One of the factors often pointed to as a cause of the Great Depression was a series of competitive devaluations - 'beggar-thy-neighbor' policies that turned into a lose-lose proposition for industrialized countries. A similar downward spiral has revealed itself during the current financial crisis.
Many countries are competing for scare capital through a variety of means, for instance, through bank deposit guarantees. Once one country makes a guarantee, others feel the pressure to do the same or see deposits depart their country. A diplomatic row broke out between Britain and Iceland over this issue just a few weeks ago. But most high-income countries have mechanisms that can help coordinate and limit the potential damage of 'beggar-thy-neighbor' policies: witness the recent EU summit on the financial crisis.
Faced with this crisis, emerging market countries have also felt pressure to adopt beggar-thy-neighbor policies as part of larger crisis packages, but there is a slightly bigger question mark about the ability of these countries to cooperate. Witness these recent measures:
- Russia extended the remit of its banking deposit agency, adding another 200 billion roubles to its budget.
- Turkey has plans to remove taxes on earnings from equities and treasury bonds.
- Brazil removed a financial transaction tax on foreign investment.
These are just a few examples I have run across - I am sure there are more to come. The problem is that if many emerging markets implement these policies, none of them gain any advantage over the other. On top of that, emerging markets may face the consequences of these decisions for years to come; blanket deposit guarantees, for instance, are notoriously hard to remove once they've been put in place. All of this suggests that the G20 - due to meet in Washington in mid-November - will be key to resolving the financial crisis.
Join the Conversation