Wednesday, August 12, 2009

Staying Afloat During the Great Recession

. Wednesday, August 12, 2009

Nouriel Roubini offers a list of countries that are doing well:

What do these countries have in common? One major theme is that they tended to have lower financial vulnerabilities due to more restrictive regulation and less developed financial markets, as well as larger and stronger domestic markets that sustained domestic demand. Moreover, they had the resources to engage in countercyclical fiscal and monetary policies, actions that were not possible in past crises. In contrast, countries that borrowed heavily to finance domestic consumption in the days of easy money are now facing sharp economic contractions. Despite the relative strength of these countries, however, their ability to return to sustained growth will depend on structural reforms that support consumption.

(bold added)

Drawing any particular set of policy recommendations from this list risks selecting on the dependent variable. Plenty of countries with less developed financial markets and strict regulation have done very, very poorly in this crises (c.f. most of E. Europe and many export-biased economies in Asia, Europe, and the Middle East). The second component -- "larger and stronger domestic markets that sustained domestic demand" -- may be more important, but there are plenty of counter-examples there are well. Another key may be found in Roubini's discussion of Latin America:

Brazil and Peru stand out for their relatively healthy fundamentals and financial systems. Both countries have benefited from being relatively closed economies and from having diversified export markets and products. They also took advantage of the boom years (2003-08), reducing external vulnerabilities and increasing savings (fiscal and international reserves). By the time these the crisis hit, both countries had well regulated financial systems that saved them from being contaminated by toxic assets. The fact that their domestic credit markets are at an early developmental stage, so consumption is not very dependent on credit, helped them shelter internal demand.

Chile has also done fairly well during the crisis by pursuing robust counter-cyclical policies, made capable by years of extreme prudence during good times. But note two of Roubini's observations about Brazil and Peru: they are relatively closed economies with poor access to credit. These are bad things that stymie economic growth (in normal times at least), make their citizens poorer, and lead to more unequal societies. In this event these circumstances led to some insulation from the global meltdown, but that is mostly a result of being somewhat disconnected from the global economy. If such policies persist in the future, they will lead to stagnant growth and underperformance.

Just look at the list. Other than China, India, and Egypt, almost every country had underwhelming growth before the crisis, and that trend could easily resume after the global recession reverses. So we should learn our lessons from countries that have shown resiliency, but we should not necessarily hold up the countries on Roubini's list as exemplars of economic performance.


Staying Afloat During the Great Recession




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