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Part 1: The global economy

This section contains three stories:


GLOBAL FINANCIAL CRISIS IS MET WITH RAPID GOVERNMENT RESPONSES

Chapter links:
  • Chapter 2

  • Chapter 3

  • Chapter 5

  • Chapter 11

  • Chapter 15
The past two months have seen the deepening financial gloom of the past year turn into a global financial crisis, with collapsing banks, a drying up of lending and rapidly falling stock markets. In the week of 6 October, markets globally fell over 20%, causing shockwaves in the global economy. Governments quickly stepped in, showing willingness to co-operate with each other in measures to shore up the financial system. We will look first at the chief causes of the current crisis, and then at government responses and their prospects of success.

Causes of the crisis
As highlighted in Chapter 11, the derivatives market, the bulk of which is unregulated, has spiralled in recent years. Derivatives can be securitized – that is, packaged as securities which can be traded and used as security for loans. However, pricing these products involves an element of guesswork and thus added risk. Adding to the uncertainty in derivatives trading has been the influx of mortgage-backed securities, mainly in the US. When property values were rising, these did not seem to pose high levels of risk: even the ‘sub-prime’ lending to borrowers with weak credit profiles seemed safe in a market of rising prices. But the US housing boom collapsed and property values fell, leading to uncertainty and distrust of mortgage-backed securities – troubled assets on which much of the financial system had come to depend. As banks’ asset bases suddenly looked shaky, share values fell and inter-bank lending fell to a trickle as banks ceased to trust each other. Businesses found banks unwilling to lend to them (the ‘credit crunch’), and people feared for their savings, investments and pensions.

Government responses
Governments stepped in quickly with a number of measures:
  • Deposit guarantees – Savers in most countries enjoy protection for money they deposit in banks (up to a defined ceiling) through savings insurance schemes, such as the Federal Deposit Insurance Corporation (FDIC) in the US. However, in the event of a ‘bank run’ affecting several large banks, these arrangements would soon run out of funds. In the current crisis, governments raised the ceiling on guarantees, and even assured depositors with savings over the defined limit that all their savings were guaranteed. This helped to contain the risk of a bank run.
  • Liquidity operations – Central banks stepped in to aid banks directly. In the UK, under the Special Liquidity Scheme, announced on 8 October, £200 billion was injected into money markets and £250 billion was made available to banks over 3 years to guarantee medium-term debt, and help to restore inter-bank lending.
  • Government purchase of mortgage-backed securities – In the US, a bail-out bill was quickly drawn up and presented to the US Congress, known as the Troubled Asset Recovery Programme (TARP). A sum of $700 billion was roughly calculated to be the amount necessary to purchase the troubled assets from banks. The US Treasury would be left with the difficult task of valuing and selling these troubled assets, but an immediate benefit would be to remove them from the banking system. However, since the passage of the bill, its policy has shifted away from this strategy to one of injecting funds directly into troubled organizations (see next item).
  • Part-nationalization – Some governments have taken over swathes of the equity of troubled banks as part of a rescue package. In its bail-out package for the banks, the US did not propose taking equity positions in banks, but by mid-November, the US Treasury announced that it was changing its policy on how to use the bail-out funds, and would be using them for recapitalization, rather than buying troubled assets. In countries with a history of nationalized industries, nationalization is more readily accepted than in the US. The US and UK are now embracing active intervention of the state, in a significant reversal of liberal market principles. In its banking crisis of the early 1990s, Sweden nationalized banks, and the UK nationalized the Northern Rock when it was near collapse in late 2007, having over-engaged in issuing mortgage-backed securities. The resort to use of taxpayers’ money in this way is often criticized: if bankers acted irresponsibly in pursuing risky practices, the market solution is to let them fail. However, governments fearing collapse of the entire system reached for public ownership to restore confidence.

Prospects of success
The recognition that government bail-outs were needed in systems such as the US and UK, which have been foremost exponents of non-intervention in markets, has been remarkable. The capitalist model, long held up by the US to the rest of the world as the example to follow, now seems deeply flawed. Some would even say it has failed. A more moderate view is that markets are not per se to blame, only lack of adequate regulation. In EU countries, there is no unified regulatory structure, and European governments have attempted to co-ordinate policies, under the EU presidency of France, led by President Sarkozy. As some banks’ liabilities are greater than their home countries’ GDP, co-operation has been necessary. However, President Sarkozy, who favours greater regulation, warns that statist solutions of the past are not the solution, and that the benefits of liberal trade and markets should be preserved.

