The economic and financial crisis has largely discredited the development paradigm of the last three decades, with its emphasis on market forces, lower taxes and downsized state capacity.
We are told that recovery from the Great Recession of 2008-09 is well under way. But the continuing turmoil in Greece and the periphery of the European Union, including Eastern Europe, suggests that recovery is certainly not universal and that the global financial crisis may be far from over.
The fact is, most of the fundamental causes of the current crisis are still with us — banks that are too big to fail, money traders who make risky bets with other people’s savings and huge global imbalances between deficit-ridden United States and surplus-generating China and Japan, among other countries. The road to future crises and economic instability, it seems, is already being paved. To stop this, it is crucial that the lessons of the crisis be learned and action taken to avoid a return to business as usual.
A key step is to acknowledge the shortcomings of the current development paradigm resulting from the economic liberalization and globalization policies introduced by US President Ronald Reagan and UK Prime Minister Margaret Thatcher in the 1980s, with Canada’s Brian Mulroney following closely behind. The eruption of the debt crises in developing countries that decade led to structural adjustment policies codified in the “Washington Consensus.”
Under these policies, market forces, lower taxes and downsized state capacity were key instruments. They led to a pattern of globalization that favoured the powerful and the rich — multinational corporations and industrial countries — over the weak and the poor — developing countries, marginalized communities and women. The benefits of globalization were markedly skewed toward the former group while costs were borne by the latter.
Globalization of capital markets has had a particularly perverse impact on developing countries. Instead of flowing from rich countries where it is plentiful to poor ones where it is scarce, capital has flowed in the opposite direction. Much of it takes the form of illicit financial outflows, facilitated by misinvoicing by transnational companies and by tax evasion by corporations and individuals. The scale of such outflows is stupendous. According to Global Financial Integrity, annual illicit outflows amount to about $850 billion to $1 trillion a year, or several multiples of current levels of official development assistance to developing countries ($120 billion a year).
The economic and financial policies prevailing in the North over the last three decades and imposed on much of the rest of the world have been largely discredited by the crisis they helped create. A new development model or paradigm is imperatively needed to strengthen the resilience of poor countries and permit development to take place. The leaders of the G20 countries meeting in Toronto this June have an unparalleled opportunity to remedy the problems of the past and effect change for the coming generation.
Some of our research at the North-South Institute indicates that doing development differently is not only possible but necessary to reduce poverty and promote sustainable development in the world.
NSI’s research on official development assistance and the global financial crisis stresses the need to scale up aid and prioritize aid delivery through country budgetary systems to finance recovery measures. But it also recognizes the importance of building a world that is less aid dependent.
To that end, more priority needs to be given to aid effectiveness, meaning aid that is consistent with the receiving government’s plans, strategies and systems. This focus on “ownership” would go beyond simply receiving aid; it would determine how aid gets used, providing the policy space necessary for developing countries to set national policies and priorities in order to determine how aid would best be spent.
It is instructive to recap how quickly the current crisis was resolved in many of the industrial and emerging-market countries. Countercyclical economic policies, comprising interest rates that were lowered to levels of near zero and fiscal stimulus programs, were swiftly enacted. Until just prior to the crisis such countercyclical policies had been discredited by mainstream policymakers and media pundits. Today few would dispute that such measures helped avert economic collapse.
As yet, there are no IMF facilities oriented toward long-term development objectives related to poverty reduction and social and economic progress. Our research indicates that such an allgrant anti-shocks facility would provide the best possible basis for emergency assistance
Unfortunately, most developing countries do not have the latitude to deploy such counter-cyclical policies, ones that cool down the economy when it is in an upswing and stimulate the economy when it is in a downturn. Their tax bases are narrow and domestic revenues meagre; they lack domestic bond markets. They are, accordingly, much more dependent on external resources in the form of aid or private financing, such as foreign direct investment. Such external resources can be unreliable, volatile and tied to policy conditions or to the development of enclaves that do little to advance key priorities. Sometimes they also have negative environmental, social and political impacts. And the taps can be turned on and off at the behest of foreign donors or foreign investors. At times of crisis, these foreign agents are more likely to turn the taps off rather than do what countercyclical policy would demand — notably to turn the fiscal taps on.
A number of international financial institutions have acted since the onset of the global crisis two years ago to significantly increase emergency financing for low-income countries. The International Monetary Fund (IMF), for example, has demonstrated a capacity to create facilities that help countries cope with natural and economic shocks. The strength of these has been in providing quick-disbursing finance; their weaknesses include onerous financial terms and/or questionable conditionality.
To date, IMF efforts have helped remedy balance of payments disequilibria and have promoted macroeconomic stability but, as yet, there are no IMF facilities oriented toward long-term development objectives related to poverty reduction and social and economic progress. Our research indicates that such an all-grant anti-shocks facility would provide the best possible basis for emergency assistance, as did the Marshall Plan after the Second World War.
The above objectives of providing more fiscal space and national ownership can be underpinned by ensuring greater domestic resource mobilization. Broadening the domestic tax base, increasing tax and public revenues, and deepening domestic financial markets (including bond markets) would mobilize more domestic resources for development and reduce dependence on aid flows and on foreign borrowing and investment. Our research in five sub-Saharan African countries (Burundi, Cameroon, Ethiopia, Tanzania, Uganda) has identified several policy options, in both the public and private sectors, that would help achieve greater financial autonomy. For instance, untapped sources for taxation, such as property tax, should be developed. Loopholes and exemptions (including tax holidays for foreign investors), which typically cause huge tax losses for developing countries, should be reviewed and closed or, at the very least, narrowed.
