Poor People Will Get Hurt And Confidence in the Market Will Fall (Development Impacts of Financial Crisis)

September 22, 2008

I have been following the lively exchanges begun by Liliana Rojas-Suarez’s post on the development impacts of the U.S. financial crisis, especially Michael Clemens's provocative post and Nora Lustig’s thoughtful reply. I agree with Nora that there can be short-run but irreversible welfare consequences from these big financial meltdowns.

A doubling of poverty, even if only for a year or two, has an impact on infant and child mortality, on schooling rates, and other welfare variables that have long-run consequences. I once calculated that the elasticity of mortality rates with respect to real rice prices (in Sri Lanka and Bangladesh) is about 0.1; that is, if rice prices rise by 10 percent, the mortality rate rises by 1 percent. It’s not hard to understand why: poor people die more frequently when their already diminished nutrient intake gets cut back. They "exit" the population, and thus do not show up in the calculated per capita income a decade later.

My own take on the likely long-run impact is somewhat akin to Vijaya Ramachandran’s comment on the setback to the global cause of accountability and good governance. Except that I think the bigger problem may be on the reputation of market-based solutions. The crisis is likely to cause a serious erosion in the confidence of policymakers in developing countries to prefer market-based approaches to development instead of state-managed approaches.

The "market" now has a bad name, as it did after the Great Depression. Last time this happened, poor countries opted for state planning and an over-reliance on poorly designed and implemented regulations which resulted in several decades of poor economic management and low per capita income growth.


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