Good friend Harsh Gupta pointed me to the article penned by Dani Rodrik and Arvind Subramanian on the recent market turmoil faced by emerging economies (Turkey, South Africa, Brazil, etc.). They do not name names but they are referring to the comments made by the Turkish Prime Minister and that of Raghuram Rajan, the governor of the Reserve Bank of India. For a great point conveyed with telling deliberation and to great effect by Raghuram Rajan, see this short video.
There is always merit in making people see what they could have done correctly themselves but the points have to be cogent and coherent. Look at this paragraph and the next one:
The Fed has received scant word of thanks for propping up the U.S. and, hence, the world economy at a time when policy elsewhere (especially in Europe) was so counterproductive.
The next one:
The Fed may not be internalizing the objectives and constraints of other countries today, but neither did emerging markets act on the behalf of the Fed then. It isn’t convincing to cloak self-interest as unselfish cooperation.
So, in the first paragraph, the Federal Reserve saved the world and in the second paragraph, the Fed may not have internalised the objecives of other countries.
If the second statement is true, then the ‘Fed saving the world economy’ was incidental. The Federal Reserve was clearly acting in the interest of the US economy in 2008-09, 2011 and 2012 when it reduced interest rates to zero (0 to 0.25%) and then repeated QE2, QE3, not to mention ‘Operation Twist’.
In the G-20 meetings, the rest of the world – emerging economies in particular – was urged to increase their domestic spending so that the developed world could export their way out of trouble. Their domestic economies were broken. What have the leading emerging markets got for boosting current account deficits and spending? A run on their currencies mainly and in some cases, accompanied by run on their bonds and stocks.
Clearly, emerging economies were doing their part in running up current account deficits. The problem is the manner in which the current account deficits came about. That is a legitimate target of criticism but that is not what the authors criticise.
Instead, the authors criticise them for their financial globalisation. It is not unfair (deliberate use of double-negative) but it misses the point too. Yes, for instance, countries like India ran up fiscal deficits and in order to help corporations get their funding, the government liberalised external commercial borrowings. Corporations too, on their part, borrowed overseas heavily unmindful of possible risks – lack of foreign currency earnings, interest rate risk, Indian rupee weakness especially in the light of the inflation-laden fiscal policy that the government has been pursuing, etc.
These criticisms are fair but up to a point. If the argument is that these countries liberalised their capital accounts too much too soon, then that point should have been made more directly. ‘Financial globalisation’ is too vague and fails to carry the impact.
Were the authors afraid of the backlash they would get in their host country if they spoke up for capital controls?
Further, are emerging nations always free to choose to reject wholly or in part and also choose their timing of ‘financial globalisation’? Is the power balance between the United States and developing economies or emerging economies equal?
The US dollar is a global reserve currency but only the US can issue this fiat currency. The United States enjoys a lot of advantages of being the most dominant global reserve currency. That privilege comes with obligations whether M/S Rodrik and Subramanian agree or not.
Never in its history has the United States displayed any mindfulness of those obligations. It is not an ‘obligation to charity’. It is a quid pro quo for the enormous interest rate advantage that accrues to the US for the rest of the world accepting its fiat currency as their reserve currency.
Prof. Ron McKinnon has written extensively about the ‘Rules of the Game’ that were supposed to undergird this post-Bretton Wood dollar standard. The United States was expected to run a balanced fiscal policy and not be overly mindful of current account imbalances. The United States has failed in both.
When the current account deficit rises, it starts looking for scapegoats in the international community to blame. It deploys protectionist trade policies. It deploys rhetoric against the so-called restrictive trade practices of other nations, both via friendly journalists, think-tanks and other outlets. The US knows but others pretend not to know that the charge of ‘restrictive trade practice’ cuts both ways and they happily play the blame-game on behalf of the United States.
Dr. Y.V. Reddy, the former Governor of the Reserve Bank of India brilliantly observed in his book that global financial markets (or, should we call them out more directly as ‘international financial institutions’?) do not treat emerging economies the same way they treat developed economies. Therefore, he said that it is symmetrical and rational for emerging economies not to treat financial markets the same way as developed economies treat them.
In a sense, that is what Raghuram Rajan said in his measured remarks delivered with great deliberation and to good effect. See link above.
In fact, given the ‘regulatory capture’ by financial institutions of policymakers in the developed world, sometimes the rest of us are hardpressed to distinguish genuine policy moves by developed nations from those aimed at benefiting their financial institutions.
So, what is the conclusion?
Developing countries did get their policies wrong to an extent. But, running up current account deficits is not one of them. The developed world wanted them to, but markets are now punishing them for it. They could have run up the current account deficit for the right reasons – domestic capital and infrastructure spending. But, that is an internal matter and does not alter the fact that they contributed to global demand which they were asked to do.
US acted in its self-interest as did developing economies. But, what the latter did was in line with the obligations enjoined upon them in G-20 meetings. What the US did was entirely for its own economy and it has not lived up to the commitments it made in those G-20 meetings in 2008-09.
There is an international power imbalance between Western and developing nations and hence, pacing or even avoiding ‘financial globalisation’ is not entirely in the hands of developing nations.
As the issuer of the global reserve currency, the United States has obligations to conduct monetary policy in a manner that is sensitive to global concerns. It is not an obligation to charity.
If it does not, other countries can choose to respond appropriately and that is exactly what Raghuram Rajan has said. That was not ‘playing the victim’ but a remarkable display of his grasp of realpolitik by warning them of the aces he has up his sleeve without showing them.
That was very well needed. M/S. Rodrik and Subramanian are off target by a wide margin.