The world economy is being shaken to the core. The global financial crisis is threatening to drag the world into protracted recession, and the prospects for growth — the key to employment and social development — are deteriorating fast. As is unfortunately often the case, the poorest countries are likely to be among the worst affected.

Taking the long view of the next 15 years in the midst of an evolving crisis of as yet unknown severity should be approached with caution. Nevertheless, I would like to offer some thoughts on what can be done now to allow the world economy — and most of all the poorest countries — to achieve sustained growth in the 15 years to come.

It is a “twist of fate” that the current crisis follows one of the most successful periods of growth the world economy has ever experienced. Between 2002 and 2007, that broad-based growth allowed many developing countries to make significant strides and demonstrated how strongly growth can contribute to development. Between 1996 and 2006, developing countries were able to increase their real income by 71 percent, compared to 30 percent in the G-7 countries. Even the least developed countries, which have experienced erratic growth patterns in the past, have been growing at an average annual rate of more than 5 percent since 2000, much faster than in the late 1990s. Only last year, many LDCs, including Bangladesh, even surpassed 6 percent. Much of this was due to rising demand for commodities, but even exporters of labour-intensive manufactures have been buoyed by high export demand. International trade and investment flows have been crucial to spreading this growth. Indeed, developing countries as a group have seen their exports nearly quadruple over the past decade. This environment has allowed the world to make substantial progress towards the MDGs, with 400 million people being lifted out of extreme poverty between 1990 and 2005. While progress has been uneven, the development gains from recent growth are undeniable.

However, if in those years we have seen the beneficial side of global interdependence, with growth spilling over from country to country, we are now facing the negative side of interdependence, where financial irresponsibility in one country can destroy economic prospects in another. Three crises have exposed the weaknesses of the international system. The troubles began with rising oil prices in 2005, which demonstrated just how much economic progress still depended on a limited supply of fossil fuels. In 2007 and 2008, food prices followed, with devastating consequences for the world’s poor. However, it was the crash of the US subprime mortgage market, and the ensuing global financial crises, that finally brought worldwide expansion to a halt.

The precise impact of the crisis remains to be seen, but the UN has already revised its growth projections for the world economy downwards, to about 2 percent in 2009, and this may still be optimistic. Even though this crisis originated in some of the world’s most advanced markets, it will clearly have a strong impact on the developing world, including the LDCs. The financial meltdown in advanced economies is filtering through to developing countries in several ways. First, the global de-leveraging process is increasingly affecting asset classes that have not so far been considered high-risk, and it is exposing more financial institutions to liquidity problems. In addition to the credit crunch, stock market panics are spreading to emerging markets, with associated impacts on exchange rates, balance of payments and foreign debt. Fears of new currency and banking crises in several emerging markets are therefore justified, even though high levels of reserves mean that some of these markets are better prepared than in the past. Second, developing countries will be affected by a global slowdown in demand, which will in turn affect their export earnings. In particular, a fall in commodity and energy prices due to the expected recession is already reducing growth in producing countries, while at the same time alleviating the burden on importers. The slowdown will further affect remittances, which have become a major source of income for countries like Bangladesh. Finally, if past banking crises are any guide, development assistance is likely to decline, as bailout packages and public guarantees are placing heavy demands on advanced-country budgets.

While the impact on any individual country will therefore depend on the structure of financial liabilities and reserves of the banking sector and its export structure, it is safe to say that developing countries are unlikely to be decoupled from the crisis. The ILO has recently estimated that the financial crisis will raise global unemployment by 20 million in 2009, and push 40 million people into extreme poverty. Together with the global food crisis, the financial crisis thus risks undoing in a matter of weeks all the progress achieved in poverty reduction over the past six years.

What lessons can we draw from this recent experience? How can we create an economic environment that will enable the world economy, and the poorest countries in particular, to achieve sustained growth without repeated, devastating reversals?

First and foremost on everyone’s mind, of course, is the need to rein in global finance. The current global crisis, along with many smaller, more regional crises, has demonstrated more forcefully than ever before that the model of deregulated global finance has failed. Contrary to the predictions of mainstream economic theory, free financial markets are not able to judge risk appropriately, and do not allocate credit effectively. Instead, they are prone to herding behaviour, irrational exuberance and the pursuit of strategies that may be rational for the individual but detrimental to the community. The significant systemic risks they carry means they cannot possibly be left unbound. We thus need to rebalance the role of markets and the role of States. Markets work most effectively in the presence of strong States. What does this mean?

The most urgent priority must be to contain the damage, and to ensure that the impending slowdown does not turn into a global depression. We must accordingly focus not only on supporting banks facing liquidity problems and providing government guarantees, so as to restore confidence, but also on pre-empting the effect on the real economy through fiscal expansion and public investment. In addition, we must soften the blow to the currencies of emerging economies through IMF assistance or emergency loans from reserve-rich countries. Here, there is much scope for more coordinated action, based on the shared objective of averting a global depression.

However, we must also address the immediate and glaring lacunae that have made this crisis possible, through improved regulation and oversight. The first priority must be to reassess the role of credit rating agencies, which have not lived up to their task of providing a sound neutral assessment of risk. We must also devise incentives in the financial sector for simpler financial instruments; and address maturity mismatches in non-bank financial institutions; and bring them under the umbrella of regulation.

Supachai Panitchpakdi is the secretary-general of UNCTAD. The article (part-1) is adapted from his recent speech at an international business conference organised by Dhaka Chamber of Commerce and Industry in the capital. The second part comes in our next edition