2 Managing Openness: Lessons from the Crisis for Emerging Markets Barry Eichengreen
Another discussion of the global financial crisis requires some justification.1 The justification for this one is that the lessons of the crisis for emerging markets and their management of openness are still not adequately understood. Important questions remain unanswered. This chapter focuses on three. First, who was hit, and why? And, in a related question, what policies should emerging markets follow to minimize the effects of global volatility? While more than a little has been written on this subject, it is not clear that a consensus has yet formed. Second, what explains the outsize response of trade that was one of the principal transmission belts for the crisis? This crisis may have been just another “sudden stop� of capital flows, not unlike the sudden stops of the past, but it was the first modern sudden stop in trade flows—something that deserves further analysis. Third, and finally, what was the role of global imbalances in the crisis? The answer to this last question again has implications for what kind of policy adjustments emerging markets should make going forward. Who Was Hit, and Why? The impact of the crisis varied enormously. Comparing demeaned real gross domestic product (GDP) growth in the third quarter of 2008 to the first quarter of 2009 at seasonally adjusted annual rates, growth fell by an astounding 35 percentage points in Latvia, 30 in Lithuania, and 25 in Estonia, compared to less than 5 percentage points in Argentina, India, and Poland. This handful of outliers, both
positive and negative, already points to hypotheses. More open economies were hit harder. Countries with large current account deficits were hit harder (see figures 2.1 and 2.2.) Countries that had restrained the rate of growth of credit and had more flexible exchange rates did better. In contrast, the role of the government budget deficit is not clear; it is not obvious that countries with larger fiscal surpluses did better, in other words (see figure 2.3).2 The question is whether these and other regularities stand up to scrutiny when analyzed using data for a larger sample of emerging markets. Rose and Spiegel (2009) are skeptical. They link the severity of the growth decline, along with some ancillary measures of financial distress, to a set of indicator variables in 2006, the eve of the crisis, and find few robust regularities. One interpretation of this finding is as confirming the weak predictive power of so-called early-warning indicators, something to which some have pointed previously.3 Crises differ. Market behavior and policy responses change, not least in response to the development of earlywarning indicators themselves. In this view, there is no telling when a country will be hit or how hard. The appropriate policy response is therefore to invest in insurance. This view, for example, has some appeal to those who live on active earthquake faults and have learned to keep flashlights and bottled water on hand. Another interpretation is that it is not so much crises that differ as countries. The impact of the same shocks and policies may be different in low-income, low-to-middleincome, and middle-income countries, given differences in market structure and development. Mody (2010) finds, for example, that the positive correlation that one might
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