortgages increased from only 9% of newly originated securitized mortgages in 2001 to 40% in 2006. They generally can apply only for Alternative-A (Alt-A) mortgages. Subprime borrowers. Prime mortgages are traditionally the gold standard and go to borrowers with good credit who make down payments and fully document their income and assets. Borrowers who fall in between prime and subprime standards who may not be able to fully document their income or provide traditional down payments are sometimes referred to as near-prime borrowers. Borrowers with poor credit and/or uncertain income streams represent a higher risk of default for lenders and therefore receive subprime loans. Subprime loans have existed for some time but really took off in popularity around 1995. Primary lenders evaluate borrowers ability to repay the mortgage based on an assessment of risk that combines such factors as income. If a borrower does not meet the minimum requirement. rising from less than 5% of mortgage originations in 1994 to more than 20% in 2006. the borrower is refused a loan. assets and past performance in repaying loans.
5%.S. 20 . the adjusted mortgage rate will be lower. High interest rates translate into high mortgage rates. If interest rates go down during the introductory period of the ARM. adding the remaining interest to the loan principal and again increasing the payments and size of the loan. However. however. a borrower must repay. This is possible because the larger first mortgage means some lenders give borrowers a more favorable rate on the second mortgage. there are sound reasons for borrowers to take out ARMs. This meant that borrowers at that time were willing to bet that when their mortgage rates adjusted. allowing borrowers to pay less than the minimum monthly interest payment. Instead some mortgages allow them to pay 10%. 61% of new conventional mortgages were ARMs. Unlike other alternative mortgages. for example. or even 3% of the purchase price of the home. This was a sensible bet and one that turned out to be correct. If interest rates go up. In 1984. and ultimately the total size of the loan. ARMs offer a low introductory mortgage rate (the cost of borrowing money for a home loan. from 12% in 2001 to 34% in 2004. they were likely to adjust downward due to falling interest rates. Negative amortization mortgages are even riskier. it is generally related to the underlying interest rate in the macro economy) which then adjusts in the future by an amount determined by a pre-arranged formula. but in general one can think of these new rates as being related to the performance of the U. the borrowers monthly payment will be larger. meaning the borrowers monthly payment will go down. There are different formulae used to determine the new mortgage rate on an ARM. Adjustable rate mortgages (ARMs) are the most common of the alternative mortgages. under certain macroeconomic conditions. increasing the monthly payment. However. The prevalence of ARMs as a percentage of the total mortgage market increased dramatically during the housing bubble.zero-down payment mortgages permit borrowers who cannot afford the traditional 20% down payment on a house to still receive a loan. Another option is to allow borrowers to take out a piggyback or silent second loan . this was a rational response to the very high interest rates at that time.a second mortgage to finance the down payment. The riskiest loans even allow borrowers to pay no money down at all for 100% financing. either the duration of the mortgage must be extended or the payments amortize the remaining principal balance over a shorter period of time. economy. Interest-only mortgages are another alternative type that allows borrowers to for a time pay back only interest and no principal.
By 2005 short-term interest rates were actually rising faster than long-term rates. plan on refinancing before their ARMs adjusted upward. Borrowers responding only to these macroeconomic conditions would have been wise to lock in these rates with a traditional 30-year fixed-rate mortgage. relatively low by historical standards. Some other force was clearly at work. from 2004 to 2006. yet ARMs remained very popular. at least until about 2004. in addition to speculation. borrowers could get these mortgages at even lower costs and. Low short-term rates until 2004 are only part of the puzzle. interest rates were abnormally low because the Federal Reserve led by Chairman Alan Greenspan lowered rates dramatically to pump up the U. however. however. 2001. In the words of a report by the Congressional Research Service. Correspondingly. By 2006 housing prices had started to slow significantly and yet introductory periods remained popular.one indicator of speculative behavior. Since ARMs tend to follow short-term rates.From 2001 to 2004. mortgage rates on 30-year fixed-rate mortgages were around 6%. 21 . economy following the attacks of September 11.S.and long-term interest rates during this period. The continuing popularity of ARMs. The persistence of nontraditional terms could be evidence that some borrowers intended to sell or refinance quickly . as long as they were confident that housing prices would continue to rise. the report goes on to note that. alternative mortgages were marketed as affordability products to lower income and less sophisticated borrowers during the housing boom. However. relates in part to the abnormally wide disparity between short.
Ultimately. primary lenders may choose to hold a mortgage until repayment or they may sell it to the secondary mortgage market. the U. After a number of legislative iterations. has contributed perhaps more than any other single factor to the growth of the subprime housing bubble from 2005 to 2007. If the primary lender sells the mortgage. mortgage market. Instead. Fannie Mae morphed into a private company. In response. 22 . it can use the proceeds from the sale to make additional loans to other homebuyers. which in turn was the root cause of the current financial crisis. in the National Housing Act of 1934 as a purely public agency. along with a healthy dose of unethical and corrupt behavior by the management of Fannie Mae and Freddie Mac. This increase in the funding available to mortgage lenders to lend was the goal behind the creation of Fannie Mae and Freddie Mac. or Fannie Mae. leaving broad swaths of the country unable to afford home financing.The Role of Fannie Mae and Freddie Mac in Creating the Credit Crisis Successive Congresses and Administrations have used Fannie Mae and Freddie Mac as tools in service to a well-intentioned policy to increase the affordability of housing in the United States. Congress created the Federal National Mortgage Association. Government created an incentive structure for Fannie and Freddie to facilitate the extension of risky nonprime and alternative mortgages to many borrowers with a questionable ability to pay these loans back. the mortgage industry was mainly concentrated in urban centers. there was no national U.S. with no federal funding by 1970. In the mortgage market. This. Fannie and Freddie may have purchased or guaranteed up to $1 trillion of risky nonprime mortgages. a government-sponsored enterprise (GSE).S. Prior to the existence of the secondary mortgage market. In the process.
selling and trading risk. Subprime and ³ self-certified´ loans (sometimes dubbed ³liar¶s loans´) became popular. As BBC¶s former economic editor and presenter. even if it went beyond their expertise. Where bank would pool their various loans into sellable assets. With soaring profits. and trading risk. the subprime. especially in the US. y y Some banks even started to buy securities from others.2008)¶. mortgages. the banker off loads the risk. Running out of whom to loan to. bad loans would be the problem of whoever bought the securities. y y Some banks loaned even more to have an excuse to securitize those loans. bad loans ment repossessing high-valued property. Securitization was seen as perhaps the greatest financial innovation in the 20th century). 23 . etc without the right controls and management. (even more complex forms of securitization) spread the risk but were very complicated and often hid the bad loans. High street banks got into a form of investment banking. no one wanted bad news. banks turned to the poor. For Example. as long as they could borrow from banks and sell those loans on as securities. Evan Davies noted in a documentary called µThe City Uncovered with Evan Davis: Banks and How to Break Them (January 14. but they are tied up for decades. buying them in order to securitize them and then sell them on. buying. So they turned into securities. selling. the riskier loans. thus off loading risky loans on to others (For banks. y Some investment banks like Lehman Brothers git into mortgages. While things were good. rating agencies were paid to rate these products (risking a conflict of interest) and invariably got good ratings. The security buyer gets regular payments from all those mortgages. Rising house prices led lenders to think it wasn¶t too riski. Some banks didn¶t need to rely on savers as much then.encouraging people to take them up. millions can be made in money earning loans. Starting in Wall Street. all wanted in. y Banks borrowed even more money to lend out so they could create more securitization. Investment banks. got into home loans.Securitisation and Subprime crisis The sub prime crisis came about in a large part of financial instruments such as securitisation. Collateralized Debt Obligations. others followed quickly. or CDOs. not content with buying.
Derivatives didn¶t cause this financial meltdown but they did accelerate it once the subprime mortgage collapsed. 24 . because of the interlinked investments. such as confirmation bias ( always looking for facts that support your view. Trying to reign in these facets of human nature seems like a tall order and in the meanwhile the costs are skyrocketing. experts such as economists and psychologists say that markets suffer from a few human frailties. Despite the benefits of a market system. as all have admitted for many years. This will be very hard to do. rather than just facts) and superiority bias ( the belief that one is better than the others. Amongst other things. Derivatives revolutionized the financial markets and mitigating risk. it is far from perfect. or better than the average and can make good decisions all the time).
Global Transmission of the Crisis 25 .
and public interventions in the United States and Western Europe. The commodity bubble peaked in mid 2008. These developments badly shook confidence in global financial institutions and markets. 26 .S. When the real estate bubble busted in the US and Europe (the UK and Spain come to mind). with a subsequent collapse. which eventually resulted in a drastic reshaping of the financial landscape. in particular losses were large in the case of metals and oil (Chart 1). In the second half of the year commodity prices declined by some 45%.Global Transmission of the Crisis The financial crisis that erupted in August 2007 after the collapse of the U. that only decelerated b the y end of the year. Most dramatically. subprime mortgage market entered a tumultuous new phase in September 2008. where experts expected a continuous increase in prices. forced mergers. investors moved to commodities. intensifying solvency concerns triggered a cascading series of bankruptcies.
27 . .Chart 1: Evolution of commodity Prices (2005=100 ) Source: IMF: Commodity Prices.
International Response 28 .
newly industrialized economies.7 The creation of the G-20 Summits is another noteworthy development. Mexico. any borrowing had to be based on what was seen as burdensome conditions. for countries seen as generally good performers. South Africa. the important group formed by the largest advanced economies. In the past. However. at the ministerial level. 29 . Up to now. The IMF would now provide assistance on the basis of fewer conditions. and in Latin America. The IMF has already indicated that it will show greater lending flexibility and can mobilize significant resources. again to support the currencies of those countries in the face of continued pressures in foreign exchange markets at least through end-2008. Mexico and Argentina. Korea. Brazil. More recently. It follows a group formed in the 1990s to discuss international financial issues. many decisions had been taken at the level of the G-7/G-8. With high financing requirements.International Response The national rescue operations have been followed by major swap transactions between the Federal Reserve of the US and a number of other central banks of industrialized economies. Korea. and Russia. and Singapore. And conditions would be fewer and more targeted than in the past. The G-20 includes the G-8 and the largest emerging. access to the International Financial Institutions has also become imperative. in order to provide sufficient liquidity in response to a steady demand for US dollars. India. This forum reflects better the growing importance of the emerging world and may also open the door to a more representative governance system at the international financial institutions (IFIs). including China. this was extended to the Central Banks of Brazil. over-represented Europe and others will need to accept the realities of the new world and shift their voting power to the ³new´ countries. and make IFIs more relevant.
