The Copenhagen Consensus and financial instability

Back in March, the Economist, along with Denmark’s Environmental Assessment Institute (which is run by environmentalist bete noire Bjorn Lomborg), announced the Copenhagen Consensus project. As their March story phrased it:

Policymakers face enormous demands on their aid budgets—and on their intellectual and political capital as well—when they try to confront the many daunting challenges of economic development and underdevelopment. Climate change, war, disease, financial instability and more all clamour for attention, and for remedies or palliatives that cost money. Given that resources are limited, the question is this: What should come first? Where, among all the projects that governments might undertake to make the world a better place, are the net returns to their efforts likely to be greatest?

You can go to the Copenhagen Consensus’ main site by clicking here. This week, the magazine reports on the report prepared by Barry Eichengreen on the costs of financial instability in the developing world. The costs are significant:

The typical financial crisis claims 9% of GDP, and the worst crises, such as those recently afflicting Argentina and Indonesia, wiped out over 20% of GDP, a loss greater even than those endured as a result of the Great Depression. According to one authoritative study, the Asian financial crisis of 1997 pushed 22m people in the region into poverty. For developing countries, currency crises are an important subset of financial crises. Mr Eichengreen, while cautioning against taking the precision of such estimates too seriously, reckons that the benefit which emerging-market countries would reap if such crises could be avoided altogether would be some $107 billion a year.

Bring on the capital controls!! Oh, wait, it’s a bit more complicated:

Wherever financial markets are absent or repressed, savings go unused, productive economic opportunities go unrealised and risks go undiversified. If India’s banks and stockmarkets were as well developed as Singapore’s, India would grow two percentage-points a year faster, according to one study. To grow fast, and keep growing quickly, countries need deep financial markets—and the best way to deepen financial markets, most economists agree, is to liberalise them. Does this mean that countries must open their financial markets to foreign capital, thus exposing themselves to the risk of currency crises? Or should they impose capital controls, confining the perversity of financial markets to national borders, where the central bank retains the power to offset it? Foreign direct investment aside, China’s capital markets are still largely closed to outsiders. Yet it has no shortage of credit. For other countries, though, the evidence is mixed. A fair reading of the studies, and there have been many, suggests that, for most countries, opening up to foreign capital will deliver faster growth in most years—punctuated by a damaging financial crisis about every ten years. Some economists argue that periodic credit crunches are the price emerging markets must pay for faster growth.

[So you’re saying we should just shrug off the $107 billion as the cost of doing business in a global economy?–ed. Absolutely not. More importantly, Eichengreen doesn’t shrug it off either, and he’s a real economist with some intriguing proposals up his sleeve — though I’m not completely convinced they would work.] You can download Eichengreen’s paper here.