The international community could also help build capacity for tax and savings mobilization through financial and tax cooperation, more coherent trade and investment policies and support to the development of the financial sector in developing countries. In the private sector, there is scope for augmenting pension and life insurance programs, which would also provide new or more channels for local savings.
Until domestic resources are mobilized to a substantially higher level, the sustainability of development initiatives will continue to be undermined by chronic aid dependence. The UN Millennium Development Goals (MDG) campaign is a case in point. While donors can help build momentum toward achieving the goals, for example, through front-end investments in areas such as universal primary education or maternal and child health care, sustainable advances in any sector will require recurrent investment and support. Some donors may continue to contribute past the MDG target date of 2015, but developing countries are likely to find that they will have to take up an increasing share of the burden soon afterwards. This means their governments will have to generate the revenues, primarily via taxation, to support the necessary expenditures.
Adaptation to climate change adds a new challenge for developing countries and presents the most urgent source of additional demand for external long-term financing. The recent Copenhagen Accord, for example, calls on industrialized countries to raise $30 billion a year for mitigation and adaptation efforts between 2010 and 2012. It also calls on them to raise an additional $100 billion by 2020 to address the onerous climate change challenges that developing countries will face.
Even though this amount may fall short of what is actually required to tackle the full costs of climate change adaptation in developing countries, $100 billion is roughly of the same order of magnitude as current aid flows from OECD donors. Faced by increasing deficits in fighting the recession, donor countries are likely to be hard-pressed to double aid flows over the next decade.
How are the additional external resources to be mobilized? New and innovative sources of financing will be required. The IMF has suggested that a Green Fund, financed in part from a redistribution of its so-called special drawing rights (SDRs), might provide a way forward.
SDRs are an international reserve asset created by the IMF 40 years ago and currently used to meet international payments obligations (they are the equivalent of money). A portion of outstanding SDRs can be made available to the poorest countries as they confront climate change. In April 2009, the G20 decided to create an additional US$250 billion worth of new SDRs. Along with a special allocation of about US$33 billion had been agreed to a decade ago, the new SDRs provide a compelling opportunity to address the climate change challenges.
Under the IMF’s quota formula, more than one-half of SDRs have been allocated to richer countries (not including emerging markets or more advanced developing countries). In other words, it is still possible to reallocate $140 billion to $150 billion for development purposes, virtually immediately. Some of it can certainly contribute toward the Copenhagen Accord’s goal of raising an additional $30 billion a year between 2010 and 2012 or toward a Green Fund that aims at mobilizing at least $100 billion in additional resources annually by the end of the coming decade.
Another possible source of innovative funding for climate change and/or other development initiatives is the application of a currency transaction tax (CTT), an option that NSI research has examined indepth. Based on conservative estimates, our research shows that $33 billion per year could be raised with a tax levied at just 0.005 percent on all global currency transactions, and without disrupting financial markets.
The research, coupled with the crisis, has resulted in financial sector taxes (both CTT and a proposed broader tax on domestic financial transactions known as FTT increasingly being viewed as prudential mechanisms to inhibit speculation as well as a way to mobilize public revenue from a sector that has been seen as paying less than its fair share of taxes.
Indeed, a report prepared by a coalition of civil society organizations recently proposed that $376 billion in revenues could be generated annually from currency ($33 billion) and financial transactions taxes on traded shares ($225 billion) as well as other securities ($118 billion) around the globe. While the above number crunching is focused on raising new funds for development, countries desperate for additional sources of revenue to help pay down deficits spawned by recent stimulus measures are also beginning to see a certain cachet in such taxes, including both Europe and the United States.
Hence while the possibility of a CTT or even an FTT may be talked about now more than ever, the tightening fiscal climate seems to have eroded the potential of these measures for international development purposes. If governments were to implement the CTT or FTT at all, the current economic climate dictates that they would likely use the monies raised to bring down their own deficits.
Moreover, Canada, host of this year’s G8/G20 meetings, has come out strongly against financial sector taxes of any kind, in part, because of the strong performance of Canadian banks during the crisis. This, however, does not diminish the fact that the global banking system was at the centre of the crisis, and even Canada did not escape the resulting economic fallout.
One thing remains certain: without radical changes in policies the world can expect recurring financial crises of similar or greater intensity to the one the world is currently climbing out of, while the underlying problems of growing inequality and social disarray continue to mount. On top of all this are the multiple threats of climate change, which, without adequate response, will visit recurring devastation particularly upon the poorest and most vulnerable parts of the world’s population.
As Canada and the rest of the G8/G20 prepare for their June meetings, they have a unique opportunity to articulate a new ethos for development that would constitute a final renunciation of the Washington Consensus, the “one size fits all” recipe that failed so miserably. Instead, as writers such as Dani Rodrik have argued, there are “many policy recipes” that suit different economic and historical contexts. Certainly, the emerging-market members of the G20, including China, India and Brazil, have demonstrated that, with policies significantly at odds with the Washington Consensus.
And yet, the farther the global financial crisis recedes into memory, the greater the strength of the forces of inertia. The G8/G20 leaders must resist this complacency, look to the evidence, and opt for doing development differently. The world is waiting.