Impact of crisis on trade of goods and services. remmitace and tourism and FDI 30 .
or about double the rate of world output. as export volumes increased significantly over the period. thus justifying protectionism. with a marked transformational impact. Under these conditions. registered a stable ratio of exports to GDP of 21% notwithstanding the impact of a strong real appreciation. but to some extent also some real depreciation of their currencies. tempered by the much lower but growing ratios for China (31%) and India (12%) which were clearly dominated by domestic developments. Over the l st quarter century the a volume of world trade had grown at an average rate of 6%. Developing Asia recorded a ratio of 55%. it would be easy to suggest that the countries that have been most open to international trade may be subject to the greatest shock on account of reduced world demand. However this should be viewed in a broader light. recorded an average ratio of Exports to GDP of 71% for the period 2002-07. In Asia the ratio of exports to GDP reflected increased volumes of trade. The NICs. remmitace and tourism and FDI Developments in Trade of Goods and Services As part of the significant slowdown/decline in world activity.Impact of crisis on trade of goods and services. trade volumes are expected to decline for the first time in many years²as a minimum by 3% according to IMF estimates. and will have more difficulty in correcting imbalances as their domestic economies may find a lower productive base to provide for their imports. Latin America which had become much more open in the 1990s. Countries that opened more vigorously to trade grew the fastest. which have become highly integrated with the rest of the world. and with the understanding that the losses. But this is taking place from the vantage point of much higher gains in the past. It may be the case that they will experience a significant short term loss. The impact will be very different in various areas of the world. even if large. may be more dependent on a few commodities. More closed economie adjusted for their s. Asian exports have grown at a rate of 10% and those of Latin America and the Caribbean by some 7%. size8. More significantly. as is being observed in Taiwan Province and in Korea. the more open traders may benefit from a more flexible productive structure that allows them to adjust more efficiently. will be temporary. 31 . and benefitted more from global prosperity.
India. With many emigrants working in the US. Central America and the Caribbean. and acted as a countercyclical force in the receiving countries. Europe. However. with adverse consequences for the well being of many millions of households among developing countries. like tourism. Maldives. The prospects for 2009 are equally dire. With emerging economies. and some countries in South America. These flows have been very stable. the impact of the consequent remittances to their home countries have helped increase prosperity and reduce poverty. with near US$110 billion to Asia. they are highly sensitive to economic conditions in the countries of employment. for the first time in a quarter century. Tourism is another area of concern. remittances started to fall in 2008. and the Middle East. Even though transportation costs are declining. and US$70 billion to Latin America. 32 . also entering into recession the prospects for this segment of economic ac tivity look particularly grim for the near future. India and some other countries in South and South East Asia. tourism from the richer countries has fallen and will continue to do so. Mexico and the Philippines being the largest recipients of workers¶ remittances. The merits of increased mobility of large numbers of workers to well-paying jobs in prosperous destinations may be subject to debate. and Mexico.9 However. Remittances amounted to some US$280 billion in 2008 (some 2% of GDP of the receiving countries). arguably the most dynamic segment of international tourism. particularly for Thailand. Remittances over the last fifteen years have become a major channel of prosperity. particularly in Asia and Latin America.Remittances and Tourism Two other areas that can be expected to show the impact of the slowdown are remittances and services. Receipts from tourists are also a significant source of income.
as they became increasingly important investors. FDI stocks and flows grew at a very fast rate in recent years. and these flows fell sharply in the second half of the year reflecting the financial crisis. The Institute of International Finance estimates that net private flows to emerging economies declined from a record US$930 billion in 2007 to below US$470 billion in 2008 and to projected flows of only US$165 billion in 2009. the countries of the CSIS and of Eastern and Central Europe began to receive increasing flows. and rapidly evolving capital markets. both Asia and Latin America became increasingly important. with sharp declines both in Asia and Latin America.Foreign Direct Investment Foreign Direct Investment (FDI) will also suffer in the short run.10 As an illustration of the size of inflows and outflows. as opposed to the previous experience when these outflows reflected capital flight. 33 . as countries deal with weakening external accounts. which allowed for a sharp increase in available capital within the private sector. cumulative flows for the year were only about one half of those registered in 2007. The information is particularly interesting as it shows the large sums of capital outflows from Emerging Economies. and resulting in a decline in lending by International Financial Institutions or IFIs. (Table 2) Also. reflecting both the emergence of new countries as origin and destination of capital flows. Net flows are projected to decline by 80% from their 2007 peak for Emerging Asia. even with some volatility in the case of Latin America. By early 2008 capital flows to developing countries had started to slow down. Most interesting was the change in the composition of these flows. This will complicate economic management. While total FDI directed to developed countries retained the lion¶s share of the total inflows (70% of the total). and by 75% for Latin America. table# 2 presents the cumulative inflows and outflows of FDI and portfolio investments for Developing Asia and Latin America for the period 1998-2007. In the end.
Some Facts and Figures 34 .
Some Facts and Figures Chart 1 Growth of GDP in Developing Asia. 35 . Latin America and the World (Annual percent) Source: WEO. IMF. . ECLAC.
IMF. . ECLAC.Chart 2 Inflation (in %) Source: WEO. 36 .
Chart 3 External Current Account. Fiscal Balance. Exchange Rates and Terms of Trade Developing and Emerging Asia 37 .
Chart 4 38 .
39 .Chart 5 Foreign Direct Investment: Recipient regions stocks (US$ billions) 1980 World Developed Economies 551 411 75 1990 1779 1414 80 365 2000 5810 4031 69 1708 2006 11999 8454 71 3156 Share in Total Developing Economies 140 Share in Total World FDI Stock 9 859 9 2388 17 7948 14 11999 Memorandum Items Capital Flows (US$ billion. World Investment Report (2007).1998-07)2/ FDI Inflows FDI Outflows Portfolio Inflows Portfolio Outflows Dev Asia 841 -151 127 -102 LATAM 728 -142 170 -103 1/ Adjusted by world export prices 2/2007 values for Asia are estimates Source: UNCTAD.
Chart 6 Growth of GDP in Developing Asia. ECLAC 40 . Latin America and the World (Annual percent) Source IMF.
41 . ECLAC. IMF.Chart 7: Inflation (in %) Source: WEO.
market data -48 -40 -41 -36 -51 -49 -29 -36 -37 -36 1 1 -13 -20 -13 -31 -26 18 -11 -- 42 .Chart 8 Selected Countries-stock Market and Exchange Rate changes June-Dec 2008 Stock Market Changes % Exchange Rate Changes % China Hong-Kong India South Korea Argentina Brazil Mexico Japan Euro Area USA(S&P500) Sources: Bloomberg.
STIMULUS PACKAGES: Selected Countries
Country Announced Amount of Stimulus Gross Debt Public Public Debt, net of International Reserves US Billion, annual China Singapore Indonesia South Korea India Peru Chile Argentina Mexico Brazil USA Japan Germany Great Britain 300 (586) 1/ 6.2 6.3 10.8 8.3 3.2 4.0 3.8 10.8 16.0 800 (1150) 1/ 250 102 30 7.1 3.2 1.3 1.1 0.7 2.5 2.2 1.2 1.1 1.0 5.6 5.2 2.7 1.1 18 92 17 32 58 31 19 59 26 57 38 153 67 44 (% of GDP, 2008) -30 2 5 11 37 1 6 46 18 46 38 128 64 41
1/Estimated expenditure in 2009. Number in parenthesis reflects announced total package Sources: National data; Press Releases; IMF; Eurostat
SCALE OF CRISES
The scale of the crisis: trillions in taxpayer bailouts
The extent of the problems has been so severe that some of the world¶s largest financial institutions have collapsed. Others have been bought out by their competition at low prices and in other cases, the governments of the wealthiest nations in the world have resorted to extensive bail-out and rescue packages for the remaining large banks and financial institutions. The total amounts that government have spent on bailouts have skyrocketed. From a world credit loss of $2.8 trillion in October 2009, US taxpayers alone will spend some $9.7 trillion in bailout packages and plans, according to Bloomberg, $14.5 trillion, or 33%, of the value of the world¶s companies has been wiped out by this crisis. The UK and other European countries have also spent some $2 trillion on rescues and bailout packages. More is expected Many banks were taking on huge risks increasing their exposure to problems.When people did eventually start to see problems, confidence fell quickly. Some investment banks were sitting on the riskiest loans that other investors did not want. Assets were plummeting in value so lenders wanted to take their money back. But some investment banks had little in deposits; no secure retail funding, so some collapsed quickly and dramatically of criticism for betting n the things going badly. In the recent crisis they were criticized for shorting on banks, driving down their prices. Some countries temporarily banned shorting on banks. In some regards, hedge funds may have been signalling an underlying weakness with banks, which were encouraging borrowing beyond people¶s means. On the other hand more it continued the more they could profit. The market for credit default swaps market (a derivative on insurance on when a business defaults), for example, was enormous, exceeding the entire world economies output of $50 trillion by summer 2008. It was also poorly regulated. The world¶s largest insurance and financial services company, AIG alone had credit default swaps of around $400 billion at that time. A lot of exposure with little regulation. Furthermore , many of AIG¶s credit default swaps were mortgages, which of course went downhill, and so did AIG. The trade in these swaps created a whole web of interlinked dependencies: a chain only as strong as the weakest link. Any problem, such as risk or actual significant loss could spread quickly. Hence the eventual bailout (now some $150 billion) of AIG by the US government to prevent them failing.
September 4. 2008 47 .The effect of this. and stock market volatility.The fallout from the collapse of the US mortgage market and the reversal of the housing boom in various important countries has turned out to be more profound and persistent than expected in 2007 and beginning of 2008. soaring commodity prices. Third World Network. the United Nation¶s Conference on Trade and Development says in its Trade and Development Report 2008 is. we are seeing more and more countries around the world being affected by this rather profound and persistent negative effects from the reversal of housing booms in various countries. that ³ The global economy is teetering on the brink of recession. As more and more evidence is gathered and as the lag effects are showing up. Economic Outlook Gloomy. as summarized by the Third World Network. say UNCTAD. increasingly restrictive monetary policies in a number of countries.´ Kanaga Raja. The downturn after four years of relatively fast growth is due to a number of factors: the global fallout from the financial crisis in the United States. the bursting of the housing bubbles in the US and in other large economies. Risks to South.
without success that currency speculators² operating through hedge funds or through the currency operations of commercial banks and other financial institutions²were attacking their currencies through short selling and in doing so.´ The bail-outs appear to help the financial institutions that got into trouble (many of whom pushed for the kind of lax policies that allowed this to happen in the first place). (It should be noted that during the debilitating Asian financial crisis in the late 1990s. However. as they are seen as having gambled with other people¶s money.) In the meanwhile. Some governments have moved to make it harder to manipulate the markets by shorting during the financial crisis blaming them for worsening an already bad situation. as well as the type of culture it creates. There seems to be little sympathy²and even growing resentment²for workers in the financial sector. is what has angered so many people. for example. banks have been nationalized (socializing profits as well as costs. while getting fat bonuses and pay rises for it in the past. 48 . Although in raw dollar terms the huge pay rises and bonuses are small compared to the magnitude of the problem. smaller businesses and poorer people rarely have such options for bail out and rescue when they find themselves in crisis. In other cases. In a number of European countries. potentially.A Crisis so severe. governments have tried to increase or fully guarantee depositors¶ savings. blaming it on their own economic mismanagement instead. and hence lives. bringing the rates of the local currencies far below their real economic levels. Asian nations affected by short-selling complained. the encouragement such practices have given in the past. when they complained to the Western governments and International Monetary Fund (IMF).) Other governments have moved to try and reassure investors and savers that their money is safe. they dismissed the claims of the Asian governments. those responsible are bailed out Some of the bail-outs have also been accompanied with charges of hypocrisy due to the appearance of ³socializing the costs while privatizing the profits.
yet other businesses will struggle to survive leading to further fears of job losses. In the wider economy. 49 . it is not just the wealthy that will suffer. but potentially everyone. the value of their homes are likely to fall in value leaving them in negative equity.A crisis so severe. banks with little confidence to lend may lend with higher interest rates. For example. With an increasingly inter-connected world. Many industrialized nations are sliding into recession if they are not already there. The real economy in many countries is already feeling the effects. People may find their mortgages harder to pay. or remortgaging could become expensive. the rest suffer too There is the argument that when the larger banks show signs of crisis. many sectors may find the credit crunch and higher costs of borrowing will lead to job cuts. As people will cut back on consumption to try and weather this economic storm. things like a credit crunch can ripple through the entire economy. For any recent home buyers.
