A world of hurt

poor village

This crisis threatens countries that can least afford it, writes James Wolfensohn

It is now clear that we are in the midst of the worst global economic slump since World War II, if not the Great Depression.

The good news is that policy makers and commentators appear to have grasped the scale of the problem in advanced economies. The bad news is that we have yet to realise the implications of the crisis for the world’s poorest countries.

Only in today’s globalised economy could a downturn spread this quickly and indiscriminately. What began as a series of tremors in the United States has been felt throughout advanced and emerging economies, and is now rippling out across the poorest and most vulnerable countries in the world.

Commodity industries which underpinned much of the recent economic success in developing countries have seen a precipitous drop in demand and a resultant collapse in prices. Harvests planted at the peak of food prices may no longer cover costs. Once-profitable mines have been mothballed.

Meanwhile, remittances are expected to contract this year for the first time since 1985, just as capital flows into developing countries are running dry. With lower export revenues, exchange rates are again under pressure, undermining macro-economic stability and the sustainability of foreign debt obligations.

The International Monetary Fund now projects emerging and developing countries will grow by just 1.5 to 2.5 per cent in 2009, following two stellar years, during which growth exceeded 6 per cent.

To some observers, growth of 1 or 2 per cent in the midst of a global recession may sound enviable. Australia is likely to record negative growth this year, while other advanced economies face contractions of 3 per cent or more in 2009.

But there are at least five reasons why the IMF’s forecast for developing countries is much worse than it sounds, and why the international community must begin seriously contemplating the risks this crisis poses to the world’s poorest.

First, the developing country forecast is an aggregate figure and masks significant disparities among economies. Taken together, China and India’s economies are likely to grow by around 5 per cent this year. When these two Asian powers are excluded, the forecast for the remaining countries’ growth falls to zero. Many developing countries will face severe recessions in 2009, and possibly into 2010.

Second, population growth is significantly higher in developing countries than in advanced countries, necessitating higher growth to maintain per capita living standards. While advanced economies have meagre population growth rates averaging 0.5 per cent, in least developed countries (LDCs), populations are growing on average by 2.3 per cent each year. This means that gross domestic product growth in LDCs needs to be at least 2.3 per cent, just for incomes to remain flat–a remote prospect for many.

Third, even a modest fall in incomes can have critical effects in poor countries. For individuals living just above the poverty line, small steps backwards can lead to desperation and extreme hardship. Most developing countries cannot afford the luxury of social safety nets, such as unemployment insurance, and thus the prospect of a downturn literally threatens peoples’ livelihoods.

According to the World Bank, the crisis will push an additional 53 million people below the absolute poverty line of $1.25 a day. As a result, between 200,000 and 400,000 more children may die every year between now and 2015 than would otherwise have perished.

Fourth, unlike in advanced economies where recessions generally have limited impact on growth trajectories in the long run, slowdowns in developing countries can have lasting effects. Recent evidence demonstrates that growth in developing countries is asymmetric: contractions are of greater consequence than recoveries.

Therefore, a bad year cannot be made up for with a good performance the following year. Work by the economists John Page and Jorge Arbache shows that in African economies during the past 30 years, growth decelerations were associated with a significant decrease in primary school completion rates, which did not pick up again during growth accelerations. Likewise, child and infant mortality worsened during slumps, but didn’t always improve when the economy turned around.

Even a year or two of poor nutrition and fewer children in school can mean decades of lost development.

Similarly, a brief period of neglecting infrastructure maintenance can have long-term consequences. If, due to tightened government budgets, developing countries allow infrastructure maintenance to lapse for even a year or two–and operations and maintenance funding is always one of the softest targets during a budget crunch–the reconstruction costs in the future can be great.

For example, in Papua New Guinea, Australia’s closest neighbour and largest aid recipient, the cost of maintaining one kilometre of road is between $1500 and $7500. If the government regularly keeps up this maintenance, its roads will be in good shape. But if maintenance is allowed to slide for a year or two, the government must then rehabilitate the road, at a cost of around $200,000 per kilometre. Let another two years go by, and the road must be reconstructed, which will cost $450,000 per kilometre. The long-term costs of deferred maintenance expenses can easily spiral out of control.

Fifth, there is a real concern that growth slowdowns in poor countries might lead to instability and conflict, and even to state failure. The crisis has already provoked protests throughout Europe, and has brought down three governments –in Iceland, Latvia, and the Czech Republic–with another, Hungary, on the verge of collapse.

This is evidence of a dangerous progression in the crisis, from a financial affair to an economic, social, political, and potentially, an international security concern. With each step along this sequence, the cost of intervening rises exponentially and our ability to contain the crisis grows more remote.

