Global Economic Crisis: Part V

The current recession which arose from the financial crisis may as pointed out in the earlier series ease by 2010 and to some countries by 2011.

The current recession which arose from the financial crisis may as pointed out in the earlier series ease by 2010 and to some countries by 2011.

This is premised on the fact that, such a financial crisis disrupts the functioning of an entire economy leading to contraction of the same economy (negative growth-GDP) for quite some time.

For countries which have seen contraction of their GDP by up to (-6%), reversing such loss in out put takes more than one financial period.

It is estimated that, the current financial meltdown will entail losses of up to $ 4 trillion which will damage financial systems so adversely that, it will take many years to rebuild the capital base of financial institutions which in turn will delay recovery of world economies.

This will see world trade decline by up to 11%, a huge loss to world economies by all standards, which is also made worse by credit crunch that limits availability of credit to enterprises, and consumers a like.

The fact is, a banking crisis disrupts the flow of credit to both households and enterprises making such important agents of economic activities stark.

By extension, such a crisis reduces investment and consumption forcing firms in heavy losses, and in the extreme bankruptcies as we have witnessed in western world.

Firms making heavy losses will also require time to write off their losses through their balance sheets, and depending upon the magnitude of such losses, it may take more than one financial period to write off the same.

Furthermore, Financial crisis jeopardizes the functioning of the payment systems, and by undermining domestic financial institutions, they may cause a decline in savings as savers choose other forms of savings rather than financial savings in fear of losing these to failing financial institutions.

This feds back into the same financial system by reducing liquidity in such systems and the cycle then continues, which if not arrested, may leading to depression (Zimbabwe is an example of a country in economic depression).

However, the actual duration of the current crisis will depend on how fast and effective mitigation measures/policies designed by the western countries start to deliver, but it should not at most exceed three financial periods.

Western countries including European Union, USA, and Japan account for 70% of world’s Gross Domestic Product (GDP) are in deep recession and until such economies get out of the same recession, the global crisis may persist.

In the first instance, these countries will have to stabilize their financial markets so as to ensure that, credit flows again to these economy without which no meaningful recovery can be anticipated.

There is no way financial systems and especially banks will recover unless and until their balance sheets are cleaned of the huge bad debts accrued. History of bank crisis and empirical evidence with regard to the recovery of financial systems indicate that, cleaning up of bank balance sheets is a major precondition for recovery of banks and thus the underlying financial systems.

The problem we may face is that, there may be time lag between policy pronouncements to that effect and its implementation. Under these conditions (which is likely) the current crisis may lag for some time.

Ideally policy pronouncements by political leaders of powerful western economies especially The USA, EU and Japan, should immediately be followed by implementation of the same to send positive signals to the financial markets which will respond to position themselves again and perform their intermediation roles critical to economic management. 

Nevertheless, economics is as it is called ‘the dismal science’ and as such no matter what aggressive best policy paths governments will take, it is not easy to know with certainty when banks will start to lend as markets behavior is highly uncertain for they depend on many players rational and irrational a combination of which impacts on the efficient operations of the financial markets.

Its is even more apparent if one factors in all the array of players such that, it is uncertain to tell when investors will be confident again to hold public liabilities, or when the beleaguered consumers now trying to reconstitute their wealth (after a disastrous loss due to securities markets crash that wiped off the life savings), will feel comfortable to start spending. And although these factors pertain more to the developed countries than to developing countries, nevertheless, impact of the crisis has hit the latter by default.

Developing countries will not necessarily fall into deep recession (although some have lived in the same state since the beginning of nation state) as is the case with western economies and even then different developing countries will feel the crisis differently.

Thus countries in conflict, those facing unstable macroeconomic environment, countries suffering sharp adverse terms of trade, countries relying heavily on trade (exports, e.g oil, minerals etc) to high-income countries in recession will be seriously affected by the current crisis.

Nonetheless the political economy of most LDCs (Least Developed Countries) will make their conditioners to wither the current crisis even more difficult.

Political climate impacts on investors’ confidence as well as savers’ propensity to save as it is associated with certainties with regard to the economic policies as well as fiscal and monetary policies pursued by such countries which become even more uncertain in crisis. 

Commenting on this, Kitchen (1986:75) observes that “commentators have not given much prominence to the impact to which political philosophy of a country has on its financial development and the way in which this influences the relationship between financial development and economic development. Yet this seems to be of some importance in explaining at least some of the divergences between countries and it also has important implications for the degree of reliance which the government places in their financial institutions as agencies of economic development”.

This explains the extent to which LDCs neglected the development of their financial systems at such a high cost that has only made them dependent on foreign savings when they should have used these very systems and institutions to mobilize their local savings and allocate these accordingly.

Dependency on foreign aid and grants as pointed out earlier has not development any nation at least in the history records of financial and economic development.

Asian economies which used this model in their early 1950s discarded it in the 1970s after they had put in place financial systems and instruments to mobilize domestic savings that substituted foreign savings.

Such a radical development/ move also required radical policy measures under which some East Asian countries embarked on forced savings of up to 50% of total earnings of an individual.

This gave rise to a huge pool of savings that was then used to finance heavy capital infrastructure projects that no external source would have financed.

Such a move would certainly not be popular with Bretton Wood Institutions, but such institutions should NOT substitute country specific policies with their straight jacket policy prescriptions (one size fits all), but rather should compliment these.

The era of Washington Consensus is long gone (where such institutions held the sway on economic views and economic management especially due to two emerging developments.

First, the current economic crisis has exposed the inadequacy of these institutions as custodians of global financial systems as they were caught off guard, not even a warning to the effect that this crisis is imminent despite having the best economists and financial experts on their payroll.

In fact, the Asian financial crisis of 1997 exposed their limitations with regards to prescribing solutions to financial crisis where their mitigation measures would have been disastrous had they been used by Asian economies (e.g. floating of currencies, which would have sparked off massive capital flight) and history of Asian financial crisis is still fresh. 

Secondly, the emergence of the group of G20 with their economic and thus financial capacity, also means that, these institutions will no longer advance the so called ‘Washington Consensus’ unchallenged, more so because, a number if not most of these countries, have used their home grown policies to spur the development of their economies.

Bretton Wood institutions cannot claim any credit to that effect except to diagnose reasons for policy prescriptions failures which even the former World Bank President James Wolfensohn had the courage to admit.

As these institutions meet with the ministers of finance in Washington for their summer springs meetings, one would expect questions as to the role of these institutions in the current financial crisis.

This may not be so as the crisis originated from the west, which dictates through these very institutions what developing countries should and should not do with regard to their financial and economic management, but the same western countries can not escape the harsh judgment by the current global financial crisis and subsequent recession that has seen their economies shrink by up to -6% GDP, rates that fits the economic malaise of a developing economy.

Amidst all this, LDCs will see their GDP fall, but a few will record negative growth of the magnitude we witness in western economies. The question is, who now has the moral authority to teach who, ethos of prudent economic management.

To be continued...

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