Global Economic Crisis: Part II

As pointed out in the first part of these series, finance is real life blood of modern economies as lack of it has proven of late. The current financial crisis has vindicated the proponents of financial development-economic development lead paradigm beyond any empirical research could have ever proven. The earliest recorded works on the influence of financial development on economic development seems to be that of Hamilton (1781) who argued that, banks were the happiest engines that were ever invented to spur economic growth. According to this view, banks would avail the required capital to facilitate the growth process by financing innovativeness, which would then enhance the accumulation of goods and services. More prominent researchers in finance and economics amply put forward their research findings with regard to the role of financial development in economic development Most notable was Schumpeter (1912) who held the view that, well functioning banks spur technological innovations by identifying and funding those entrepreneurs with the best chances of successful implementing innovative products and production process than any government bureaucracy would do even with minimal political interests. According to Schumpeter, a banking system and entrepreneurship were the two crucial factors and development agents. He observed that, the capacity of the banking system to create credit empowered entrepreneurs with the necessary purchasing power with which to command the directional use of productive resources to where there were better rewards than a state can ever achieve. Thus, the Schumpeterian view of the relationship between finance and development is premised on the impact of financial intermediaries on productivity growth and technological change. Financial systems facilitate the transfer of funds from saving units to investing units, thereby ensuring the development of real sector. This also implies that any disruptions/impediments in a financial system would certainly constrain the development of the same real sectors. This then explains the reasons behind the impact of credit crunch on the entire global economies and the current global recession that is consequent to this crunch. Credit crunch defined simply as a cute shortage of credit to the underlying economy is a result of market failures in western financial systems which due to globalization and integration had outgrown the traditional state regulations. This was also premised on a complacent view that, financial markets would regulate themselves under the guise of financial liberalization that underpinned capitalist/market economies. Whereas it is true that, there is no substitute for market forces, and that the entry of state as a forces only bleeds chaos rather then order. It is also true that, the role of the state as a moderator/regulator should not have been understated, the consequence of which has lead to the current crisis- financial and as a result; recession. Impact on African Economies It is now believed that, developing countries will lose up to US $700 billion as a result of the current recession, and that Sub-Saharan Africa alone will lose up to US $ 50 billion. The most pessimistic analysis suggest that, some countries in Sub-Saharan Africa would face ‘bankruptcy” as they will not be able to meet their foreign obligations as and when they fall due as a result of falling external receipts whether from their exports, remittances, and or foreign aid. It is also predicted that, this crisis will push up to 90 million people into extreme poverty as government revenue from taxes fall below levels that can not sustain a viable state. Nevertheless, at the onset of the credit crunch, most experts financial or economists believed that, the continent would survive this crisis due to the fact that, it was not fully integrated into the world economy. Although this argument was valid in so far as Africa’s financial markets are concerned at least to some extent; it was not true for trade whose end product is finance. African economies are integrated to world economies in matters of trade both in goods and services so much that, the current financial crisis has started to be felt much more than ever imagined. This has seen African exports of primary products lose value to as much as 50% which in turn affects state delivery of essential public services as well as constraining her ability to meet current obligations. With regard to financial crisis and its impact on African economies, one has to draw a line. As pointed in part one, financial systems in Africa (with exceptions of stock markets) will wither the crisis by default as these are still at their rudimentary stages of development, too traditional to have strong relationship with modern financial markets. African financial markets are not only shallow, and with many missing markets but also inefficient since they provide neither the array of financial assets and financial instruments that would stimulate savings nor the array of financial systems that would allocate the savings competitively to viable investments. As a result, these markets have not been able attract foreign savings/assets through sale of financial instruments and derivatives as is the case with western financial markets. This is again by default due to the fact that, the systematic risks inherent in our economies can not allow such markets to hold/sell such instruments to international clientele which has by default minimized the enormity of the current crisis to African financial markets. This state of our financial markets has been compounded by low levels of monetization of African economies (low ratios of money supply to GDP) which also means that, our economic activities are not monetized to the extent that they would influence our financial systems which would feed back into the economy with serious effects. Monetization of an economy impacts on the extent to which financial intermediaries can mobilize and allocate savings in an economy. In economies like ours where monetization rates are low, most savings are held in non-monetary form such as real estate, live stock etc rather than in financial savings as is the case of western economies. Under these conditions, African economies especially those which rely heavily on agricultural economy (including ours) may not feel the effect of the crisis as would have been the case if we had high levels of financial savings. Thus for instance, in case Rwanda where 90% of the population do not operate bank accounts, current financial crisis is but a media hyper. Such large part of our population live on informal sector, where cash/credit is seldom used, and rather barter and or subsistence structures thrive will certainly feel limited impact of the crisis if any. In these times, agricultural based economies may in fact take advantage of the crunch to produce more food for both domestic demand and for export to make up for the short fall in export earnings of their traditional exports. Nonetheless, the low levels of monetization and a large informal sector (while acting as a cushion to the impact of the crisis) would also negate any stimulus measures governments in Africa would put in place to keep their economies growing. This is so in that, any stimulus package such as lowering bank rates (central banks’) which would then release liquidity to commercial banks from which they would increase their lending to the real sectors of the economy; repurchasing of treasury bills from financial institutions (which would also avail liquidity to commercial banks to lend), running high deficits by the sate to finance infrastructure projects that would then create jobs (among the few available stimulus measures) may nonetheless not reach the informal sector in its low levels of monetized; so as to be felt by majority of the people in these countries, and on the contrary may only end up benefiting the urban elite at the expense of majority poor which would compound poverty levels . To be continued...