The 2008 financial crisis: Implications for developing economies
This paper examines the 2008 financial crisis and implications for developing countries, especially for Africa. It examines some of the causes of the financial crisis especially in the United States where the dilemma originated. Implications for a global recession and impacts for Africa are highlighted. However, the implications of the financial crisis for the African continent cannot be addressed in detail in this paper; rather this paper will focus on a few key examples of the financial crisis and its impacts on a few African countries for understanding. The paper ends with recommendations and ways forward for African governments to combat the current and future financial impacts.
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. Situations that are often called financial crises include stock market crashes (i.e. a sudden dramatic decline of stock prices) and the bursting of other financial bubbles (i.e. trading in high volumes at prices that are considerably at variance with the value of a property of a good or a commodity), and currency crises (i.e. when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange) to name a few. Examples of commodities include crude oil, wheat, precious metals, property as well as currencies which are the unit of exchange that facilitates the transfer of goods and/or services. The world financial system is a complex collection of institutions established with the intention of bringing together people who want to borrow and those who want to lend to ensure and enhance the transfer of funds. The world financial crisis could thus be viewed as a systematic meltdown of the various institutions as well as constituents of the world’s complex financial system. The 2008 financial crisis was mostly related to flawed regulatory regimes and sub-prime mortgage lending, especially in the United States. However, the developing world in general and Africa in particularly has always been most affected by almost every other global economic crisis that has occurred in recent history, although the 2008 financial crisis has so far, not had such an immediate impact on the developing countries, including those in Africa.
Much has been reported on the 2008 financial crisis which was stated by many to be the worst since the Great Depression in 1929. The Great Depression was an economic slump in North America, Europe, and other industrialised areas of the world that began in 1929 and lasted until 1939. It began with a catastrophic collapse of stock-market prices on the New York Stock Exchange and during the next three years, stock prices in the United States continued to fall. By late 1932 prices had dropped to only about 20 percent of their value in 1929. By 1933, 11,000 of the United States’ 25,000 banks had closed. The failure of so many banks, combined with a general and nationwide loss of confidence in the economy, led to much-reduced levels of spending and demand and hence of production, thus aggravating the downward spiral. The Depression hit hardest those nations that were most deeply indebted to the United States (i.e. Germany and Great Britain). In Germany, unemployment rose sharply beginning in late 1929 and by early 1932 it had reached 6 million workers or 25 percent of the workforce. Britain was less severely affected, but its industrial and export sectors remained seriously depressed until World War II. Many other countries had been affected by the slump by 1931. Developing countries that were dependent on the export of primary products, such as those in Latin America, were already suffering a depression in the late 1920s. More efficient farming methods and technological changes meant that the supply of agricultural products was rising faster than demand, and prices were falling as a consequence. Initially, the governments of the producer countries stockpiled their products, but this depended on loans from the USA and Europe. When these were recalled, the stockpiles were released onto the market, causing prices to collapse and the income of the primary producing countries to fall drastically. Clearly, with the 2008 financial crisis, world governments (especially the industrialised nations) did not learn lessons from the Great Depression. However, the current financial crisis is not necessarily following the pattern of the Great Depression, since the two disasters are very different, although lessons could have been learnt from this incident.
Causes of the 2008 financial crisis?
It is clear that the United States as during the Great Depression is indisputably undergoing a financial crisis and is perhaps headed for a deep recession, but what caused the financial crisis of 2008? The answer to this question is multi-fold including the introduction of trade liberalisation policies by the global elite, financial speculation and personal greed by many individuals and organisations. Firstly, financial liberalisation was implemented by global elite states across the world to assist corporations to find new ways of making money, which has contributed to the financial crisis. By the 1970s, profits in the manufacturing sector were declining, the economy was stagnating, and the elite wanted more profitable ways to make money that didn’t require hiring much workforce. A need to reduce investments in manufacturing for profit gain was required. With declining profits, capital reacted by promoting economic restructuring with the aim of increasing profit margins at the expense of workers’ wages, reduced social welfare spending, squeezing underdeveloped countries with the help of the IMF. Elites begin speculating on anything, including commodities and gambled on the fluctuations in stock, bond and currency values. Banks and corporations ran up trillions in debt and then resold this debt onto investors to reduce risk. Indeed, debt drove the whole system and without it, there would not have been the explosion in the financial sector. Manufacturing companies also restructured and, in a sense, became investment and financial institutions in their own right. Blind greed, arrogance and short-sightedness drove this system and a handful of people made trillions.
