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The state of the world economy, developing country finance short-falls and donor responses

Written by Dirk Willem te Velde


As some people speculate about why developing countries were not hit as badly as expected by the global financial crisis, the World Bank's Global Economic Prospects Report is a painful reminder of the overall effects of the crisis in both developed and developing countries, which were, in fact, much bigger than initially expected. Are we getting used to the unprecedented orders of magnitude of effects which now form part of the crisis narrative?

The GEP estimates that global GDP fell by 2.2% in 2009 (the worst performance since the Second World War), although it is expected to recover to 2.7% this year. The UN's World Economic Situation and Prospects (WESP) suggests that the crisis has already knocked off at least 7% of world growth. The GEP expects developing country growth to grow by 5.2% in 2010, up from 1.2% in 2009. The growth slowdown in 2009 has varied across countries in sub-Saharan Africa (SSA), with oil exporters and middle-income countries affected more severely, at least initially, than low-income, fragile, and less globally integrated countries. GDP per capita fell by 1% in SSA. Globally, the crisis may have led to an additional 64 million people falling into poverty. The GEP, however provides little explanation of why some countries have done better than others. Sectoral composition, exposure to transmission mechanisms, policy and institutional responses all of which differ by country (see e.g. the ODI synthesis phase 1, which will soon be updated using phase 2 studies).

Transmission belts

The crisis has had a major impact on external finances as various transmission belts have been affected. The GEP estimates, for example, that merchandise trade volumes contracted by 17.6% in 2009, with goods and services down some 14.4%; remittances are expected to be down by 6%, which tallies with the findings of an ODI study on remittances. Foreign direct investment (FDI) has been declining. UNCTAD's investment monitor suggests that FDI to both developing countries and Africa fell by one-third in 2009 – as we predictedat the beginning of the crisis.

Our own work for the AERC suggests that SSA has faced a $130 billion short-fall.

While the global recovery is gathering pace, it remains weak, suggesting a square root (with the right bar lower than the left bar) pattern of growth rather than a V shape. Moreover, the GEP lists a host of factors that bring further risks especially on the downside: "The waning growth impact of the fiscal stimulus, a progressive end to the inventory cycle, uncertainty about the extent to which private sector confidence will step in and sustain the recovery, and the possibility of a second round of bank failures either in developed or developing countries are among the factors that could contribute to a more pronounced slowdown of growth in the second half of 2010 and into 2011—potentially yielding a double-dip growth recession". The WESP suggests that a “premature exit from the stimulus measures and a hard landing of the dollar due to the renewed widening of the global imbalances” might add further risks.

There may also be considerable long-term effects through higher borrowing costs; the GEP suggests that the boom before the crisis was unsustainable, and that the crisis will lower developing country growth by between 3.4 and 8% of GDP over the coming 5-7 years – which means around an additional 46 million more poor in the long term compared to a non-crisis scenario.

Global imbalances

Global imbalances are easing and are less pronounced than before the crisis. The GEP expects them to unwind a little further. China's current account surplus is expected to decline from an estimated 5.6% of GDP in 2009 to 4% by 2011, while the US current account deficit is projected to stay at around 3% of GDP until 2011. Overall, the extent of global imbalances, measured as the absolute value of current account balances as a percentage of world GDP, is projected to decline from its peak of 5.9% in 2008 to 4.5% in 2011. There is no analysis of what is a sustainable current account balance. The UN's WESP foresees a widening of the global imbalances.

What next?

While the GEP does not contain much of a new discussion on appropriate policies responses, there is some discussion on whether countries should insulate themselves from a crisis (answer: no because they will forego the positive effects from openness) and insure themselves through reserves (answer: this can be very expensive in practice).

In the coming year we will all be analysing why some countries did better than others. ODI will soon release phase 2 of the country case studies (written by developing country researchers), which suggests that it is specific policies, as well as economic fundamentals, that have helped developing countries weather the storm, with some poor countries affected hardly at all.

Donor responses to crisis

The GEP includes one reference on donor responses: "The recession has cut sharply into the revenues of governments in poor countries. Unless donors step in to fill the gap, authorities in these countries may be forced to cut back on social and humanitarian assistance precisely when it is most required." So have donors been stepping in?

The GEP does not provide answers, but the work by ODI on this issue suggests that donors have responded in different ways, with multilaterals such as the IMF responding more extensively than bilateral programmes. But overall, the response has been nowhere near enough to counteract the large financing gaps that have emerged during the crisis, even though the crisis did not have the feared devastating impact on growth in developing countries.

While developing countries may have confounded the worst predictions – and this needs to be celebrated – there is still much work to be done by both developed and developing countries to ensure that low income countries come out of the crisis in a healthy shape. Do you think this is likely in 2010?