The financial crisis and wealthy countries 50 .
argued. However. seen as a bailout for the culprits while the ordinary person would be left to pay for their folly. the Bush Administration offered a $700 billion bailout plan for the US financial system. but to preserve it. which could be part of a deeper root cause of the problem). It took a second attempt to pass the plan. This bailout package was controversial because it was unpopular with the public.The financial crisis and wealthy countries Many blame the greed of Wall Street for causing the problem in the first place because it is in the US that the most influential banks. Perhaps fearing an ideological backlash. Joseph Stiglitz. as former Nobel prize winner for Economics. The US House of Representatives initial rejected the package as a result. or partnationalize some failing banks to try and restore confidence. The crisis became so severe that after the failure and buyouts of major institutions. Bush was quick to say that buying stakes in banks ³is not intended to take over the free market. a charge by many in developing 51 . the US capitulated and the Bush Administration announced that the US government would buy shares in troubled banks. starting with Britain. but with add-ons to the bill to get the additional congressmen and women to accept the plan. sending shock waves around the world. the plan ³remains a very bad bill:´ In Europe. a number of nations decided to nationalize. Eventually. former Chief Economist of the World Bank and university professor at Columbia University. This illustrates how serious this problem is for such an ardent follower of free market ideology to do this (although free market theories were not originally intended to be applied to finance.´ Professor Ha-Joon Chang of Cambridge University suggests that historically America has been more pragmatic about free markets than their recent ideological rhetoric suggests. The US resisted this approach at first. as it goes against the rigid free market view the US has taken for a few decades now. institutions and ideologues that pushed for the policies that caused the problems are found.
China seems to be contemplating more capitalist ideas.) Despite the large $700 billion US plan. Paul Craig Roberts also argues that the bailout should have been to help people with failing mortgages. the total US bailout is $9.7 trillion. This also reflects how the crisis has spread from the financial markets to the ³real economy´ and consumer spending. such as some notion of land reform. By February 2009.´ (Interestingly. Enough to pay off more than 90 percent of America¶s home mortgages (although this bailout barely helps homeowners). And that would restore the value of the mortgage-backed securities that are threatening the financial institutions [and] the crisis would be over. to stimulate and develop its internal market. while Europe and US consider more socialist-like policies. not banks: ³The problem. is the defaulting mortgages.countries that rich countries are often quite protectionist themselves but demand free markets from others at all times. So there¶s no connection between the government¶s explanation of the crisis and its solution to the crisis. such as some form of nationalization. according to the government. About $600bn is marked to buy up mortgage-backed securities while $200bn will be aimed at unfreezing the consumer credit market. others echo Stieglitz¶s concern above. While the US move was eventually welcomed by many. For example. China hopes. so the money should be directed at refinancing the mortgages and paying off the foreclosed ones. could be one way to try and help insulate the country from some of the impacts of the global financial crisis. This. 52 . according to Bloomberg. banks have still been reluctant to lend. and perhaps the sign of the times. former Assistant Secretary of the Treasury Department in the Reagan administration and a former associate editor of the Wall Street Journal. This led to the US Fed announcing another $800 billion stimulus package at the end of November.
2008 Yet. it will be harder for it to argue in favor of its free market ideas. others argue that it may be too early to write of the US: The director of a leading British think-tank Chatham House. ³Even its debt can be overcome. is over« The American free-market creed has self-destructed while countries that retained overall control of markets have been vindicated. Dr Robin Niblett « argues that we should wait a bit before coming to a judgment and that structurally the United States is still strong. the US is already stretched militarily. evidenced by its challenges in Iraq and Afghanistan. in which the balance of power in the world is being altered irrevocably. wrote in the London paper The Observer: ³Here is a historic geopolitical shift. and its declining image in Europe. On the practical level. The political philosopher John Gray. in Afghanistan and Iraq. some commentators were writing that the US was in decline. who recently retired as a professor at the London School of Economics. On the philosophical level. if its own markets have collapsed.´ ² Paul Reynolds. Asia and elsewhere.A crisis signaling the decline of US¶s superpower status? Even before this global financial crisis took hold. ³America is still immensely attractive to skilled immigrants and is still capable of producing a Microsoft or a Google. ³The era of American global leadership.´ ³How symbolic that Chinese astronauts take a spacewalk while the US Treasury Secretary is on his knees. BBC. October 1. reaching back to the Second World War. US superpower status is shaken. The BBC also asked if the US¶s superpower status was shaken by this financial crisis: The financial crisis is likely to diminish the status of the United States as the world¶s only superpower. It has enormous resilience economically at a local and entrepreneurial level. Some see this as a pivotal moment. and is now stretched financially.´ he went on. 53 .
³And one must ask. October 1.´ ² Paul Reynolds. US superpower status is shaken. ³But the US must regain its financial footing and the extent to which it does so will also determine its military capacity. decline relative to who? China is in a desperate race for growth to feed its population and avert unrest in 15 to 20 years. it will have fewer forces. BBC. If it has less money. India has huge internal contradictions. Russia is not exactly a paper tiger but it is stretching its own limits with a new strategy built on a flimsy base. Europe has usually proved unable to jump out of the doldrums as dynamically as the US. 2008 54 .
Others needed rescuing. where the economy was very dependent on finance sector. getting the banks lending again. In Iceland. some nations have stepped in to nationalize or in some way attempt to provide assurance for people. Shore up employment. The EU is also considering spending increases and tax cuts to be worth ¼ 200 billion over two years. a number of major financial institutions failed.Europe and the financial crisis In Europe. The plan is supposed to help restore consumer and business confidence. This may include guaranteeing 100% of people¶s savings or helping broker deals between large banks to ensure there isn¶t a failure. For example. The banking system virtually collapsed and the government had to borrow from the IMF and other neighbors to try and rescue the economy. and promoting green technologies. economic problems have hit them hard. 55 . In the end. public dissatisfaction at the way the government was handling the crisis meant the Iceland government fell A number of European countries have attempted different measures (as they seemed to have failed to come up with a united response).
Asia and the financial crisis 56 .
Many Asian countries have seen their stock markets suffer and currency values going on a downward trend. 57 . Japan. However. While their banks seem more secure compared to their Western counterparts. Although this is a very impressive growth figure even in good times. A number of nations urged the US to provide meaningful assurances and bailout packages for the US economy. Both have poured billions into recovery packages. Asia has not had a subprime mortgage crisis like many nations in the West have. Japan is so exposed that in January alone. Much of it is fueled by its domestic market. Many Asian nations have witnessed rapid growth and wealth creation in recent years. which has suffered its own crisis in the 1990s also faces trouble now. However. the speed at which it has dropped²the sharp slowdown²is what is concerning. Asia has had more exposure to problems stemming from the West. mostly from the West. Asian products and services are also global. this crisis has shown that in an increasingly inter-connected world means there are always knock-on effects and as a result. Japan¶s industrial production fell by 10%. are the largest economies in Asia. and a slowdown in wealthy countries means increased chances of a slowdown in Asia and the risk of job losses and associated problems such as social unrest. it is very dependent on exports. India and China are the among the world¶s fastest growing nations and after Japan.Asia and the financial crisis Countries in Asia are increasingly worried about what is happening in the West. and it is expected that in data will show that by March 2009 that India¶s growth will have slowed quickly to 7. similarly has also experienced a sharp slowdown and its growth is expected to slow down to 8% (still a good growth figure in normal conditions). for example.1%. as that would have a knock-on effect of reassuring foreign investors and helping ease concerns in other parts of the world. Many believed Asia was sufficiently decoupled from the Western financial systems. the biggest monthly drop since their records began. even that has not been enough to shield it from the effect of the global financial crisis. China. In addition. However. From 2007 to 2008 India¶s economy grew by a whopping 9%. there was increased foreign investment in Asia. This lead to enormous investment in Western countries. China also has a growing crisis of unrest over job losses.
a major meeting between the EU and a number of Asian nations resulted in a joint statement pledging a coordinated response to the global financial crisis. as IPS also noted in the same report. A side-story of the emerging Chinese superpower versus the declining US superpower will be interesting to watch. which at the moment mostly affects the rich West.´ Whether this will happen is hard to know. This time however.Towards the end of October 2008. It would of course be too early to see China somehow using this opportunity to decimate the US. This is very significant because Asian and other developing countries have often been treated as second-class citizens when it comes to international trade. the World Bank¶s chief economist (Lin Yifu. What seems to be emerging is that Asian nations may have an opportunity to demand more fairness in the international arena. Similar calls by other developing countries and civil society around the world. one of the Chinese state-controlled media outlets demanded that ³We want the U. the financial crisis could mean the US is less influential than before.S.´ Asian nations are mulling over the creation of an alternative Asia foreign exchange fund. 58 . however.´ They also added. While the Western mainstream media has often hyped up a ³threat´ posed by a growing China. a well respected Chinese academic) notes ³Relatively speaking. China is a country with scarce capital funds and it is hardly the time for us to export these funds and pour them into a country profuse with capital like the U. However.´ For example. This time. economically. which would be good for other developing regions. have come to no avail. maybe because they see an opportunity in this crisis. but market shocks are making some Asian countries nervous and it is not clear if all will be able to commit.S. Asian leaders had called for ³effective and comprehensive reform of the international monetary and financial systems. for years. to give up its veto power at the International Monetary Fund and European countries to give up some more of their voting rights in order to make room for emerging and developing countries. ³And we want America to lower its protectionist barriers allowing an easier access to its markets for Chinese and other developing countries¶ goods. this coordinated response is dependent on the entry of Asia¶s emerging economies into global policy-setting institutions. as Inter Press Service (IPS) reported. finance and investment talks. as it has its own internal issues. too. Asian countries are potentially trying to flex their muscle.
