Economic Forum: Global Economic Crisis: Part III

As pointed in earlier series, the current world recession which is just close to 1933 depression except by a few symptoms such as massive closure of firms, and consequent job losses and through these very low standards of living across board, has seen the world lose up to 40% of its wealth in unprecedented short period of time.

As pointed in earlier series, the current world recession which is just close to 1933 depression except by a few symptoms such as massive closure of firms, and consequent job losses and through these very low standards of living across board, has seen the world lose up to 40% of its wealth in unprecedented short period of time.

Such loss of wealth is so alarming that, it will economies take decades to recoup it. However, what seems to be worrying is the fact that, most measures taken by western economies (such bank/insurance bail outs and nationalization which has cost these countries up to USD 8.4 trillion dollars) to mitigate the effects of the financial crisis and its consequent recession seems uncoordinated which worries most experts.

This is premised on the fact that, western economies are highly integrated (‘close to one economy’) so much so that, intervention measures used by such economies should ideally be coordinated if they are to bear results.

Such stimulus which are aimed at boosting spending have been put at 2 % of GDP or 2 trillion dollars if they are to make impact to the underlying economies.

Some countries such as Japan (second largest economy, and France seem not to have met the above targets which will have negative consequences to management of recession).

Nevertheless, what is also worrying to most experts is that, no one seems to know the extent of the current financial crisis so as to prescribe precise/targeted measures to that end.

Moreover, history seems to be repeating itself for even in 1993 great depression, world leaders (who meet in London) did not agree as to the extent and  mix of measures; financial and economic that were necessary to pull the world out of that depression, and no wonder then that, it dragged on longer than should have been the case.

Some commentators put it that “The great depression was made ‘great’ by lack of cooperation”. Differences seem to have emerged between the USA and UK on one part, and France and German on the other as to the best measures to mitigate the crisis.

The former favour stimulus package which is expected to hit USD 8.4 trillion mark, while the latter favour strong financial regulation. Apparently, the two are not mutually exclusive during such a crisis.

Stimulus packages are supposed to kick start recessed economies by stimulating depressed demand and cushioning bank operations to avail credit. Financial regulations can only make sense when economies are in the growing episodes.

“Put simply, you have a dying patient (read economy with failing financial systems) who needs resuscitate before you tell the same how to behave in future’.

Certainly, close supervision of activities of financial systems as hedge funds, private equities, and derivatives trading is critical as these under-priced risk causing the financial markets to crash.

Thus, given that the group of G20 countries account for 90% of the world economic out put, 80% of the world trade and two thirds of the world’s population, inaction by such a powerful group will be catastrophic to world economy as it will send negative signals to world financial markets/investors/consumers and other economic agents whose negative reaction will induce further cycle of economic down turn.

This is a period where assurance and optimism should be key words by leaders of these economies. One only hope that, the G 20 meeting set for London this week will make a fundamental difference.

Impact on African Economies:

Although the impact of the financial crisis has been slow in reaching African countries, it is here, dramatic and severe, which also calls for dramatic and severe responsive measures by leaders if these economies are to survive this crisis.

Political expedience, inaction, or indifference by such would leaders will spell doom to such economies, as the impact of economic down turn are real and takes time to reverse.

Already tourism which accounted for large portion of foreign earnings to these countries is low by up to 30%, and Diaspora remittances down by 25%. It is also estimated that, foreign direct investments (FDI) which reached USD 928 billion in 2007, will fall to USD 165 billion.

This is so in that, as world trade declines due to recession, private sector investments will also decline, and whatever is available will be confined to western economies at the expense of developing countries.

This will also see donor funding reduced, given that, whereas these pegged to 0.7% of GDP of developed countries (although few countries reach these targets), the same countries are running negative GDPs of between 2-5%, and have no obligation (except ‘moral’) to contribute to the development agenda of African economies. 

This is aggravated by fall in world trade by 2.8% in 2008, which will mean less demand for exports from developing countries which has seen commodity prices for such primary exports as copper (from Zambia) fall by 50%, Diamonds from Botswana by 60%, minerals exports by DRC fell by similar margins, as well as petroleum revenue from African Petroleum producing countries.

This then implied not only loss of jobs and livelihood of people affected, but a cut in budgets of most of these countries by almost the same margins and by extension their ability to deliver essential goods and services.

Stock markets:

Although most experts have zeroed on problems facing banks in western economies as having sparked off the current crisis, it is worth noting that, stock markets (part of financial markets for long-term capital by way of bonds or shares) have been hit most.

The current financial crisis has wiped off between 40%-60% of market capitalization of most stock markets, which also translates into loss of savings to the same tune of players in the stock markets who are usually institutional shareholders (acting on behalf of individuals) and individual shareholders themselves.

The rapid evolution of stock markets in LDCs (least Developed Countries) as part of their financial restructuring was a major event in financial history.

IFC (1997) points out that, portfolio flows to emerging countries rose ten fold between 1989 and 1995, and that aggregate market capitalization (the total sum of market values of securities traded on a given stock market) rose from USD 488 billion in 1988 to USD 2,2245 billion in 1996.

Although development of stock markets in Africa show evolution process indicative of the early stages of their development, nevertheless their development has been linked to the belief that, financial markets should and can spur economic development.

Ngugi, Murinde and Green (2001:17) points out that, “most African countries are revitalizing existing stock markets and establishing new ones in order to facilitate mobilization of long-term capital.

This interest is born out of the fact that, whereas financial markets are traditionally used to mobilized both short-term and long-term capital, it is the latter that is in short supply among LDCs and especially in Africa, and yet it is vital for their development.

Financial development theory predicts a positive relationship between stock market development and economic growth which is attributed to the ability of securities markets to mobilize long-term capital and facilitate its efficient allocation (Levine and Zervos, 1996; Boyd and Smith, 1997; and Caprio and Demurgic-Kunt, 1998). Stock markets affect growth in two ways.

Firstly, by increasing the firm’s efficiency by eliminating premature withdraw of capital from the firm, and thus accelerate not only the growth of human capital but that of the per capita in put. Secondly, stock markets affects growth by raising a fraction of long-term resources devoted to the firm.

Research done by Levine (1990) which compared growth rates of a stock market economy with a none-stock market economy, found out that, a stock market economy grows more faster than non-stock market economy because stock markets eliminate premature liquidation of the firm’s capital.

Consequently, such capital  that is maintained in the firm for a long period of time will facilitate the accumulation of human capital, bringing with it the innovative skills that can be used to manipulate other resources to generate growth. 

This is consistent with research done by Dimitri (1998) who found out that, equity market capitalization in fast growing economies of Malaysia, South Korea, and Singapore rose from 7% in 1985 to 250% (relative to GDP) in 1997; their high growth episodes.

That securities markets as part of financial markets induce growth is no longer an academic debate. Their role in development is crucial not only in the mobilization of both domestic and foreign savings (FDIs) but also allocation efficiency which more often than not exceeds bank based allocative mechanisms.

Securities markets have had profound effect on the current global financial crisis and its consequent recession; especially reactive in nature that cuts across most sectors of economies. We discuss these in our next series.


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