The myth of ‘de-coupling’ as poor catch the recession cold

Guest blog by
20 December 2009

When did it start to sink in that poor countries are highly vulnerable to the impacts of the global recession?

The developing world was going to prove resilient, and even flourish, during the onset of recession in 2008. So said the financial analysts.

Now, at the tail end of 2009, the premise for that initial optimism – the facts that developing economies were weakly linked into the global financial system, that lending was relatively low and without risk, and that internal demand was resilient – has disintegrated.

It’s increasingly clear that the opposite is true: globalisation has knitted the financial fortunes of countries poor and rich together more tightly than we thought. That makes the once widely held notion of ‘de-coupling’ — ensuring economies operate independently of one another, so that a decline in one economy has no effect on another – look redundant.

And this economic bind means poorer nations have been swift to catch the recession ‘cold’.

A number of high-profile figures are pointing at the recession’s chilly symptoms in developing countries: UN Secretary-General Ban Ki-Moon, for instance, and South Africa's Trade and Industry Minister Rob Davies, who recently argued that the recession’s impact on developing countries demonstrates a clear need for a reform of world trade rules.

So now, some time after the first rumbles of the global crash, the knock-on effects in developing countries are becoming worryingly obvious.


Joined up

We’re just a lot more joined up, financially, than we had really grasped. And for the poor living in poor regions, that is bad news.

Way back in June, for instance, Timothy Homan reported in financial news site that the World Bank had scaled back its prediction for economic growth in the developing world from 2.1 to 1.2 per cent. These are dramatic drops from the growth rates of 8.1 and 5.9 per cent experienced by developing countries in 2007 and 2008.

A depressing trend has begun to emerge. By the end of 2009, developing countries are expected to have lost income worth at least US$750 billion, with the poorest region, sub-Saharan Africa, losing an expected US$50 billion. The direct consequences include falling employment, and growing poverty and hunger.

And the UN estimates that some 100 million more people are expected to go hungry as a result of the recession, the first rise in hunger in 20 years. Further, an extra 50 million people will be trapped in absolute poverty (that is, severely deprived of basic human needs), according to the Overseas Development Institute (ODI). The ODI has closely followed the impacts of the recession on a number of developing countries.

The ODI argues that the recession has affected developing countries through three key ‘transmission belts’ – trade, remittances and foreign direct investment. These belts ‘couple’ economies in the developed world with the developing world, so that changes in one economy have knock-on effects on another. What this ultimately has meant, says the ODI, is increased poverty.

What about trade? Many developing countries rely on international trade for economic growth opportunities. Back in April Tom Gjelten, reporting on the US-based National Public Radio, explains that trade has been slowing owing to falling demand and a credit squeeze.

The ODI estimates that Indonesian exports of electronic products fell 25 per cent, while garment exports from Cambodia dropped 60 per cent. Unemployment has flourished, even in renowned developing country success stories. Kenya’s high-value labour-intensive horticultural industry shed 1200 jobs in 2009 when flower exports dropped by a third.


Down to a trickle

Remittances — the transfer of money by foreign workers to his or her home country — meanwhile slowed. Remittances are a massive source of cash inflows to developing countries and play an important role in stimulating economic growth and supporting livelihoods in the developing world.

But it’s now believed that the flow of remittances from the developed world to the developing is decreasing, with Africa seeing the sharpest decline in received remittances (Kenyan remittances were down by 27 per cent in the year to January 2009). The Migration News reported that the World Bank revised its estimates of remittances growth downwards after recording the first falls for a decade in 2009, dropping 10 per cent to US$290 billion. A story in reports that this has also been the case in the Caribbean with, for example, a US$300 million decrease in remittances since last year.

Finally, what of foreign direct investment? FDI is a measure of foreign ownership of productive assets, such as factories, mines and land, and represents a flow of money from one country to another. FDI tends to move between developed countries, but is also a vital source of investment and income for many developing countries.

Financial flows to developing nations have been badly affected by the global recession. The World Bank (reported in Bloomberg) estimates that after peaking at US$1.2 trillion in 2007, capital inflows – the flow of money to developing countries — are predicted to fall to US$363 billion this year, indicating ‘increasingly grave economic prospects’ for developing nations.

In particular, portfolio investment flows fell significantly in 2008, with some signs of significant shifts from inflows of money to net outflows of money. Changes in foreign direct investment are symptomatic of a general draining away of money from developing countries back to their investment source, sell-off of government bonds, and sharp falls on stock markets throughout the developing world — all phenomena associated with so-called ‘capital flight’.

So what’s the prognosis for the developing world?

A lack of local financial infrastructure to cope with shocks, weaker trading systems and local demand levels tied inextricably to export have increased the virulence of this cold.

There is no obvious cure for this virus as yet. But it’s clear we need to deploy the right tools among developing nations, coupled with positive transmission from developed nations that are on the mend. And that’s how 'coupling’, while perhaps part of the problem, may remain an important transmission for the solution..