The impact of financial meltdown in the West on the developing nations

The ADB raises the alarm for South Asian bond market amidst the financial meltdown in the West.

…As global credit markets tighten in the wake of events on Wall Street, the need for Asia, and in particular South Asia, to develop and strengthen domestic bond markets as a source of long term, local capital, has never been more acute.

...Participants shared information on bond market development, and looked at obstacles to further progress. In the case of the five countries of South Asia - Bangladesh, India, Nepal, Pakistan and Sri Lanka - they sought to identify measures that could help them increase the availability of long term, local currency financing.
...While many initiatives have been taken in Asia in recent years to create deep, liquid bond markets, the depth and maturity of such markets varies greatly, with countries in South Asia lagging counterparts in East and Southeast Asia. Typically, governments in South Asia have relied on bank borrowings and external aid as their main sources of finance in the past.

“Financial market diversification supported by well capitalized and judiciously regulated institutions has been at the heart of the tremendous growth that we have witnessed in East Asia,” said Simon Bell, Sector Manager for the World Bank’s South Asia Finance and Private Sector Development group.

There is just a press release; no papers or anything to support or to explain the present status of South Asian bond market. I would love to see more on this front rather than just releasing a press release of ‘he-said-that-she-said that’ format! I would love to explore the development and current status of bond market in South Asia. Hopefully, the ADB will put up files and papers from the conference soon on its website. Or am I missing a whole lot due to ignorance?

Most of the papers available so far are focused on the impact of the financial meltdown on the emerging markets, which overshadows its impact on poor, developing nations.

Here is one paper which analyzes the implications of sub prime crisis in the emerging markets.

This paper discusses some of the key characteristics of the U.S. subprime mortgage boom and bust, contrasts them with characteristics of emerging mortgage markets, and makes recommendations for emerging market policy makers. The crisis has raised questions in the minds of many as to the wisdom of extending mortgage lending to low and moderate income households. It is important to note, however, that prior to the growth of subprime lending in the 1990s, U.S. mortgage markets already reached low and moderate-income households without taking large risks or suffering large losses. In contrast, in most emerging markets, mortgage finance is a luxury good, restricted to upper income households. As policy makers in emerging market seek to move lenders down market, they should adopt policies that include a variety of financing methods and should allow for rental or purchase as a function of the financial capacity of the household. Securitization remains a useful tool when developed in the context of well-aligned incentives and oversight. It is possible to extend mortgage lending down market without repeating the mistakes of the subprime boom and bust.

Here is a nice piece from the NYT about the impact of this crisis in the developing countries that depend on foreign capital and have American-style trade deficits.

…The crisis, by squeezing the flow of capital, threatens countries from the Baltic to Africa that depend on foreign money to finance their deficits.

…There are more than 20 countries with current-account deficits that exceed 5 percent of their economic output, Mr. Strauss-Kahn said, putting them in what the fund considers the endangered category. Mr. Strauss-Kahn declined to name names, but outside economists listed Bulgaria, Estonia, Romania and Turkey as among the red flags in Europe. In Africa, they said, South Africa and Nigeria were worrisome; and in Latin America, Venezuela and Ecuador.

Here is one interesting thought:

In a paper I had analysed this decoupling/recoupling issue. There are two channels via which shocks are transmitted- trade flow and financial flow. The trade channel usually impacts with a lag but the financial channel is immediate. This is worrisome as it is a possibility that the crisis has got nothing to do with the economic fundamentals of the economy.

Here is one more link from the Center for Global Development. The CGD has a series of thoughtful blog posts from a wide range of experts.

Here is Shanta Devarajan (did I mention that Shanta is now running a new blog, which focuses on Africa; earlier he used to run a blog focusing on South Asia) asserting that despite the US subprime mortgage crisis, South Asia will continue to grow.

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Update: Here is an interesting perspective (a socialist twist and anti-capitalist agenda) about the impact of global financial crisis on the workers around the world.