In the past eight months, four African nations have succumbed to military coups–a reminder that the risk of political and civil unrest is already high in countries with extreme poverty and weak institutions. This risk will only escalate under mounting economic stress. Research on growth and conflict in sub-Saharan Africa demonstrates that every 1 per cent decrease in GDP growth increases the likelihood of civil conflict in the following year by 2 percentage points.

As 2009 growth projections for Africa are now 3 per cent lower than they were before the crisis, this suggests the risks of conflict in African countries are now, on average, 6 per cent higher than they would otherwise have been.

These gloomy forecasts can only be avoided by a collective response in which both advanced and developing nations act as partners. It is only right that advanced nations should shoulder some of the responsibility for the impact of the crisis on the developing world.

While there has been plenty of debate as to who is most to blame for this crisis–lax regulators, greedy bankers, profligate consumers and borrowers–the world’s poor must be considered innocent victims.

Furthermore, developing countries and their governments lack the resources to shield themselves from the worst effects of the crisis. These resources are not just monetary but include institutions, service delivery mechanisms and other capacities.

The convening of the G20 heads of state, in Washington last November and more recently in London, offers hope that we will assume this collective responsibility. The G20 is, by definition, a more representative group than its more limited predecessor, the G7, and has already given greater attention to the needs of developing countries. Among the wide-reaching commitments agreed on in London, those on concessional loans, trade finance, and tax havens hold particular promise for developing countries.

Ultimately, whether these agreements are acted upon remains an open question. At the Washington meeting, the G20 leaders pledged to reject the temptation of protectionism by resisting the imposition of new trade barriers, only for 17 members to renege on this promise. On many other issues, such as the reaffirmed commitments to the Gleaneagles aid targets and the vow to complete the Doha Round of trade liberalisation, there is the same sense that action may not follow words.

The failure to move beyond lip service when considering the fortunes of the developing world could easily be written off as a common character flaw among our political leaders. A more forgiving explanation is that our leaders may sometimes overlook the threat posed by economic collapse in poor countries.

It is easy to ignore crises that occur in small, far-away countries. Their problems pose no apparent threat to the world economic order, international markets or trade.

However, when economic failure leads to state failure, conflict spillovers, and even the development of new terrorist havens, their importance to people living in the West is brought into sharp focus.

Although it is sometimes a struggle to concentrate global attention on poverty alleviation as a goal in itself, in today’s integrated world, sovereign default, a military coup, or instances of social unrest will be cause for concern wherever they take place.

Assistance to developing countries should rightfully be seen as an investment in global stability. The cost to the international community of even one or two additional failed states would surely rival the amounts currently being spent to rescue the financial systems of advanced countries, and completely dwarf the amounts being spent to help poor countries weather the downturn.

The easiest and least expensive method for handling state failure is to stop it before it occurs, which requires action today.

Governments in developing countries will need to adjust to lower tax revenues and export earnings while avoiding macro-economic instability and limiting the burden on the poor.

The best way advanced countries can support these goals would be to significantly increase foreign aid. However, given the fiscal constraints facing donor countries and the demands of citizens to focus spending on their ailing domestic economies, such an outcome looks increasingly unlikely. Indeed, many donors have already announced plans to scale back their assistance.

But even in the absence of new funds, there is much that can be done. Developing countries and their donor partners must work together to craft country-specific responses to the crisis which follow the same basic principles of fiscal stimulus adopted in advanced economies: spend money as quickly as possible, while getting the greatest expansionary “bang for the buck”.

This includes, for example, speeding up the disbursement of funds, which have already been committed as aid but which have yet to be delivered to recipient countries–an estimated $80 billion, or about 50 per cent of the total spent on aid last year.

It also means altering the composition of aid, so that less is spent on technical assistance–ie, paying generous salaries to Western-based consultants–and more is spent in recipient countries. Perhaps above all, shielding vulnerable countries from the crisis demands that governments honestly re-assess their priorities, so that even when faced with shrinking budgets, both basic services and public investments crucial to spurring business creation are guaranteed.

Throughout this crisis our actions have been driven by a concern for the so-called systemically significant, whether it be propping up banks considered too big to fail or including large emerging economies in shaping the international response.

It is by this same reasoning that we have largely ignored the plight of the poorest countries. Accounting for only around 1 per cent of global GDP, the world’s least developed countries appear of little significance when it comes to restoring global growth. But this view fails to consider the potential evolution of the crisis into something worse.

With each step along the financial-economic-social-political-security path, the systemic significance of the poorest countries grows. We share a collective responsibility to prevent this path from being taken.

James Wolfensohn is Chairman and CEO of Wolfensohn & Company, and from 1995 to 2005 was the ninth President of the World Bank