LETTERS TO THE EDITOR

Summer 2009

by Anders Nordström

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Sir,
Jean-Michel Debrat and Simon Maxwell make a good case for Europe to respond constructively to the severe impacts that the global recession is having on developing countries. But their five priorities for redesigning EU development cooperation are long on general aspirations and rather short on specifics. That is partly because they focus on where the impact will be (exports, remittances, foreign direct investment, trade credits etc) rather than on the underlying causes. It is therefore worth looking in more detail at the channels through which the global recession is affecting the developing world.

The origin of the recession was a global financial crisis triggered by a banking crisis in the U.S. and Europe. This resulted in a severe contraction of global capital markets and a corresponding threat of financial mercantilism. So, just as the global recession hit hard, developing countries found they could no longer raise the capital required to finance necessary adjustments. Developing economies are therefore being thrown back onto their domestic financial sectors for both capital and financial services. This, then, is one specific area where the EU should direct its efforts.

There are many ways the EU can help to develop the domestic financial sectors of partner countries, including the imaginative use of the financial resources mentioned by Debrat and Maxwell. The EU could help to develop forms of financial risk sharing, such as guarantees or subordinated debt instruments, which do not remove the incentives from banks to assess risks and cut costs.

The EU can also ensure that the impacts on middle- and low-income countries are taken properly into account when the whole international architecture of financial regulation is being redesigned. These effects were neglected after the crisis in 1997-98; such mistakes must not be repeated. We must listen to the developing world and consult the institutions that were created to promote financial sector development in partner countries, such as the Financial Sector Reform and Strengthening Initiative (FIRST) and Making Financial Markets Work for Africa.

The EU can also provide appropriate technical assistance. The follies of the last few years may have damaged Europe’s financial sector, but the EU still has a wealth of knowledge of, say, retail and commercial banking, capital markets, microfinance and the development of savings and co-operative banks. FIRST and programmes like ESMID and the Toronto Centre are building on the opportunities for knowledge sharing. The Toronto Centre, for instance, combines high-level regulatory capacity-building and change management, guided by top-level financial system players. ESMID promotes a holistic development of local and regional debt markets, which in turn creates mutually beneficial links between public and private finance.

Emerging market economies and poorer nations are experiencing different types of impact from the global recession. But the overall message of this crisis is clear: globalization means all countries share the pain as well as the gain. Global recession also underscores the link between the health of the financial sector and economic growth. Robust financial sectors are an engine of growth, but growth is destroyed when financial sectors collapse.