As
2008 entered its final month, predictions of where
the world economy is heading turned dire. The World
Bank projected world output to grow by a mere 0.9
per cent in 2009 (as compared with 2.5 per cent in
2008 and a high of 4 per cent in 2006) and world trade
to contract by a significant 2.1 per cent (compared
to positive rates of growth of 6.2 per cent in 2008
and a high of 9.8 per cent in 2006). (Chart 1). Moreover,
the World Bank could identify no possible driver for
a recovery in the coming months.
Chart
1 >> Click
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Other projections are even more pessimistic. Chapter
1 of the UN's World Economic Situation and Prospects
2009, released in advance at the Doha Financing for
Development conference, estimates that the rate of
growth of world output which fell from 4.0 per cent
in 2006 to 3.8 per cent in 2007 and 2.5 per cent in
2008 is projected to fall to -0.5 per cent in 2009
as per its baseline scenario and as much as -1.5 per
cent in its pessimistic scenario.
Finally, the recently released preliminary edition
of the OECD's Economic Outlook for end-2008 shows
that GDP in most OECD countries declined in the third
quarter and is likely to fall also in the fourth (Chart
2). In the event, GDP growth in the OECD area which
fell from 3.1 per cent in 2006 to 2.6 per cent in
2007 and 1.4 per cent in 2008 is projected to fall
to -0.4 per cent in 2009 (Chart 3), and the unemployment
rate which rose from 5.6 per cent to 5.9 per cent
between 2007 and 2008 is expected to climb to 6.9
per cent in 2009 and 7.2 per cent in 2010.
Chart
2 >> Click
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Chart
3 >> Click
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If these predictions turn out to be true, the prognosis
is that what was a recession in 2008 could turn into
a depression in 2009. Looking back, 2008 was a year
when the recession unfolded. The recession in the
US, reports indicate, is not recent but about a year
old and ongoing. Short term indicators are disconcerting,
but do not convey the real picture. Preliminary estimates
of GDP growth in the United States during the third
quarter of 2008 point to decline of half a percentage
point. But GDP growth during the previous two quarters
was positive at 2.8 and 0.9 per cent respectively.
The only other quarter since early 2002 when growth
was negative was the fourth quarter of 2007. Thus,
going by the popular definition of a recession-two
consecutive quarters of decline in real gross domestic
product-the US is still to slip into recessionary
contraction.
But the independent agency which is the more widely
accepted arbiter of the cyclical position of the US
economy is the Business Cycle Dating Committee of
the National Bureau of Economic Research. This committee,
which adopts a more comprehensive set of measures
to decide whether or not the economy has entered a
recessionary phase, has recently announced that the
recession in the US economy had begun as early as
December 2007. That already makes the recession 11
months long, which has been the average length of
recessions during the post-war period. There is much
pessimism on how long this recession would last as
well. According to the OECD, for most countries "a
recovery to at least the trend growth rate is not
expected before the second half of 2010 implying that
the downturn is likely to be the most severe since
the early 1980s, leading to a sharp rise in unemployment.''
In fact, differential in the distribution of the impact
of the recession and a recovery in 2010 are the only
positive elements in analyst predictions. Most predictions,
as for example that of the World Bank, hold that the
decline in growth rates in emerging markets would
be much less than in the US. Thus, growth in developing
countries as a whole is expected to fall from 6.3
percent in 2008 to 4.5 per in 2009, only to recover
to 6.1 per cent in 2010. This is mainly due to China
and India without which the figures are more disappointing,
but still relatively creditable 5, 2.9 and 4.7 per
cent respectively. (Chart 4). In fact, expectations
now are generally that developing countries would
grow at relatively high rates in normal times. Thus,
Hans Timmer, who directs the bank's international
economic analyses and projections is reported to have
declared: ''You don't need negative growth in developing
countries to have a situation that feels like a recession.''
Chart
4>> Click
to Enlarge
However,
even here, the numbers are proving to be disconcerting.
China's growth has been slipping even if still relatively
high. But nobody can ignore the fact that manufacturing,
which is the engine of growth in that country is hugely
dependent on exports to developed country markets,
especially the US. Second, according to Bank of Korea
estimates, South Korea's economy will contract in
the last quarter of 2008 and grow at its slowest pace
in 11 years in 2009. According to its estimates, the
economy, the fourth largest in Asia, would shrink
by 1.6 per cent in the fourth quarter of 2008, and
grow only at 2 per cent in 2009, and 3.7 per cent
for full 2008. And the month-on-month annual rate
of growth of India's Index of Industrial Production
fell by 0.4 per cent in October, for the first time
in 15 years.
