The global credit and banking crisis sparks questions about the system of finance – the world of globalisation – that has brought prosperity to billions of people world-wide since the end of the Cold War.
For three entwined changes happened with the fall of the Berlin Wall and the collapse of Soviet communism at the end of 1989:
First, the relatively protected economic environment that had existed for 40 years since the end of the Second World War moved rapidly towards greater integration of national and regional economies, in part sparked by the simultaneous application of digital technologies to communication flows.
This is the policy and technology phenomena we understand today by the term ‘globalisation’. For example, McKinsey has calculated that the total value of the world’s financial assets climbed by 17 percent between 2005 and 2006 to reach $167 trillion, and cross-border capital flows grew to a record $8.2 trillion.
Financial flows have, in this process, become delinked from the production of tangible assets. In 1980, the value of the world’s financial stock was roughly equal to world GDP; a quarter century later it had risen to three times world GDP.
By 2004, daily derivatives and foreign exchange trading market were together $7.6 trillion, exceeding the annual value of global merchandise exports. Leveraging was in.
Second, half the world’s population including citizens of India, China, Viet Nam and Russia along with the Soviet Union’s former client states became participants in the global market economy.
Twenty million rural Chinese have moved to the cities annually over this time where they are three times as productive.
This has resulted in a manufacturing and consumer boom. Export markets are ground zero of this change. In 1989, some 300 million workers in the world in export activities, today, more than 800 million.
In 1980 China’s exports were less than $20 billion, last year, it exceeded $1 trillion.
Third, as a result, there was a massive increase in the world’s labour supply and the flow of skills, exerting downward pressure on wages and upward pressure on productivity. In essence, countries were able to import deflation. The consumer boom was fed by a credit expansion facilitated by a combination of low-interest rates and extension of mortgage markets in developed economies.
In this, mortgage lending had become so profitable, and was so unregulated, that banks and brokers began lending to borrowers and under conditions that expanded the risk and the moral hazard involved.
Such high-risk loans were then repackaged – ‘sliced and diced’ – and sold to others around the world, from Tokyo to New York to Shanghai.
Thus the whole financial system, where sub-prime loans had expanded to 20 percent of all mortgages by 2006, up from nine percent a decade earlier, became vulnerable to a change in house prices or market sentiment.
Now, what started off as a localized crisis in the US mortage market has expanded into a global liquidity crisis.
So what is the likely environment that countries and businesses will have to operate in, and how might this affect Africa?
For Africa there are factors which lessen and worsen this crisis.
In some respects Africa is largely shielded from the immediate crisis because its financial systems, rudimentary and parochial, are not integrated with the global financial system.
African economies have historically, with few exceptions (South Africa is one) progressed or struggled quite independently of the health and efficacy of their financial markets.
For example, in many (though not all) African countries, interest rate levels – and levels of credit provision – are of little consequence for economic activity because reliance on credit is so low to begin with.
Further, sub-Saharan banks generally have minimal balance sheet exposure to foreign banks and securities, and therefore the type of balance sheet contagion now seen in Europe is unlikely to occur.
Looking at the longer-term, African financial sector growth is far more reliant on local factors – inflation, economic health, the long hard road of building sound domestic institutions, achieving a regulatory ‘sweet spot’ balancing supervision and market flexibility – than the health of global institutions.
To be continued ...
Professor Herbst is provost of Miami University; Mills heads the Johannesburg-based Brenthurst Foundation; Trejos is Professor at INCAE Business School in Costa Rica.