Michael Spence: Ongoing Growth Needs Global Financial Regulation

The economist says the resilience of developing nations during the world economic crisis is encouraging, but long-term growth needs a global strategy.

April 01, 2010

| by Joyce Routson

While the United States seems still to be picking itself up from an 18-months-long recession, less-developed countries already have passed through the worst of the crisis and are well on their way back.

That’s what A. Michael Spence, dean emeritus of Stanford GSB, told a student audience April 15 in a speech sponsored by the student-run Public Management Initiative. Spence is chairman of the independent Commission on Growth and Development, a think tank studying global economic policy.

“Although recovery in advanced countries remains fragile, developing countries appear to have weathered the storm quite well,” Spence said. He said growth in China and India “is bouncing back toward pre-crisis levels.” Brazil is growing after a sharp dip, and other countries are trading again at pre-crisis levels.

“Reasons for this remarkable resilience are many and they offer guidance for advanced and developing countries alike,” Spence said.

It’s even more remarkable considering that capital flowed out of developing countries to shore up damaged balance sheets in advanced countries. So why did the less-advantaged countries come back sooner?

Spence said developing country banks played a large role. Rapid responses by central and domestic banks prevented a severe credit freeze, and reserves helped offset some of the capital outflow. Some countries also depreciated their currencies.

“Bank balance sheets had been strengthened after the 1997-98 financial crisis and were unencumbered by the overvalued securitized assets and complex derivative securities that caused much of the damage” to financial institutions in the United States and Europe, he said.

Despite developing countries’ varying capacity to inject their economies with needed fiscal stimulus, “many were capable of at least some countercyclical measures without destabilizing their public finances,” said the Nobel laureate.

Part of the fallout from the response by developing countries is that in the future they may limit their dependence on foreign finance, and instead fund investment from domestic savings. That has pros and cons, especially when “the basic pillar of high growth has been leveraging the global economy’s knowledge and demand,” Spence said.

“Indeed, worries about rising protectionism in a low-growth environment” are valid, Spence said. “This is particularly important for poorer and smaller developing countries in which domestic consumption and investment is a poor substitute for global demand.”

But he sounded a hopeful note: “Those developing countries that maintain a stable macroeconomic environment, a countercyclical mindset, and steady progress on governance, education, and infrastructure will thrive.”

While the emerging countries’ resilience and speedy recovery is an encouraging sign for the global economy, it’s not a substitute for a long-term solution to an “unregulated financial system that remains a cause for concern,” he said. Financial regulation and a coordinated approach to rebalancing global demand are necessary for sustained growth, as well as effective management and priority setting by the G20 nations.

In 2001, Spence shared the Nobel Prize in economics with George A. Akerlof of the University of California, Berkeley, and Joseph Stiglitz of Columbia University. The three were honored for their work on signaling theory and credited by the Swedish Academy with creating the field of information economics. Spence is a senior fellow at the Hoover Institution and Philip H. Knight Professor and Dean, Emeritus, at Stanford GSB.

Each year, students in the Public Management Program select a topic to explore in detail throughout the academic year. The Public Management Initiative topic for the current year is “Debating Tomorrow: How will business change after the crisis?”

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