Global Meltdown and its Impact on the Indian Economy 59 .
felt that the Indian economy will grow at about seven per cent in 2008-09 and at six per cent in 2009-10. later it was found that the Foreign Direct Investment (FDI) started drying up and this affected investment in the Indian economy. This was the result of large scale defaults in the US housing market as the banks went on providing risky loans without adequate security and the repaying capacity of the borrower.Global Meltdown and its Impact on the Indian Economy With the collapse of Lehman Brothers and other Wall Street icons. The basic cause of the crisis was largely an unregulated environment. Although at one time it was thought that this crisis would not affect the Indian economy. The principal source of transmission of the crisis has been the real sector. the situation became worse. the lender institutions saw their balance-sheets go into red. generally referred to as the µMain Street¶. there was growing recession which affected the US. But once the housing market collapsed. US demand for imports from other countries indicated a decline. This crisis engulfed the United States in the form of creeping recession and this worsened the situation. 60 . mortgage lending to subprime borrowers. Since the borrowers did not have adequate repaying capacity and also because subprime borrowing had to pay two-to-three percentage points higher rate of interest and they have a history of default. A redeeming feature of the current crisis is that its magnitude is much lesser than that of the Great Depression of the 1930s when unemploy-ment rate in the United States exceeded 25 per cent. the European Union (EU) and Japan. It was. it stands at 6.5 per cent and is predicted to remain around eight per cent in 2009. As a consequence. therefore. The lesson of this experience is that India must exercise caution while liberalising its financial sector. Currently.
61 . (iv) No penalty to be charged in case of pre-payment. a vicious cycle of weak demand and falling output developed in the Indian economy. To reduce the impact of the crisis. firms reduced their workforce. 2008. To lift the economy out of the recession the Government announced a package of Rs 35. (ii) Loans from Rs 5-20 lakhs: Maximum interest rate at 9. is expected to fall by 50 per cent of its total revenues.The industries most affected by weakening demand were airlines. public sector banks announced to provide small home loans seekers loans at reduced rates to step up demand in retail housing sector. (iii) No processing charges to be levied on borrowers. real estate. Indian exports suffered a setback and there was a setback in the production of exportoriented sectors. which earned about $ 50 billion as annual revenue. (i) Loans up to Rs 5 lakhs: Maximum interest rate fixed at 8. (v) Free life insurance cover for the entire outstanding amount.5 per cent. This would reduce the cushion to set off the deficit in balance of trade and thus enlarge our balance of payments deficit. A weakening of demand in the US affected our IT and Business Process Outsourcing (BPO) sector and the loss of opportunities for young persons seeking employment at lucrative salaries abroad. It provided some relief by cutting down excise duties. Weakening demand led to producers cutting production. Consequently. The government advised the sectors of weakening demand to reduce prices. to reduce costs.000 crores in the first instance on December 7. The main areas to benefit were the following: (a) Housing²A refinance facility of Rs 4000 crores was provided to the National Housing Bank. Industrial production and manufacturing output declined to five per cent in the last quarter of 2008-09. This led to increase in unemployment but the total impact on the economy was not very large. India¶s famous IT sector. Following this. hotels. Besides this.25 per cent. It has now been estimated that sluggish demand for exports would result in a loss of 10 million jobs in the export sector alone. but such simplistic solutions were doomed to failure.
brick kilns etc. the textile sector has been seriously affected. said: ³It is a disappointing package. gems and jewellery. The allocation of Rs. To boost the infrastructure. The government hopes to disburse Rs 15. however. The IIFCL will be permitted to raise further resources by the issue of such bonds so that a publicprivate partnership (PPP) programme of Rs 1.000 to 20.00. An allocation of Rs 1400 crores has been made to clear the entire backlog in the Technology Upgradation Fund (TUF) scheme.000 crores through tax-free bonds. it is the payment of arrears only. (d) Exports²Exports which accounted for 22 per cent of the GDP are expected to fall by 12 per cent. 1.This means a borrower can get a loan up to 90 per cent of the value of the house. the small and medium industries (SMEs) too get a boost by manufacturing all kinds of fittings and furnishings. meaning thereby at lower rates or a changed repayment schedule. (IIFCL) has been authorised to raise Rs 14.400 crores has been pending for many years and thus.000 crores under the ne w package. It would have been much better if more concrete measures have been taken to reverse the downturn in the exports of readymade garments and avoid further job losses in the textile sector.000 crores in the highway sector is promoted. more especially highways and ports. the India Infrastructure Finance Company Ltd. cement. The housing package is the core of the government¶s new fiscal policy. These funds will be used to finance infrastructure. It will give a fillip to other sectors such as steel. however. Besides. handicrafts. The success of the housing package will.´ © Infrastructure²The government has been proclaiming that infrastructure is the engine of growth. (b) Textiles²Due to declining orders from the world¶s largest market the United States. leather. depend on the State governments efforts to free up surplus land so that land prices come down and the cost of housing becomes reasonable. The government¶s fiscal package provides an interest rate subsidy of two per cent on exports for the labour±intensive sectors such as textiles. but the Federation of Indian Export Organization (FIEO) felt the measures are not 62 . The Apparel Export Promotion Council (AEPC) Chairman. It may be mentioned that µrefinance¶ refers to the replacement of an existing debt obligation with a debt obligation bearing better terms. There is nothing new in it.
(e) Small and Medium Enterprises (SMEs)²The government has announced a guarantee cover of 50 per cent for loans between Rs 50 lakhs to Rs 1 crore for SMEs. G. the government will instruct state-owned companies to ensure prompt payment of bills of SMEs so that they do not suffer on account of delay in the payment of their bills. Just within a month.5 per cent to 5. In short. 5000 crores as credit from the RBI. the new package included the following measures:1. 2. Pillai.5 million jobs in the export sector alone during 2008-09 on account of the $15 billion decline in the expected exports. realty companies have been allowed to borrow from overseas to develop ³integrated townships´. the RBI cut the repo rate.K. To boost investment and spending to revive growth. 3. has estimated a loss of 1. from all global projections that the next year (2009) is going to be a very difficult year for the global economy. the government announced another package to bail out the Indian economy. Export-Import Bank also gets Rs. the fiscal package is aimed at boosting growth in exports. Dr Montek Singh Ahluwalia said: ³We should expect. drawback benefits have been enhanced for some exporters. With this end in view. To help the realty sector. The lockin period for loans covered under the existing schemes will be reduced from 24 months to 18 months to encourage banks to cover more loans under the scheme.enough as they will not make the exports price-competitive and. the Commerce Secretary.5 per cent and also reduced the Cash Reserve Ratio (CRR)²the share of deposits which has to be kept with the RBI from 5. auto.´ The purpose of the new package announced on January 1. 63 . To revive exports which has resulted in a contraction of industrial output. which it charges on short-term loans to banks from 6. textiles and small and medium enterprises. therefore. more especially in the United States. 2009 was to minimise the pain. Besides. will not boost exports.5 per cent to five per cent. real estate. The aim is to encourage growth and boost employment which have been threatened by the recession in the world economy.
000 crores to boost demand in the economy and thus reduce the impact of recession. 2009. To boost infrastructure. On February 24. this measure is designed to reduce the prices of colour TV sets.00. ports etc. public sector banks would provide finance firms funds for commercial vehicles. credit card charges. As a consequence. washing machines. To make more funds available. Besides. Assessment of the Impact of the Fiscal Package There is no doubt that the government is motivated with good intentions and is thus aiming to spend a huge amount of Rs 1. In addition. phone bills. colas. Non-Banking Finance Companies (NBFCs) need no government approval to borrow from overseas for infrastructure projects.000 crores from tax-free bonds.4.000 crores for developing infrastructure in roads. Cement prices are likely to drop Rs 4-5 per bag of 50 kg while steel prices may cost Rs 500-600 per tonne less. refrigerators. detergents. This will sustain the growth momentum on infrastructure. gems and jewellery on February 26. In addition to this. Besides. cars and commercial vehicles. The purpose is to seek much bigger FII investment. the government decided to cut service tax form 12 per cent to 10 per cent²a reduction by two per cent. Since 90 per cent of the manufactured goods attract 10 per cent excise duty. ceiling on foreign institutional investments (FIIs) in corporate bonds has been increased to $ 15 billion from $ 6 billion. the government announced a slashing down of excise duty from 10 per cent to eight per cent²a reduction by two per cent. 6. depreciation benefit on commercial vehicles has been increased form 15 per cent to 50 per cent on purchases. Commerce and Industry Minister Kamal Nath announced a small relief package of Rs 325 crores for leather. the aim of other measures is to boost 64 . soap. It is hoped that Tata Motors and Ashok Leyland¶s sales would revive. To stimulate the Commercial Vehicles (CVs) sector. (IIFCL) has been allowed to raise Rs 30. Besides. the India Infrastructure Finance Company Ltd. textiles. airline tickets. 2009. 5. tour packages etc. The entire stimulus package of Rs 30. the States will get one-time funding from the Centre to buy buses for urban transport. which pose a serious handicap to growth. A two per cent reduction in service tax will directly touch the lives of over 500 million persons by reducing monthly expenses. would cost less.
For reducing corruption. In case corruption is not simultaneously curbed to reasonably low levels. the chances of Indian exports increasing in these countries appear to be very dim. it may delay and reduce the much-desired effect in enlarging infrastructure.9 per cent in 2009 as against 2.exports and help sectors like textiles and small and medium industries which are labourintensive and generate more employment. corruption can be curbed to a great extent. Similarly. EU and Japan. Since the G-3 economies of the US. namely. the US. The World Bank has projected the world output to grow at 0. By cutting arbitrariness in decision-making. Transparency instils confidence in the government. EU and Japan are affected seriously by the present recession. It may result in the Indian infrastructure network being geared into a temporary employment generation programme with much smaller impact on the economy as against the intended objectives. for instance. If these predictions come out to be true. instead of only highways and urban housing.5 per cent in 2008. But the Indian economy is predicted to grow at about seven per cent in 2008 and about six per cent in 2009. there is a fear of the recession in 2008 turning into a depression in 2009. But the success of the fiscal package will depend on the quality and speed of implementation so that delays in implementation may not aggravate the economic recession to move into the dangerous zone of depression. health and sanitation can also result in a more inclusive growth process. Thirdly. two things need to be ensured²transparency and avoidance of arbitrariness. Thus. inward looking policies should be preferred as against the outward looking approach of integrating the Indian economy to the 65 . This would require special emphasis. the chances of our exports increasing are very limited unless the G-3 economies. a much larger expenditure on primary and secondary education. Secondly. One of the major stumbling blocks which may neutralise the positive effects of large expenditure on infrastructure is corruption. are able to bring about a positive shift in their growth in the near future for which the predictions at present are not very optimistic. there is a need to orient the fiscal package towards inclusive growth so that the weaker sections benefit. on rural infrastructure²rural roads and housing. The natural conclusion is that the Indian economy should concentrate on developing the domestic market.
