A New World Beyond The Global Economic Crisis

(This article will appear in the next Jan/Feb edition of Leadership magazine.)

The global economic crisis of 2008 – which most experts agree is far from over – is turning into a major shakeout of the world as we know it. The world that will emerge on the other side of the crisis is bound to be very different and the crisis is having a far bigger impact in far more ways than most of us can yet imagine.

It is not merely about economics or banking systems. It affects global power relations, the internal stability of countries, political systems, financial and business systems, the war on poverty and disease, unemployment, consumer behaviour, property markets, entire industries such as the automobile industry, the fight against global warming, the scramble for resources, ideologies, food production and security....yes, almost every aspect of life as we know it.

As Prof Andre Roux, Director of the Institute of Futures Research at the University of Stellenbosch puts it: “It is a trend break, a disruption of previous beliefs about relations between variables, stakeholders, organisations, ideologies, and paradigms. What we have here is a trend break similar to the Great Depression, the two world wars, the fall of the Berlin wall, 9/11. So, life will not be the same as it was a year ago.”

While revolutionary changes are starting to take place in many spheres such as the motorcar industry, or the newspaper industry, it is especially in the two areas of global power relations and financial systems – closely intertwined in our globalised world – where the biggest impacts are being felt. From there it is a ripple effect that touches everything else.

Balance between state and markets

“A very important issue already emerging is a re-examination of the balance between state and markets,” says Prof Roux. “Some say capitalism has failed, others say it is misunderstood. I don’t think capitalism will go away. But at the same time I think we are rediscovering the fact that even in capitalism governments and states do have a role to play.”

Roger C Altman, a former US Deputy Treasury Secretary, writing in the latest edition of Foreign Affairs, says the US and some European governments have nationalised their financial sectors in contradiction of modern capitalism in an attempt to re-establish stability.

“Much of the world is turning a historic corner and heading into a period in which the role of the state will be larger and that of the private sector will be smaller,” says Altman. The crisis, he says, reflects the greatest regulatory failure in history.

Systems overhaul

On January 15 the World Economic Forum released its report entitled The Future of the Global Financial System; A Near-Term Outlook and Long-Term Scenarios which it had developed in collaboration with global strategy consulting firm Oliver Wyman.

According to the report, with the onset of the current financial crisis, an initial unwinding of global imbalances that were built up over the past decade has been experienced after years of expansionary monetary policies, financial deregulation and excessive credit utilization.

The report explores a near-term outlook for global financial system characterized by an expanded scope for regulatory oversight, back to basics in the banking sector, some restructuring by alternative investment firms and the emergence of a new set of winners and losers in the insurance industry.

Over the long-term, the report finds that a range of external forces and critical uncertainties have the power to significantly shape the global financial system. In particular, the World Economic Forum’s study found that the pace of geo-economic power shifts from today’s advanced economies to the emerging world and the degree of international coordination on financial policy are the two most critical uncertainties for the future of the global financial system.

Future scenarios

The report came up with four future scenarios, each describing key forces and turning points that could fundamentally shape the governance and structure of the global financial system in the next decade. In the first, called Financial Regionalism, three major blocs on trade and financial policy take shape. In the second, called Re-engineered Western-centrism a highly coordinated and financially homogenous world has yet to face up to the realities of shifting power and the dangers of regulating for the last crisis rather than the next. In the third, called Fragmented Protectionism, the world is characterized by division, conflict and currency controls that deepen the long-term effects of the financial crisis. And in the fourth, Rebalanced Multilateralism, initial disagreement is overcome in the context of rapidly shifting geo-economic power.

Another report released two days earlier by the World Economic Forum predicts a rather gloomy scenario ahead in which massive government spending to support financial institutions will threaten the already precarious fiscal positions in countries such as the US, United Kingdom, France, Italy, Spain and Australia.

Global Risks 2009 identifies deteriorating fiscal positions, a hard landing in China, a collapse in asset prices, gaps in global governance and interconnected risks stemming from the scramble for natural resources and climate change policy as the pivotal risks facing the world this year.

Interconnected risks

With major developed economies under severe pressure due to massive spending by governments to bail out failing financial institutions, it is unlikely much financial assistance will be given to poor nations to fight global warming as pledged by developed nations at the UN climate change conference in Bali.

Roux agrees that due to the financial squeeze fighting diseases, poverty alleviation or global warming may not top the agendas of countries. The downside is that even temporary setbacks can have a long-term effect as deteriorations might become irreversible. Roux also fears that this situation could undo the investments of the last few years in the search for alternative energy sources.

Altman supports a similar view, pointing out that with Obama about to inherit a US$1 trillion plus budget deficit, the largest ever incurred by any country in history, international spending in the form of aid and donations will not be forthcoming. The IMF will have to provide, and that institution too is stretched to the limit. And Altman believes Western capital markets will not return to full health for years.

Consumer depression

Prof Roux also points out that in most countries, but especially the US and Europe, the net worth of consumers fell dramatically and that they are tremendously depressed. They will be very conservative in time to come, spending little, which will slow down growth. In the US, says Altman, major drops in corporate profits are likely “because consumers are deeply frightened and have stopped spending on discretionary items”. This will create a vicious circle where less spending, lower incomes and higher unemployment will lead to even weaker economies.

Post-crisis unemployment is on the decline worldwide, and South Africa is no exception. With the pressures being felt in most countries, it is speculated that much of the South African Diaspora may return home. Roux says it is a good thing as we need their skills, but he is not sure there will be enough jobs for them back home under present conditions.

