The Nature of the Domestic Business Environment of the Global Financial Crisis - Essay Example

?Examine critically the nature and lasting impacts for domestic business environment of the global financial crisis of 2007 Modern business without aglobal context will be an incomplete study because of the change of the trade environment of countries after the integration of the world economies better known by the term ‘globalization’. There were business relations among countries in the past but modern technological up gradation and innovative trade policies have increased trade beyond geographical boundaries, increased investments and thus helped in economic development of many countries (What is Globalization, 2011). Globalization is increasing the interdependence among the economies. However, the developing countries are enjoying increasing access to markets of developed economy that facilitates easy transfer of technology and capital movements but it is increasing the inequality among the global economies. The negative aspect of globalization is that instability or downturn in any major economies of the world results in the downturn of the global economy as a whole. This is because the domestic economic developments of countries determined not only by the domestic policies but also by international policies and economic situations. Thus in order to implement any developmental policies not only the domestic impact but also the global impact of that policy has to be considered (Balakrishnan, 2004). Moreover globalization may create more unemployment problems because of increasing firm closure and lower wages of the employed. This is because increasing competition often wipes out the small firms that are incapable to compete and secondly more use of modern and advanced technology in production adversely affects some companies manufacturing unimproved machineries (Moffatt, 2011). There is coexistence of both positive and negative impacts in every aspects and globalization is no exception. Thus to study modern business in the global context the most important issue that need to be considered is the impact of the global financial crisis which triggered the global economy during 2007. Globalization has increased the financial movement across countries because of lucid monetary controls and regulations and thus financial globalization is associated with the financial crisis of 2007. The paper discusses the nature and impact of the crisis on the countries’ business environment. The Financial crisis – nature and impact The people of topical times are still living with the recollections of the Great Depression of the 30s. There has been no record of economic avalanche of same scale and duration till this date, but the recent global financial crisis is not less important. The economic recession of 2007 has already found its position in the records of American politics. It is less brutal than the great depression of 1929 but has thrown its shadows on worldwide politics and economy. The crisis of 2007 will be considered as a short follow-up to the 1929 depression. The government policies and concern have been held responsible once again for the financial crisis – “Americans have lost faith not only in the [Bush] administration, but in its economic philosophy: a new corporate welfarism masquerading behind free-market ideology; another version of trickle-down economics, where the hundreds of billions to Wall Street that caused the problem were supposed to somehow trickle down to help ordinary Americans. Trickle-down hasn’t been working well in America over the past eight years.” (Stiglitz, October 2008) The social, political and economic perils of the global financial crisis of 2007 will continue to persist for another few months. The American government and European Union have thrived for a united effort to counter the recession. It seems like a group action on the part of the national leaders will be more valuable in restoring the backbone. The world has altered a lot since the Second World War. The harmony among different nations and their joint effort to expand the world as a whole had come across as a prolific achievement. Today, the world has attained a place from where it can succeed over any recessive platforms. The economic and social affluence of the world as a whole is the principle aim. The defining moment has come when the representatives of different nations, need to stand up and show our united efforts to strategize the looming crisis meltdown. A series of conferences were held by the European Union in context of the financial slowdown. The recent financial crisis began with markets being hit hard by the biggest ever U.S. bank failure. The property analysts in the United States had carried on an analysis and a thorough market survey way back in 2002-2003 and had concluded that the prices of properties in the U.S. would appreciate irrevocably at the rate of 10 to 12 percent in each year. This had encouraged the U.S. banks to lend huge money to the borrowers who gave their properties as mortgage. But as the years passed by, the veils of presumption were removed. Contrary to what was assumed and analyzed, the prices of properties began to decline. The borrowers utilized the chance and refused to repay their loans. The banks realized that a huge loss in the form of bankruptcy was waiting for them. The system collapsed bringing down with it financial institutions, which held these housing mortgages worth billions. The stage was set for another economic depression. There was no way that the banks could recover the lost money. Markets were hit by the biggest U.S. bank failure ever. Stock markets fell sharply. The effects were felt in other parts of the world too, as the stock markets of Europe and Asian countries suffered an arrant beating. The U.S. banks were almost paralyzed and failed to recover from the trauma (“EU, US push leads to UN global crisis talks”, 2008”). In the increasing ‘interconnected’ world global crises affects every individuals and not a specific economy only but rather the global economy. During 2006, the sub prime mortgage market of US experienced a collapse and the housing sector of the country and of other industrialized countries had a reverse boom. This along with increasing complexity in some financial instruments results in weakening the global financial system as a whole (Shah, 2010). The core of this problem