however. there are serious limitations faced by the government because it has to fight terrorism on the one hand and financial meltdown on the other. The government has to undertake a huge expenditure at the Central as well as State levels to enhance security.5 per cent during 2008-09.5 to seven per cent of the GDP. But the Finance Minister has not agreed to the abolition of the FRBM Act since it would be imprudent to relax or abrogate the FRBM. it may increase to three to 3. but don¶t loosen it without a better alternative. there is also likely to be shortfall in tax revenues. has to be postponed. The government will not be able to reduce the fiscal deficit to 2. If the government is also able to push the fertiliser prices to lower levels which is possible in the changed circumstances. though it may now be lower due to a very sharp decline in international crude oil prices from $140 per barrel to about $ 40 per barrel at present. along with a fiscal package to boost the Indian economy. This is quite large but it is inevitable in the present situation. Fourthly.000 crores ($ 7. To quote Dr Ishar Ahluwalia: ³The FRBM is like a chastity belt.5 per cent of the GDP. as against the minuscule announced by the government.´ It may. A compre-hensive view of the fiscal deficit (as shown in the Budget and kept outside the Budget) would be in the rang e of nine to 9. It is difficult to precisely estimate this expenditure at this stage since it entails larger recruitment of police and paramilitary forces along with equipping them with the most uptodate weapons. It is due to this reason that the chieftains of industry want a much bigger package to bail out the Indian economy. Consequently. the Budget deficit is bound to increase. although there is a demand for a much larger Fiscal Package to bail out the Indian economy. But this is inevitable and the target of reducing it according to the schedule prescribed by the Fiscal Responsibility and Budget Management Act. 66 . the Indian fiscal package of Rs 35. be mentioned that the quasi fiscal deficit (the deficit left out of the Budget) is presently estimated as six per cent of the GDP. But there is a massive increase in expenditure to combat terrorism.5 per cent of GDP. eventually the total fiscal deficit (shown as well as kept outside the Budget) may come down to 6.world economy is followed during the last decade. To conclude: As against the US package of $ 800 billion to bail out the US economy and the Chinese package to $ 580 billion to salvage its economy. This is a welcome relief.3 billion approximately) is a small measure to boost the Indian economy. It is heartening that the Prime Minister intends to insulate the Indian economy from the world economy.
Now that the three packages have been announced. we suffer from inordinate delays and this results in cost overruns which the nation has to bear. Additional employment generation by helping SMEs will be a step towards inclusive growth since they are labour intensive.000 crores through the IIFCL is commendable. It is easier to provide funds. The intention to create infrastructure by expanding highways and ports and to spend Rs 1. Commerce. The huge amount of funds placed with the India Infrastructure Finance Company Ltd (IIFCL) would require identification of new projects or expansion of the existing projects. As the G-3 economies of the US. the expectation of seven per cent growth of the GDP in 2008-09 and six per cent in 2009-10 reflects a fairly good performance of the Indian economy. This would require proper planning which may take more time and does not provide immediate benefit. Industry and Rural Development should get together to ensure that the planned expenditure²budgeted and provided in the two stimulus packages² is quickly translated into productive capacities so as to create the much -needed multiplier effect on private investment. the Indian economy will also benefit from their reversal of recessionary trends. In this situation. To upgrade the level of infrastructure spending by a factor of two requires gigantic efforts of co-ordination between different 67 . it may be more prudent to expand rural roads and rural housing so as to promote more inclusive growth. it is high time that the policy-makers in the Ministry of Finance. The government has been provided relief with the sharp fall in the international price of crude oil and this should be taken advantage of in reducing expenditure to subsidise oil imports. but international factors will influence the process. public sector undertakings or private sector corporations. may be the State governments.00.But the plan to spend more on housing is commendable if it can be implemented in a short time and an effective manner. EU and Japan pick up. However. This is not an easy task because the IIFCL is only a funding agency and implementation has to be carried out by other entities. It may not be possible to reduce the fiscal deficit during 2008-09 since much larger expenditures are needed to combat terrorism and as there is recession in the Indian economy. The government should have transparency and avoid arbitrariness in the implementation so that corruption can be kept within reasonable limits. but it is more difficult to ensure their speedy and proper utilisation. In infrastructure.
therefore. The package has also provided finances to the non-banking finance companies (NBFCs). is yet to decide if the investment would be marked to market for the second quarter. concentrate its efforts to remove hurdles in the path of implementation. the State governments must improve the share of their implementation and cooperate with the Central Government to improve various infrastructure projects in their domain or in collaboration with the Centre. The country's second largest bank.´ This is a useful tool to fight recession and it has also been tried in several countries. This suggestion should be implemented until such time that the economy gets revived. To quote: ³Jobs must be protected even if it means some reduction in compensation at various levels. but there is serious lack of skill with the NBFCs on project appraisals and to ascertain the creditworthiness of the borrowers and the accompanying project risks. rather than retrenching workers and thus add to job losses. employers should cut wages all along the line to reduce costs. which stands to lose the most among Indian lenders. It needs to be emphasised that implementation holds the key to bail out the Indian economy from the economic crisis. which has filed for bankruptcy in the United States. It had already made provisions of $12 million on these bonds and a further $28 million worth of provisioning might be required if 50 per cent recovery is assumed. the bank said. 68 . Similarly. Following an analyst report this morning. (f) ICICI example: ICICI Bank today said it might need to make an additional provision of $28 million (Rs 188 crore) on its exposure to bonds issued by investment bank Lehman Brothers.agencies for speedy implementation. The government should. There has to a national campaign for training the NBFCs in project appraisals. ICICI Bank issued a statement saying its UK subsidiary had an exposure of around $80 million to Lehman's senior bonds. Pranab Mukherjee has suggested that to reduce the pain of recession.
The process may take about a year. but Edelweiss said the bank's profits may not see a significant impact.585." ICICI Bank Joint Managing Director & CFO Chanda Kochhar said. The public sector bank's exposure is less than $10 million and with the SPV outside the ambit of bankruptcy proceedings.50.33 million) and may have to provide for possible losses." a senior bank executive said. The ICICI Bank shares fell 5.55. For other Indian banks.4 per cent. Bank of Baroda and SBI both said they had no direct exposure. the impact will be much lower.8 per cent and 3. which is facing a cash crunch.5 million with Lehman Brothers in Singapore.35 on the Bombay Stock Exchange. BoB may have to make a small MTM provision. SBI said it has made the required provision for $5 million and had no exposure to AIG. Axis Bank said it had carried out an inter-bank transaction of $1.82 per cent to Rs 591. We will see at the end of this quarter whether to include this component of provisioning in our balance sheet. "So far. Kochhar refused to comment on exposure to other firms."There is panic and turmoil in the overseas markets. Once we have clarity on the settlements. Axis Bank shares closed 6 per cent higher at Rs 696. BoB has subscribed to credit-linked notes issued by a special purpose vehicle floated by Lehman. we do not have a clarity on Lehman's bankruptcy. respectively. Public sector players such as State Bank of India and Punjab National Bank have exposures in the range of $5 million each. while SBI was the among biggest gainer with its share price rising 6. we will talk to our lawyers to work out the details. A report issued by brokerage firm Edelweiss said ICICI Bank's UK subsidiary might have to book mark-to-market losses of up to $200 million for its exposure to firms hit by the global financial turmoil. Bank of Baroda and PNB shares rose 4. 69 . which have much smaller exposure to Lehman.49 per cent to close at Rs 1. Bank of India sources said it had a direct exposure of Euro 8 million ($11.
Africa and the financial crisis 70 .
however. Africa¶s generally weak integration with the rest of the global economy may mean that many African countries will not be affected from the crisis. African countries could face increasing pressure for debt repayment. it can be expected that foreign investment in Africa will reduce as the credit squeeze takes hold. (Effectiveness of aid is a separate issue which the previous link details. which would make any more aggressive demands of repayment all the more worrisome. may face some problems. Much of the debts owed by African nations are odious. foreign aid. which is important for a number of African countries. 71 . The wealthier ones who do have some exposure to the rest of the world. however. Africa may yet enjoy increased trade for a while.) In recent years. In the long run.Africa and the financial crisis Perhaps ironically. at least not initially. As the crisis gets deeper and the international institutions and western banks that have lent money to Africa need to shore up their reserves more. there has been more interest in Africa from Asian countries such as China. as detailed further below. This could cause further cuts in social services such as health and education. is likely to diminish. or unjust debts. one way could be to demand debt repayment. which have already been reduced due to crises and policies from previous eras. as suggested by Reuters. As the financial crisis is hitting the Western nations the hardest. Furthermore.
Latin America and the financial crisis 72 .
for example). despite concerns about the financial crisis. compared to a downgraded forecast of 3% for the rest of the region. A number of countries in the region have come together in the form of the Latin American Pacific Arc and are hoping to improve trade and investment with Asia. alone. Diversifying in this way might be good for the region and help provide some stability against future crises. 73 . Due to its proximity to the US and its close relationship via the NAFTA and other agreements. As such Latin America will also feel the effect of the US financial crisis and slower growth in Latin America is expected. For the moment. the integration is going ahead.9%. Mexico is expected to have one of the lowest growth rates for the region next year at 1.Latin America and the financial crisis Much of Latin America depends on trade with the United States (which absorbs half of Latin America¶s exports.
Crises In Context 74 .
In poorer countries. While this of course is better than nothing it signifies that many leading nations have not had the political will to go further and aim for more ambitious targets. but are willing to find far more to save their own banks. social and emotional. for example.A crisis of poverty for much of humanity Almost daily. but a combination of personal. but they only aim to halve poverty and other problems. many of whom are not to blame for their own predicament. regional. suffer a daily financial. such as the UN Millennium Development Goals. and²importantly²international influences. There are some grand strategies to try and address global poverty. 75 . some half of humanity or more. national. unlike with the financial crisis. There is little in the way of bail out for these people. crisis of poverty. but these are not only lofty ideals and under threat from the effects of the financial crisis (which would reduce funds available for the goals). poverty is not always the fault of the individual alone.
It could reduce. outweighing foreign aid by almost a factor of 5. when monetarily it would be so easy to do so. anyway). could help poor countries pay off (legitimate) debts. This lost tax revenue is significant for poor countries. the issue of tax havens is important for many poor countries. As such the Millennium Development Goals to address many concerns such as halving poverty and hunger around the world. but it cannot be expected that current levels of aid (low as they actually are) can be maintained as donor nations themselves go through financial crisis. and also help themselves become more independent from the influence of wealthy creditor nations. Politically. Almost an aside. A UN-sponsored conference slated for November 2008 to address this issue is unlikely to get much attention or be successful due to the recession fears and the financial crisis. 76 . whereas it is 36% for the rich countries. it may be this latter point that prevents many rich countries doing more to help the poor. or eliminate the need for foreign aid (which many in rich countries do not like giving. An important source of revenue.Poor nations will get less financing for development The poorer countries do get foreign aid from richer nations. will be affected. as Inter Press Service notes. But this capital flight is estimated to cost poor countries from $350 billion to $500 billion in lost revenue. Tax havens result in capital moving out of poor countries into havens. domestic tax revenues account for just 13% of low income countries¶ earnings.