These developments make predictions of a significant
growth recovery in 2010 appear optimistic. A question
that troubles analysts is how long this recession
will last. The recovery assessments are based on the
assumptions that the crisis in financial markets would
be resolved soon and that there would be no negative
feedback loops both between the real sector and the
financial sector (which would exacerbate the financial
crisis) and within the real sector (which would intensify
the crisis in the real economy), before the positive
effects of intervention by governments materialize
in full. Such assumptions are indeed tenuous, increasing
the lack of certainty about a recovery. Thus, job
losses in the US are increasing the number of housing
foreclosures. Around 7 per cent of mortgage loans
were reported to be in arrears in the third quarter,
and another 3 per cent are at some stage of the foreclosure
process. According to the Mortgage Bankers' Association,
about 2.2 million homes will have entered foreclosure
proceedings by the end of this year. This would intensify
the financial crisis as well as dampen consumer spending,
and could worsen the downward spiral.
Yet, unemployment figures suggest that at the moment
the recession is only intensifying. On December 5,
2008, the Bureau of Labour Statistics in the US reported
that employers had reduced the number of jobs in their
facilities by 533,000, taking the unemployment rate
in the US to 6.7 per cent. This reduction-which is
the highest monthly fall in 34 years-comes after job
losses of 320,000 in October and 403,000 in September.
Total job losses through 2008 are 1.9 million. This
means that the 2.5 million jobs that President-elect
Obama is promising to deliver through his fiscal stimulus
package would just about recover the jobs lost during
the recessionary period preceding his swearing in,
and leave untouched the backlog of unemployed and
those entering the labour force during this period.
While 2008 was the year of crisis, the origins of
this crisis go back to the middle of 2007 when evidence
that homeowners who had borrowed to finance the property
they purchased had begun defaulting on their debt.
Soon it became clear that too many people with limited
or poor creditworthiness had been induced to borrow
large sums by banks eager to exploit the large amounts
of liquidity and the low level of interest rates in
the system. An unsustainable proportion of defaults
seemed inevitable. What was disconcerting in the events
that followed was that this ''sub-prime'' problem soon
spread and created a systemic crisis that soon bankrupted
a host of mortgage finance companies, banks, investment
banks and insurance companies, including big players
like Bear Sterns, Lehman Brothers and AIG.
The reasons this occurred are now well known. The
increase in sub-prime credit occurred because of the
complex nature of current-day finance that allows
an array of agents to earn lucrative returns even
while transferring the risk. Mortgage brokers seek
out and find willing borrowers for a fee, taking on
excess risk in search of volumes. Mortgage lenders
finance these mortgages not with the intention of
garnering the interest and amortization flows associated
with such lending, but because they can sell these
mortgages to Wall Street banks. The Wall Street banks
buy these mortgages because they can bundle assets
with varying returns to create securities with differing
probability of default that are then sold to a range
of investors such as banks, mutual funds, pension
funds and insurance companies. Needless to say, institutions
at every level are not fully rid of risks but those
risks are shared and rest in large measure with the
final investors in the chain. And unfortunately all
players were exposed to each other and to these toxic
assets. When sub-prime defaults began this whole structure
collapsed leading to a financial crisis of giant proportions.
The crisis had a number of consequences in the developed
countries. It made households whose homes were now
worth much less more cautious in their spending and
borrowing behavior, resulting in a collapse of consumption
spending. It made banks and financial institutions
hit by default more cautious in their lending, resulting
in a credit crunch that bankrupted businesses. It
resulted in a collapse in the value of the assets
held by banks and financial institutions, pushing
them into insolvency. All this resulted in a huge
pull out of capital from the emerging markets: Net
private flows of capital to developing countries are
projected to decline to $530 billion in 2009, from
$1 trillion in 2007. The effects this had on credit
and demand combined with a sharp fall in exports,
to transmit the recession to developing countries.
All of these effects soon translated into a collapse
of demand and a crisis in the real economy with falling
output and rising unemployment. This is only worsening
the financial crisis even further.
A crisis of this nature requires holes to be plugged
at many places simultaneously. While there is wide
agreement that what is needed is a globally coordinated
and huge fiscal stimulus, the actual effort on the
ground remains fragmented and meagre. Because of this
results are disappointing, threatening to make this
crisis the most protracted in a long time. Year 2008
is likely to be remembered as a year in which a crisis
of immense proportions unfolded.
