In praise of financial plumbers: want a formula for achieving developing economy success? Begin with sound, independent supervisors

International Economy, The, Spring, 2004 by John G. Heimann

During the past thirty years, the developing nations around the globe have been buffeted by a series of economic and financial crises. Inevitably, this has resulted in substantially increased unemployment, stagnant growth, lowered living standards, attacks on globalization, and eventually challenges to the institution of democracy. Hungry people do not much appreciate the benefits of globalization simply because few, if any, of these benefits have come their way. As they see it, globalization benefits the rich nations and the rich elites but not them.

Economic problems can rise from a number of causes over which an individual developing nation has little influence. Countries whose economies are based upon natural resources--oil, copper, coffee--cannot control the pricing of these commodities in global markets. Prices are demand-driven, not supply-driven. Nevertheless, regardless of commodity pricing, countries can control their own domestic finances, the prudent handling of which will diminish the negative impact of global market turbulence.

The correct balance of fiscal and monetary policies is within national governments' reach. Spending and tax policies, on the one hand, and a monetary policy that stimulates growth without fueling inflation are key. The International Monetary Fund requires the proper balance when imposing conditionality on countries seeking financial assistance.

Countries that need the financial support of the IMF accept these programs as the cost of getting the money. But many other nations do not balance fiscal and monetary policy since there is no meaningful enforcement mechanism. These sovereign nations create their own destiny, that is until they get into trouble and apply to the IME And once a country has a flawed macro-economic policy, the inevitable economic disaster is exacerbated by a weak financial system.

We have learned by experience that when a nation has poor macro-economic underpinnings and a weak financial system, there is bound to be a disaster that will have dramatic, if not devastating, effects. Similarly, when a nation has a reasonably good balance of macroeconomic policies but still hosts a weak financial system, the inevitable result is the same. But if there is a financial system that is relatively robust, even in a relatively poor macroeconomic setting, the results are far more benign. There are problems, of course, but they are not nearly as severe as when the financial system is weak which, by definition, means poorly supervised.

Since the financial markets of the world are inextricably interlinked, the problems in one country quickly are exported to others. Problems of a domestic nature often ripple out to weaken or destroy other economies far from the initial trouble. Such was the case with the Latin American crisis in the 1980s, the problems arising in South East Asia in 1997, and Mexico's peso crisis in 1994-1995.

If we simply recognize the reality that sovereign nations will do what they will and in that process continue to create periodic economic crises, then it just makes common sense to strengthen that set of activities which will minimize the damage done by short-sighted politicians.

If we are to improve the ability of developing countries to withstand inevitable swings, instead of just relying solely upon spouting the macro-economic gospel, it would be prudent to strengthen the financial systems and financial institutions within those nations. This requires supervision with teeth and people who are capable of bringing this to pass.

More must be done to educate and train supervisors to do their job well, especially in developing and transitional economies in which these activities are often given short shrift in terms of funding and support. Add to this picture the differences between education and training in one country and the next, and the result is little supervisory consistency across borders and a mixed application across the globe.

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Despite the growing need for supervisory prowess, getting countries to focus on the importance of allotting sufficient resources to the task is tough. Perhaps the issue is too arcane to capture the attention it deserves. Perhaps people just assume that since the need is so clear, that the job has been done.

It doesn't help that some doubt that increased supervisory systems are a priority in the first place. These naysayers believe that financial institutions can police themselves. Sadly, experience shows that unless pushed, most financial institutions won't take the steps necessary to strengthen themselves and/or the system as a whole.

Moreover, supervisors can't toot their own horns to gather public support because simply mentioning a success might cause a bank run. After all, who wants his money in a bank with a whiff of danger? Instead, the very nature of the job shines the spotlight on supervisors only when things go wrong.

Creating vibrant supervision also may take more effort and dedication than most countries are willing or able to spare. Not only do education and training demand a lot of money and hard work, but also the crucial setting up of independent agencies can be too politically charged to accomplish easily.