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Development challenges in view of the recent financial and economic crisis

In a 2009 book entitled This Time is Different: Eight Centuries of Financial Folly, Reinhart and Rogoff document that financial crises have occurred regularly over last 200 years in both developed and undeveloped countries.  Additionally, they point out that developed economies recover from financial crisis relatively quickly.  In a conversation with William Easterly, however, Reinhart stated that in some situations, e.g., the 1930s Great Depression, developing economies take much longer—over 20 years in some cases—to return national income to pre-crisis levels (Easterly 2010, July 29).  Sustained periods of economic distress can throw millions of people into extreme poverty, create political instability, and destroy families’ well-being for generations. 

Camp Immaculee, Cite Soleil, Haiti

Many economies do not yet present consistent signs of recovery from the recent financial and economic crisis.  According to the World Bank’s 2010 Global Economic Prospect Report, the global economy gross domestic product (GDP) will grow at rates of 2.9% in 2010, 3.3% in 2011, and 3.5% in 2012.  These projections are based on expected growth of developing economies, which will experience national income increases significantly higher than those that will be seen in developed economies—between 5.7% and 6.2% for the 2010-2012 period.  However, many firms are responding by reducing inventories and increasing workers’ productivity, thus unemployment continues to be high worldwide (Enterprise Surveys 2010).  As a result, developing economies face challenges that could jeopardize sustainable recovery.

Major challenges that developing economies will face include: reduced export earnings, high unemployment, financial instability and reduction in domestic lending, decreased financial flows from developed economies, and reversion of achievements against poverty.

Declining economic activity and increasing spare production capacity in developed countries will reduce their demand for commodities from many developing regions, e.g., Africa and Latin America.[1]  The World Bank (WB) estimated that non-energy commodity prices declined 21.6% in 2009 (WB Pink Sheet, July 2010).  Thus, it is reasonable to expect unemployment to rise in developing countries that heavily rely on economic activities such as mining and oil and gas extraction, affecting their growth prospect—e.g., Africa’s GDP growth dropped from 5.7% to 1.7% in 2009 (WB 2010, April 23).

Camp Immaculee, Cite Soleil, Haiti

The reduction in export earnings in developing countries is attributed to decline in price and demand for their commodities as well as decline in global trade.  The International Monetary Fund (IMF) estimated that world trade declined 10.7% in 2009 (IMF World Economic Outlook Report, April 2010, p. 20).  World trade volume is expected to increase 7% in 2010 and 6.1% in 2011.  However, improvement for developing economies could be jeopardized if exports are linked to international credits, as financial markets still tremble.

Low levels of economic activity, combined with high unemployment, may start a second round of financial stress in developing countries.  As the number of business and non-business bankruptcies increases, more individuals and firms fail to repay loans.  This raises the levels of non-performing loans and threatens solvency of the financial system.

On the government side, the financial crisis imposes restrictions in the fiscal budgets of high-income and high-indebted countries.  Thus, a decline in aid to undeveloped countries is expected.  This might affect many economic and social projects that invest in human capital and small businesses, reduce long-term growth in developing countries, and raise the number of individuals in extreme poverty by 26 million by 2020, according to World Bank figures.

The financing gap in developing countries may also be exacerbated by decline in income from tourism and remittances from developed nations.  This represents a major challenge for small open economies, such as Dominican Republic, where remittances and tourism, mostly from the US and the EU, represent up to 13% of GDP.[2]

Finally, there is danger of reversion of achievements against poverty.  Developing countries face challenges from reduced international credit and declining bilateral aid.  Therefore, it is important to ensure that they receive resources to finance projects that offer the highest return and long-term economic growth, such as infrastructure (energy, roads, communications, etc.) and human development (education, child mortality reduction, etc.).  Although the effects of this financial crisis remain to be seen, it is expected that many developing economies—especially African countries—will miss most of the Millennium Development Goals by the 2015 deadline (WB 2010). 

It is essential that policymakers understand the challenges developing economies face in light of the recent financial crisis.  To resolve this crisis, policymakers must understand how it affects developed and undeveloped economies, as both are affected differently, and how to apply the appropriate financial and fiscal reforms in each scenario.  

Photo credits: mediahacker

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[1] As of June 2010, the Federal Reserve Bank’s manufacturing capacity index was 71.4%, about 10 points below its pre-crisis levels in 2007.

[2] See Central Bank of Dominican Republic (2010).

References

[1] Becker, G. (2010, July 7). Five major defects of the financial reform bill. Message posted at:      http://www.becker-posner-blog.com/2010/07/five-major-defects-of-the-financial-reform-bill-becker.html

[2] Central Bank of the Dominican Republic (2010). GDP and Balance of Payments Tables. Retrieved August 3, 2010, from http://bancentral.gov.do/

[3] Easterly, W. (2010, July 29). When financial crises are devastating to a country’s long-run prospects.   Message posted at http://aidwatchers.com/2010/07/when-financial-crises-are-devastating-to-a-countrys-long-run-prospects/

[4] Enterprise Surveys (2010). Financial crisis survey indicators, February-March 2010. Retrieved August 3, 2010, from http://www.enterprisesurveys.org/financialcrisis/

[5] Federal Reserve Bank. (2010). Industrial production and capacity utilization. Retrieved July 15, 2010, from http://www.federalreserve.gov/releases/g17/current/default.htm

[6] Sinai, A. (2010). The business cycle in a changing economy: Conceptualization, measurement, dating.  American Economic Review, 100(2): 25-29.

[7] The World Bank. (2010, April 23). Assesing Africa’s pulse: This is the time to invest, says World Bank Africa chief economist. Retrieved from http://go.worldbank.org/LEOZTPYSI0

[8] The World Bank Commodity Price Data (Pink Sheet). (2010). Commodity price index for middle and low income countries, July 2010R. Retrieved August, 2010, from http://go.worldbank.org/2O4NGVQC00

[9] Naude, W. (2009). The financial crisis of 2008 and the developing countries. UNU-WIDER discussion paper no. 2009/01. World Institute for Development Economics Research: http://www.wider.unu.edu/stc/repec/pdfs/rp2009/dp2009-01.pdf

[10] Rajan, R. (2010, July 9). How inequality fueled the crisis. Message posted at: http://www.project-syndicate.org/commentary/rajan7/English