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The Impact Of ‘Great Recession’ On The Developing World – Analysis

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In his 1941 novel You Can’t Be Too Careful, H. G. Wells wrote that the “crisis of today is the joke of tomor­row”. For much of the developing world that relies on capital from inter­national financial markets to fund its growth, the joke tomorrow may be in extremely poor taste.

Though the exercise is naïve, it is useful to divide the developing world into two categories – globalizers and non-globalizers. For the latter, the response to the current “Great Recession” is often a slightly puzzled “What crisis?”, as many international organizations’ workers have found since 2008 when talking to poor peasants in some West African countries. Being removed from global markets (both financial and commodity) may have inhibited their long-term growth pros­pects but at least it has insulated them from the worst effects of the crisis. For the former, on the other hand, the current mess is likely to have several serious repercussions.

The first, and most obvious, will be the availability of physical capital to finance investment. An important structural difference between these groups of nations, whose consequences have not been highlighted in the current crisis, lies in the fact that long-term growth in industrialised nations is essentially driven by increases in total factor productivity, while in the devel­oping world growth is driven by the accumulation of factors of production. It is therefore arguable, ceteris paribus, that a prolonged hiatus in investment in physical capital will have much more serious consequences in globalised developing countries than in their developed counterparts.

One possible positive outcome of this is that, since it is driven by accumula­tion, the growth of globalised develop­ing countries has, after a very sharp blip, returned to its previous levels. The same cannot be said of industrialised countries, which may experience a permanent shock to their long-term growth rates (which were already relatively low before the crisis).

However, the income shocks experi­enced by poor households may have permanent consequences for the accumulation of human capital (when economists talk about “human capi­tal”, they mean education and health). Faced with severe, albeit temporary income shocks, and lacking adequate insurance or mechanisms to compen­sate for loss of income, poor people pull their children out of school and send them to work. Even when the good times return, the children in question almost never return to school.

Similarly, when their income is under pressure, the poor rarely take their children to doctors. As a result, temporary shocks can have devastat­ing consequences on educational attainment and the health of the young (and ultimately on growth) in globalised developing countries. Given the magnitude of the current world crisis, one can venture to argue that the world is now seeing a massive increase in child labour in the glo­balised developing world, as well as a resurgence in diseases that have hitherto been held in check.

Compounding this, credit rationing in globalised developing countries has become more severe, which has knock-on effects on labour markets and thus on urban poverty. Investors in many developing countries are starved for credit, and are increasingly being forced to fund part of their investment in physical capital from retained earnings. This has resulted in severe downward pressure on wages which, in countries without social safety nets and where organised labour is non-existent, exacerbates poverty in urban areas. The cases of Brazil and Venezuela come quickly to mind here.

Finally, while growing poverty in urban areas contribute to stem­ming rural-to-urban migration, increased protectionism in developed countries has reduced agricultural exports from globalised developing countries, producing the inverse effect. Though there are very few universal lessons from Development Economics, one that is accepted by most scholars is that a sine qua non of development is an increase in agricultural productivity. If devel­oped countries continue to succumb to protec­tionist pressure, we may witness permanent effects on the growth of agricultural productivity in the devel­oping world.

Reductions in investment in physical capital, increases in child labour, dete­riorations in child health and education, collapses of agricultural productivity: the list does not make for pleasant read­ing. And let us not forget that H. G. Wells also wrote The War of the Worlds…

In economics jargon, the argument would be that growth in globalised developing countries is Neoclassical (a shock to invest­ment depresses GDP per capita but ultimately returns to the previous steady-state) while that in industrialised countries follows some sort of endogenous growth process.

This article appeared at Diplomatic Courier and is reprinted with permission.

Richard Rousseau

Richard Rousseau

Richard Rousseau, Ph.D. is a specialist in international relations. Formerly professor and chair of political science departments at different universities in Georgia, Kazakhstan, Azerbaijan and the United Arab Emirates, he has authored over 800 academic, analytical and commentary articles. His research interests include the former Soviet Union, international security, International political economy and Globalization

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