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The next stage of the crisis

The next stage of the crisis
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First Published: Tue, Dec 23 2008. 09 32 PM IST
Updated: Tue, Dec 23 2008. 09 32 PM IST
Is it now time to prepare for the third stage of the unfolding global crisis? The crisis began in the market for US subprime mortgages in the summer of 2007. It then spilled over into the rest of the global financial system, as investors realized that banks in other countries held complex derivatives based on reckless subprime lending in the US. The credit markets froze in fright. The financial system was close to collapse by September, but now seems to have stabilized despite many cracks in the edifice.
Then came the second stage. Around a year after the first subprime defaults were reported, the damage to the global financial system was widespread enough to affect the real economy of output and jobs. Though the US recession is now said to have started at the end of 2007, it is only over the past three months that world economic growth has really tumbled. Most forecasters have cut their expectations of growth around the world. Many expect this to be a long and deep recession. International Monetary Fund first deputy managing director John Lipsky said in a 10 December speech at Frankfurt that the major advanced economies are contracting in unison for the first time in the post-war era. He also added that a new IMF forecast for 2009 that is due in January would predict a further fall in global growth.
If finance was the epicentre of the first stage of the crisis and the real economy of the second stage, then the geopolitical implications are likely to visit us in the third stage that may begin around 12 months from now. I think there are three issues worth tracking.
First, deep recessions will force political leaders to focus on domestic problems rather than multilateral ones. Economic nationalism is the most obvious threat. Economies are now being supported by huge increases in government spending as well as bailouts and nationalizations of key industries. That means the power of governments over markets could grow. There could also be creeping protectionism as governments try to protect domestic companies.
This is dangerous stuff. The US Smoot-Hawley Tariff Act of 1930 tried to protect American companies against imports. It led to similar legislation in Europe. World trade shrank and the recession of the 1930s worsened. The lessons of that decade are unlikely to be forgotten, but it is quite possible that governments will use other means to protect “their” industries and damage the world trading system. On the other hand, other key multilateral issues such as climate change, too, may fall off the map of global concern.
Second, there could be shift of global power away from the West. “Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would have played. These weaknesses will eventually be repaired, but in the interim, they will accelerate trends that are shifting the world’s centre of gravity away from the United States,” says Roger C. Altman, a former US deputy treasury secretary, in an article in the January/February issue of Foreign Affairs, a bimonthly journal.
Altman believes that China will be a major beneficiary of this power shift, partly because of its strong finances—a budget surplus, a current account surplus and nearly $2 trillion in foreign exchange reserves. India fares poorly on each of these three parameters of financial soundness. We have reason to worry if China uses this crisis—as it very well may—to further its geopolitical leverage.
Third, these will be trying times for several autocratic regimes. Many of them are heavily dependent on profits from commodities such as crude oil. This is no coincidence. Economists have shown that countries rich in natural resources tend to be more repressive and corrupt. Governments in normal countries that tax citizens are forced to give something in return: good governance, stability and security, for example. But rulers sitting on huge natural resources do not need tax revenues to run the show. They are far more likely to destroy civil society.
The recent commodity boom helped strongmen such as Vladimir Putin and Hugo Chavez intensify their power over opponents. The fall in commodity prices will harm them. We have already seen the pace at which Russia’s economy is unravelling, harming not just its oligarchs but the Putin regime as well. The economic crisis and recession will shift power away from dictators, though it is tough to guess whether this shift will be smooth and orderly. What will crude oil at, say, $20 a barrel mean for Saudi Arabia, Iraq, Iran and other current and potential trouble spots.
Policymakers have had some success right now in stabilizing the financial system and are fighting a tougher battle to beat recession. Managing the geopolitical implications of the global economic crisis will not be easy either.
Your comments are welcome at cafeeconomics@livemint.com
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First Published: Tue, Dec 23 2008. 09 32 PM IST