…But this means that taxes from working people are once again being used to rescue capitalists, demonstrating the boundless parasitism of financial elites. Nouriel Roubini, a New York University economist, describes this as “socialism for the rich, the well-connected and Wall Street (i.e. where profits are privatized and losses are socialized).” Meanwhile, the biggest finance capitalists like JP Morgan are gobbling up these distressed capitals at firesale prices — further concentrating capital in the hands of a tiny finance oligarchy.

…An estimated 2.2 million or 1 in every 50 households in the US face foreclosure. Those who continue to own homes would be 20-30 percent poorer in terms of household wealth as home values drop as a result of the collapse in the housing bubble. According to one estimate, a collapse of 30 percent in US home prices from their over-inflated peak would wipe out $6 trillion of household wealth and leave 10 million households with negative equity in their homes — they owe more on their homes than they are worth — increasing the likelihood of a new round of foreclosures and credit losses.

• The global credit crunch means reduced capital flows for third world countries who are chronically dependent on foreign capital inflows to pay for older debts, sustain imports from the advanced capitalist countries and paper over chronic deficits they incur as imperialist states plunder their economies.
• Most un-industrialized countries who are dependent on exporting agricultural products, raw materials, minerals, low-value added manufactures and services (e.g. business process outsourcing) to the advanced capitalist countries will be faced with shrinking exports due to the combination of depressed consumption in the North.
• Aside from being dependent on low-value commodity exports, un-industrialized countries are also dependent on the export of labor, particularly to the wealthy industrialized countries…his means higher unemployment in labor-exporting countries, reduced earnings for foreign remittance-dependent households, and lower consumption spending in the domestic economy.
• As financial instruments and stock markets become less attractive to financial investors, speculative capital shifts more into commodities trading such as oil, minerals and agricultural commodities. This is contributing to the precipitous rise in food and energy prices beyond what conditions in the real economy warrant, thereby rapidly eroding the real incomes of the vast majority especially in the third world.

Tata Nano and paddy fields: Lewis dual sector model at stake in India

David Pilling argues that it is vital that more labor from low-productivity farm sector migrate to higher-productivity industry so that India achieves an economic growth rate that has power to reduce poverty and increase prosperity in a large scale. He draws out a recent day dichotomy: the tussle between Tata’s Nano factory in West Bengal and protests by farmers displaced from land where the factory is to being built. He argues that if there is to be large scale industrialization, then India better solve these problems and let the process of prosperity roll forward.

…As many as 600m people, or about 47 per cent of China’s population, live in cities, at least 100 of which have swelled to more than 1m inhabitants.

In India…of the 406m labour force in 2000, 78 per cent lived in rural areas against just 22 per cent in towns and cities. The structural transformation from low-productivity farm labour to higher-productivity industry has been painfully slow. Today, agriculture employs about 60 per cent of the workforce but accounts for a measly one-fifth of national output. The predominantly urban, “organised” sector produces 40 per cent of output with just 7 per cent of the workforce.

…India’s information technology and service sector, no matter how dynamic, simply cannot absorb enough labour. To truly shine, India will need millions, perhaps tens of millions, more manufacturing jobs.

…More fundamentally still, as the dispute over land in West Bengal shows, it is hard to engineer mass migration in a democracy. In contrast to 18th century Britain and 21st century China, the vote of a dispossessed Indian peasant is worth the same as that of a would-be industrialist. Collectively, it is worth more. “You have to hand it to Indian democracy,” says Mr Hasan. “It does give you a voice. But that makes it very difficult to negotiate change.”

It is really hard to solve these kind of problems because the poor farmers can easily vote out the party which takes decision in favor of industries trying to displace people from their land to make factories. Term it ironical or whatever, the reality is that this is democracy. The poor farmers have no choice. Same applies for the manufacturing industries because if they cannot get land, then they will not invest.

This is very tricky problem for the politicians. The leftist parties take advantage of these situations and win election on the back of popular slogans. Though low quality or even absence of education and healthcare are one of the roots of these problems, I don’t think they are as important as Pilling thinks in creating this kind of deadlock. A major problem lies in the century old caste system and the scourges associated with it. Remember, India is a very culturally, ethnically, and politically divided country. Let short, quick judgment not overshadow other important constraints!