Another reason for the financial crisis was precipitated by government manipulations and greed by lenders. From January 2001 to June 2004, the Federal Reserve System (i.e. Fed) sharply lowered the interest rate for federal funds. In response, mortgage rates plummeted from almost 8 percent in 2002 to 4-6 percent in 2006. Hence, banks issued mortgages to all kinds of buyers and speculators, some of whom were allowed to put down no collateral for risky home loans. Mortgage lenders were happy to lend money to people who couldn’t afford their mortgages. A mortgage is a secured loan used to purchase property and is financially agreed between the lender and borrower. One of the largest mortgage lenders in the US, Countrywide, founded in 1969 offered exotic mortgages to borrowers with a questionable ability to repay them. Generally, lenders who approved these loans absolved themselves of responsibility by packaging these bad mortgages with other mortgages and reselling them as “investments.” Lenders had no reason not to sell homes as they made a cut on the sale, then packaged the mortgage with a group of other mortgages and erased all personal responsibility of the loan. Thousands of people took out loans larger than they could afford in the hopes that they could either make a profit from the house or refinance later at a lower rate. A lot of people got rich quickly and people wanted more. Lenders lent money regardless because there was supposedly no risk to them, and were able to charge higher interest rates and make more money on sub-prime loans. If the borrower’s default, they simply seized the house and put it back on the market. On top of that, they were able to pass the risk off to a mortgage insurer or package these mortgages as mortgage-backed securities. Higher house values mean that lenders could lend out even bigger mortgages, and it also gave lenders some protection against foreclosures. All of this translates into more money for the lenders, insurers, and investors. When too many buyers couldn’t afford to make their payments, it causes these lenders to suffer from liquidity issues and to sit on more foreclosures than they could sell.
However, the US economy is more complex than made out to be, so blame should not fall only on a single sector. The problem is one of layered irresponsibility between many parties. Those alleged to be at fault include the following: The US Federal Reserve (as above), which slashed interest rates making credit cheap; Home buyers, who took advantage of easy credit to bid up the prices of homes excessively; Congress, which continues to support a mortgage tax deduction that gives consumers a tax incentive to buy more expensive houses; Real estate agents, most of whom work for the sellers rather than the buyers and who earned higher commissions from selling more expensive homes; The Clinton administration, which pushed for less stringent credit and down payment requirements for working and middle-class families; Mortgage brokers, who offered less-credit-worthy home buyers subprime, adjustable rate loans with low initial payments, but exploding interest rates; Former Federal Reserve chairman Alan Greenspan, who in 2004, near the peak of the housing bubble, encouraged Americans to take out adjustable rate mortgages; Wall Street firms, who paid too little attention to the quality of the risky loans that they bundled into Mortgage Backed Securities, and issued bonds using those securities as collateral; The then Bush administration, which failed to provide needed government oversight of the increasingly dicey mortgage-backed securities market; An obscure accounting rule called mark-to-market, which can have the paradoxical result of making assets be worth less on paper than they are in reality during times of panic; Collective delusion, or a belief on the part of all parties that home prices would keep rising forever, no matter how high or how fast they had already gone up. However, not to divert from the root cause of the problem which has been the functionality of the financial and banking system, along with the roles of the US capitalist government in this functionality. Unfortunately, in the UK and US government is using tax payer’s money to help out greedy bankers. Example, the US government also agreed that the Federal Reserve would supply $85 billion to bail out American International Group (AIG), the world’s largest insurance company. Since mortgage lenders have made substantial sums of money leading to the crisis, does this mean that they will get away? Why should taxpayers have to pay for somebody else’s mess? Do developing countries such as in Africa also indirectly pay for the failings of banks?
Impacts on developing countries
What began as a slump in the US housing sector is now a global crisis, spreading to both developed and developing economies. The poorest countries, including many in Africa, will be significantly affected by the crisis even though the channels of transmission are likely quite different from those operating in emerging markets. Financial sectors in low-income countries are less integrated into global financial markets; as a result, the direct impact of the crisis is likely to be more limited. However, this does not mean that they will not be affected.
