Guest Roast: From Crisis to Resilience: Rethinking Macroeconomic Vulnerability

By Anuradha Seth

The frequency of global financial and economic crises has increased over the past decade and a half, and they appear to have become a systemic feature of the international economy. The risk of economic growth and human development achievements being undermined by such volatile international developments is fostering an overall re-think about the inner nature of crises, the growing vulnerability of developing countries and their capacity to be resilient in the face of these shocks.

In 2000, 189 nations made a promise to free people from extreme poverty and multiple deprivations and set a fifteen-year target in which to achieve eight Millennium Development Goals (MDGs) ranging from eliminating hunger and ensuring environmental sustainability to ending gender disparities and achieving universal primary education. As the 2015 MDGs deadline approaches, the debate around a new framework for understanding macroeconomic vulnerability and resilience is gaining momentum among a wide array of stakeholders, ranging from academia, civil society and grassroots movements, to international organizations, development policy-makers and the media.  Yet, as a new research piece by the United Nations Development Programme (UNDP) argues, at present, there is no uniform approach to understanding macroeconomic vulnerability or resilience in the context of financial and economic crises in developing countries. Meanwhile, traditional approaches are challenged as too narrow in scope to actually provide tools for the assessment of vulnerability or accurate information for the planning of national and international responses to crises.

Traditional Approached Being Questioned

Broadly, two distinct approaches can be identified. The first approach addresses macro-economic vulnerability principally in relation to financial crises—namely currency, debt or banking crises.  Currency crises, for instance, are seen as driven mainly by macroeconomic imbalances in the financial sector of developing economies and by fragile domestic financial systems. Hence, policy recommendations to build resilience to such shocks are focused on containing credit growth and the money supply, ensuring flexible exchange rates and guarding against expansionary fiscal policies. This is because the over- expansion of credit puts pressure on the banking system, raising the likelihood of bank failures and because a fixed/pegged exchange-rate regime puts pressure on the exchange-rate leading to a currency crisis.  However, the empirical and theoretical assumptions underlying many studies and articles that support this approach have been long questioned—in particular, the assumption that markets are self-regulating and inherently efficient.

A second approach frames macroeconomic vulnerability in the context of both economic and financial crises. The focus here is on identifying the structural determinants and transmission channels through which an economy is exposed to crises, reflecting the rapid integration of developing countries in international trade and finance. This broader perspective argues that the growing dependence of many developing countries on exports (specifically primary commodities—goods in their raw or unprocessed states, such as agricultural products and raw minerals); their increased dependence on foreign investment for economic growth; and limited fiscal and institutional capacity renders them vulnerable to economic and financial shocks. Yet, there is no clear agreement on which structural determinants and transmission channels are the primary drivers of macroeconomic vulnerability. Some argue that the size and location of an economy are critical determining factors as small economies face limited natural resources and have a limited ability to exploit economies of scale, and issues of location such as remoteness and insularity increase transportation costs and the cost of importing raw materials. Others focus on trade dependency or dependency on international private capital flows as the primary conditions that expose an economy to shocks via the vicissitudes of the international trading system.

Inequality: The Missing Driver

A major determinant of macroeconomic vulnerability that is either totally neglected or barely mentioned by these studies is that of rising income inequality. The staggering escalation in inequality contributes to global and domestic economic and financial instability by fostering a political environment that lends itself to risky investment behavior and the emergence of asset bubbles. For instance, when wealth is concentrated with a small part of the population, those at the top end of income distribution find themselves with a pool of excess capital and search for profitable opportunities to invest. In the absence of effective management and regulatory controls, the search for high-return investments leads to speculation, the emergence of bubbles and high asset prices.

The critical importance of inequality as a driver of crisis is clear when one is confronted with the fact that the average income of the world’s richest 5 per cent is 165 times higher than the poorest 5 percent. In a world where the richest 5 percent earn in 48 hours as much as the poorest in one year, understanding the linkages between rising income inequality and the greater frequency and severity of the financial and economic crises is central to proposing policies that build systemic resilience and enable a less volatile growth process. Rising Inequality also lowers overall productivity by reducing the purchasing power of middle- and low-income households, reducing total demand and economic activity.

The recent—and lasting—economic and financial crisis, along with renewed calls for a re-think on traditional approaches to economic growth and development, offers us the opportunity to embark on a more comprehensive framework for the assessments of macroeconomic vulnerability in developing countries.  Such a framework should allow for a comprehensive mapping of all the structural conditions and transmission channels that drive the vulnerability of developing economies, including economic inequality. Understanding the links between income surging inequalities and worsening global crises is central to new policies that build resilience and promote less volatile growth, but coping with crises only after they erupt limits options for concerted action to tackle inequality.

Calls for a re-think of existing approaches should ultimately help us deliver policies for resilience that build coping capacities to withstand and counteract a shock and reduce exposure to shocks, while advocating for global coordination mechanisms to minimize the frequency of global crises themselves.

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Anuradha Seth is the Senior Policy Advisor on Macroeconomic Policy and Poverty Reduction with the Poverty Practice of UNDP’s Bureau for Development Policy in New York.

The full report on ‘Towards Human Resilience: Sustaining MDG Progress in an Age of Economic Uncertainty’ is available on UNDP public website. A shorter version of the report was recently published by the International Policy Centre for Inclusive Growth as its Working Paper No. 94.




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