Macroeconomic Management

From Singapore to Shenzhen, Special Economic Zones—SEZs for short—have helped underpin the rapid export-oriented growth of East Asia. In an effort to replicate these sleepy-fishing-village-turn-thriving-metropolis success stories, many countries in the developing world have created economic zones of their own—and their growth has been dramatic. In 1986 the International Labor Organization’s SEZ database reported 176 zones in 47 countries; twenty years later in 2006, there were more than 3,500 zones in 130 countries.

Various policy objectives have motivated the creation—and exponential expansion—of SEZs around the world. Generally, governments have created these zones to attract foreign direct investment, to alleviate large-scale unemployment, to support wider economic reform strategies, or to experiment with the application of new policies. The model has been extremely successful in many countries—in the Dominican Republic, for example, it allowed for the creation of more than 100,000 manufacturing jobs. However, such successes have not been universal or without controversy in the past, nor are they guaranteed in the future. In a post-crisis world with a changing macroeconomic and regulatory environment, new challenges have emerged, and some of the principles underlying traditional economic zones are no longer sustainable.

In the aftermath of the global economic crisis, financial market regulators have proposed a myriad of reforms to better govern the banking sector and to enhance its resilience to future shocks. In fact, in September 2010, a number of measures were agreed upon by the Basel Committee on Banking Supervision, an international forum designed to foster cooperation and develop standards on banking supervisory matters. The cornerstone of these reforms—collectively known as “Basel III”—is a commitment to stronger capital and liquidity requirements, which will ensure that banks are better able to absorb losses in the future. Other significant measures include reforms to improve supervision, risk management, governance, transparency, and disclosure in the financial sector.

As I argued in a recent article, “Reviving a Policy Marriage,” such a harmonization of financial supervision and macroeconomic management can be the key to happy cyclical endings in the long-term. However, concerns have been raised that the costs of moving to higher capital ratios may lead banks to raise their interest rates and reduce lending in the short-term, which can pose financing problems for emerging markets that are dependent on global banking flows.

In the most recent edition of the World Bank’s Economic Premise series, authors Swati Ghosh, Naotaka Sugawara, and Juan Zalduendo examine the short-term impacts of the regulatory changes proposed under Basel III on emerging markets.

A newsclip in the DECPG Daily dated April 19, 2010, noted: “After Greek aid talks were delayed by disrupted air travel, Greek bond premiums relative to German bunds spiked again on Monday.  Air travel disruptions caused by Iceland’s recent volcanic eruption delayed the start of talks on a potential bailout package.... The delay could further weigh on already anxious markets”.  As it turns out, spreads on Greek bonds continued to rise, and significantly, even after the EU-IMF rescue package was finalized.  The reasons why are explored in an article Christophe Chamley and I wrote for The Economists' Voice. 

The basic idea is as follows.  Suppose a country is experiencing fiscal solvency problems. Then an official loan rescue package could spark a sell-off by private creditors if they perceive the official loans as senior to their own claims unless primary fiscal surpluses are raised substantially.  The sell-off would tend to depress bond prices and raise spreads relative to the benchmark country.

This is not the first time an official country bailout has run into trouble--nor will it be the last.  In 2001, Homi Kharas, Sergei Ulatov and I wrote a paper on the 1998 Russian crisis in which we argued that the design of the official rescue package hastened the Russian meltdown.  Here's what we said on page 43 of the paper:“A debt-based (official) liquidity injection that aims to boost confidence could worsen public debt dynamics while offering heavily exposed (private) investors a convenient selling opportunity....the financing portion of the package could actually trigger a crisis if the market is sufficiently skeptical about the implementation of fiscal and structural reforms. This argument is even stronger if the (official) liquidity injection involves debt that is perceived to be senior to existing claims of private creditors."

There has been an ongoing debate on the future need for foreign aid—a debate made ever more crucial by the current budget constraints in many countries as a result of the financial crisis. Some contend that aid budgets should be ramped up to counter the continued existence of severe poverty in the world; others argue that aid has been ineffective in the past, and in some cases, stymied growth in developing countries. In between these two poles, we are confronted with the new realities of foreign development aid.

As emphasized by Wolfgang Fengler and Homi Kharas, authors of Delivering Aid Differently—Lessons from the Field, the recent transformations in the foreign aid environment are threefold. First, strong growth in the developing world has changed the face of aid recipients. Where developing countries were once collectively grouped as the “Third World,” previously poor countries and regions are transcending the need for aid—and some are becoming donors themselves. Second, a new troupe of actors is stepping onto the donor stage. In addition to the aid provided by traditional donors, a vast array of international non-governmental organizations, philanthropic foundations, multinational corporations, and faith communities are assuming a larger role than ever. Third, innovation, information, and technology are changing the delivery of aid. In terms of building local capacity to take on today’s development challenges, the transfer of knowledge is now becoming as important as financial aid itself.