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Reforming the International Financial System for Development resources

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xviii Foreword capacity, exacerbated by the earlier easy availability of cheap credit. With the slowdown, FDI will slow further in 2009, and investment recovery, like job recovery, is expected to lag considerably behind, even after output recovery takes place, owing to the huge overhang of underutilized capacity. Shrinking economies, especially falling consumption in the United States and other rich countries, have already reduced export opportunities for developing countries, also undermining the strategies favored by conventional wisdom and promoted by the major international financial institutions. Fifty percent of US imports are from developing countries. So, shrinking demand in rich countries will adversely impact developing countries’ exports, and consequently, growth prospects. The slowdown in exports of developing countries adversely affects industrial production and overall output growth, especially in the major export-oriented newly industrializing countries, particularly in Asia. In Latin America and Africa, export growth, mainly driven by primary commodities, has also been adversely affected, after half a decade of growth propelled by higher raw material, especially mineral prices.1 These high commodity prices began to fall sharply from the second half of 2008. In the short run, developing countries should stimulate domestic demand, so as to offset weakening foreign demand, as China has been doing. But for the poorer countries, the scope for doing so is more limited; they typically need more foreign aid to cope with the drops in export earnings because of weakening commodity prices. In the long run, however, they need to engage in active investment and technology policies to diversify their economies and to reduce their dependence on a few primary commodity exports. Immediate policy responses are needed to stabilize financial markets and international capital flows, halt economic decline and initiate as well as sustain recovery. Many emerging market economies have also adopted measures to ease credit conditions and stimulate private spending to counter the deflationary impact of the crisis. However, most developing countries face resource constraints in mounting countercyclical policies. More effective policy responses depend critically on adequate international liquidity on ap- propriate terms and conditions through multilateral financial institutions. To be sure, finance ministers and central bankers have already injected trillions of dollars into the financial system, lowered interest rates at which they lend to private banks, and embarked on some reflationary policies despite ominous inflationary warnings, especially by market fundamentalists. But while such actions have undoubtedly helped to stabilize financial markets, at least temporarily, they certainly will not be enough to redress the G24 all chapters 12-06-10.indb 18 6/12/2010 1:03:28 AM

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