The major developed countries, whose excesses in credit derivatives markets were largely to blame for the recent financial turmoil, are all facing recession. It was hoped that the government measures outlined above would encourage lending, benefiting businesses in the ‘real economy’. Central banks have reduced interest rates, despite inflationary pressures, in order to encourage economic activity. In a concerted effort, central banks in the US, Canada, the UK, Switzerland, Sweden and the eurozone, all reduced rates by 0.5% simultaneously on 8 October 2008. China also made an adjustment, but China and other large emerging economies have generally remained on the sidelines. These economies have continued to enjoy robust growth, while the developed economies have been slowing over the past year. Most forecasters, including the IMF, are now revising downwards estimates for growth in the developed countries, estimating that some will either stagnate or contract over the next year, implying high unemployment and declining consumer spending. The consequences are already being felt in China, as growth is slowing and demand in western markets for its manufactured goods is weakening. As Chinese manufacturers are forced to cut back their production, jobs and consumer demand in China are showing signs of slowing. Plummeting stock exchanges of late have afflicted the large emerging economies. Russia and Brazil both suspended trading in the turbulent week of 6 October, to calm markets.

A meeting of the G20 countries took place in Washington, D.C., on 15 November, under the auspices of the IMF. The G20 group, formed in 1999, consists of both developed and developing nations. Its members are the G8 (Canada, Japan, Germany, France, Italy, UK, US, Russia) plus Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Saudi Arabia, South Africa and Turkey. The 20th member is the EU presidency, if that is not held by a G7 country. France was represented both as a G7 country and EU presidency. In addition, Spain and The Netherlands were represented, bringing the number to more than 20 countries. The meeting discussed only broad principles, including the need for transparency and better regulation of the global economy, scheduling further meetings to discuss details. Significantly, the meeting expressed a wish to continue multilateral trade negotiations, despite the failed talks in July 2008 (see next item).

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THE COLLAPSE OF THE WTO DOHA ROUND OF TRADE NEGOTIATIONS

Chapter links:
  • Chapter 6

  • Chapter 15

  • SX 6.1

  • CF 15.2
The Doha Round of multilateral negotiations, which was launched in 2001, had ambitious aims to open markets in agriculture, manufacturing and services, with a focus on development. A series of meetings has ensued, culminating in what was meant to be a final attempt to reach agreement in Geneva in July, 2008. However, after nine intense days of meetings between representatives of the major negotiating countries, the parties failed to agree. Earlier meetings had foundered on the differences in bargaining positions of the rich countries and the developing ones. Rich countries demanded that developing-country markets for their goods (including agricultural commodities and manufactured products) be opened, while developing countries demanded the dismantling of protectionist barriers in rich countries’ markets. Brazil, as a large agricultural producer, has attempted to put forward a compromise solution, urging developing countries to go further in opening their markets. However, at the Geneva meeting, representatives of the US and India, who dominated the discussions, took strong positions which could not be reconciled. The talks stumbled on the provision of a ‘special safeguard mechanism’, which would allow developing countries to protect small farmers from sudden surges in imports of agricultural commodities. This is a sensitive issue for India, as some 70% of its billion plus population consists of small farmers, many of whom are engaged in subsistence farming. The outspoken Indian trade minister, Kamal Nath, contrasted their position with America’s 2 million farmers in an export-oriented agricultural sector, who would continue to be heavily subsidized.

The breakdown of the talks is likely to lead to further fragmentation in world trade, with increasing use of bilateral trade agreements and an upsurge in the use of the WTO’s dispute resolution procedure. The use of bilateral agreements has been growing for several years. The major developed and emerging economic powers in today’s world have sought agreements with a range of countries, typically covering issues well beyond trade, which benefit the interests of the major power. This trend is now likely to accelerate. Similarly, for developing countries, resort to the dispute settlement process is now a growing prospect. A complaint by Brazil against illegal subsidies to US cotton farmers was upheld by the WTO in June 2008. Although this decision gave Brazil the right to retaliate by imposing sanctions on US goods, it had not done so, in the hope that the Doha negotiations would agree across-the-board reductions in a number of US subsidies affecting Brazilian exports, including ethanol and other farm products besides cotton. Brazil is now likely to take further action through the WTO on cotton and on the US import tariffs levied on Brazilian ethanol.

