Globalisation and the Aftermath of the Global Financial Crisis: Theory and Practice - Coursework Example

Globalisation and the Aftermath of the Global Financial Crisis: Theory and Practice” (Name) (Institution) (Course/Grade) (Name of Tutor) Date Introduction Between late 2007 and 2010, the world was in a global recession. Leading economies such as the US and the UK were in financial turmoil, and the effects trickled down to other countries such as Germany and France. Two leading economies not severely affected by the crisis were China and Australia. The recession was characterised by high food prices, fall in general demand, fall in housing prices, higher energy costs and unemployment around the world. Twenty seven million people were rendered unemployed in 2009, increasing g global unemployment to over 200 million, the highest level ever (Swan 2010). These elements combined to destabilize the global economy that led to negative growth rates in GDP in a number of countries. This paper assesses the dimensions and causes of the crisis, and how Australia, Europe and North America fared during the crisis and after and also evaluate free market economic theory in the aftermath of the Global Financial Crisis in regards to immigration. Causes of the financial crisis There are different theories on what caused the 2008 global financial crisis. A report by Brookings Institution economists Martin Baily and Douglas Elliott acknowledges three different theories (Thomas et al., 2011). The first is that the crisis was caused by the US Federal government through housing market intervention through Fannie Mae and Freddie Mac. This intervention inflated a housing bubble that triggered the crisis. The second theory brought forward by the report is that banks, greedily manipulated the financial system and politicians capitalised on the opportunity at the cost of homeowners. The third theory is that there relaxed policies and failure of supervision of the financial market by the US government. However, it is interesting to note that all these theories point to the fact that the crisis started in the US and was felt across the world with major economies suffering at different degrees. An alternative theory opposed to the three theories suggests that the crisis was caused by a culmination of ten factors. Ten factors combined to cause the crisis hence attributing the crisis to just one factor is not realistic. The factors listed in the fourth theory by Thomas et al. (2011) explain a domino effect that started way back in the last millennia. The first and second factors identified include a credit bubble in the late 1990s in the US and Europe with rising housing prices. This was followed by excess liquidity in the market. A third factor was triggered by the above conditions in the form of increased non traditional mortgages in an insufficiently regulated market. Many borrowers took mortgages which they could not pay. As individual homeowners failed to service their mortgages, highly leveraged institutions incurred massive losses. This was a result of failed credit rating which would have protected such institutions (fourth factor). In essence, mortgages were turned into toxic assets. Credit rating agencies, whether knowingly or unknowingly, wrongly rated such securities as safe investments leading to financial institutions amassing highly correlated housing risk (5th factor). In a bid to rescue their situation, the institutions funded such exposures with short-term debts (6th factor). A high number of funs starved institutions with exposure to collapsing assets in from of housing could trigger a chain reaction where failure of one firm led to failure of others (7th factor). Other firms, in unrelated cases or markets, were engrossed in a common shock (8th factor). Failure or merger of a number of institutions caused a panic in the market (9th factor) leading to a lack of trust and confidence in the financial system leading to the eventual financial crisis. In Australia, the origins and causes of the global financial crisis were relatively different. The Blundesll-Wignall and Atkinson (2008) explained that the crisis was caused by “by global macro policies affecting liquidity and by a very poor regulatory framework that, far from acting as a second line of defence, actually contributed to the crisis in important ways” (Cited in Blundesll-Wignall, Atkinson & Lee, 2008, p.2). The position taken by the Australian reserve Bank according to the authors is that the crisis was an exogenous occurrence that forced by Australia government to undertake endogenous responses. Lin and Treichel indicate that the actual eruption of the crisis happened in September 2008 with the collapse of Lehman Brothers as a result of accumulated toxic mortgages. Credit to private sector declined and interest rates sky rocketed. The result was a collapsed financial system in the US that led to equity markets around the world being affected. The different theories on how the financial crisis started agree on one that the crisis started in the US caused by the housing bubble. However, a combination of factors contributed towards the actual collapse of the financial system. Low interest rates encouraged banks and mortgage brokers to sell mortgage to people who could not even afford it. Credit rating agencies on the other hand rated these mortgages highly that institutional investors demanded mortgage-based products more than corporate bonds. With the evaporation of the housing bubble and increase in interest rates, the crisis had set in (Crotty 2008). Therefore, the US housing and mortgage market coupled with poor regulation of financial institutions caused the financial crisis that affected the world economy in various ways. Colander et al. (2009) summarises this to say that the crisis was caused by the US government spending more it could afford in the anti terror wars and accumulating high debt. So did this crisis happen all over sudden? Economic