Monday, March 09, 2009

The financial crisis: consequences for developing countries and options for development policy

A written statement (pdf in German) of WEED for a public hearing on the financial crisis of the German Parliamentary Committee for Development Cooperation and Policy sheds light on the consequences of the global crisis and the options for development policy. According to the author, the hypothesis that the financial crisis will not affect development countries resulted to be wrong.

Already in 2008 stock markets in emerging economies faced average losses of 40% (i.e. South Africa 30,3%, Brazil 43%, China 65,6%, Russia 70,9%). Countries like the Ukraine or Pakistan had to ask for IMF support to avoid bankruptcy. Growth expectations also dropped dramatically. While development countries' economies grew 7.2 points in 2007 and 6,9 points in 2008, the average prognosis for 2009 is 4,6 points. Pessimistic scenarios even speak of growth rates of 0,1 for Africa and -0,2 for the Caribbean. Nonetheless this might only be some of the first consequences of the global crisis with other effects to follow at a later stage.

Different countries face different challenges. Countries like Brazil, which have a relatively strong economy and a big domestic market, have a stronger standing than countries with smaller markets and less diversified economies. Also economic effects of the financial crisis can have different influences on economies. The decreasing demand on raw materials for example caused by the economic breakdown will give countries which need to import these materials the chance to buy at cheaper rates. On the other hand raw material exporters will suffer under the low prices. Nonetheless many development countries belong to the second group of countries.

The paper speaks of two ways of infections, one through effects of the financial crisis on the real economy of a country and the second through the involvement in the same financial speculations that caused the crisis at the beginning. However, only some of the emerging economies were actually involved in direct financial speculations. Most effects are caused by the effects of the financial breakdown on the real economy.

Since the biggest world economies face recession this will lead to a demand reduction and negative trade growth for the first time since 1982. Additionally the UN estimates a decrease of foreign investment in the South of 10%. Both will lead to unfavorable financial situations and an increase of debts in the mid-term. Besides these rather direct effects, developing countries face specific indirect effects like the decrease of remittances and a possible decrease of ODA. Although ODA reduction did not happen so far there is the fear that necessary increases of financial funds to reach the MDGs will not take place.

Also the rapid growth in food prices was largely caused by financial speculations. This was denied when the prices spiked in 2007/2008. By then other causes were made responsible, like a global raise in demand, underinvestment in agriculture or the production of bio-fuels. However, when the prices recovered to a normal level in summer 2008 these reasons became less valuable since they only affect the markets in a long term thus could not be the cause of such rapid changes.

According to the report the price curve shows the typical pattern of a speculative bubble. When the real estate crisis started, financial investors simply started to look for investment alternatives and moved to the commodity markets, and speculated with oil and agriculture products. This bubble blasted when even trading in the commodity market became too risky in summer 2008.

The report says that also the German Federal Bank was involved in agricultural speculations. According to the UN this kind of speculation resulted in a 8% raise of extreme poverty in Sub-Sahara Africa and erased the success in the reduction of poverty between 1990-2004.

The WEED statement stresses the opportunities for a global financial system reform which need severe acting by the current global governance system. According to the paper the G20 is a appropriate institutional framework to lead such process. Additionally the participation of civil society and labor organizations needs to be institutionalized. The plans for stronger regulation and monitoring need strong financial and legal backup.

by Martin Behrens

For more on the financial crisis see the Euforic newsfeed on finance and development.