As Dadush (2008), Director of Development Prospects Group noted:
“The direct impact of the crisis is less dramatic in the financial sectors of the poorest countries…but they will be hit nevertheless by slower export growth. Global trade is expected to decline by 2.5 percent in 2009 reduced remittances by migrant workers, and lower commodity prices that will affect commodity-exporting countries.”
Developing countries at first sheltered from the worst elements of the turmoil are now much more vulnerable, with dwindling capital flows, huge withdrawals of capital leading to losses in equity markets, and towering interest rates. GDP growth in developing countries only recently expected to increase by 6.4 percent in 2009 is now likely to be only 4.5 percent, according to economists at the World Bank. The poorest countries will be harmed through slower export growth (e.g. Cameroon’s exports of wood to the US have collapsed, putting over 40,000 jobs at risk). Other impacts for developing countries include reduced remittances, and lower commodity prices (which will reduce incomes in commodity exporters). The crisis may also lead to a reduction in private investment flows, making weak economies even less able to cope with internal vulnerabilities and development needs. According to the World Bank, the effects of financial crisis on the African continent could manifest through drying up of liquidity and capital inflows, aids programmes and trade. Many African banks that may be planning to seek funds from the developed economies may not be able to source capital. Some developing countries will be hit much harder than the average experiencing growth which is negative in per capita or even absolute terms. Sharply tighter credit conditions and weaker growth are likely to cut into African government revenues and governments’ ability to invest to meet education, health and gender goals to name a few. The poor will be hit hardest. Current estimates suggest that a one percent decline in developing country economic growth rates traps an additional 20 million people into poverty. Already 100 million people have been driven into poverty as a result of high food and fuel prices. Of the 20 developing countries whose economies have reacted most sharply to the deterioration in conditions (as measured by exchange rate depreciation, increase in spreads, equity market declines and large current account deficits), seven come from Europe and Central Asia, and eight from Latin America. Africa, however, is still very vulnerable to the economic crisis being one of the poorest continents in the world.
Food, fuel and job insecurity in Africa
High food prices from 2007 through mid-2008 also had serious implications for food and nutrition security, macroeconomic stability, and political security. The global financial crisis and economic slowdown have pushed food prices to lower levels by decreasing demand for agricultural commodities for food, feed, and fuel. The availability of capital has also decreased at a time when accelerated investment in agriculture is urgently needed. The food and financial crises have strong and long-lasting effects on emerging economies and poor people. As capital becomes scarcer and more expensive, the expansion of agricultural production to address the food crisis has been cut short. Africa is on the receiving end of food tariffs and subsidies by the US, EU and Japan and this has distorted the economics of its food production and caused some viable crops not to be grown locally. The price of petrol has roughly doubled in the past year and in addition to the direct effects on the cost of travel, there are knock-on effects on the price of products, such as food, which need to be transported. The world financial crisis has pushed aside the attention of policymakers from the threat of rising food prices. Across the developing world, the purchasing power of poor and middle-income families has declined with slowing economic growth. The collapse of the financial system which held the wealth of individuals and corporations meant an overnight sharp fall in different kinds of incomes, particularly permanent income. These developments resulted in sharp fall in demand (as demand even depends more on permanent income) and corresponding fall in supply and hence production. Cuts in production necessitated cuts in employment as well as income and hence demand. All these have dynamic implications for Africa.
The global financial crisis and the resultant job and food insecurities have affected bushman poaching in Africa due to food shortages. People have turned to wildlife as their source of food because other food sources become inaccessible. Due to the global financial crisis, the logging companies in Cameroon are now retrenching their workers and which has intensified poaching. The spiral of unemployment so created has led the jobless to turn to poaching as an alternative means to survive. The shrinking of demand in richer economies suggests a cut in production levels at plants that are located in Africa, potentially reducing consumption of fuel, metallic and other primary products. Hence, the earnings of African companies (and it’s people – if included in wealth production) will decline.