experts and politicians have in the past expressed their reservations over the large debt that the US government has accumulated by funding the Iraq and Afghanistan wars. However, it is apparent the early warning signs used by the world band, IMF and other economic institutions were caught off guard by the crisis. Colander et al (2009) argue that the economics profession has led the world down by using economic models that do not serve effectively as early warning systems to inform policy makers. The authors argue that the models in use disregard key factors such as “including heterogeneity of decision rules, revisions of forecasting strategies, and changes in the social context” (p. 2) that are critical in indicating and influencing the performance of markets. They also accuse the modern economic experts of not fully embracing the study of crisis phenomena, as is the case with earlier economists. By extension therefore, it can be argued that the crisis was in part caused by a lackluster attitude by economics towards financial crisis phenomena which should have enabled early warning systems to governments and financial institutions. This translates to poor regulation caused by poor or irrelevant economic theory. Economic circumstances and performance by regions Australia Australia was not been spared by the global recession. The GDP fell by a significant amount though there were no significant job losses as year 2009 saw the creation of 180 000 job opportunities according to the Treasury head, Swan Wayne. As a net exporter of energy and other resources, the economy did not suffer the same way as other global economies. However, a fall in demand of exports as a result of slowed economic activity in major economies led to a fall in demand for Australian exports. This had a direct impact on the Australian labour market as indicated by statistics presented by the Australian Bureau of Statistics. During the recession, one of the intriguing things that came up was that leading global economies were cutting down on their lending rates while Australia was doing the contrary. In lowering the rates, the government was cutting down on the money supply (contractionary) in the economy as one of the monetary tools of regulating money supply. From the past the federal bank has used this policy to control inflation. Specifically, increasing lending rates will carry over on other rates thereby causing an increase across the divide (Welch & Welch, 2009). As such, there will be increased savings due to the high rates and decreased borrowing due to the high rates. These effects will combine and work collectively in reducing the money supply in the economy. After the recession the Rudd government introduced a fiscal stimulus package of about US$50 billion aimed at jump-starting the slowing economy after the global financial crisis. Furthermore the Reserve Bank of Australia cut interest rates to historic lows. Consequently, the economy grew by 1.4% in2009, 2.5% in 2010, 2.1% in 2011, and 3.3% in 2012. Unemployment was highest at 5.7% in 2010 and fell to 5.2% in 2012 (Index Mundi 2013). North America While the US economy apparently triggered the global financial crisis, her northern neighbour faired comparably well. In fact, Canada was the only G7 country that did not have a government bank bailout. As a country that accounts for 2% of the global trade its stability was important to the world. As of January 2006, the country was enjoying a declining real GDP growth at 3.77%. By March 2007, the economy grew at only 1.82% before picking up again in October same year to hit 2.97%. However, the economy changed course and the GDP shrunk by 3.23% as of July 2009. The country’s banking system was equal to the task owing to strong regulatory measures and practices as noted by a World Economic Forum reported which ranked the country the best out of 134 countries in terms of sound banking systems. The US president himself, Barrack Obama also acknowledged the supremacy of Canada in managing its economic system when he said “Canada has shown itself to be a pretty good manager of the financial system and the economy in ways that we haven’t always been” (Porter 2008, p. 1). This statement is a clear indication by the presidency that the cause of the crisis is largely attributable failure in managing the American financial system by the regulatory bodies appropriately and hence was avoidable. During the recession, the US recorded 6.8 million job cuts. However, the situation was not this bad prior to the recession and economic indicators had not signalled any crisis ahead. In the first half of 2006, the US economy was growing at an average of 3% dipping in mid 2007 hitting 1.4% before picking up again to stand at 2.7% October 2007. Afterwards, the economy dipped with the lowest being July 2008 at -3.9%. GDP recorded a negative growth rate of 6% in the fourth quarter of 2008 and first quarter of 2009. Unemployment hit the highest level since 1983 at 10.1% as of October 2009. Europe The economies of Western Europe were among the heaviest hit by the crisis after the US. These economies registered negative GDP growth rates such as the UK, Spain and Greece with massive job cuts; half a million jobs cuts in the UK, 3 million across the Euro economies. Spain and Greece seemed to be the hardest hit with the countries seeking bailout from their European counterparts. However, these bailouts have been termed as destructive. The countries are yet to recover from the crisis four years on. For instance, in Greece, the unemployment rate was 7.7% in 2008 but has sky rocketed to 27.2% by February 2013. The National Statistics Institute (INE) in Spain reported that unemployment among the youth has reached 57.22% as of April 20th 2013. In France, the situation is almost the same with unemployment standing at 10.6% as of December 2012 (Index Mundi, 2013). Schelburne (2009) gives a number of reasons why these economies were affected greatly. These