Crisis Talk - The World Bank Group

The Double-Edged Sword of Emerging Market Growth

The Economist has two interesting articles this week about capital flows in India. The Indian government is currently confronted with the a challenge of nurturing the growth of India's financial markets and multinationals, while mitigating the risks of excessive "hot money" flowing into the economy.

Proponents of capital controls point to India's success in avoiding the worst of the Asian financial crisis in the late 1990s and the current crisis, which was in part achieved by limiting the amount of money flowing in and out of the economy (for example, foreigners are limited in the amount of local bonds they can purchase).

Yet, India remains a sponge for foreign capital. The Economist notes that foreigners have invested $13.8 bn in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year. The Sensex, India’s most widely watched stockmarket index, has surged by almost 100% since its March lows.

Advocates of a stricter capital controls are facing a strong resistance from the market...

What's New in Decoupling?

I recently wondered what the relationship between developed and emerging economies would look like during the recovery phase of the crisis:

Will a robust emerging market rebound boost OECD growth? Or, are we due to see a multi-speed global recovery?

John Authers points out that, thus far, the recovery has been quite heterogeneous:

The grand theory was that decoupling by emerging markets would be good for everyone- they would grow even if consumers in the developed world caught a cold, and help everyone through. The latest data suggest a decoupled world, but that does not seem so positive.

Authers highlights the Reserve Bank of India's recent decision to raise rates and the "stunning" recovery in South Korea. Meanwhile, consumer confidence in the US is awful. He concludes:

Asian economies are already at the point where overheating is the main danger, while US consumers, for all the money thrown at them, are still not feeling any better. This is not encouraging.

Meanwhile, equity indices are down and the dollar is up. Perhaps investors were a bit too sanguine, and are now sobering up?

South-South Trade Tensions

John Authers argues that the newsworthy economic story of late isn't dollar weakness; rather, it is the weak renminbi:

Many, if not most, hopes for global recovery are pinned on China buying goods from countries such as Brazil. Commodity prices, a key driver of equities and forex rates, also move in response to the new orders received by China's manufacturers.

This currency regime makes it far harder for such countries to sell to China. So it is no wonder that currencies are back at the top of the agenda.

China's currency is 15 percent cheaper against the dollar than it was in 1993. Meanwhile, many emerging market currencies are returning to their pre-crisis exchange rates.

China has been building stronger trade relations with the Global South for quite some time. It is now South Africa's top export destination. But many of these partnerships are built around China purchasing commodities, and selling manufactured goods. With a weakening currency, China is likely to purchase fewer non-commidty goods from its trading partners. This may lead to growing trade tensions, particluarly with countries who are not endowed with commodities.

Emerging Market Wrap Up

Today's FT has a comprehensive summary of the current state of emerging markets. Not surprisingly, China and India are the clear winners, while the picture in the rest of the world is more murky. Perceived government mismanagement has steered investors away from Argentina and Venezuela, while Central and Eastern European nations, particularly Russia, continue to suffer the most.

The article, "Developing nations shine amid the crisis gloom", is well worth the read, and has some excellent quotes from leading emerging market investors, like this one from Robert Buckland, global head of equity strategy at Citigroup:

The financial crisis has been the making of the emerging markets in that they are no longer some kind of super-cyclical play.  It is no longer the case that if you downgrade US GDP by 1 per cent, the emerging market GDP will be downgraded by 2 or 3 per cent.  The balance sheet management of the emerging markets has been better in this crisis than the developed world.

Decoupling, anyone?

Economic Crises and Migration: Location, location, location

This morning's International Conference on Diaspora for Development featured an excellent discussion led by Hans Timmer, director of the World Bank's Development Prospects Group, and Dilip Ratha, lead economist and author of the Bank's migration blog. Messrs Timmer and Ratha discussed the impact of the crisis on migration patterns and remittance flows, providing several key insights.

First, to quote Ratha, "The more we learn about remittances, the more we realize how little we actually know." Overall remittance values are difficult to predict due to the size and informality of the sector.

That said, here is the 2008-9 outlook on remittance flows:

• Total estimated remittances for 2008 were $328bn
• Remittance flows in 2009 are expected to drop by 7-10 percent. This negative growth trend began in September 2008
• Paradoxically, remittances have become a more important source of external financing in many countries, as foreign direct investment has dropped by up to 50 percent

Buiter on Emerging Markets

Willem Buiter is among the foremost European monetary economists who is providing commentary on the unfolding crisis. (Charles Goodhart and Martin Hellwig round up the top-3). Here is what Buiter wrote recently on his blog:

The prospects of the emerging markets depend:

• First, on their dependence on external demand
• Second, on their dependence on external finance and,
• Third, on the scope for expansionary domestic demand management and the ability of the authorities to use it intelligently and flexibly.

Where Economic Freedom is Still in Fashion

In the East and South. With the advent of the economic crisis, Western pundits have immediately jumped on the "capitalism is dead" story. Things French are in fashion - and not only French kissing.
 
Yet in Eastern Europe, where I have travelled extensively over the past few months, the opposite is true. Policymakers are even more determined to divest the state from the remaining state-owned enterprises, the remaining subsidies to inefficient sectors. No one is talking about the death of capitalism, and certainly no one is talking about state ownership of banks. According to Arvind Subramanian, the same sentiment is prevalent in India and China.
 
Why is that? First, because only a decade ago Eastern Europe underwent a big "adjustment," and in many countries this was blamed on the corruption and incapacity of state-owned institutions. This changed society in two ways: the average citizen considers herself a freemarketeer in economics issues, and a new class of politicians came about, espousing free markets. 

Tomorrow's Trade

Editor's Note: Caroline Freund is a Senior Economist in the Research Department of the World Bank and runs a research project on the effects of the economic crisis on trade.

Tension is developing between trade and employment policies in some countries. The need to reduce costs and improve profits has pushed many companies to restructure production globally, with the result of increased foreign outsourcing. For example, Dell, the world's number two PC maker, recently announced plans to shift manufacturing from Ireland to Poland to cut costs. The monthly minimum wage is over $2,000 in Ireland, compared to $406 in Poland.

Other firms that are reportedly planning to expand outsourcing in emerging markets include: the major entertainment company Warner Brothers, Ireland's Wedgewood, and Japan's Renesas. Financial companies - which already account for about 25 percent of revenues of the large Indian service offshoring companies Infosys and Wipro - are also expected to increase outsourcing to cut costs. This fragmentation of production will help firms improve productivity, while softening the blow of the financial crisis on low and middle income countries, which gain both jobs and technology. The allocation of resources around the world will be improved, leading to gains from trade.

However, government policies are countering this force. The incoming U.S. administration has signaled an end to tax breaks for companies that outsource abroad and promised tax credits to companies that maintain or increase U.S. workers relative to those abroad. In France, state aid will not be offered to
auto companies that plan to shift jobs to lower wage countries. Lou Dobbs, among others, is calling for similar restrictions on a U.S. auto package.

Even without restrictions, industrial subsidies are a threat to trade. They are contagious, and could result in a subsidy war that would leave everyone worse off. (See, for example, a recent article from Jagdish Bhagwati in the Financial Times on this type of scenario.) In addition, they pull resources away from more productive uses. It's not just the industrial countries at fault. Recent trade policy reversals in the developing and emerging markets are also of concern. At least 15 (including Brazil, China, India and Russia) have plans to expand protection in some sectors.

Yes, creating jobs and maintaining income during the downturn is crucial. But this is a global recession. World leaders should choose policies that stimulate domestic demand, without inflicting pain on others.