by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in the Financial Times
October 7, 2008
© Financial Times
The financial rescue plan passed by the US Congress is viewed as flawed but necessary to head off panic in financial markets and loss of confidence in the economy. It seems a holding operation, a Plan C or D that might need augmentation via a Plan A.
A vital component of a Plan A is likely to be additional money. For one thing, there is suspicion that the amount of toxic assets is considerably greater than the rescue plan provides for. For another, more money may be required to address the problem in the housing market by providing relief to subprime and marginal borrowers. And finally, further fiscal stimulus could become necessary if recessionary forces take hold.
Where will this additional money—perhaps as much as another $500 billion—come from? The US taxpayer is wary. Joe Six-Pack has ponied up a lot already, and done so with no great confidence that the money was for a worthwhile cause or that it will be well spent.
Enter China. Ken Rogoff of Harvard cheekily characterized the vast Chinese accumulation of US Treasury bonds over the past five years as the biggest foreign assistance program in history. Why not push that further? Here is a thought experiment.
The Chinese government could offer to lend up to $500 billion (from its current stock of $1,800 billion) to the US government for the rescue of its financial sector. Its previous assistance—buying US bonds—was indirect and unconditional. Not so in this case.
China's loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of Western donors since the postwar period, would now be embraced by China.
What would be the nature of the strings—or "conditionality" as the US Treasury, a longtime practitioner of this art, has called it? Conditionality as imposed by the World Bank and International Monetary Fund was underpinned by an ideology that favored markets and globalization. But there was also an assumption that either borrowing third world governments did not understand their benefits or the reformers there needed a "spoonful of sugar" to help overcome any internal opposition.
China would impose two conditions. First, it would declare that the offer of money was conditional on the US government's adopting a particular approach to rescuing the banks, namely to favor in the next round the use of government money to recapitalize the banks. Europe has been using this approach and evidence suggests it is the most effective way of dealing with large-scale financial crises.
The US government—like third world governments in the past—has been unable to adopt the most efficient course of action. This stems from an ideological obsession against "socializing" banks or because inducement is necessary to overcome any domestic opposition to it.
The second condition would relate to "social safety nets," which had become standard embellishments to World Bank/IMF adjustment programs. China would stipulate that monies be devoted to cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership. Chinese conditionality on this front would achieve an outcome that several economists on the left and right have argued for on grounds of fairness, and also to address the fundamental problem in the housing market.
For China, this offer of help would have three virtues. First, it would be riding to the rescue of a situation partly created by its own policies of undervalued exchange rates, which led to lax global liquidity conditions. Second, its economic interest would be served because successful US efforts at rescuing its financial sector could help avert an economic downturn, protecting China's exports, its growth engine.
Perhaps most important, it would seal China's status as a responsible superpower willing to deploy its economic resources for the sake of protecting the world economy. And if the means for achieving that are by providing the current hegemony with the largest aid package the world has ever seen with a healthy dose of sensible conditionality, well, what could be more statesmanlike than that?
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