Africa’s poor cotton farmers had hoped that reductions in US cotton subsidies would be agreed in Geneva. At the Geneva talks, Mamadou Sanou, the trade minister of Burkina Faso, represented three other West African cotton-producing countries (Mali, Senegal and Benin). Prior to the Geneva meeting, the US had provisionally agreed a reduction in cotton subsidies. However, the US had stated that it would only reduce its cotton subsidies if China lowered its trade barriers to US cotton exports. In the event, cotton subsidies were not discussed at Geneva, and the failure of the talks meant that it felt no obligation to act on the issue. The African countries watched from the sidelines as their hopes of reductions were dashed. Although Brazil is now preparing to resume its case against the US at the WTO, this could take years. African leaders are hoping for the Doha talks to resume, despite the fact that the Geneva meeting had been envisaged as the final one.

They could well see a resumption of talks, as many negotiators, including the Indian trade minister, are urging that the talks should be viewed as a ‘pause’ rather than a ‘breakdown’ (Beattie, A., ‘Hangovers but no anger on the morning after’, Financial Times, 31 July 2008) The G20 meeting of 15 November raised the possibility of continuing the Doha process. Thus, further meetings in 2009 and even 2010 could be organized. However, as protectionist tendencies grow in response to economic slowdown, the hopes for multilateral accord look remote.

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  • Bhagwati, J., ‘The selfish hegemon must offer a New Deal on trade’, Financial Times, 20 August 2008. Professor Bhagwati expresses the arguments from the point of view of developing countries. http://us.ft.com/ftgateway/superpage.ft?news_id=fto081920081345476228

  • Financial Times, ‘The World Economy 2008’ (Special Report), 10 October 2008. This supplement covers a range of topics. It has a section on multilateral bodies, including the WTO.
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GLOBAL ISSUES OF POVERTY AND FOOD INSECURITY TAKE ON URGENCY

Chapter links:
  • Chapter 2

  • Chapter 5

  • Chapter 13

  • Chapter 15
Surging food prices have become a global phenomenon. Three broad causes are responsible:
  • Growing demand – The new middle-class consumers in emerging markets such as China are eating more protein-rich foods such as meat. Meat production creates extra demand for cereal crops and water. Population pressures in the developing world generally are also contributing to increased demand. China has half the world’s cultivated lands, but because of growing demand, has become an importer of food, and its government now prioritizes security of food supply.

  • Spiralling energy prices – Large-scale food production depends heavily on energy, as modern farming is largely industrialized. Moreover, the cost of fertilizers is linked to energy costs. The ‘green revolution’ which brought about dramatic rises in productivity in the 1960s was made possible by extensive use of fertilizers and widespread irrigation, but these depended on cheap fuel and abundant water. The situation today is much changed: energy has spiralled in price and water is becoming scarce in many regions.

  • Slowing growth in productivity of the world’s cultivated lands – Supply of food is now struggling to keep up with demand, as the world is consuming more than it produces. Crop failures due to drought, flooding and extreme weather are becoming more common due to climate change.