The global food price crisis in 2007-08
Nigeria and the financial crisis
The persisting global financial meltdown is adversely affecting Nigeria to the extent that the nation’s economy is now in deep crisis. With a sharp drop in market capitalisation on the Nigeria Stock Exchange, this has plummeted government revenues. Nigerian representatives who attended the sixty-third General Assembly, Second Committee 24th Meeting of the United Nations on the 4 November 2008, noted that the financial crisis had compounded matters by inducing fears over aid delivery. The unprecedented fall by 40 per cent in the international prices of oil, attendant of the global financial crunch compounded by the persistent Niger Delta Crisis of Nigeria, signals that, if the global financial meltdown persists, Nigeria could suffer a major setback. The effects of the crises on agricultural and rural development and the economy of Nigeria may contribute to a lack of foreign investments arising from the cash crunch; decaying infrastructures likely to weaken the supply side of the nation’s food market, food unavailability, low rate of domestic food supplies and imports; with reduced foreign exchange earnings from oil, the prospects of the government to invest in agricultural programmes within the next four years is bleak. In addition, there could be the collapse of infrastructures (energy, water, communication and transportation) due to funding inadequacy. Bad economic conditions and high international food prices might result in worsening market conditions in the coming months. There is no doubt that Nigeria’s integration into the world economy and markets due to its oil reserves has placed the country into difficulties. Had Nigeria rather nationalised its natural resources (i.e. oil), the country would have been in a more stable position. The impact of the recession is not uniform across the continent and is dependent on country respective levels of integration into the global economy and position in the international division of labour.
Although the financial crisis is affecting African countries, there are some measures that African governments can take to limit future impacts on their nations. There is no doubt that developing country budgets will need to adjust to a new fiscal reality. Therefore it is essential that African governments exercise caution and invest in their countries. Governments need to increase budgets for social development and public expenditure rather than decrease budgets. This will be essential for restoring high-quality economic growth over the longer term. However, in order for this to occur, we need good governance in Africa. This will also be important in developing African responses and solutions that meet the demands of African people instead of corrupt African officials and the interests of western economies. African governments must, therefore, build capacity and fast-track the movement towards the economic and political integration of the continent.
The dependence on commodity export earnings (i.e. oil, agriculture) and potential volatility through global economic instability means that Africa’s approach to the current volatile state of the world’s major economies should be more visionary. Example, benefits of its oil reserves such as in Nigeria and recently Uganda must be secured for the interest of citizens through nationalisation, similar to countries such as Venezuela which has reduced the power of international corporations from extracting resources from the country that do not benefit locals. Similarly for food, instead of Africa being on the receiving end of food tariffs and subsidies by the US, EU and Japan and which has distorted the economics of its food production. It is essential that African government create subsidies for local farmers so that viable crops can be grown locally for people. There must be an explicit recognition of the basic right to sustain food production and promote food sovereignty at the local level through re-nationalisation of agricultural produce and the end to trade-distorting subsidies in developed countries. However, pressure on developed countries for financial assistant and aid must continue due to decades of western corporate resources plundering and increased African poverty, since these finances rightfully belong to Africa and should not be seen as a ‘donation’ from the west. In addition, any debt that African countries are said to own to developed countries through previous loans must be cancelled.
Finally, unlike the United States and other western nations who did not learn from their mistakes of the Great Depression, African governments can learn from the mistakes of the west. If there is a bank failure, government intervention should be via preference shares and loans and not via tax payer’s money that should rightfully be used for the interest of nationals and poverty alleviation. It is essential that African governments increase co-operation within Africa and ensure the development of its people rather that relying on subsidies and trade with western nations under western rules (i.e. IMF/WTO) that pose a risk to national interests. Not to say that there are no benefits that can arise from economic globalisation, but the problem is that when political interest are involved, this can be damaging for poor nations. As Nelson Mandela noted, on November 16, 2000, during a lecture at the British Museum, “…if globalisation is to create real peace and stability across the world, it must be a process benefiting all. It must not allow the most economically and politically powerful countries to dominate and submerge the countries of the weaker and peripheral regions. It should not be allowed to drain the wealth of smaller countries towards the larger ones, or to increase inequality between richer and poorer regions.” Unfortunately, globalisation currently is failing as can be seen from the financial crisis of 2008 as individuals are motivated by self-interest and greed expressed best through the pursuit of financial gains. Globalisation is also failing as signalled through the concerns from citizens globally against an unequal playing field and in the interest of the finance community. It is, therefore, essential that governments look towards African solutions for African problems and listen to its people if the continent is limit the impact of global insecurities and prosper for the interests of its own people.
Leonard, L. (2009) The 2008 financial crisis: Implications for developing economies, Ugandan Parliamentary Briefing, Royal African Society, United Kingdom, 26 February