The Catch-up Game

• Author: Archana Kumar
• Position: Senior Editor on the staff of Finance & Development
• Pages: 29-31

An academic and a policymaker share insights on what makes countries grow, in good times and bad

Page 29

The current financial crisis has brought the issue of growth and stimulus back into sharp focus. To gain insights into this issue, Archana Kumar from Finance and Development magazine turned to two experts: Michael Spence, a Nobel Prize-winning economist, and Mahmoud Mohieldin, Minister of Investment of the Arab Republic of Egypt. Both have served on the Commission on Growth and Development-a group of policymakers and academics that came together for two years to explore the causes, consequences, and internal dynamics of sustained high growth. The commission, which completed its work well before the financial crisis took such a severe turn, recently published its findings in The Growth Report: Strategies for Sustained Growth and Inclusive Development.

F&D: What are the critical actions needed in advanced economies to lessen the impact of the financial crisis on the real economy?

Spence: We face two scenarios in the developed economies. One, if we don't effectively solve the credit crunch problem, it will cause extraordinary and widespread damage to the economy outside the financial sector. And that scenario will be worse than anything we've seen in the post-war period. There is a reasonable chance that with a focused global effort-I mean an internationally coordinated one-we can avoid that scenario. It will not immediately settle the stock markets because they are operating on a completely different dynamic that has to do with fear, but it is still important and policymakers should focus on that. So I would put that at the top of the list.

The second scenario is a little harder to get people to focus on, but because we have already seen tremendous growth slowdown, we need both a well-thought-out fiscal stimulus that has a time dimension to it and a plan to restore fiscal balance in the long run that can prevent further chaos in the financial markets. Larry Summers, among others, has talked about this at some length.

So those would be my two candidates: deal with the real effects of the financial crisis and, to the extent possible, recapitalize the financial system; and then focus on the fiscal side. Of course, the financial system cannot be recapitalized fast enough to solve the credit lockup problem, so it has to be solved with direct interventions of various kinds: guarantees for transactions that are being cleared in the interbank transaction system, the U.S. Federal Reserve buying commercial and municipal paper, and so on.

"We need both a well-thought-out fiscal stimulus and a plan to restore fiscal balance in the long run."

Spence

Mohieldin: The first thing is restoring confidence, and the second thing is restoring confidence. The issue of trust and confidence in, and the credibility of, the financial system is very crucial today. Whatever we can do to restore confidence is going to be beneficial, not just for the developed countries but also for the developing countries.

As Professor Spence just mentioned, we need to think of some shortcuts- some supportive measures-until we can get the financial institutions back in order. To fund crucial development projects...