A crisis that need not have happened 77 .
which critics of regulation have often preferred. during periods of boom no-one (let alone the financial institutions and their supporting ideologues and politicians largely believed to be responsible for the bulk of the problems) would want to hear of caution and even thoughts of the kind of regulation that many are now advocating. And at the same time. 78 .A crisis that need not have happened This problem could have been averted (in theory) as people had been pointing to these issues for decades. not just the black-and-white capitalism and communism. But a regulatory capitalist economy is very different to a state -based command economy. of course. Yet. Of course. the most extreme forms of capitalism can also lead to the bigger bubbles and the bigger busts. the style of which the Soviet Union was known for. the irony that those same institutions would now themselves agree that those ³anticapitalist´ regulations are required is of course barely noted. they could be described as more regulatory or managed rather than completely free or laissez faire capitalism. To suggest anything would be anti-capitalism or socialism or some other label that could effectively shut up even the most prominent of economists raising concerns. However. The points is that there are various forms of capitalism. Such options now being considered are not anti-capitalist.
they are too big.´ ² Joseph Stiglitz. The Guardian. and Washington looks ill-equipped to guide us out. The fruit of hypocrisy. America¶s financial system failed in its two crucial responsibilities: managing risk and allocating capital. 2008 79 . September 16. 2008 Some of these regulatory measures have been easy to get around for various reasons. investors. Dishonesty in the finance sector dragged us here. it is extremely important to invest in it too. this crisis wasted almost a generation of talent: ³It was all done in the name of innovation. all right. Regrettably. Some of America¶s best and brightest were devoting their talents to getting around standards and regulations designed to ensure the efficiency of the economy and the safety of the banking system.´² Joseph Stiglitz. and we are all ² homeowners. many of the worst elements of the US financial system « were exported to the rest of the world. Given its crucial role. too important to be allowed to fail. but not in ways that made the economy stronger. However. Dishonesty in the finance sector dragged us here. he captures the sentiments of a number of people: ³ We had become accustomed to the hypocrisy. They were innovating. Some reasons for weak regulation that entrepreneur Mark Shuttleworth describes include that regulators y y y Are poorly paid or are not the best talent Often lack true independence (or are corrupted by industries lobbying for favors) May lack teeth or courage in face of hostile industries and a politically hostile climate to regulation. taxpayers ² paying the price. The fruit of hypocrisy.Quoting Stiglitz again. all of a sudden they demand state intervention: they must be bailed out. The industry as a whole has not been doing what it should be doing « and it must now face change in its regulatory structures. Shuttleworth stresses. September 16. workers. Unfortunately. The banks reject any suggestion they should face regulation. and any regulatory initiative was fought away with claims that it would suppress that innovation. they were far too successful. rebuff any move towards anti-trust measures ² yet when trouble strikes. The Guardian. and Washington looks ill-equipped to guide us out.
completely ³freed´) could be destructive leading to cycles of recessions. and that the tiny minority who control and benefit most from the economic process are the only people competent to direct it. 2008 80 . The triumph of the global ³free´ market. To mitigate against the worst effects of these cycles. labor and resources all add up. which for years has drawn many of our best and brightest young people into investment banking.This band of greedy oligarchs have used their economic power to persuade themselves and most others that we will all be better off if they are in no way restrained²and if they cannot persuade. argues that free markets have undermined democracy and led to this crisis in the first place: ³What creates a crisis of the kind that now engulfs us is not economics but politics. they have used that same economic power to override any opposition. he supported the idea that governments could use various fiscal and monetary measures. He advocated an interventionist form of government policy believing markets left to their own measure (i. at the expense of other areas in much need: ³How much has our nation¶s future been damaged by the magnetic pull of quick personal wealth. which has dominated the world over the last three decades has been a political triumph. Opinion. His ideas helped rebuild after World War II. Who voted for the markets? The economic crisis makes it plain: we surrendered power to wealthy elites and fatally undermined democracy. December 19. public service and just about everything else?´ ² Paul Krugman. The Madoff Economy. professor Robert Skidelsky. until the 1970s when his ideas were abandoned for freer market systems. The economic arguments in favor of free markets are no more than a fig leaf for this self-serving doctrine of self-aggrandizement. The Guardian.e. depressions and booms.It has reflected the dominance of those who believe that governments (for which read the views and interests of ordinary people) should be kept away from the levers of power.´² Bryan Gould.British economist John Maynard Keynes. 2008 The wasted capital. Keynes¶ biographer. at the expense of science. is considered one of the most influential economists of the 20th century and one of the fathers of modern macroeconomics.Paul Krugman also notes the wasted talent. New York Times. November 26.
that the ³free´ market cannot be challenged. We are all Keynesians now.´ ² Bryan Gould. for more than three decades « what is happening now is a triumph of reason and evidence over ideology and interests. he argues that the democratic process has been abused and manipulated to allow a concentration of power that is actually against the idea of free markets and real capitalism: The uncomfortable truth is that democracy and free markets are incompatible. some members of President-elect Barack Obama¶s economic team ² had earlier inflicted enormous costs on developing countries. The moment of enlightenment came only 81 . ³« after having been left in the wilderness. why regulation was needed. their whole raison d'etre.Furthermore. many are now turning to his policies and ideas to help weather the economic crisis. Even the right in the United States has joined the Keynesian camp with unbridled enthusiasm and on a scale that at one time would have been truly unimaginable. especially people working in the financial markets. The whole point of democratic government is that it uses the legitimacy of the democratic mandate to diffuse power throughout society rather than allow it to accumulate²as any player of Monopoly understands²in just a few hands. Who voted for the markets? The economic crisis makes it plain: we surrendered power to wealthy elites and fatally undermined democracy. in effect. as they have done. But many. Democracy is then merely a sham. why there was an important role for government to play in the economy. « No amount of cosmetic tinkering at the margins will conceal the fact that power has passed to that handful of people who control the global economy.´ The misguided policies that resulted ² pushed by. The Guardian. they abandon.Economic theory has long explained why unfettered markets were not selfcorrecting. almost shunned. among others. pushed a type of ³market fundamentalism. ³If governments accept. It deliberately uses the political power of the majority to offset what would otherwise be the overwhelming economic power of the dominant market players. 2008 Despite Keynesian economics getting a bad press from free market advocates for many years. November 26.
much of the money flowing into the banks to recapitalize them so that they could resume lending has been flowing out in the form of bonus payments and dividends. Financial markets did well through capital market liberalization. like a contagious disease. Instead. even if they imposed large costs on others. February 6. how could any developing country defend to its citizens 82 . too. the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. The Guardian. December 5. The Guardian. Still. the worry at Davos was that there would be a retreat from even our flawed globalization. Worse still. ² Joseph Stiglitz.when those policies also began inflicting costs on the US and other advanced industrial countries. ² Joseph Stiglitz. Money was flowing to those who had caused the problem. 2008 Some at the top. But the playing field has always been uneven. however. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well. Fear and loathing in Davos. The neo-liberal push for deregulation served some interests well. have tried to play the role of victim: Indeed. the poorest will suffer most in the long run: « This crisis raises fundamental questions about globalization. some American financiers were especially harshly criticized for seeming to take the position that they. which was supposed to help diffuse risk. demanding massive bailouts and threatening economic collapse otherwise. 2009 And as much as this crisis affects wealthier nations. were victims « and it seemed particularly galling that they were continuing to hold a gun to the heads of governments. and that poor countries would suffer the most. Today. Getting bang for your buck. rather than to the victims. If developing countries can¶t compete with America's subsidies and guarantees. it has enabled America¶s failures to spread around the world.
February 6.the idea of opening itself even more to America¶s highly subsidized banks? At least for the moment. financial market liberalization seems to be dead. Fear and loathing in Davos. ² Joseph Stiglitz. 2009 83 . The Guardian.
Dealing with recession 84 .
Finally it is at this time that public infrastructure work. education. increased borrowing is supposed to offset the reduction in taxes. Tax reduction is something that most people favor. government involvement in such activities is supposed to be minimal. the Eurozone. being the prime example). because higher taxes during downturns means more hardship for more people. many people. However. Often. However. etc. Reduce taxes. At such times governments attempt to stimulate the economy. However. reduced interest rates is an attempt to encourage people to take part in the economy. This includes the US. which can potentially employ many. starting in the US. or are in it. Even the other forms of ³interference´ is usually frowned upon.Dealing with recession Most economic regions are now facing recession. Reduce interest rates. Borrowing at a time of recession seems risky. under free market ideals. hopefully affording people a better chance to weather the economic storm. pragmatic 85 . as the real economy starts to feel the pinch. but the idea is that this should be complimented with paying back during times of growth. and yet during times of economic downturn it would seem that a reduction in tax would result in reduced government revenues just when they need it and then spending on health. Likewise. would be at risk. and Spend on public works such as infrastructure. and many others. most states realize that markets are not always able to function on their own (the current financial crisis. is palatable. Standard macroeconomic policy includes policies to y y y y Increase borrowing. reducing interest rates sounds like there would be less incentive for people to save money. when banks need to build up their capital reserves.
Paul Krugman addresses this noting the difference between private consumption and government stimulus: But [private spending is] not what we¶re talking about when we talk about stimulus spending: we¶re not talking about the government buying consumption goods for the public at large. infrastructure investments may not need to be as direct from government and private enterprise may be able to contribute. Instead. South Korea reduced its interest rates. ² Paul Krugman. UK and elsewhere was that interest rates were too low during good times). and so on. a reversal of some of these policies are required. 86 . it requires that during economic good times. individuals make better choices on consumption than governments. things like roads. For example. many governments have started to contemplate these kinds of measures. New York Times. sewage systems. interest rates may need to increase (one reason for the housing booms in the US. as has Japan. communication networks. England. 2008 Each of these measures should no doubt come under scrutiny from opposition parties and the media. December 22. Bad anti-stimulus arguments. and many others. that governments may be afraid to make such choices. but some. we¶re talking about spending more on public goods: goods that the private market won¶t supply. Nobel prize winner for economics. taxes should increase again to offset the reduction in borrowing. Some are also against government-based stimulus packages. Many have looked to borrow billions or in some way come up with stimulus packages to try and kick-start ailing economies. to ensure they are appropriate. such as tax hikes during good times can be so politically sensitive. China. borrowing should be reduced and debts should start to be repaid. And every Econ 101 textbook explains that the provision of public goods is a necessary function of government. While these might be reasonably standard things to do. thus making economic policies during bad times even riskier as a result. and most politically sensitive of all. arguing instead that tax cuts alone should do the job. or at any rate won¶t supply in sufficient quantities.and sensible adoption of market systems means governments can guide development and progress as required. Nonetheless. various European countries.
then other industries will all cry for more money. some nations are turning to the IMF which is prescribing the opposite policies: Many are already turning to the International Monetary Fund (IMF) for help. The banking system virtually collapsed and the government had to borrow from the IMF and other neighbors to try and rescue the economy. The economic problems have led to political challenges including protests and clashes. It would appear to be an example where high interest rates may be inappropriate. for example. It may be that this time round a more fundamental set of measures need to be considered. November 6. ² Joseph Stiglitz. or it may take even longer to take effect. The automobile industry in the US. more and more companies are announcing losses. However. The worry is that. Let¶s throw away the rule book. possibly global in scope. when would it stop? In addition. at least in some cases. is feeling immense pressure with some of the largest companies in the world facing huge problems and are asking the government for some kind of bailout or assistance. While developed countries engage in stabilizing countercyclical policies. the severity of these economic problems means that these strategies are not guaranteed to work. having already bailed out the banks with enormous sums of money. economic problems have hit them hard. as Joseph Stiglitz warns. Iceland has raised its interest rates to some 18%. If the automobile industry is bailed out. 87 . 2008 In Iceland. driving away capital when they need it most. Yet. the IMF will go back to its old failed recipes: fiscal and monetary contraction. The very core of the global financial system is something many are now turning their attention to. the US public generally seems against this. layoffs or other problems. people are becoming very nervous about the economy and spending less. partly on advice from the IMF.Even then. as quarterly figures for various companies start to come out. The Guardian. closures. which would only increase global inequities. Bretton Woods II must establish economic doctrines that work in emerging economies as well as in capitalism¶s heartland. developing countries would be forced into destabilizing policies. For example. where the economy was very dependent on the finance sector.
