Global Economic Prospects 1998/99 :
Foreword

by Joseph Stiglitz

There is a single set of events that dominates the world economic scene today as it has for more than a year: the global economic crisis that began in Thailand on July 2, 1997, spread from there to Indonesia and Korea, then to Russia, then to Latin America. Few countries have not been touched by the global forces that this crisis--by some accounts the worst since the 1980’s debt crisis--has unleashed. Some countries have gone, in the space of a few short months, from robust growth to deep recession. The social consequences of this economic downturn are already manifest, with interrupted education, increased poverty, poorer health.

In the midst of this uncertainty, it is important for us to have a sense of where the global economy is going, what has brought us to this juncture, and what can be done both to enhance our current prospects and to make another such calamity less likely. Global Economic Prospects and the Developing Countries 1998/99 lays out the anatomy of the crisis in a clear and concise fashion, and assesses both the short- and long-term outlooks for the world economy and the developing countries in the aftermath of the crisis.

A current snapshot of the world economy shows an economic situation dramatically different from just a year ago. What started as a regional economic slowdown grew into a global crisis. According to the report, 36 countries that account for more than 40 percent of the developing world’s GDP and more than a quarter of its population will likely see negative per capita growth in 1998. In 1997, by comparison, per capita income fell in only 21 countries that accounted for 10 percent of the developing world’s GDP and 7 percent of its population.

It is easier to describe where the world’s economy is today than to forecast where it will be in the coming year. The art and science of economic forecasting is always risky, but it is on particularly shaky grounds when it comes to trying to forecast turning points. Indeed, inadequacies in forecasting undoubtedly contributed to the downturn: had the magnitude of the downturn been accurately foreseen, less contractionary policies might have been pursued, and the ensuing recessions might not have been as deep--these are among the lessons that are drawn out in Chapter 2. But to be fair to the economics profession, standard macro-models, augmented by an understanding of the role that weaknesses in the financial sector played in the crisis (a point also emphasized in Chapter 2), strongly suggested a major slowdown, if not necessarily of the severity of what occurred.

But while forecasting is thus inevitably highly risky, the task of putting together the forecast--including exploring the links among the various parts of our integrated world economy, both among countries and markets--helps draw attention to sources of weakness and strength. By focusing on the downside risks and upside opportunities, it helps focus attention of policymakers not only on the actions that they should take today, but on the kinds of contingencies for which they should be prepared.

As a development institution, the World Bank is especially concerned about long-term prospects for the developing countries. Though we cannot predict, with any accuracy, when the world economy and the developing countries will fully recover from the current downturn, we do know this: there have been crises before, and the world has always recovered from them. And after recovery, the determinants of growth are underlying forces--savings, demography, the pace of technological change. Crises can, of course, have long-lasting effects that tend to persist: European unemployment rates have yet to return to the levels of 20 years ago prior to the oil crisis. Many analysts attribute this to the attrition of skills that accompanies prolonged unemployment. Similarly, undoing the effects of the massive corporate failures that have plagued several of the affected countries will not be easy.

This report argues, however, that while 1998 was and 1999 will be very difficult years for developing countries, in the longer term growth could still reach the record setting rates of the early 1990s. But this will happen only if policies to prevent a deeper global slump are implemented quickly In recent weeks, the G-7 countries have taken a number of important policy steps in this direction to foster world economic recovery and to prevent a global recession.

Understanding the nature of the East Asian crisis and the response of the international community is vital to shaping how well we rise to the challenge of crises in the future. Last year, when it became clear that there would not be a magic bullet to fix Asia’s financial crisis quickly, we were encouraged by our clients and shareholders to launch a research project to provide an in-depth examination of the causes of the crisis, an impartial analysis of the world’s response, and some guidance on how we can make crises such as this less frequent and less painful. Chapters 2 and 3 represent our interim report on those research findings. We should be clear: there is not unanimity on many of the key issues. This report cannot resolve all of the outstanding issues. It is our hope, however, that it will serve a constructive role in moving the international discussion on these questions forward, by identifying areas where there is and where there is not a consensus; and when there is not, trying to identify the reasons, whether it is alternative models of the economy or interpretations of the evidence.

There are inevitably a multiplicity of factors that contribute to any complex phenomenon such as the crises that have beset East Asia. This is especially the case because the situation in each of the countries differed, in some respects, markedly. But our research concludes that the origins of the crisis lay fundamentally in the interaction between institutional weaknesses in managing domestic financial liberalization and international capital market imperfections. Unlike the Latin America debt crises of the 1980s, the East Asian crisis was not characterized by excessive sovereign borrowing or severe macroeconomic imbalances. As a result, policies that were successful in responding to the debt crisis were not necessarily optimal in the circumstances of East Asia;. The initial policy responses may have failed to recognize quickly enough the costs of exacerbating the downturn at a time when banks and private businesses were already in trouble, demand was falling, and capital was flowing out. In the event, the crisis had serious social consequences, in part because of the absence of social safety nets. The report suggests that the lesson to be learned from these events is that in future financial crises, the primary role for fiscal and monetary policy should be to shore up demand, expand the social safety net, recapitalize banks, and restructure corporate debt. Social safety nets in particular must be a central component of the policy response to a crisis.

The report also explores how to avoid future crises. In an age of large-scale private capital flows, developing countries face very complex problems in managing these flows but have little experience with the institutional and regulatory safeguards necessary to prevent crises. But even industrial countries have, in recent years, faced financial crises. Some of the more recent crises have occurred in industrial countries with advanced institutional structures and high levels of transparency. We know too that establishing the strong institutional infrastructure required to make markets work effectively, to enable the economy to experience stable and sustained growth, are tasks that will not be accomplished overnight, even in countries with a high level of commitment to make the necessary reforms.

When a single car has an accident on a bend in the highway, one might infer something about the driver or his car. But when, at the same bend, there are accidents day in and day out, the presumption changes--there is probably something wrong with the road. The fact that such a large number of countries have been affected by this crisis and required large official bailouts suggests some fundamental systemic weaknesses. In order 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 and where necessary, restrictions on capital inflows. In some cases it may be necessary to reverse the excesses of financial sector deregulation, especially in situations where countries lack the capacity for the required regulatory oversight. In each case, we need to ask what are the benefits and costs of the proposed reforms; and we need to look at the impacts on growth, stability, and poverty. The balance of benefits and costs of different policy reforms may differ in different countries. We need to recognize that in many of the poorest countries we are not likely to have, in the immediate future, robust safety nets. We have seen the devastation to the lives and livelihoods of millions of people that financial crises can have on innocent bystanders. We are seeing poverty increase overnight, undoing the slow progress that has been taking place year by year. For the poor people in those many developing c ountries without an adequate safety net, the risks are indeed high, perhaps unacceptably so.

While the consequences of the crisis have been severe, the report ends on a note of optimism. 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--from better bankruptcy laws, a greater willingness to accept standstills and arrangements entailing more equitable burden sharing, to a greater receptivity to interventions designed to stabilize capital flows, to a greater 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. The two together--improvements in domestic institutions and in the international financial architecture--will enable greater numbers of countries to be able to enjoy more of the benefits--and minimize the risks--of the global economy.

Summary Global Economic Prospects 1998/99
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The 1998-99 edition of Global Economic Prospects and the Developing Countries

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