lies in the ‘speculative bubble’ in the US housing market that started in 2006 and causes financial failures and ‘global crunch’ of many economies. The continuous increase in the prices of housing in the US economy made homeownership more profitable that result in the increase of the share of residential investment to 6.3% of the total Gross Domestic product of the country that was the highest since 1950-51. The supply of houses increased continuously which results in the fall of housing prices at an accelerating rate resulting in the collapse of the boom of the housing sector of the economy. It not only affected the housing sector of the economy but also the credit market of personal and automobile loans. The crises not only affected the economic environment of the world but it also changed the social thinking of individuals. The crises started affecting the global economy from the mid of 2007 and also continued to 2008. The stock markets crashed, and many financial institutions faced bankruptcy. The economically rich nations also suffered and to hold their financial institutions they had to provide them with rescue packages. Large banks, investment houses and insurance companies have declared themselves bankrupt or have been rescue with financial packages and continuous reduction of interest rates. Leading indicator of economic activity that is revealed by the shipping rate has fallen considerably (Shiller, 2008; Shah, 2010; Nanto, 2010) The crisis in other words exposed the weakness of the interrelated and interconnected financial market of the present day world. The global financial crises resulted in a global energy crisis accompanied by a global food crisis. Speculation pushes the oil prices and it results in increase demand of fuel from grains that resulted in increasing price of food grains because of reducing supply. A few less developed countries have tried to protect themselves from the increased price of food grains through export control measures. However, hoarding in the domestic market reduced the supply of food grains in the local market and thus the domestic price of food grains remained high despite of such restrictive measures. However, it is not possible to forecast the exact effect of the downturn and its extent but it is likely to result in a slower rate of economic growth over the succeeding years. According to some economists it may result in a ‘lost decade’ that Mexico experienced after its increasing spending during the boom in the oil price in 1980s and also Japan in 1990s after the bubble in the housing sector of the country. The global financial crisis reveals that collapse of any regional financial market will not affect the global system but a slide solely in the US economy will bring down the global market with it. This is because the United States has been the main guarantor of the financial system as dollar is considered the standard currency for global transactions. The financial crisis spread at two levels. First, it affects the industrial countries with increasing mortgage debt, reducing investments and defaulting of the credit of the capital market. The second level crisis affects the developing countries or the emerging economies of the world that fall as a pray of their dependence on the economies of the developed countries (Shiller, 2008; Shah, 2010; Nanto, 2010). The financial crisis occurred due to the macroeconomic policies that affected the liquidity at a global level. The liquidity reservoir started overflowing from the year 2004 due to 1% interest rate in USA, 0% interest rate in Japan, continuous accumulation of funds in the Sovereign Wealth fund and a fixed exchange rate in China. The crisis also occurred due to the weak functioning of the regulatory system that instead of defending contributed to the crisis. The crisis does not fall on suddenly but it is the impact of the distortions of the past policy actions (Wignall, Atkinson, & Lee, 2008). The financial crisis had the effect on developing economies in many ways. Firstly, the stock markets of the developing countries could face ‘financial contagion and spillovers’. The share market price fluctuates. The MSCI index that includes the stock markets of India, China, South Africa and Brazil fell over 23%. The need is to understand the financial linkages and to find a way out to ‘minimize contagion’. Secondly, international trade and trade policies affected the developing countries. Growth of the economies of China and India has increased their imports and hence exports, which affected by the price rise during the downturn. Thus, the slowdown of the growing economies adversely affects the other poor economies of the world. Thirdly, due to recession in the developed countries, the number of migrants from the developing to the developed world reduces and this implies a reduction in the remittance of the developing countries. Fourthly, the crisis reduces the foreign direct investment and the equity investment in the developing economies. Fifthly, since the banks of the developed countries are also under pressure of reduced liquidity, there is a reduction in the commercial lending. Thus, there is a reduction in investments in economies of Pakistan, Argentina, Iceland and Ukraine. The aid budget has been reduce due to debt problems and fall in the capital adequacy ratio of the developed countries. The impacts on the developing economies vary in terms of the policy responses and the economic characteristics of the countries. Countries that export products of high-income elasticity, countries depending more on foreign remittance and foreign direct investments, countries with weakly regulated security market and countries with high current account and government deficit affected more by the financial crisis (Velde, 2008). Measures adopted The governments of the developed countries were suggested to take the ownership of the ‘distressed financial institutions’, take the guarantee of the proper repayment of the loans and advances, handling the risk associated with the poor collaterals and regulate the system in the course of time. The liabilities of the banks need to be guaranteed. The deposits should be covered to minimize the gap between the covered and the uncovered deposits. Assets of banks should be distinguished. The bad assets should be separated from the good ones. If bad loans are not removed there will be need of more capitals