Rethinking the international financial system And Banking System 89 .
Whether these changes can happen is hard to predict. who typically have little say in how the global economy is shaped. internationally. to reform of international financial institutions such as the World Bank and IMF.Rethinking the international financial system? Many people are now calling for fundamental reforms of the financial systems. This crisis however has seen even powerful countries contemplate changes that would be more favorable to emerging nations. not just during this crisis. This includes international banking and finance. Traditionally powerful countries have resisted these calls²that have been voiced for decades. Part of the reform suggestions also include giving more voice and power to poor countries. 90 .
(Fractional reserve banking often allows banks to have small reserves against which loans can then be made out for larger amounts as usually most people do not withdraw their cash deposits at the same time. Part of this is because larger institutions have been resistant to changes that would actually create more healthy competition. Bank of England deputy governor Sir John Gieve said the ³fundamental rethink´ meant increasing capital and liquidity requirements at institutions with ³strong restraints on the build up of risk. This too is significant as it suggests restraint for an industry that otherwise is a strong proponent of financial market liberalization and supportive of very rapid growth.) The Bank of England¶s governor. and inadequate transparency. The recognition here appears to be that maybe slower but more stable long term growth is better and sustainable in the long run rather than short bursts of high growth followed by disruptive bursts. often regarded as the Bible of capitalism. simple regulatory systems may be easier to implement and more robust. In a short but very powerful article he concludes. one is not likely to get strong enforcement. Part of the problem has been our regulatory structures. 91 .Reforming international banking and finance? Leaders of the Bank of England have also called for fundamental international banking reform.´ Some of the ideas considered are quite significant. Better regulation is required to reign in the financial markets and bring back trust in the system. Joseph Stiglitz argues that failures in financial markets have come about because of poorly designed incentive structures. and more resistant to regulatory capture. but can then lead to a crisis through encouraging more loans which get riskier as competition increases. Mervyn King. We have to design robust regulatory systems. something Adam Smith had long noted in his Wealth of Nations. where gaps in enforcement are transparen Relatively t. some of which can be very violent as the current crisis is showing. such as increasing the reserves banks must have. a moral hazard in reverse. inadequate competition. If government appoints as regulators those who do not believe in regulation. This works well in good times. even went as far as saying a ³little more boredom´ would not be a bad thing for the industry.
the financial system [has] resisted many of the innovations that would have increased the efficiency of our economy. knew their financial position. these agencies need to be much more heavily regulated or even replaced by an international public body. rather than pro-cyclical as it currently is (i.´² Joseph Stiglitz. y Not just expanding the capital adequacy requirement. questioning whether trade liberalization for poor countries is always good. A crisis of confidence. y Stricter regulations of tax havens and private equity funds. Accounting was so creative that no one. making credit a bit harder to get during good times). October 22. Ha-Joon Chang adds some additional thoughts when commenting on Jeffery Sach¶s suggestions such as the Tobin Tax and changing emissions trading towards a more straight forward carbon tax. It will not be completed overnight. 2008 Professor of economics at Cambridge. By reducing the scope for these socially unproductive innovations. but that they now say poor countries should liberalize straight away.e. Meanwhile. including the following: y The introduction of a country bankruptcy code that will enable orderly sovereign debt restructuring. but also making it counter cyclical.Well-designed regulations may protect us in the short run and encourage real innovation in the long. The agenda for regulatory reform is large. Much of our financial market¶s creativity was directed to circumventing regulations and taxes. But we will not begin to restore confidence in our financial markets until and unless we begin serious reform. (He has been one of the more vocal critics of that idea and argues that rich countries developed using more protectionist policies and moved to free trade once they were industrialized. and is worth looking at for more depth on the political aspects of economic dominance over the centuries. Chang also voices concern about IMF reforms. The Guardian. we can divert creative activity in more productive directions. not even the banks.) 92 . Chang said a lot more could be entertained. y Credit rating agencies play a critical role in today¶s financial system and given the damages they have inflicted by blessing all those toxic assets. either because of historical amnesia or because they want to ³kick away the ladder´ they climbed to achieve industrialization. The Institute for Economic Democracy has also suggested this for many years too. which have greatly contributed to increasing opacity in the financial market.
they do not support the whole economy in the way a bank does. in which government lending to ³uncreditworthy´ companies and government investments in ³unequityworthy´ companies are all to be classified as illegal subsidies.Reforming International Trade and the WTO A number of developed countries have seen their automobile sectors struggling and asking for bailouts. direct subsidies and regulations on foreign investment. such as the subsidies for agriculture. R&D and reduction of regional 93 . Therefore. This proposal was objected to by the developing countries. which use many of these measures. What is going on in the automobile industry in Europe and the US exposes the inherent contradictions and inequities in the current international trading system. represented by the WTO. thus revealing a fundamental problem with the World Trade Organization system: The [major car-producing countries outside Asia] are trying to present their bail-outs [to the car industry] as green initiatives to avoid having their subsidies declared ³illegal´ in the WTO. Having spectacularly bailed out their banks recently by investing astronomical sums in ³unequityworthy´ companies. the Americans and Europeans would be completely undermining their position if they also lent huge sums of money to ³uncreditworthy´ carmakers. Bailing out car-makers could result in other industries asking for similar bailouts. not because of a sudden care for the environment and climate change. they need to be able to say that the huge subsidies that they are giving to their car industries are ³legal´ subsidies aimed at greening. but was supported by the Europeans. Back in the summer of 2007. So what have most governments done? Professor Ha-Joon Chang raises the concern that developed countries have spun the proposed assistance as a ³green´ issue. bailouts for the auto-industry is more controversial. While banking bailouts could be understood as it affects the entire economy. while they support many jobs. such as tariffs. but to by-pass WTO rules on subsidies. The system bans policy tools that developing countries use more. the US government proposed a new subsidies rule in the WTO. while being very generous with the tools that the rich countries need. with some minor qualifications.
disparity. Now that they need to use direct subsidies in large quantity, the rich countries are just going ahead ² only they are painting everything green. By so blatantly going against the WTO rules, the rich countries have implicitly admitted that the present world trading system is not working. Rather than trying to cover this up by painting everything green, they should start a serious rethink on how to truly reform the system so that not just the rich countries but also the developing countries can use policies that are more suitable to their conditions. ² Ha-Joon Chang, Painting carmakers green; Developed nations are trying to get around WTO subsidy rules by portraying their industry bail-outs as green initiatives, The Guardian, February 3, 2009
Reforming the Bretton Woods Institutions (IMF and World Bank)?
The Bretton Woods system of international finance devised by 44 nations after the Second World War, mostly represented by the IMF, World Bank, was designed to help reconstruct and stabilize a post-war global economy. In the 70s, the purpose of these international financial institutions (IFIs) shifted towards a neoliberal economic agenda, championed by Washington, (also known as the Washington Consensus). It was at this time that policies such as structural adjustment started to be pushed to much of the developing world, following a ³one size fits all´ prescription of how economies should be structured, which had disastrous consequences for much of the world¶s population. As journalist John Vandaele writes, From then on the Bretton Woods Institutions (BWIs) were very asymmetrical organisations. The rich countries didn¶t need the BWIs any more, but with more than 60 percent of the vote they called the shots in both institutions. Developing countries really depended upon the BWIs, but didn¶t have a lot to say there. And so the BWIs developed into an instrument of western power. ² John Vandaele, Bretton Woods II: New Lifeline for Ailing Giants, Inter Press Service, October 28, 2008 The same policy prescriptions led to predictable problems such as
Developing countries opening markets before they were really ready to do so (something often forced through by ³gun-boat diplomacy´ during colonial times)
Rich countries became ³judge and party,´ as Vandaele puts it: ³When they forced developing countries to open their markets, it was no coincidence that western multinationals tended to be among the first beneficiaries.´
Worsening poverty from things like structural adjustment policies that sapped the ability of poor country governments to make decisions about how their economies would be run.
