There is, we sense, something seriously wrong with a world economy that has produced deep financial crises in a growing number of countries, and resulted in chronic economic stagnation or decline in others. Unfortunately the architectural designs proposed by the rich countries are inadequate to the challenges facing the world community.
We had better start with a clear idea of the global home in which the human family is living. There are about six billion of us, so that we may imagine six family members. On the top floor lives one person in a luxury penthouse, representing the billion or so in high- income countries. This lucky soul enjoys an average annual income of about $25,000 and a life expectancy of 76 years.
The upper tier owns virtually all of the world's corporate wealth. The developed countries are home to approximately 99.4 per cent of the total market value of the 500 largest listed companies in the world.
Five of the six family members, or five billion people, live on the lower floors. They have an average income of about $1,200 per person, though in terms of purchasing power the number is perhaps three times higher. These five-sixths of humanity are extremely poor and virtually without financial capital.
The upper tier of this lower group constitutes the so-called emerging markets. These are the economies with the wealth, social organisation and geographic conditions that make it possible to attract capital from international private investors. There are two family members, two billion people, living in this "exalted" state among the poor.
Some countries in this group, such as Korea, have had great success in raising living standards, while others have faced difficulties for decades, punctuated by short periods ofgrowth. Many of these countries, including Korea, Mexico, Brazil, Thailand, Malaysia and Indonesia, have suffered deep financial crises.
In a nutshell, these "lucky" middle-income developing countries were credit-worthy enough to attract large amounts of international capital, but had enough structural problems to be vulnerable to a financial panic. In one such country after another, foreign investors abruptly withdrew funds they had invested. The abrupt withdrawal destroyed the banking sectors to which they had been lending, and caused the economies to suffer short-term declines in income.
These crisis countries are, none the less, among the lucky developing countries. They were successful enough to attract private foreign investment, even if the investment proved volatile and destructive.
Half of humanity, three of our six family members, live huddled in the basement of the human home, too economically unstable to attract foreign investment, and therefore too poor even to experience an emerging-markets crisis. The average income of these three billion people is perhaps $1,000 a year in purchasing power. Not only are they bereft of financial assets, but life expectancy is 10 to 20 years less than in the penthouse, and they are vulnerable to diseases almost unknown in the top floors.
Our financial architects have devoted a considerable amount of time to thinking about the penthouse, and the emerging-market level just below, and almost no time to thinking about the half of the family living in impoverishment in the basement. The current system works fine for the penthouse. As for the emerging markets, the lessons of recent years are clear, although the confusion that reigns has prevented a consensus on needed measures. Every one of the major crises in recent years - Brazil (1999), Indonesia (1997), Korea (1997), Mexico (1994), Russia (1998), Thailand (1997) - went through similar phases.
Each of the countries that succumbed to crisis started with a national currency pegged to the dollar. Each attracted large capital inflows, including short-term loans from international banks. In each country, the currency became overvalued, leading investors to withdraw their money in anticipation of a devaluation.
Each country defended the currency until it had depleted its foreign exchange reserves. And in each, this was followed by a panic by foreign investors, in which the remaining short-term debts were abruptly recalled. The International Monetary Fund then stepped in with a "rescue plan", but failed to stop the panic, and the downturn proceeded with ferocity.
There are three lessons for the economic architect. First, emerging market currencies should be allowed to float, since countries with pegged currencies too often run out of foreign reserves. Second, these countries should abstain from taking short-term loans from international banks. Short-term inflows easily become short-term outflows. And third, these countries should not turn to the IMF for help. The IMF advice itself has often added to the economic destruction.
Our house will remain on shaky foundations unless the architect pays vastly more attention to the impoverished souls in the basement. Many of the three billion of the world's poorest live in countries whose governments have long since gone bankrupt under the weight of past credits from foreign governments, banks, and agencies such as the World Bank and the IMF. These countries have become desperate wards of the IMF.
There are two fundamental needs for these desperately vulnerable souls. First, their debts should be cancelled outright, and the IMF sent home. Second, these countries need help in mobilising the world's science and technology to address their unsolved problems.
Let us tell our architects to redouble their efforts to build a home with enough room in the upper floors for all of the human family.
The writer is Galen L Stone professor of International Trade at Harvard University, and director of the Harvard Institute for International Development. He is an economic adviser to governments in Latin America, Europe, Africa, the former Soviet Union and Asia.Reuse content