The War for Wealth: The true story of globalization

I just finished reading The War for Wealth: The true story of globalization, or why the flat world is broken, written by Gabor Steingart. I picked up this book from the library last week mainly because it included an interview with Paul Samuelson.

This book is light read yet a compelling one. You will neither find rigorous arguments, data, and detailed descriptions like you get in books written by Rodrik, Stiglitz, or Bhagwati nor you will find anti-globalization (anti-trade) sentiments resonated in Lou Dobbs’ and, to so degree in, Naomi Klein's books. This is not an intellectually challenging book on globalization but is thought-provoking. It looks more like a journalistic work; reporting style writing and not so surfacial but also not too in-depth analysis! The analysis is heavily skewed towards the plight of working class in the US (and to some degree in the Europe). Steingart dismisses Thomas Friedman's idea that "the world is flat" by arguing that disproportionate gains from trade and globalization do not add up to the world being a flat world.

He accentuates, over and over again, the differences between capital and labor market (labor market is not and cannot be flat) and how cheap labor in China and India are gaining and how middle class is emerging in these countries while in the West there have been erosion of low-tiered jobs and slow erosion of middle class.

He refutes the prevailing notion (on trade related debate) of structural adjustment in the job market by presenting statistics on job losses not only in the low-tier jobs but also in the blue-collar jobs. Meanwhile, service sectors jobs are also not increasing in the West. This means that globalization has been unfair, i.e. it is not producing win-win situation, as predicted by some trade theories, in the West. It is a win-lose situation in the West and a win-win situation in the emerging developing nations like India, China, Vietnam, and Brazil.

He also has objection with the profit-minded capitalists who overlook basic labor and environment standards in factories in China and back-office service companies in India. Steingart is worried that the US will be left behind even in knowledge market as Chinese and Indian government pour in more and more money for research and development; he fears that the next Einstein would be from India or China.

He argues that globalization is not debated as is see in reality. He also presents seven fallacies of globalization debate. His book also contains an interview with Paul Samuelson, who also resonates Steingart's argument (or it might be the other way round) that globalization has produced a win-lose situation in the US and the Europe.

…The war for wealth, a bitter struggle for a share of affluence, and the related struggle over political and cultural dominance in the world, are the real conflicts of our day. The war on terror is overblown, the man in the White House has set the wrong priorities, and the public— deliberately or not—is being kept in the dark over the true extent of the global shift of power and wealth. (pp.ix)

…The opponents and proponents of today’s globalization are united in being mistaken. Without knowing it or wanting it, they are part of a single party one could call “America, Don’t Move.” This party appears on no ballot, never holds party conventions, and has never organized a fund-raiser. It doesn’t send any of its luminaries to appear on Meet the Press or post promotional videos on YouTube, nor does it hire pollsters to investigate the opinions of farmers, housewives, and minorities. (pp.9)

Steingart’s seven fallacies of globalization debate (pp.10-21):

1. The natural progression for a developed economy is to move from an industry-based to a service-based economy.
2. Economics and morals have nothing in common.
3. The new world is flat.
4. The tide of globalization automatically lifts all boats.
5. Globalization is a great work of peace.
6. The nation can no longer do anything for the people in its care.
7. Globalization is a hot issue.

The flat world is broken!

…Within a period of time that would amount to barely a blip in history, 3 billion additional people and there- fore 1.5 billion new workers joined the world’s labor force and helped bring about an unprecedented shift in the balance of power. The West’s 350 million well-trained but costly workers, who until then had been responsible for a large segment of world production, became a minority almost overnight. (pp.133)

…The world is by no means running out of work, as some claim. As long as the number of goods that are produced, sold, and consumed increases, there can be no loss of jobs. At the beginning of the twenty-first century, the global economy is experiencing one of its biggest growth spurts in decades. Despite the advent of the Internet and industrial automation, the sheer volume of jobs continues to increase. What has changed, however, is the distribution of labor in the context of a global labor market. This labor market is unlimited—but not for the Western worker. (pp.141)