Roux says that typically governments have tended to solve such problems with fiscal policy, spending more and/or reducing taxes. But this creates longer term problems as debt levels rise. Most experts believe using monetary and fiscal stimuli will be relatively ineffective.

Like Altman many analysts believe a return to normalcy is a very long way off. “The West’s financial system is already a shadow of its former self,” says Altman. To keep the balance sheets stable, Western financial institutions will have to reduce their leverage much more by withdrawing credit from the world for at least three to four years, he believes.

China steps into the void

Against this background ongoing global power shifts are also likely to be affected one way or another, and even accelerated. Evidence of this is the prominence China’s Premier and Russia’s Prime Minister Vladimir Putin will enjoy at this year’s World Economic Forum Annual Meeting in Davos-Klosters, Switzerland, from 28 January to 1 February. Wen Jiabao will occupy centre stage when he addresses a special session on the first day of the meeting, while Putin will address the opening meeting. The theme will be shaping a post-crisis world. In previous years the influential Davos gathering was always dominated by the G8 major industrialised countries.

“China has become a global power whose cooperation is essential to relaunch global economic growth,” said Professor Klaus Schwab, Founder and Executive Chairman of the World Economic Forum. It is clear China, will achieve a stronger relative global position. It is already the world’s strongest country in terms of liquidity. There is also a growing view that a US led by Obama and less distracted by the war in Iraq will understand that the United States’ most important bilateral relationship should be with China.

China’s leap to centre stage was also evident in November when a meeting of the G20 countries, proposed by France’s President Nicolas Sarkozy and hosted by President George Bush, was held to discuss ways out of the global economic crisis. With foreign exchange reserves close to $2 trillion China is one country that can come to the aid of countries hard hit by the crisis, either directly or by injecting cash into the International Monetary Fund. This meeting was ample evidence of the power shifts taking place.

According to Prof Roux the Western nations have realised that they cannot tackle the crisis alone. “So they invited China, they invited Saudi Arabia, because they wanted these countries to bail them out, to supply some cash. I think we certainly are looking at a reconfiguration at the global economic and the political level,” he says. Instead of just one super power, America, the world will in future be looking at a number of major powers.

Altman says the crisis has significantly weakened the US and Europe, accelerating trends that are “shifting the world’s centre of gravity away from the United States”. With the unfolding recession heralding the deepest global economic slump since the 1930s, Altman says for the medium term it is clear that the global roles of the US and Europe will shrink along with their economies.

India, Saudi Arabia & Russia

Other countries of which the G8 are forced to take much more notice in the rapidly shifting pattern of global power relations are Saudi Arabia and India. British Prime Minister Gordon Brown has already approached the wealthy oil-producing Saudi Arabia to bolster the IMF’s coffers, while the country was a prominent presence at the G20 meeting.

For Russia the global financial crisis could not have come at a worse time, says Steven Sestanovich in a special brief for the Council on Foreign Relations. Just when the country was making good progress on all fronts and had high confidence in the future, re-establishing herself as global player, the crush came, plunging its stock market by 70% and causing an outflow of 20% of its forex reserves. The crisis, together with the steep drop in oil prices took a toll on Russia's resource-based economy, slowing growth and sending unemployment higher, says Sestanovich.

“That has put Russia's leaders under tremendous pressure as they try to prevent an explosion of social protest that could threaten their rule.” With US$500 billion still in forex reserves Russia remains financially strong, but the global crisis will slow down its geopolitical ambitions.

Initial responses to the crisis by Russia tend to point to a flexing of its muscles with some hints of tightening authoritarian rule, increased anti-Western rhetoric and punitive measures for those countries not carrying out its wishes. For example, in January Russia cut off the natural gas supplies to Ukraine r to punish, it seems, Western-leaning Ukraine for seeking to join NATO and the European Union.

However, despite the muscle flexing, Russia has also consistently emphasised throughout the crisis so far the importance of further reform, cooperation with other countries and a view that it sees the crisis as part of a large shift in the international balance of power. Russian President Dmitry Medvedev is on record saying that the emerging economies, especially in Asia, will have to be the leaders in unravelling the world economic crisis. Russia wants to be a leading part of this transformation and it will be interesting to see what Putin tells the WEF meeting in Davos.

Increased risk of conflicts

Meanwhile, there can be little doubt that the global economic crisis is also threatening the established political order and relations between nations. The European Union’s development aid commissioner Louis Michel warns that the effects of the global recession will fuel existing conflicts, spark terrorism and jeopardise global security in general. Other world leaders such as French President Nicolas Sarkozy have echoed these sentiments.

Aid to many underdeveloped nations – particularly in Africa – is also likely to come under pressure because of the crisis. Together with existing grinding poverty in many of these countries, exacerbated by droughts, diseases and high global food prices, the stage is set for more conflicts and instability. Researchers Raymond Fisman of Columbia Business School and Edward Miguel of the Centre of Evaluations for Global Action University of California say a 5 percent drop in national income in African countries increases the risk of civil conflict in the following year to 30 percent.

A new Bretton Woods?

Since 1944 world finance has been governed in terms of the Bretton Woods agreement reached by the 44 Allied nations fighting Hitler. That agreement created the World Bank and the International Monetary Fund and aimed to increase and spread international trade in order to minimise the possibility of future wars and to avoid another Great Depression. Now, almost 65 years later that agreement has dramatically run out of steam.

Together the outcome of the recent G8, G20 and other meetings and the forthcoming WEF meeting in Davos may yet lead to a new Bretton Woods type of agreement, taking the world into a new era. Until that much uncertainty will prevail.