For more than a year, the global economic crisis, which began in Thailand July 1997 and spread rapidly throughout east Asia, and then to Russia and Latin America, has dominated the world economy. Almost every country in the world has been affected to some degree. In just a few short months, some went from robust growth to deep recession.
The social consequences of this sharp downturn are already apparent: children dropping out of school, millions of people either falling back into poverty or coping with already desperate circumstances, and poorer health.
The crisis caught most economic forecasters off-guard. Even today, no one can predict how long the crisis will last or how deep it will be. But in the midst of this great uncertainty, it is important for us to have a sense of where the world economy is going, what has brought us to this juncture, and what we can do to improve our current outlook and to make another such global calamity less likely.
A new World Bank report tries to provide this information. Global Economic Prospects and the Developing Countries 1998/99 examines the anatomy of the Asia crisis and assesses both the short and long-term outlooks for the world economy in its wake. As the report makes clear, there is not unanimity on many of the key issues surrounding the crisis. But it is another step toward understanding the nature of the crisis, analysing the world's response, and providing some guidance on how we can make crises less frequent in the future.
A snapshot of the world economy today shows a situation dramatically different from just a year ago. Developing countries have been hardest hit. Their per capita growth is expected to slow this year to 0.4 per cent, down from 3.2 per cent last year. In 1998, 36 countries that account for more than 40 per cent of the developing world's gross domestic product and more than a quarter of its population will likely see negative per capita growth. By comparison, in 1997 per capita income fell in only 21 countries that accounted for 10 per cent of the developing world's GDP and 7 per cent of its population.
How did east Asia, the site of miraculous economic growth for three decades, find itself in the eye of such a storm?
There is no single culprit for the problems that have beset the region. The economic situation in each country differed. But Global Economic Prospects concludes that the origins of the crisis lay fundamentally in the interaction between two things: the difficulties of domestic financial liberalisation and the problems associated with volatile inter-national capital markets.
Unlike the Latin America debt crises of the 1980s, the east Asian crisis was not characterised by excessive sovereign borrowing or severe macroeconomic imbalances. Although the current crisis has proved to be much harder to remedy, it has taught us that the primary role for fiscal and monetary policy in future financial crises should be to shore up demand, expand the social safety net, recapitalise banks, and restructure corporate debt. Social safety nets in particular must be a central component of the policy response. Excessively contractionary policies, in economies beleaguered by highly indebted firms, lead to high rates of bankruptcy, making the tasks of corporate and financial sector restructuring and the restoration of business confidence more difficult.
The crisis in east Asia revealed how difficult it is for developing countries to manage enormous private flows without adequate experience.
To deal with the risks posed by large capital flows, especially significant when financial systems are weak, the report suggests that reforms must be comprehensive, and include a combination of more flexible macroeconomic policies, tighter financial regulation and, where necessary, restrictions on capital inflows. Financial sector liberalisation, which can greatly increase the risk of a crisis, must be accompanied by stringent regulatory oversight.
While the policy mix will vary according to each country's particular circumstances, social protection needs to be at its centre. Sadly, the poorest countries are unlikely to develop robust safety nets in the immediate future. In Indonesia and Thailand alone, the number of people falling back into poverty in 1998 could reach 25m. For poor people in countries without an adequate safety net, the crisis has had devastating consequences.
Nevertheless, there is some cause for optimism. Although 1999 is likely to be another year of slow growth in developing countries, their situation could improve in 2000 and following years. Policymakers have recently announced a number of welcome steps designed to foster world economic recovery in the medium-term including interest rate cuts in the United States and Europe, a fiscal stimulus and financial revitalisation package in Japan, agreement on a Brazilian fiscal package and a precautionary line-of-credit, and a Japanese-led $30bn assistance package in Asia.
The crisis has also forced international financial institutions to examine how they responded to the crisis, and what lessons they might take on board in managing future crises.
The World Bank, for its part, has re-affirmed its belief that social policy concerns need to be centre-stage. While never a substitute for sound, pro-growth economic policies, social safety nets can help cushion the worst effects of the crisis on the poor and other vulnerable groups. After all, it is people, not governments, that live out the harsh reality of crisis.
Another lesson we have taken to heart is that a standard "one-size-fits-all" response to a financial sector crisis, such as east Asia's, clearly did not work and imposed a heavy cost on many in the region.
We must adopt a more comprehensive approach to crisis management that adopts more flexible exchange rates, tighter fiscal policy, and where necessary, some form of restrictions on short-term private capital flows. In other words, we must be more nimble and open-minded when responding to crises, and less influenced by the standard rescue formulae that worked well back in the 1980s debt crisis or, in more recent years, in Mexico's economic crisis.
While the World Bank and its sister institutions continue to reflect on the lessons of east Asia, wider events over the past year may well herald a new, more realistic and stable environment for developing countries.
We now have a better understanding of the institutional infrastructure that is required to make market economies work. The international community is giving serious attention to necessary improvements in the international financial architecture. There are many such improvements. The most important include: better bankruptcy laws; greater receptivity to interventions designed to stabilise capital flows; greater willingness to accept debt repayment standstills and arrangements entailing more equitable burden-sharing; and more recognition of the need for responses to crises that are better adapted to the circumstances of the country, and to protecting the most vulnerable within them.
These improvements in domestic institutions and in the international financial architecture will enable greater numbers of countries to enjoy more of the benefits and minimise the all-too-obvious perils of the global economy.
The author is senior vice-president and chief economist of the World Bank in Washington, DC