Samuelson’s take on the outcome of globalization:

…The globalization leads to a win-win situation for people in China. That’s true for the poor people in China and for the wealthier people in China. In the United States, the development appears to be very different. Highly specialized and professional members of the workforce will profit, while the run-of-the-mill working-class people will be the losers. It’s a win and lose situation. (pp.267)

…In the globalized society, we will see a deeper split within the developed nations. I think the lower half of the income distribution will be the losers. Globalization means two things: in all probability it means an increase in inequality, and in all probability it also means a loss of serenity. Globalization brings us more prosperity, but it also leads to more uncertainty, tension, and enhanced inequality. In America, it has already led to a cowed workforce. Even for an MIT graduate, things have changed. (pp. 270)

Finally, Samuelson’s advice:

My first piece of advice would be: choose the middle way. There is no substitute for the market mechanism— but the market mechanism has no brain, it has no heart. Without political programs it will inevitably breed inequality. My second piece of advice would be: globalization in its current shape and speed makes the world a more insecure and nervous place. We should try to slow down, and, in our own long-run interest, try to be less aggressive. (pp.274)

Oh, I don’t want to miss this! Samuelson on Keynes and Schumpeter:

…First, I was against Keynes because he was contradicting what all my wonderful professors believed. But finally I decided, am I going to let reality take over or am I going to let ideological reverence prevail? My teacher at Harvard University was Joseph Schumpeter, the famous Austrian economist who had come to Harvard from Weimar Bonn University. Schumpeter was erroneous on the Great Depression. He saw it as a healthy thing. His diagnosis was that the Great Depression was a good thing because it was going to improve productivity. Well, of course it didn’t. Of the 40 most gifted graduates in the physical sciences and the 40 most gifted graduates in the biological sciences, in my first year none had a job for the next year. What good was that going to do for the productivity of the subsequent U.S. economy?

...It used to be said that Schumpeter’s nose was out of joint, that he was kind of jealous of Keynes. He said to me: “You are in favor of Keynes because you are a socialist.” I said: “Professor Schumpeter , I come from the University of Chicago—the citadel of capitalism! When was I ever a socialist? You don’t have to be a socialist to be in favor of Keynes.” And he said: “Well, you are a socialist in the sense that you don’t revere the capitalist system.” Well, that was true. I spent my first 15 years under the rule of pure capitalism, and it had lots of advantages and lots of disadvantages. (pp.165-6)

Here is a video of Steingart's talk:

Links of Interest (09/23/2008)

Economics for everyone- The Paradox of Poverty

How financial madness overtook Wall Street (excellent review of how we got into this financial mess and what’s up next)

Why Paulson is wrong

Why Paulson is (maybe) right

Cash for Trash

An emerging consensus against the Paulson Plan

Anatomy of the financial crisis

Economists’ find three fatal pitfalls in Paulson’s plan

Putting Doha on life support

A systemic crisis demands systemic solutions

Development impacts of the financial crisis

An analysis of the so-called export-led growth (interesting paper from the IMF… the main point is that solely focusing on export-led through tradable sector might not be wholly right; non-tradable sector led-growth could be as powerful as tradable export-led growth)

Budget undermines free market policy: FNCCI

More on the same budget stuff

Here is a PDF file of the actual Opinion page on print:

Here is an image file of the same page.

Budget 2008/09: Enter Socialism with Inflation

My latest Op-Ed published today is titled “Enter Socialism with Inflation”. It is about the quantity and quality of budget presented on September 19, 2008 by Finance Minister Dr. Baburam Bhattarai,  to the first elected parliament of the Federal Democratic Republic of Nepal.

Although I am happy that sectoral priorities have been quite upfront and to the point this time- putting hydropower and tourism on the top of priority list- I am not satisfied with the inflated budget, econ-political slogans, policies to tame the private sector, promotion of cooperatives, plans to revive sick and moribund firms, and complete disregard to rising inflation rate. This budget is crafted with a socialist and planner mentality, which might not necessarily lead to a servile state but is certain to screw up individual and private sector incentives, which is the last thing Nepal needs if it wants to see the light of a double-digit growth rate.

