Global Economic Crisis: Policy Responses in Developing Countries

Mehdi Shafaeddin

The global economic crisis is a wake-up call for developing countries, particularly low-income ones, to reconsider their long-term industrial and development strategies as the short-term counter-cyclical macroeconomic policy tools available to them are very limited. It is not going to be easy, but it is necessary. Some selective import restrictions under the “balance of payments clause” of the World Trade Organization (WTO) and capital controls would be helpful, but not sufficient. A debt moratorium, debt forgiveness and other concessional financial flows are urgently needed, and will help, to provide low-income countries with some temporary relief. But what is essential for their long-term development is to increase their capacity to take the risk of external shocks and instability in export earnings. To do so, a different development and industrial strategy is required to diversify and upgrade their structure of production and trade.

Of course, there is no “one-size-fit-for-all” development strategy for developing countries, including the low-income ones, as they include diverse economies despite their common problems. Nevertheless, one may make some common as well as specific policy proposals as follows. First, it should be emphasized that the market alone is not the only tool of coordination of economic activities; there are roles for market, enterprises and government. But, the relative importance of each should change during the process of industrialization and development. At early stages of development the government’s role is crucial; so the capacity of the government machinery for formulation and implementation of policies should be strengthened. As the country develops, the relative role of market and enterprises increases and that of the state should decrease.

Secondly, highly populated countries have a better chance of pursuing trade and industrial policies on their own; landlocked and smaller countries, which are in proximity to each other, may enter industrial collaboration, production sharing together with preferential trade agreements and joint industrial policies. In both cases there is need for a dynamic, flexible and targeted industrial policy based on the principle of dynamic, rather than static, comparative advantage.

Thirdly, the development of a competitive industrial structure also requires development of the agricultural sector- where feasible- in order to enhance the supply of food, particularly noting that international food prices seem likely to remain high in the future.

Fourthly, foreign direct investment (FDI) in general, and in export processing zones (EPZs) in particular, should be managed, controlled and targeted in order to serve the objectives of the industrialization and development of the home country. Control of capital flows in general should be a part of long-term development strategy.

Finally, remote Island countries which depend on tourism may consider following a policy consisting of foreign reserve management and specialization in various types of tourism. For example, some may specialize in sports tourism, others in health tourism, luxury tourism, academic tourism, etc. Further, they may invest in areas which provide backward linkages to the tourism sector such as food processing. They may also get involved in production sharing in cases where they are in proximity to each other (e.g. some Asian Pacific Islands).

There are some constraints, imposed through WTO rules, on implementation of the trade and industrial policies proposed above, but low-income countries, particularly least developed ones, still have some room to manoeuvre. They should, however, resist further loss of their policy space through the WTO and especially Economic Partnership Agreements (EPAs). International Financial Institutions also should reconsider their policies towards low-income counties.

Implementation of such policies is not going to be easy. But he alternative is not only underdevelopment, but also the risk of human tragedy, particularly in Sub-Saharan African countries where a large portion of the population faces extreme poverty, health risks, and malnutrition. The international community also has responsibility in this respect.