Hit and run. Photo by <a href="http://www.flickr.com/photos/chozno01/2049157702/">Claudio</a> (<a href="http://creativecommons.org/licenses/by-nc-sa/2.0/deed.en">CC</a>).
Hit and run. Photo by Claudio (CC).

Policy Innovations Digital Magazine (2006-2016): Commentary: The G-20's Global Hit-and-Run

Apr 24, 2009

Many poorer countries are now suffering direct effects from the financial crisis, including sharp declines in exports to developed countries, decreased remittances, and the general inaccessibility of capital. In October and November of last year, U.S. imports from all developing countries fell 3.2 percent, and imports from Sub-Saharan Africa plummeted 11.5 percent.

So-called emerging-market countries with millions of very poor citizens are also suffering: Worldwide exports from Brazil dropped 29 percent in December alone, and India's overall 2008 exports were down 15 percent. On top of these challenges, developing countries face a shortfall in meeting their international financial obligations, ranging from $216 billion to as much as $1 trillion by some estimates.

The human effects of these economic problems on poor people will be substantial. Nonetheless, the recent G-20 summit was reported as very good news for the poor. Summit attendees pledged more than $1 trillion to the International Monetary Fund, some $100 billion of which is to be lent to developing countries in short order. The new loans will help these countries "a lot," according to Paul Krugman and others.

By choosing to increase funding for the IMF, which will in turn make loans to developing countries, the G-20 has opted to leave the burden of adjustment with the poorer countries. This policy decision reflects moral judgments about who should bear the costs of the financial crisis. Alternate policies are available. Fiscal stimulus in the developed economies, as the IMF proposed, would increase consumption and offset the sharp decline in exports. And greater "vulnerability funds" made available to poor countries, as the World Bank requested, might also do some good.

What principles should we use to determine a fair distribution of costs when bad things like financial crises happen?

The crisis has been compared to a number of more familiar catastrophes, such as the sinking of the Titanic and a tsunami. Neither analogy works. Unlike the Titanic, the global economy is still very much afloat. And unlike a tsunami, the crisis is man-made, not a product of Mother Nature. A car crash is a better analogy.

A car crash involves damage to people and property. When a crash occurs, the main question is how the costs of rectifying or compensating for the damage should be distributed. The law—specifically, the law of torts—has principles for determining the allocation of cost.

Generally, a driver must bear the costs of a crash, first, if she caused it; second, if she drove in a negligent or reckless fashion; and third, if this misconduct was causally relevant to the outcome. Even when a driver causes a crash, if she has behaved as a reasonable person would, then she is not at fault and not typically liable for damages. More concretely, if a car hits a pedestrian who is crossing the street because the driver took her eyes off the road to send a text message, then the driver usually pays. If a driver keeps her eyes on the road and hits someone who has dashed without looking into the street against a traffic light, then she usually doesn't pay. If neither the motorist nor the pedestrian has acted carelessly or recklessly, then the losses to each are either borne by each, or they can be offset by a third party—perhaps the community at large.

A great deal of the damage resulting from the economic crisis cannot plausibly be characterized as resulting from the misconduct of developing countries. The unstable global environment has produced many changes to the circumstances of these countries, many of which were not only impossible for them to control but also quite difficult to foresee. India's exports had never fallen before 2008, and they even grew by 35 percent in the five months before they began falling. Remittances, often thought to be resistant to recessions, were projected to fall by only 0.9 percent as late as November of last year; now they are slated for a 5 to 8 percent decline in 2009.

Even if some developing countries did contribute to the costs they now face, it doesn't follow that they should bear their full burden. After all, other countries contributed to the harm as well. As when the driver negligently takes her eyes off the road and the pedestrian recklessly charges into the street, the shared fault entails shared costs.

Connections between the actors' negligence might further alter the distribution of costs. If the pedestrian turns out to be the driver's teenage nephew, and he ran out into the road because the driver sent him a message instructing him to do just that, then the driver should probably bear the lion's share of the costs.

These complex webs of interrelated responsibility are manifest in the financial crisis. Hungary, for instance, borrowed heavily over the last decade, and now faces grave difficulty in repaying its foreign-currency debts following a currency collapse. But, as Jeffrey Sachs argues, such excessive borrowing was recklessly encouraged by the U.S. Federal Reserve's decision to hold interest rates at historic lows after the September 11 attacks.

Critics may respond that difficulty repaying one's debts is simply a risk of borrowing money, but there are circumstances that make otherwise binding contracts unenforceable. If an unanticipated hurricane of unprecedented ferocity—or a devastating financial crisis that was not predicted by most reasonable observers—wreaks havoc on a country's economy, these events ought not be viewed as part of the normal background risk that people or governments ought to consider when entering into contracts or making other financial decisions.

Many legal systems recognize this, and distinguish between ordinary and extraordinary events. When extraordinary events, including so-called acts of god, lead to nonperformance of contracts, the duty to perform them is normally excused, and the contract is viewed as impracticable. When the performance of a contract becomes impossible for reasons other than the negligence of the contracting parties, it can be treated as void under the doctrine of frustration.

It is important to note that most developed-country governments are not treating this crisis as business as usual, letting the market reward the prudent and punish the imprudent. Rather, they have addressed the crisis with a raft of bailouts, often saving institutions that made terrible business decisions—including some $180 billion for the thoroughly discredited AIG.

Going forward there will be plenty of debate about the true causes of the crisis and the extent to which negligent or reckless behavior was at its root. Most commentators blame the crisis primarily on affluent, developed countries, especially the United States. The U.S. Congressional Research Service has compiled a dismally long list of causes—including the Federal Reserve's easy-money policy, the deregulation of financial institutions, the permission of extremely high leverage ratios, and unsustainable levels of debt—all of which put America and other developed countries in the driver's seat. A UN commission of experts, headed by Joseph Stiglitz, echoed this perspective.

Such evidence wouldn't make affluent countries responsible in a court of law for the costs borne by poor and emerging markets, but it's more than enough to show that, ethically, poor countries are owed better than an opportunity to acquire more debt. One could go further and question whether in this case the driver is responsible for flaws in crafting the rules of the road—more concretely, that the developed countries have designed an unstable international financial system and have encouraged developing countries to undertake policies that have made them particularly vulnerable to the current crisis. But one doesn't need to go that far in order to question the fairness of the G-20 deal.

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