Save the Emerging Markets
by
Dani Rodrik
CAMBRIDGE– If the world were fair, most emerging
markets would be watching the financial crisis engulfing the world’s advanced
economies from the sidelines – if not entirely unaffected, not overly concerned
either. For once, what has set financial markets ablaze are not their excesses,
but those of Wall Street.
Emerging markets’ external and fiscal
positions have been stronger than ever, thanks to the hard lessons learned from
their own crisis-prone history. We might even have allowed these countries a
certain measure of schadenfreude in the troubles of the United States
and other rich countries, just as we might expect kids to take perverse delight
from their parents’ getting into the kinds of trouble they so adamantly warn
their children against.
Instead, emerging markets are suffering
financial convulsions of possibly historic proportions. The fear is no longer
that they will be unable to insulate themselves. It is that their economies
could be dragged into much deeper crises than those that will be experienced at
the epicenter of the sub-prime debacle.
Some of these countries should have known
better and might have protected themselves sooner. There is little excuse for
Iceland, which essentially turned itself into a
highly leveraged hedge fund. Several other countries in Central and Eastern
Europe, such as Hungary, Ukraine, and the Baltic states, were also living
dangerously, with large
current-account deficits and firms and households running up huge debts in
foreign
currency. Argentina, the international financial system’s enfant
terrible , could always be relied on to produce a gimmick to spook
investors – in this case a nationalization of its private pension funds.
But financial markets have made little distinction
between these countries and others like Mexico, Brazil, South Korea, or
Indonesia, which until just a few weeks ago appeared
to be models of financial health.
Consider what has happened to South Koreaand Brazil. Both economies have
experienced currency
crises within recent memory – South Koreain 1997-1998 and Brazilin 1999 – and
both subsequently took steps
to increase their financial resilience. They reduced inflation, floated their
currencies, ran external surpluses or small deficits, and, most importantly,
accumulated mountains of foreign reserves (which now comfortably exceed their
short-term external debts). Brazil’s financial good behavior was rewarded as
recently as April of this year when Standard & Poor’s raised its credit
rating to investment-grade. (South Koreahas been investment-grade for years.)
But both are nonetheless getting hammered in
financial markets. In the last two months, their currencies have lost around a
quarter of their value against the US dollar. Their stock markets have declined
by even more (40% in Braziland one-third in South Korea). None of this can be
explained by economic
fundamentals. Both countries have experienced strong growth recently. Brazilis
a commodity exporter, while South Koreais not. South Koreais hugely dependent
on exports to advanced
countries, Brazilmuch less so.
They and other emerging-market countries are
victims of a rational flight to safety, exacerbated by an irrational panic. The
public guarantees that rich countries’ governments have extended to their
financial sectors have exposed more clearly the critical line of demarcation
between “safe” and “risky” assets, with emerging markets clearly in the latter
category. Economic fundamentals have fallen by the wayside.
To make matters even worse, emerging markets
are deprived of the one tool that the advanced countries have employed in order
to stem their own financial panics: domestic fiscal resources or domestic
liquidity. Emerging markets need foreign currency and, therefore, external
support.
What needs to be done is clear. The
International Monetary Fund and the G7 countries’ central banks must act as
global lenders of last resort and provide ample liquidity – quickly and with
few strings attached – to support emerging markets’ currencies. The scale of
the lending that is required will likely run into hundreds of billions of US
dollars, and exceed anything that the IMF has done to date. But there is no
shortage of resources. If necessary, the IMF can issue special drawing rights
(SDRs) to generate the global liquidity needed.
Moreover, China, which holds nearly $2 trillion in foreign
reserves, must be part of this rescue mission. The Chinese economy’s dynamism
is highly dependent on exports, which would suffer greatly from a collapse of
emerging markets. In fact, China, with its need for high growth to pay for
social peace, may be the country most at risk from a severe global downturn.
Naked self-interest should persuade the
advanced countries as well. Collapsing emerging-market currencies, and the
resulting trade pressures, will make it all the more difficult for them to
prevent their unemployment levels from rising significantly. In the absence of
a backstop for emerging-country finances, the doomsday scenario of a
protectionist vicious cycle reminiscent of the 1930’s could no longer be ruled
out.
The United States Federal Reserve and the
International Monetary Fund have both taken some positive steps. The Fed
has created a swap facility for four countries (South Korea, Brazil, Mexicoand
Singapore) of $30 billion each. The IMF has
announced a new quick-dispersing short-term facility for a limited number of
countries with good policies. The questions are whether these will be
enough and what happens to those countries that will not be able to avail
themselves of these programs.
So when the G-20 countries meet in Washingtonon November 15 for their crisis
summit,
this is the agenda item that should dominate their discussion. There will be
plenty of time to debate a new Bretton Woods and the construction of a global
regulatory apparatus. The priority for now is to save the emerging markets from
the consequences of Wall Street’s financial follies.
** Dani Rodrik, Professor of Political Economy at
Harvard University’s John F. Kennedy School of Government, is the first
recipient of the Social Science Research Council’s Albert O. Hirschman Prize.
His latest book is One Economics, Many Recipes: Globalization, Institutions,
and Economic Growth.
Copyright: Project Syndicate, 2008.
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