  • In the 1960s, huge rises in productivity in the major producing countries led to abundant cheap food, even food ‘mountains’. Research on further improving productivity thus rather lost impetus, and productivity is rising only slightly, although demand is soaring. What is now needed is research into growing food with a minimum amount of water and fertilizer. These innovations are most urgently needed in Africa, where poverty and hunger are rife. In many of these countries, agriculture once thrived, but gradual degradation of the soil – now so thin and poor in nutrients it can hardly support crops – has resulted in these countries becoming net food importers. In the EU’s new member states in Central and Eastern Europe, soil degradation affects one-third of the land. In China, industrial pollution is leading to low productivity, combined with the effects of contaminated water or depletion of water, under strain of demand from industrial and urban users.
Consequences and solutions
In poor developing countries, the fears of social unrest are growing. Food riots have occurred in a number of countries, including Haiti and Bangladesh. As prices of basic commodities rise, hunger is spreading in the growing urban areas, particularly in the poorest countries of Africa. Food represents 50% or more of what the poorest consumers buy, and price rises – such as the doubling of the price of rice in three months – have caused the food import bills to rocket. The UN, under the World Food Programme (WFP), provides emergency food aid to countries in greatest need. However, the costs of this emergency aid have risen steeply, in line with global prices, leaving the agency facing a shortfall of funds at a time when the need is greatest. The WFP announced a change of policy in September 2008. It would shift away from buying its food stocks from the developed countries (especially the US), and start purchasing from the world’s poorest farmers. This policy shift acknowledges a change in its role from providing emergency aid to promoting development. It is now seeking to buy from 350,000 farmers in sub-Saharan Africa, Latin America and Asia. These farmers have lacked access to markets and suffer from poor infrastructure such as storage depots. They stand to gain from the WFP proposal, which has the added benefit of reducing transport time, as the food will be near to the places where it is needed. The new procurement programme is being funded in part by the Gates Foundation and the Buffett Foundation.

The IMF has also stepped in to help developing countries suffering from deteriorating balance of payments as a result of steep rises in food and oil prices. Although oil prices have recently fallen, the fear is that, in the long term, supply strains will push them back up. The IMF is particularly concerned that food and oil prices could seriously weaken the economies of up to 75 developing countries. It has doubled funding to Burkina Faso, Kyrgyzstan, Mali, Niger and Benin.

Long-term food security
Food insecurity is not confined to poor countries. Governments of all countries which rely on imports are concerned that both supply and prices fluctuate for products traded in world markets. Alarms sounded when exporting countries restricted exports in the summer of 2008. They included India, Russia, Argentina and Vietnam. Some countries are now actively seeking to acquire land abroad to invest in agriculture, producing crops in foreign lands which would be shipped to the investing country. Saudi Arabia and other oil-rich Middle Eastern states have made such investments. China has also tentatively looked at buying farmland abroad. Daewoo Logistics of South Korea has leased 1.3 million hectares of farmland in Madagascar to grow food for South Korea using labour from South Africa. This is a 99-year lease, and covers about half of Madagascar’s farmland.

Other countries which have expressed interest in providing land include Sudan, Ethiopia and Ukraine. Sudan’s investment ministry is selling 17 large-scale farming projects covering 880,000 hectares. Ethiopia is also keen to provide hundreds of thousands of hectares. These potential host countries have high levels of poverty, and it is not clear how they would benefit from the foreign investment envisaged. The nightmare scenario would see crops being transported out of a country while local people suffer from hunger. That fear is heightened by the mechanisms written into lopsided bilateral trade agreements devised by the investors, which restrict the host country from imposing export restrictions in times of food crisis. Sudan is currently in receipt of emergency aid from the WFP, which feeds 5.6 million people in the country. Nonetheless, Sudan could soon be exporting food to rich nations such as Saudi Arabia.

The director-general of the UN Food and Agriculture Organisation (FAO) has warned that moves by countries to gain food security through direct investment in overseas production could amount to food ‘neo-colonialism’ (Blas, J. ‘UN warns of food ‘neo-colonialism’’ Financial Times, 20 August 2008). It is particularly concerned that host countries generally have weak legal environments and farmers have weak rights of tenure and little access to compensation. A framework such as the Extractive Industries Transparency Initiative which attempts to control corruption in oil, gas and mining industries, could be devised. However, this could take a long time to agree, and rich countries wish to secure deals immediately to commence food shipments from the next plantings. It would also suffer from the weaknesses of voluntary codes of practice generally. It should be borne in mind that although some of the parties would be private-sector organizations, the power would rest with the sovereign players, such as investment groups acting under the sponsorship of their governments. Countries which have so far expressed interest in acquisition of foreign agricultural land, such as China and the Middle Eastern states, are governed by regimes which are among the world’s least transparent and accountable to their peoples. Fear of social unrest among the poorest sections of these societies is driving their governments to seek security of food supplies.

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