A Decade since the Global Financial Crisis and Implications for Georgia

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The FINANCIAL — The global financial crisis of 2007-08 is considered to be the most severe global slowdown since the Great Depression of the 1930s. The financial crisis in the US led to the European Debt Crisis and a global recession. The global financial crisis was more severe for advanced economies than for developing countries and the bounce-back has been more vigorous for the latter.

e Great Depression was preceded by a margin-debt-fuelled bubble in the US, with private debt blowing out during the crisis and then collapsing. Exactly the same happened in 2007-08 – only with mortgage debt on top of exploded private debt.

To what extent the global financial crisis is having long-term impacts is an issue of more precise research, but the following results are quite incontrovertible evidence that the global financial crisis is still having a significantly negative effect on economies, even though ten years have already passed.

Taking some of the largest economies in the world and comparing their real GDP each year to their real GDP level before the crisis (in 2006), it might be noticed that they still could not overcome the crisis that happened ten years ago. Inspecting real GDPs (in USD), out of China, Japan, the US, UK, Italy, Greece and Spain, only China managed to remarkably boost its real GDP after the global financial crisis.

Even though China had very limited financial losses due to strict capital control, the global crisis resulted in decreased economic growth, increasing deflation pressure, decreased export due to fallen international demand, and suppressed investment demand. Despite this, China almost tripled its real GDP (in USD) in 2017 compared to the before-crisis real GDP level. The real GDP (in USD) of the other six countries in 2017 remain close to the level of 2006 or even lower.

As for Japan, its real GDP increased every year from 2007-2011, compared to 2006, and is 11% higher in 2017. During these ten years, China and Japan managed not to drop their real GDP below the level of 2006. US real GDP compared to 2006, each year increased more steadily and reached up to 17% higher real GDP in 2017. The only year when the US had lower real GDP than in 2006, was in 2009 when it was 1% lower. The global financial crisis turned out to be harsher for the UK, Italy, Spain and Greece. All of these countries in 2017 have had much lower real GDP (in USD) than they had in 2006. There are some other negative political or endogenous factors and these slowdowns could not be directly attributed only to the long-term effects of the global crisis, but anyway, it is reasonable to state that the global crisis intensified the negative effects of other factors and countries still could not fully overcome it.

As for the Caucasus region, out of Russia, Armenia, Azerbaijan and Turkey, in 2017 Georgia has had the highest increase of real GDP (in USD) compared to 2006. Since the global financial crisis, Georgia and Armenia have never reached a lower real GDP in USD than in 2006. It seems that the crisis had a weaker effect on developing countries than on developed ones. Russia has 52% lower real GDP in USD than it had before the crisis (in 2006). Turkey has 25% lower; Azerbaijan 2% higher; Armenia 15% higher; and Georgia 26% higher real GDP in USD, than in 2006.

Could economists have forecast the Global Financial Crisis?

Head of the UK Treasury admitted in 2016 that economists failed to spot the build-up of risk before 2007 and were guilty of “a monumental collective intellectual error”. Economists supported austerity policies, hoping for automatically restored equilibrium, resulting in prolonged failure. Leading economists hesitated to publicly predict the crisis before it hit, but in fact, the crisis was expected considering the runaway bubble in asset markets caused by too much bank credits. US private debt to GDP increased steadily from 10% (1865) to 143% (1933), in 1945 (37%) up to 2009 (170%). The third phase began in 2015 (146%).

Is the next financial crash on the horizon?

Looking for the potential source of the next financial shock, the economists of Deutsche Bank warn that there are a number of areas that look at extreme levels and if there is a crisis within the next 2-3 years, it would be hard to look at these variables and say that there was no way of spotting them:

1. Given near zero interest rates, creaking balance sheets and high levels of debts, central banks and governments could find themselves powerless to tackle a recession if it occurs; or they will simply go for cul-de-sac tactics. E.g. monetization to pay for a fiscal splurge.

2. Given the recent inflation and Trump’s fiscal challenges, if central banks end up conducting increased QE again, we go back to negative rates once again.

3. More political and economic uncertainty is expected from Italy, with high Populist Party support and underperforming economy, huge debt burden, and a fragile banking system.

4. Considering rapid credit expansion, debt fuelled growth, hugely active shadow banking system, ever-expanding property bubble, the greater issue might be ‘when’ rather than ‘if’ the credit bubble pops in China.

5. In absolute terms Japan continues to make slow progress, trying to manage large budget deficits and QE and the highest public debt ratio in the developed world at a time when the population is falling and ageing.

6. With the election of Donald Trump, the vote for Brexit and the rise of the anti-establishment vote in France, populism has exploded across the globe. The level of uncertainty will surely remain high and if negotiations between the UK and EU break down, Brexit could create a financial crisis.

How could Georgia be less vulnerable to foreign crises?

In Georgia, the global financial crisis coincided with the August War; Russia’s occupation of Georgian territories in Abkhazia and South Ossetia. For better or worse, the war turned out to weaken the negative effects of the global financial crisis in Georgia, due to foreign aid. In general, the crisis is a negative shock to investment, export earnings and remittances. According to the IMF, about half of all developing countries have 5%-10% CA deficits (Georgia – 13%) and FDIs to these economies are halved during the global crisis. As a result, developing countries’ collective GDP growth declines to less than 5%, compared with more than 7%. Hopefully, Georgia will not need to receive war-related aid anymore and such a crisis will remain a once-in-a-century event, but some economists still predict that a crash could happen in the near future. The top trading partners of Georgia are: Turkey, Russia, China, Azerbaijan, Ukraine, Armenia, Germany, the US, Bulgaria and Italy. Crisis in these countries could have a critically negative influence on the economy of Georgia.

IMF reports that developing countries are more resilient to global crisis, but it has a lagged effect on them. IMF recommends the following policies for developing countries to be less vulnerable to the global financial crisis:

1. Fiscal easing for sustaining aggregate demand. Use resources in a noninflationary manner, without draining international reserves on crowding out the domestic private sector, as this sector is the main source of long-term growth.

2. Reduce unproductive expenditures. E.g. generalized subsidies, excessively large government employment, and “white elephant” projects.

3. Stimulating labour-intensive infrastructure projects, supports to the poor and delivers fiscal stimulus.

4. Countries experiencing continued or renewed price pressures may need to tighten monetary policy.

5. Countries with flexible exchange rates should allow them to function as shock absorbers. It will generally not be effective to impede needed adjustment in the real exchange rate or dissipate reserves through intervention.

6. Protectionist measures should be avoided. Limiting imports lowers welfare by distorting incentives, and new barriers can be hard to rescind when the current pressures subside.

7. Financial institutions could initiate balance sheet repair. Where capitalization is weak, fresh equity may need to be raised or medium-term funding sources sought, even if the cost of doing so is high.


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