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The New New Normal
If the West doesn't shape up, the rest of the world will just go around it.
On my travels around the world this fall and at international meetings of economists and policymakers, one thing has become crystal clear: A growing number of developing-country officials are increasingly worried that "irresponsible" political behavior in the United States risks undermining the well-being of their citizens. Indeed, the 16-day government shutdown this October and the congressional brinkmanship over the debt ceiling that threatened a payments default are just two points in a seemingly endless series of strange developments that risk fueling unnecessary financial and economic instability in the rest of the world. And with Europe still struggling to regain a more robust economic footing, the developing world takes little comfort in operating in a global economic system that is constructed on the assumption of a stable, rational, and responsive West.
Being on the receiving end of Western-induced economic disruptions is not a new phenomenon for developing countries. Only five years ago, they felt the full impact of a financial crisis that peaked in the United States with the disorderly collapse of Lehman Brothers. With the frightening fragility of the Western banking system fully exposed, developing countries struggled to counter the collapse in global GDP and trade. Fortunately, and to the surprise of many, emerging economies bounced back from the global financial crisis much better — and much faster — than most analysts had predicted. Moreover, they have handily and consistently outperformed the West in terms of growth and job creation.
But that may not last — and that would primarily be the West’s fault. The West’s current phase of economic policy inconsistency has a lot to do with the difficulties that democracies with short election cycles face in dealing with the consequences of low growth and persistently high unemployment. Five years after the 2008 financial crisis, and after billions of dollars poured into recapitalizing banks, Europe and the United States have not yet been able to kick-start their economies into escape velocity and return to sustainable high-growth rates and proper job creation. And disappointments have a habit of generating even greater disappointments. Rather than step up to the challenges, the political system in general, and the U.S. Congress in particular, has become much more susceptible to paralyzing polarization. In the process, policymaking has become more fragmented, and countries have become more insular and notably less open to holistic policy approaches that break the hold of prolonged downturns.
But while Americans can gripe and moan about their political dysfunction — and yes, eventually force a change through the ballot box — the rest of the world has no choice but to frown and bear it. The implications go beyond bracing for the occasional government shutdown and threats of technical default by the issuer of the world’s reserve currency. They also affect the very manner in which the global economy functions.
Economic and financial resilience is key if developing countries are to navigate what is, to borrow an elegant phrase from outgoing U.S. Federal Reserve Chairman Ben Bernanke, an "unusually uncertain" outlook. And here, developing countries have to come to terms quickly with — and respond to — four increasingly entrenched realities: The global economic system anchored by the West will remain volatile going forward; multilateral reform is essentially stuck, eroding the already thin possibility that coordinated policies could improve the common good; developing countries have fewer economic and financial defenses at their disposal today as compared with five years ago; and they face greater temptation to return to bad old habits or remain in denial.
Like a poorly equipped car on a frustratingly long and bumpy journey, developing countries must weather the potholes created by the West with fewer spare tires. Financial cushions are less robust this time around; lower international reserves and greater corporate and household debt have left many countries less resilient to the shocks caused by American congressional dithering. Ironically, crisis managers in key countries seem to have become a little more complacent, either denying the growing potential for financial instability (Turkey) or engaging in pointless blame games (Brazil).
Even the more agile policymakers in Asia and Latin America convey a sense of frustration, if not fatalism and helplessness, when it comes to an obvious and inconvenient truth: Developing countries are structurally wired into a global system — be it trade, finance, regulation, or multilateral governance — that is anchored by an increasingly insular and less predictable West. The post-World War II system is based on the assumption that the core will act rationally and responsibly when it comes to its global economic and financial functions. And lately, this has not been the case.
Developing countries are powerless to rewire the system quickly, especially as there is no other economic and financial superpower to replace the United States at the core. No wonder China expressed annoyance at U.S. congressional behavior, particularly as it threatened the estimated $1.3 trillion Beijing holds in bonds issued by the U.S. government. Yet even Beijing can do little save complain. Like other developing countries, China can’t bail on the global economic system. It can only advocate better policymaking in the West, while at the margins tweaking some "south-south" trade and financial relationships.
But this impotence is not a permanent condition. If the United States and Europe can’t figure out how to limit the damage that subpar politics is doing to their economies, the developing world will begin to seriously experiment with bolder approaches that sidestep the tired and obstructionist core of the global financial system. It might not happen today or tomorrow, perhaps not even this decade, but it will happen. And the effect could be material and irreversible. Indeed, the resulting fragmentation could well end up making the global economy less efficient, undermining both actual and potential global growth and making it more prone to cross-border tensions.
We should certainly all hope that it’s just a matter of time before the West returns to being a more responsible and consistent steward of the international monetary system. We should also all hope that institutions like the International Monetary Fund will soon be empowered to fill the void that national governments have created. But all these things are just that — hopes. They speak to what needs to happen, not what likely will based on current realities.
As much as we should all hope for a better-functioning global system, developing countries will continue to be exposed to an unusual degree of Western economic malfunction, and U.S. congressional dysfunction in particular. If I were a policymaker in Latin America or Asia, I’d be packing a few more spare tires and planning for quite a bumpy road.