Folklore is riddled with tales of a lone actor undoing a titan: David and Goliath; Heracles and Atlas; Jack and the Beanstalk, to name a few. Financial institutions seen as too important to fail have become even larger and more complex since the global crisis. We need look no further than the example of investment bank Lehman Brothers to understand how one financial institution’s failure can threaten the global financial system and create devastating effects to economies around the world. We’ve been looking at how to fix the too important to fail problem, and favor market based measures to help reduce the likelihood and impact of a failure. Global regulators have come up with a new set of tighter rules for all banks, known as Basel III, as a starting point to make the system less risky and address a number of regulatory issues. Implementation may take several years, however, while systemic institutions continue to grow in size and complexity, and may resume their risky practices. So in the interim, we’d like to see rapid, credible, and visible actions.
Sub-Saharan Africa’s “frontier markets”—the likes of Ghana, Kenya, Mauritius, and Zambia—were seemingly the destination of choice for an increasing amount of capital flows before the global financial crisis. Improving economic prospects in these countries was a big factor, but frankly, so too was a global economy awash with liquidity. Then the crisis hit. And capital—particularly in the form of portfolio flows—was quick to flee these countries as was the case for so many other economies. Fast forward to 2011. Capital flows are coming back to the frontier, but in dribs and drabs. In our recent Regional Economic Outlook we examined the experience of sub-Saharan Africa’s frontier markets, with a view to understanding how they can best make use of these inflow to meet their own development and growth objectives.
Most policymakers in the Middle East and North Africa agree that stronger economic growth is a crucial component of any strategy to address the region’s persistently high levels of unemployment and raise its living standards. One question that arises is: What role can the financial sector play? It is well known that a dynamic and vibrant financial sector will improve economic outcomes for a country, leading to faster and more equitable economic growth. The key to answering this question, therefore, is to look to the past and examine how the financial sector has contributed historically to growth in the region. Unfortunately, the experience in the Middle East and North Africa has not been as successful as in other regions. How, then, can policymakers in the region enhance the financial system’s contribution to growth?
Asia’s vigorous pace of growth has seen the region play a leading role in the global recovery. But there are signs that higher commodity prices are spilling over to a more generalized increase in inflation. Expectations of future inflation have picked up. And accommodative macroeconomic policy stances, coupled with limited slack in some economies, have added to inflation pressures. Against this backdrop, the need for policy tightening in Asia has become more pressing than it was six months ago, especially in economies that face generalized inflation pressures. How should policymakers address these challenges?
With all the anxiety generated by the troubles of Portugal, Greece, and Ireland, it is easy to forget that a different part of Europe was in the spotlight two years ago, facing equally dire predictions of bank runs, fiscal ruin, and devaluation. Today, many economies in emerging Europe are quietly staging a strong comeback. Most impressive is the turnaround in the three Baltic countries, which suffered record deep recessions in the wake of the 2008/09 financial crisis. Take Lithuania, which grew an eye-catching 14.7 percent in the first quarter of 2011. Given this good news, what more can policymakers do to sustain the recovery—and prevent a new boom-bust cycle? Raising the long-term growth trend is key.
Corporate tax codes in the United States, most of Europe, Asia and elsewhere in the world, create a significant bias toward debt finance over equity. The crux of the issue is that interest paid on borrowing can be deducted from the corporate tax bill, while returns paid on equity—dividends and capital gains—cannot. This debt distortion is not new. What is new, however, is that we have come to realize that excessive debt (or leverage) is much more costly than we had. The global financial crisis was a stark lesson about the risks of excessive leverage ratios in financial institutions. Designing a better system will ultimately pay off. And now is the time for change. A recent IMF Staff Discussion Note offers two alternatives that reduce or eliminate the more favorable tax treatment of debt.
Banks―and the loans they provided in the run-up to the crisis―are at the heart of Europe’s problems today. Yet it would be wrong to conclude that the crisis was caused by too much financial integration. In fact, the real problem may have been that there was too little financial integration. Policies to promote deeper integration of Europe’s banks―including through cross-border merger and acquisitions―should be part of the solution. Further progress in strengthening the institutions of the European Union (EU) is also needed. What’s more, further European economic integration would unlock substantial efficiency gains, which would help to restore growth in the crisis-affected countries.
Much of the debate over global rebalancing has focused on the U.S.-China trade imbalance. But that’s missing the bigger picture. With the growth of cross-border supply chains—a signature feature of Asia’s trade in recent decades—it would be misleading to focus on bilateral imbalances and exchange rates. Instead of specializing in producing certain types of final goods, Asian exporters increasingly have specialized in certain stages of production and become vertically integrated with each other. So, as Asia’s economies strive to rebalance their growth models, we need to understand better how the regional supply chain affects the way exchange rates and shifts in global demand work.
For decades, countries in the Middle East and North Africa have relied heavily on food and fuel price subsidies as a form of social protection. And, understandably, governments have recently raised subsidies in response to hikes in global commodity prices and regional political developments. Like many things, there may be a time and a place for using subsidies. But, they need to be better targeted. And, often, there will be better alternatives. Alternatives that do a better job of protecting the poor. Subsidies enjoyed by all are typically poorly targeted, so they are not the most cost-effective way to provide social protection. They really should be regarded as stop-gap measures. But, better targeting subsidies or replacing them with more effective social safety nets is a complex process, so buy-in from the public is crucial to success.
The so-called BRIC nations—Brazil, Russia, India and China—could be a game changer for how low-income countries build their economic futures.
The growing economic and financial reach of the BRICs has seen them become a new source of growth for low-income countries (LICs).
LIC-BRIC ties—particularly trade, investment and development financing—have surged over the past decade. And the relationship could take on even more prominence after the global financial crisis, with stronger growth in the BRICs and their demand for LIC exports helping to buffer against sluggish demand in most advanced economies.
The potential benefits from LIC-BRIC ties are enormous.
But, so too are challenges and risks that must be managed if the LIC-BRIC relationship to support durable and balanced growth in LICs. (more…)