1. Post-Financial Crisis: Options for Africa Joseph E. Stiglitz African Development Bank January 2010

2. Lessons from the Financial Crisis No country is immune from crisis –We are less sure than we were before about what we mean by “good institutions” and “good policies” Many thought that the U.S. had both But it clearly did not

3. Lessons from the Financial Crisis Developing countries have been among the innocent victims of the crisis –Affected through financial markets, trade, investment, and remittances –Countries that were most integrated into the global economic system were most affected Globalization is a double-edged sword –But some countries have managed globalization better than others But even those that were less integrated have been affected Magnitude of impacts differ –Those with financial surpluses better able to withstand crisis –Those with better safety nets have done better –Those with better regulated financial systems have done better

4. Lessons from the Financial Crisis Crisis has exposed weaknesses in certain economic theories/policies –Especially policies that advocated deregulation, unfettered markets As exemplified by Washington Consensus policies Capital and financial market liberalization contributed to the rapid spread of the crisis around the world –Theories based on “rational expectations” and “rational behavior” called into question Multiple examples of irrationality Bubbles do exist Booms and busts have marked capitalism from beginning But market advocates forgot the lessons

5. Some Lessons for Economic Theory/Policy Central bank doctrines also shown to be flawed –Non-independent central banks did better than independent central banks –Focus on inflation detracted from focus on growth, employment, and financial sector stability Loss from crisis orders of magnitude greater than any losses from inflation –Bernanke/Greenspan doctrines that one can’t tell a bubble before it breaks, that central banks don’t have instruments to deal with bubbles, and that it is better to clean up mess after the bubble breaks than to deflate the bubble have all been shown to be badly flawed Government played vital role in saving the economy –But that means government has a responsibility to prevent crises from happening –Especially true for developing countries—they can’t afford the kinds of actions that the US and Europe took

6. Some Further Lessons for Economic Theory/Policy Unfettered markets are not self-correcting, not necessarily stable, not efficient –Financial markets failed to perform their central role in managing risk and allocating capital at low transaction costs –Had high transaction costs Not all innovations are “good” –Financial innovations did not increase overall efficiency of the economy –Did not help ordinary individuals manage the risks that they faced –Increased risk –Financial sector repeatedly resisted innovations that would have improved the well-being of society An efficient electronic payment mechanism An efficient mortgage system Indexed government securities

7. Some Further Lessons for Economic Theory/Policy Underlying problems –Misalignment of incentives Social returns not equal to private rewards Problems of corporate governance –Pervasiveness of agency problems Modern capitalism markedly different from nineteenth century capitalism –Pervasiveness of externalities America’s financial markets imposed huge costs on America’s workers, homeowners, taxpayers, retirees… America’s failures imposed huge costs on rest of the world

8. The Big Lesson What is required is the appropriate balance between the market and the state –Balance will differ from country to country and from time to time Government has a role not only in “preventing accidents” but also in promoting good innovations –Industrial policies

9. The Crisis will have Long-Run Impacts on the Global Landscape Some of the policies pushed on developing countries caused the crisis, exacerbated the magnitude of the downturn, and contributed to the rapid spread –Undermining the “authority” of those institutions and individuals who pushed these policies

10. New Global Governance The move from G-8 to G-20 is an important step –But there are still 172 countries not represented Only one sub-Saharan country in G-20 –G-20 lacks political legitimacy and representativeness –Failed to mobilize adequate funds to help the poorest countries Most of the money was in the form of short-term loans And G-20 turned to the same institutions that played a key role in the failures –Though the IMF has made marked changes in some of its stances

11. Other Successes and Failures Rhetoric against protectionism may have helped modulate protectionist response –But still, most of the G-20 took protectionist actions Reforms to the international institutions important –Choosing the head on the basis of merit long overdue –But reforms still too little and too slow Failed to get agreement on global regulatory reform –Reforms have been slow in coming –And are not likely to be adequate –Suggesting another crisis down the road –Especially because of the poor conduct of the bailouts, which has exacerbated the too-big-to-fail problems

12. Recognized importance of dealing with global imbalances –Imbalances weren’t responsible for this crisis, but could cause next But solution was not well thought out –US needs to save more –But if China were to consume more, would have little effect on US exports –Real problem is not too much global savings –Real problem is too little investment directed at global needs Climate change Development

13. Failed to recognize/address key global problems –Growing inequality Weakening global aggregate demand –High levels of risk/failure of financial markets and international institutions to manage risk well implies high demand for reserves Weakening global aggregate demand –Uncertainty about the price of carbon