because of the potentiality of credit destruction in the time of recession. Asset management programmers like the Trouble Asset Relief Program (TARP) could be undertaken. Another method recommended by the Financial Market Trends in 2008 is to nationalize the effected banks, sort out the bad assets and then resale the banks to private sector. Another way out is to encourage large capital banks to ‘take over’ the weaker banks. The government ensures certain guarantees for the asset losses of the former with the merger. Selling common shares or preferred shares to private individuals or to the government can recapitalize the asset-cleansed. But this method is unsuitable for the long run as it may crate moral hazards (Wignall, Atkinson, Lee, 2008). The US congress approved a TARP of 700 billion US dollars that can be utilized either by buying toxic assets or can be directly invested in banks. The US government injects money amounting to 125 billion US dollars directly to nine banks of the country namely Bank of America/Merrill Lynch, Bank of New York Mellon, Citi, Goldman Sachs, JP Morgan, Morgan Stanley, Wells Fargo/Wachovia, and State Street. This capital investment was in exchange of preferred shares and warrants. The government also provides much more than 700 billion dollars to commit on loans and guarantees. The governmental body of UK also decided to invest money directly in the banking sector. The other European countries also decided to inject new money directly and also to ensure loan advances to be provided as a part of the coordinated action. (Wignall, Atkinson, Lee, 2008). Concluding remarks In view of the long-term effect of the crisis the policy makers suggest to focus on policies to be sustainable. Focus is given in three main areas. Firstly the incentive system that mainly contributed to the crisis should be reformed. Tax schemes, macroeconomic policies, governance etc should be reformed and these reforms should not be conflicting to the objective of the policies. More importantly the reforms should be an overall reform considering the interactions of each and every sectors of the policy area and not a partial one. Secondly the cost of the capital should match the risk associated with it. The cost of capital can be lowered if the creditors can be ensured that the banks are supervised properly and have less chance of failure. Policies related to the future should ensure that the credit market of the economy and the equity market are well separated. The rules of capital that applies to the ‘risky businesses are targeted solely to them and the cost of leverage is high. Moreover banks should be regulated keenly and supported in need. Consumer banks should separate from the banks handling international business. Banks can get with ‘high risk financial firms’ but that will be guided by clear capital rules that protect the solvency of the banks. Banks should be well capitalized and supported by the ‘Lender of the Last resort’. But some economists suggested that the fast and the foremost step to undertake is the merger of the large institutions with the weak ones to avoid the chance of a long-term impact. A less radical approach first emphasizes on the Non Operating Holding companies that constitute of the consumer banking, wealth management, investment banking etc as they are much more transparent and easy to regulate. The most important of all is to reform the regulating authority and ensure that the High Risk Financial Organizations pay a higher cost of capital. (Wignall, Atkinson, & Lee, 2008) With the government as the owner of the institutions, guarantor of assets and liabilities, competitions will be reduced and the cost of the capital will also be low because of the support of the government. Some assets may be resold to the private sector in the process of recovery for increasing the profits of the taxpayers but it is a long-term phenomenon and requires considerable time. References 1. Balakrishnan, C (2004), “Impact of Globalization on Developing Countries and India”, available at (accessed on 19th January 2011) 2. “EU, US push leads to UN global crisis talks”, (2008), The Europe Weekly, available at: http://www.neurope.eu/articles/90312.php (accessed on November 29, 2008) 3. Moffatt, M (2011), “Globalization Unemployment and Recession”, available at (accessed on 19th January 2011) 4. Nanto, D.K. (2010) ,Global Financial Crisis, Diane Publishing 5. Shah, A (11th December 2010, Global Financial Crisis, Global Issues, available at < http://www.globalissues.org/article/768/global-financial-crisis> (accessed on 19th January 2011) 6. Shiller, R.J (2008) ,The Subprime Solution, Princeton University Press 7. Stiglitz, J. (2008), Good Day for Democracy, The Guardian, available at: http://www.guardian.co.uk/commentisfree/2008/oct/01/useconomy.congress (accessed on January 22, 2009) 8. What is Globalization? (2011) The Levin Institute, the State University of New York available at (accessed on 19th January 2011) 9. Wignall, A, B, Atkinson P &Se Hoon Lee (2008), The Current Financial Crisis: Causes and Policy Issues, OECD, available at  (accessed on 20th January 2011) 10. Velde, D.W.T. (October 2008)The Global Financial crisis and the developing countries available at (accessed on 19th January 2011) Appendix: Glossary 1. Bankruptcy – the state of complete surrender of an entity to reveal its inability to pay the debts. 2. Bad asset – an asset whose value is lower than what the owner claims it to be 3. Fixed exchange rate – the pegged exchange rate (currency of one nation bound to that of another or to the price of gold) maintained within a narrow band as decided by the government. 4. Great Depression –recessonary phase or an economic slow down (or downfall), which took place before the World War II (during 1929-30). 5. Trickle-down – An economy is encouraged to grow such that the benefits of the same or the wealth finally shower upon the poorer sections of the same. 6. Sub-prime – Loans extended to people who undergo problems to meet the repayment agenda. 7. MSCI index – stock market index of 1500 world stocks 8. Mortgage market – credit obtained with the help of a real property as a security 9. Speculation – taking risks in financial investments in hopes of higher future returns (sort of gambling) 10. Welfarism – regulations, policies and strategies (evaluated on the basis of consequences) related to a welfare state Read More