Read the full article here. My preliminary notes on this budget article is here. Extended summary of the budget is here.

Sept. 19, 2008 will definitely go down as one of the most important dates in the history of the Federal Democratic Republic of Nepal. On that day, Finance Minister Dr. Baburam Bhattarai presented the first budget, albeit two months late, for the coming fiscal year. The first thing that will be noted in the economic history of Nepal will be the heavy, inflated size of the budget, which amounts to Rs. 236,015,900,000. Another thing that will be noticed with raised eyebrows will be socialist stunts like grand but empty slogans, attempts to restructure and tame the private sector, huge deficit financing and high inflation.

…positive aspects, however, are eclipsed by grand and unrealistic plans, digressive policies to revive sick industries, an ambitious GDP growth rate, ignorance of inflation resulting from increased salaries and deficit financing and unrealistic revenue estimation. Considering the quality of the existing social and political institutions, it will not be long before he realizes that these grand plans and expectations are only good on paper.

…Dr. Bhattarai has waved a socialist wand to tame the private sector, which has been largely unhappy with the budget, by creating a parallel body to foster cooperatives. Make no mistake; this is not an assault on the private sector. However, this is definitely a move that will discourage individual and private sector incentives, which are dearly needed now to stimulate entrepreneurial instinct and increase investment.

By placing the Cooperative Board and the Investment Board -- both to be part of the Economic Council chaired by the prime minister -- on an equal footing, the finance minister has embarked on a grand socialist stunt the like of which has not been seen anywhere in the world for the past two decades. Without a clear demarcation of their responsibilities, the interests of these two boards are sure to collide, particularly in the agricultural sector where there is a real possibility of private sector investment being crowded out. Dr. Bhattarai needs to be reminded that the private sector is more efficient than cooperatives, and that if we want to attain a double-digit growth rate, then the last thing needed is a planner mentality and a clash between cooperatives and the private sector.

…These magnificent plans will also bring down the purchasing power of the rupee. Market prices are going to come under tremendous pressure from deficit financing to the tune of Rs. 42 billion, an increase in wages and allowances, cancellation of debts owed by poor farmers to agricultural banks, injection of money into sick industries and the expected increase in remittances and foreign aid.

The mammoth budget, social security investment, post-conflict reconstruction and investment plans will push inflation over the expected rate of 7 percent for the next one year. Since this jeopardizes the exchange rate in the medium term, diminishes export competitiveness and fosters inflation embedded on expectations, the central bank will be forced to raise the interest rate. This will strain lending and investment thereby putting a question mark on the promise of double-digit growth.

The finance minister has given the country a fresh dose of socialist planning agenda filled with unrealistic promises of double-digit growth and prosperity, and a recipe for rising prices. Yes, this budget will find its place in history as being socialist, inflationary, populist, ambitious and unrealistically grand!

Read the full Op-Ed piece here.

Development Diary: Sachs and Bono blog about MDGs

Jeffrey Sachs and Bono are writing a blog for the FT from the MDGs summit starting today. Here is a link to the blog.

Earlier, development economist Paul Collier wrote an Op-Ed in the NYT calling for vigorous pursuit of MDGs, increase in aid, and offering a sense of hope to help the bottom billion.

Easterly would stab this paragraph:

The laggards in the struggle for the MDGs are not the poor countries or their ostensibly corrupt governments.  The laggards are the rich world, so full of promises and high rhetoric and so low on delivery.  The MDGs are falling short because of a lack of promised financing to put in place the clinics, schools, roads, power, and other investments needed for their success.  Six years ago, the rich countries pledged in Monterrey, Mexico to “make concrete efforts toward the international target of 0.7 per cent of GNP in official development assistance.”  Yet the United States stands are 0.16 per cent, Japan at 0.17, Italy at 0.19, Canada at 0.28, Germany at 0.37, and France at 0.39.