14. Copenhagen—A Major Failure No agreement on how to share the burden –Not even an agreement on what should be the underlying principles –Though there was some reaffirmation of long- standing principles of common but differentiated responsibilities No agreement by developed countries on how to fulfill their previous financial commitments to developing countries for mitigation and adaptation

15. A Missed Opportunity Addressing problem of global warming could have helped fuel robust recovery –Uncertainty about future price of carbon will weaken investment in energy sector

16. Potential large costs to Africa –Region likely to be affected by global warming –With fewer resources to finance adaption Need incentives to maintain forests –Providing a global public good –One positive development at Copenhagen

17. A New Global Balance of Economic Power Growth in Asia continues to be robust With benefits to commodity exporters around the world China’s influence growing –As countries recognize the need for diversification –Countries that were more diversified did better –China played large role in debate over global reserves –Without agreement with China, a deal in Copenhagen was not possible –China is playing an increased role in Africa Impact on aid already evident Impact on investment likely to gr ow –China’s economic model has obviously worked –And many find its policy of non-intervention attractive Though there may be long-run consequences for civil rights, democracy

18. A Post-Crisis Economic Strategy for Africa Global Diversification Diversification of sectors Industrial Policies Agriculture Managing Resources Preparing for the Next Crisis

19. A Post Crisis Economic Strategy for Africa: Global Diversification Globalization has changed economic geography Should take advantage of new markets in Asia And new sources of investment funds Ready to take advantage of rising wages in Asia which will change global comparative advantage But Africa should recognize that it must break out of commodity-dependence –Whether it is Western or Eastern

20. A Post Crisis Economic Strategy for Africa: Sectoral Diversification Structural adjustment contributed to the de-industrialization of Africa –14.3% manufacturing share in 2006 less than 15.9% in 1965 Even countries that followed Washington Consensus policies have attracted little investment outside of natural resources

21. The Developmental State Markets on their own won’t lead to Africa’s development Government will need to take a role Including by pursuing Learning, Industrial, and Technology Policies (LIT) –Recognizes that what separates developing countries from developed is not only a gap in resources but also a gap in knowledge –Finance can be key instrument (developmental banks) Private financial markets not developmentally oriented Typically much too short term focused Great Recession forcing a rethinking of capital and financial market liberalization policies –Government needs to provide the pre-conditions for private sector Physical and institutional infrastructure Education and health But government has to do more than that In almost every successful country, governments have pursued such policies

22. Agriculture LIT policies also apply to agriculture In recent decades there has been a lack of investment in agriculture –Infrastructure (roads, irrigation) –Technology But also weaknesses in institutional infrastructure –Credit markets –Marketing –Extension services With the result that productivity and incomes are low With such a large fraction dependent on agriculture, only way to address poverty, meeting MDGs

23. Land is key issue Africa has moved from land abundance to land scarcity –Climate change may be exacerbating problems But institutional arrangements have not changed in ways that reflect this Will be one of key challenges going forward

24. Managing Resources Better Many African countries will remain resource dependent But resource wealth has to be carefully managed –Countries like Chile that did so have managed storm better –Maximizing value obtained Using new global competition to extract the maximum rents –Making sure that resources are well used Transparency is key –Macro-economic management High level of volatility Risks of exchange rate appreciation (Dutch disease)

25. Key Lessons Some countries have managed resources well (Botswana); most have not –Rich countries with poor people –Resource extraction doesn’t give rise to employment; as a result of appreciation, there is often job destruction; little “learning” –Lower growth, more inequality (natural resource curse) –If wealth below ground is not reinvested above ground, country is poorer

26. Preparing for the Next Crisis Advanced industrial countries have not addressed their fundamental problems –Banking sectors more concentrated; too-big-to-fail problem worse –Global imbalances little improved –Little progress on climate change Strategy requires reducing exposure to risk and increasing capacity to respond to risk –Objective of diversification strategy And a strategy of greater regional cooperation, greater self-reliance –Greater care in liberalization strategies –Stabilization funds/build-up of reserves Those countries with large reserves performed better

27. Learning the lessons from this crisis –Without government intervention the world would have been in a major depression –Need to strengthen state capacities, get a better balance between the market and the state –Inflation targeting achieved neither growth nor stability New frameworks required for monetary policy

28. Even if we had managed this crisis perfectly, there will be crises in the future Need to be prepared –Automatic stabilizers –Flexible systems of social protection

29. Goal: Sustainable Growth with Stability and Shared Prosperity Before, too much focus on stability, too little on growth In the end, there was neither growth nor stability What growth that occurred was not shared and was not sustainable Comprehensive post-crisis agenda provides an alternative way forward