Although such institutions have rarely been held accountable for such policies and their effects, for many years, people have been calling for their reform, or even for their abolition. Lack of transparency in these institutions has not helped. There have been signs of discontent, however. As mentioned on the structural adjustment page on this site, the IMF and World Bank have even admitted their policies have not always worked. For example, back in 2003, they warned that developing countries face an increasing risk of financial crisis with increasing globalization because effects in one part of the world can more easily ripple through an interconnected world. ³Financial integration should be approached cautiously,´ they warned. In addition, they admitted that it was hard to provide a clear road-map on how this should be achieved, and instead it should be done on a case by case basis. While former chief economist for the World Bank, Joseph Stiglitz is now a well-known critic of the IMF/Washington Consensus ideological fanaticism, as also mentioned on that previous page, others at the IMF have also started to question things, noting that developing countries have not benefited from following these ideologies so rigorously. Fast forward a few years to this financial crisis and there are more calls for reform of the global financial system, perhaps with a difference: the crisis now seems to be so deep and affecting rich countries as well that even some rich countries that benefited from the inequality structured into the global order are now calling for reform. In addition, although developing countries had called for reform many times before, they now have a slightly stronger voice that in the past. People within the IMF/World Bank are now themselves publicly entertaining the thought of reform. The World Bank¶s own president, Robert Zoellick has said the idea of the G7 ³is not working´ and that a ³steering group´ of more nations would be better. With the limited role the IFIs have played in this crisis, until recently, it seems their significance may be dwindling. Fewer countries have turned to them as last resort, and when they have, they have been able to push for far less stringent conditions than in the past. Some countries have looked to other countries like China, Russia and Arab countries, first.
but they have been moving at glacial speed. ² Joseph Stiglitz. the costs would simply be too high. Joseph Stiglitz also adds that these financial institutions have been slow to respond in the past and now: We may be at a new ³Bretton Woods´ moment. Yet. as John Vandaele added ³This is as much a rescue operation for two organisations that have lost muscle as a call for a new financial architecture. Let¶s throw away the rule book.´ Governance issues such as better representation. as many have called for this²and more²in the past 2 or 3 decades. 97 . As Vandaele also adds. It is to be hoped that it will not take us that long this time: given the level of global interdependence. They did nothing to prevent the current crisis. but often faced charges of hypocrisy as these institutions lack many of these fundamentals. Bretton Woods II must establish economic doctrines that work in emerging economies as well as in capitalism¶s heartland. These and other proposals are not new however. It took the world 15 years and a world war to come together to address the weaknesses in the global financial system that contributed to the Great Depression.There are still some concerns that some countries turning to the IMF will find themselves being prescribed the old formulas that are now quite criticized. The old institutions have recognized the need for reform. The Guardian. November 6. Nicolas Sarkozy has called for major changes to the IMF and World Bank.´ Sarkozy¶s ideas include tighter supervision of the international banking system and a crackdown on international tax havens to address harmful tax competition between states. he¶d better keep in mind that developing countries want more voice. more transparency and accountability are some of the things these institutions have long tried to promote. and there is concern about their effectiveness in responding to it now that it has hit. 2008 French President and head of the EU presidency. ³if Sarkozy is serious about a Bretton Woods II.
indicated how emerging nations might be gaining more prominence. Some are also wondering whether the resolve of nations such as China to support an alternative to a US dollar dominated world will really hold up. Japan. the meeting was of the G20 and not the G8. France. Saudi Arabia. China for example. Although it is an informal structure. As well as the EU being represented as a bloc. Australia. The G20 represents the G8. Italy. It has therefore poured billions into domestic stimulus packages. although the poorest 20% (over 160 nations) are not represented by this group. has 98 . South Korea. Indonesia. Mexico. South Africa. As many noted. until now it seems. the US and others wanted to focus on ways to address the current crisis with specific short term measures. Turkey.For a while now. a more global UN conference on Financing for Development towards the end of November has received far less media attention. the G8 retained its influence. However. The G20 was actually set up in 1999 in the wake of the financial crisis that hit Asia. Russia. The United States invited the G20 for a financial crisis meeting in mid-November. These divergent aims threatened to make the talks less effective. continuing on from the 2002 Monterrey conference. China for example is being asked by Britain¶s Gordon Brown to provide billions from its dollar reserves to help out while China is worried about the increasing slowdown in the domestic economy and the need to stimulate its own internal markets. While many emerging nations and even some European countries wanted the meetin to gs discuss fundamental reforms to the global financial system. talk of G20 meeting rather than just the G8 has signified this possible power shift. Canada. the EU as a bloc and 12 emerging economies: Argentina. India. This is to include all 192 member states and is broader in scope. At the same time. IMF and World Bank representatives are usually present at G20 meetings. it comprises 90% of the world¶s economic output and some 80% of the world¶s population. China. the United Kingdom and the United States of America. Brazil. Germany. implying that it is not likely to provide so much money to institutions such as the IMF. Some emerging nations such as China are now finding domestic pressures may outweigh their contributions to global resolutions.
However. China is feeling the effects. it would benefit. It has meant more exports for China.benefited from the US development model driven by consumption. Would it want that to change? 99 . now as consumer confidence in the US has been seriously rocked. But if it can see a future where that model is revived.
As the world¶s eight largest economy and home to 2 of the world¶s top 16 banks. The eventual outcome of the G20 meeting seemed mixed. Those who benefit from a system are less likely to be receptive to change. in April 2008. If history is any indicator. For example. power and greed politics always ruin good ideas. even amongst the more powerful nations are already showing. They also agreed to meet at the end of March 2009 to follow up. or want to steer change in a direction that will be good for them. 2 percent went to emerging countries and 1 percent to other developing countries. But others argued that the meeting outcome seemed more vague than concrete and only these principles seemed to have been agreed without anything more concrete. this is still not that much and this crisis shows that more is needed in a more deeper and meaningful way. It has full EU support for being present at this meeting as well as support from a number of Latin American countries. a meeting of the G20 (G7 plus some developing nations) sees Spain (the world¶s 8th largest economy) missing out of either classification. Spain. it wants to see in-depth reform of the global financial system and focuses on IMF reform as well as giving more representation to emerging nations. however. For example. Like France. sometimes (incorrectly) equating calls for regulation with protectionsim. to resist protectionism. They agreed to use government spending to fight a spreading recession. and to revive stalled negotiations for a new global trade pact. The call to resist protectionism has been a prime concern from the Bush Administration. This will be hard to predict.Reform and Resistance Will any of these changes occur in an effective way? In recent months these institutions have warmed to changes in these areas. sees this as US retaliation for the country withdrawing its troops from Iraq. but that may not mean good for everyone. the US has not invited Spain to a financial crisis summit for mid-November. to tighten lax oversight of markets. And tensions. The calls for regulation have typically been to make companies more transparent and ensure the financial 100 . it was decided that rich countries at the IMF would give in 3 percent of the votes. Developing countries also got mor e assurances about increased say at international financial institutions through promises of reform at the IMF and World Bank. However.
´ ² International economic architecture: cleaning up the mess?. Qatar. will be crucial for much of the world. APEC nations have agreed to resist protectionist measures. The promise of rearchitecting the global financial system more fundamentally seemed to wither away slightly.´ He continued. Paul Krugman suggests that protectionism may be necessary for a while as these are not normal conditions where the case for protectionism may be on weaker grounds. president of the UN General Assembly said: ³Only full participation within a truly representative framework will restore the confidence of citizens in our governments and financial institutions. Perhaps partly because of lack of mainstream media attention. any way: G20 governments. Most member states are generally industrialized. Whether that actually happens and to what extent those with power are willing to truly share power is something that we will find out in the course of the next year. held by the United Nations General Assembly. represents almost half of all world trade. The APEC trading bloc. the G20 had little time to effect much and could not do it alone. November 27. so as a group. As the Bretton Woods Project noted. Critics argue that the G20 can never tackle this agenda alone. however. Bretton Woods Project. History has shown that once economies mature they benefit from less protectionist measures (but also shows that nations on early stages of development may also benefit from it). ³Solutions must involve all countries in a democratic process.mess created can be avoided in the future. for example. 101 . the more democratic alternative was the Doha conference on financing for development meeting at the end of November in Doha. Nonetheless. the Doha conference also resulted in weak pledges and disappointment. swept off their feet by the financial crisis. Reform of the IMF and World Bank. other regions around the world agree that generally free trade is desirable over protectionist policies. at least for industrialized nations. As Miguel D¶Escoto. were never going to be able to reach a consensus on deeper reforms within the few weeks taken to prepare the summit. 2008 Hardly mentioned in the mainstream media by comparison.
A financial crisis of this proportion may signify the beginnings of such a shift. 2008 Although history often shows that those with agendas of power tend to win out. and the transparency. history also shows us that power shifts. Inter Press Service. and hence democratic control. as Vandaele also finds.More generally. And so. Slowly. 102 . ² John Vandaele. Democracy Comes to World Institutions. The most powerful international institutions tend to have the worst democratic credentials: the power distribution among countries is more unequal. is worse. it is perhaps only at a time of crisis that more fundamental rethinking of the entire economic system can be entertained. October 27.
Rethinking economics? 103 .
104 . leading to both wider discussion but also more entrenched views. a more compassionate capitalism. Harvard professor of economics. a warning from Adam Smith. They complain only of those of other people. and thereby lessening the sale of their good both at home and abroad. Some have been writing for many years that while the current economic ideology is flawed. Those with power and money are less likely to agree to a radical change in economics where their power and influence are going to diminish. the political spectrum and thinking on economics has narrowed. Others may yet argue that the bailouts by large government will distort the markets even more (encouraging bad practices by the big institutions) and rather than more regulation. regardless of whether it is good for everyone or not. Others argue that capitalism is so flawed it needs complete doing away with. They say nothing concerning the bad effects of high profits. It is perhaps ironic to quote. limiting the ideas and policy options available. Stephen Marglin. Even mainstream media. and will be able to lobby governments. but capitalism nonetheless. debate will increase in the mainstream. produce compelling ads and do whatever it takes to maintain options that ensure they benefit.Rethinking economics? During periods of boom. given he is held up as the leading figure of the economic ideology they promote: ³ Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price. They are silent with regard to the pernicious effects of their own gains. an even freer form of capitalism is needed. It may be that during periods of crisis such as now. This will also attract ideologues of different shades. at length. especially when it brings immense wealth and power. for example. it only needs minor tweaking to correct it and make it work for everyone. notes how throughout recent decades. people do not want to hear of criticisms of the forms of economics they benefit from. the time comes to rethink economics in some way. usually quite supportive of the dominant neoliberal economic ideology entertains thoughts that economic policies and ideas need rethinking. What seems clear is that at least for a while.
and not his. Book I. Additional paragraph breaks added for readability) 105 . It is by this superior knowledge of their own interest that they have frequently imposed upon his generosity. (Everyman¶s Library. 1991). even when given with the greatest candour (which it has not been upon every occasion) is much more to be depended upon with regard to the former of those two objects than with regard to the latter. are commonly exercised rather about the interest of their own particular branch of business. To widen the market may frequently be agreeable enough to the interest of the public. Sixth Printing. The interest of the dealers. It comes from an order of men whose interest is never exactly the same with that of the public. upon many occasions. and who by their wealth draw to themselves the greatest share of the public consideration. they have frequently more acuteness of understanding than the greater part of country gentlemen. Their superiority over the country gentleman is not so much in their knowledge of the public interest. for their own benefit. who have generally an interest to deceive and even to oppress the public. 231-232 (Emphasis added. and can serve only to enable the dealers. and persuaded him to give up both his own interest and that of the public. not only with the most scrupulous. but to narrow the competition must always be against it. is always in some respects different from. by raising their profits above what they naturally would be. to levy. is always the interest of the dealers. and even opposite to.Merchants and master manufacturers are « the two classes of people who commonly employ the largest capitals. however. As during their whole lives they are engaged in plans and projects. in any particular branch of trade or manufactures. their judgment. an absurd tax upon the rest of their fellow-citizens. As their thoughts. 87-88. To widen the market and to narrow the competition. and ought never to be adopted till after having been long and carefully examined. pp. and who accordingly have. from a very simple but honest conviction that their interest. that of the public. as in their having a better knowledge of their own interest than he has of his. however. than about that of the society. but with the most suspicious attention.´² Adam Smith. both deceived and oppressed it. The Wealth of Nations.The proposal of any new law or regulation of commerce which comes from this order ought always to be listened to with great precaution. was the interest of the public.
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