Southern Africa: Who is Behind the Meltdown?

Ann Bernstein, The Namibian, 19 February 2009

THIS is the second year that I have been privileged to participate in the World Economic Forum as a faculty member. What did I learn at Davos?

South Africans should not underestimate the depth of the global economic crisis, the difficulty of turning things around or the impact of this situation South Africa.

Global economic growth is now projected to fall to a mere 0,5 per cent in 2009, its lowest rate since World War Two. Output in high income countries is expected to fall by two per cent, the first annual contraction since 1945.

Industrial production, merchandise and commodity exports are in free fall.

In 2010, there may be anaemic growth but slight recovery will not become a building block for more rapid growth unless we fix the financial system and deal with unsustainable global imbalances.

How did the financial crisis happen? Many sessions seemed to take this question for granted. It was assumed that reckless, greedy banks and the failure of regulation were the primary "culprits".

WIDESPREAD VIRUS

The mix of ingredients leading to this huge crash is more complex.

Governments failed to find a solution to global trade imbalances that for many years allowed the US and other western economies to finance consumption binges with cheap borrowed money from Asia.

Ken Rogoff, Harvard professor and former chief economist at the IMF, argues that global imbalances are at the root of the problem.

Enormous capital inflows into the US - of about US$700-billion (about N$7-trillion) to US$800-billion per year - put enormous stress on the system, helping to bid up asset prices and increase leverage.

Another culprit was the political push from the US Congress for more and more Americans to own their own homes - remember all the pressure on banks for redlining geographic communities as bad risk areas?

The misjudgements and reputed misdeeds of government-created organisations in the housing arena - Fannie Mae and Freddie Mac - also played their part.

And, of course, the way in which banks and many new associated institutions were managed and regulated was a core ingredient - not only because of sub-prime mortgages and derivatives but also the lack of capital underpinning institutions.

What regulations there were and how these were implemented and applied - or not - needs to be unpacked and assessed.

People asked how could banks have been so stupid? The rejoinder is that banks were enablers and beneficiaries of a more widespread virus.

Regulators, households and other borrowers, investors, credit rating agencies, politicians and central bankers all accepted the premise that this time asset prices couldn't fall because the "great moderation" in inflation and economic volatility had drastically reduced credit risk.

And - like lemmings - if everyone else is making so much money and thinks this is sustainable, most people will go along with it.

SYSTEM FAILURE

What I don't understand is how everyone believed supposedly independent rating agencies which seemed not to have bothered to investigate investments and organisations they were charged with assessing.

Or how the Securities and Exchange Commission managed to ignore numerous complaints about Wall Street fraudster Bernard Madoff and other crooked players. Separating out the components of this witches brew and weighing the importance of different factors is a critical exercise.

This would cover system failure, the particular faults in the banking system, the errors of politicians - from policy to regulation and oversight - the failure of specialised institutions, the role of governing boards in both public and private sectors and certain key policy assumptions.

All this has yet to be clearly investigated and placed into a coherent account.

Analysis and investigation needs to go much further than humiliating a few chief executives - although some certainly invite derision. Understanding exactly what happened, acknowledging past mistakes and punishing crimes are essential first steps.

INTERDEPENDENCE

What does the crisis mean for emerging markets? It's easy to point fingers at the US as China and Russia enjoyed doing.

But as the Philippines president, the Thai prime minister and a leading Turkish businessman argued: "Everyone benefited from American prosperity."

We are all interdependent in a global economy; whatever the criticisms of the US, their well being and ours, depends on US recovery.

The notion of decoupling - that the large Asian economies could drive their own and global growth - was rejected universally by speakers as an unfounded myth.

After sharp economic deceleration last year, Asia will experience a continued slowdown this year as its four biggest economies (Japan, China, India and South Korea) grapple with steep declines in demand for their exports.

Many people hope that somehow China can turn the world economy around - or at least continue to bid up the prices of African commodities. Dream on.

Until the financial crisis, nearly one quarter of global consumption came from US consumers, who spent nearly three times as much as Chinese and Indian consumers combined. Americans will have no option but to be more frugal over the next 10-20 years.

A senior executive from the Bank of China dashed hopes that Chinese consumers could replace their American counterparts. American consumption is currently around US$10-trillion. Chinese consumers only account for US$1,5-trillion and, despite efforts to increase domestic consumption, China is in no position to make up the difference.

What can be done outside the US and China to restart the global economy?

A senior business leader from Egypt called for a globally co-ordinated effort on the part of government leaders and suggested that the solution should be a government fuelled "infrastructure boom" to replace consumer spending.

Others, including South Africa's finance minister, called for reform of the IMF as a means of dealing with the crisis.

However, no one put details on the table of how this might work and critically, who would pay if developing countries wanted a bigger say in multilateral institutions.

Do we need to rethink capitalism? It's important to remember that the market-based system as a whole has not failed.

Over the past three decades, market-oriented economic policy has enabled hundreds of millions of people to escape from poverty. The financial sub-system failed.

It now needs careful, thorough modification that avoids the dangers of under-regulated financial markets and the slower - but no less deadly - poison of excessive financial market regulation, which encourages rent-seeking, bad decisions and curbs innovation.

It was a gloomy Davos. Nonetheless as someone said, "it's too good a crisis to miss the opportunity".

Whoever seizes the opportunity to lead will determine the shape of the next decade and perhaps beyond.

South Africa needs to make sure we weather this storm and are well-positioned to take advantage of growth opportunities when they finally come. This will require some hard choices if we are to make the most of this crisis.

- Business Report

* Ann Bernstein is executive director of the Centre for Development and Enterprise (South Africa). She was at Davos as an African faculty member.