are: 1) many European banks held a significant percentage of their toxic assets in the US 2) poor design of the regulatory and institutional structures in most economies that could not handle the crisis 3) regional financial institutions also had poor regulatory structures to deal with the crisis 4) some European banks over relied on international wholesale financing 5) European banks were highly leveraged than their US counterparts 6) European banks were more exposed than US banks by virtue of lending more to emerging markets 7) high trade linkages with the US -domino effect 8) elimination of lender of last resort backing for national commercial banks and sovereign debt by the European monetary system 9) policy makers ignored the importance of counter-cyclical macroeconomic policy 10) emerging economies in eastern Europe had higher foreign-currency denominated debts 11) emerging economies in eastern Europe were exempted from some policy enactment 12) individual housing bubbles that weakened mortgage market and 13) nationalistic competitive concerns negatively impacted government assistance efforts. However, the impact and the perceived causes were not as uniform across the region as portrayed by the above causes. Free market economic theory vs the immigration policy in Australia and US The free market theory is synonymous with western capitalism. The free market theory posits that supply and demand in a free market place with no government interferences, will naturally reach a state of equilibrium where the maximum possible social good is achieved. This approach is based on the classical and neo-classical concept of a non invisible hand in the market. However, this approach has been criticised on different grounds. In fact, this approach is blamed for causing the recent global crisis where excessive demand in the US and some parts of Europe for housing, also known as the housing bubble caused the crisis. As discussed earlier, one of the main causes of the crisis was poor regulation of the housing and financial market. Such claim to regulate the markets undermines the claim that western capitalism is based on free market economics. Sikorski (2011) notes that free market economic approach had caused similar problems to the 2008/07 financial crisis in Asia some years back. He writes that “East Asia had learned a healthy scepticism towards American free-market financial theory, having taken painful medicine prescribed for their own crisis a decade earlier and they have seen that their own mode for market development-with less freedom and more control- was quite a legitimate formula” (p. 75). Free market theorists say that demand will create its own supply. In the face of globalization and labour mobility, this issue requires to be relooked again. Taking this policy of free markets, it would imply that demand for labour in the developed world such as UK, US and Australia would create supply from the less developed world where there is excessive supply of labour. However, this is not the case. The high number of immigrants, legal and illegal in developed countries has been accused of driving up unemployment in the developed world. It is assumed that these individuals take up the job opportunities that would have been taken up by the locals. In Australia for example, the population of immigrants has been on the rise with about 26.8 per cent of the estimated resident population comprised those born overseas as of 2010. China is one of the countries that have contributed to this upsurge in immigrants. Theirs supply of labour to Australia has been very helpful to the economy. The department of immigration in 2010 Intergenerational Report notes that without immigration, labour supply in Australia would not increase at all in the next few years. By 2036, it is estimated that the baby boom generation will be retiring hence a need to replace that workforce. In essence, the labour demand in Australia should be allowed to create its own supply without restriction by immigration laws (department of immigration 2013). The US on the other hand is busy fighting excessive inflow of immigrants. In the past, high labour demand by US corporations led to increased labour wages. This had a direct impact on the profitability of firms. In response, the firms resulted to outsourcing especially in labour intensive industries such as garment manufacturing. The demand for labour inside the US was thus lowered through exporting job opportunities. However, exporting jobs did not stem high inflow of immigrants. The law of free market theory posits that individuals seek to optimize their utility. In spite of exporting jobs, the quality of life in the US is relatively higher than in many countries. Consequently, even countries that imported jobs from the US such as China, the inflow of immigrants remains high. For this reason, the US has enacted stricter laws to limit the inflow of immigrants from countries such as China. The lifestyle in the US has created demand and according to the free markets theory, individuals will respond to the law of demand. However, the strict immigration laws will keep the situation in check. Free market theorist claim that man is a rational being. Classical economics argued that man is bound to behave in manner that maximises his utility. Man was thus termed to behave in a ‘homo oeconomicus’ way (Olsen 2001). Accordingly, all individuals are expected to react in a similar manner to events. Therefore, given that events in life were random and unpredictable, the market would also be random and unpredictable. This is not the case however. The fact that some firms withhold information from others implies that some players in the market have an unfair advantage over the others. In this regard, players act according to the information they have meaning that human behavior is not homogenous. In terms of immigration, it might be interpreted to mean that some employers will be willing to higher cheaper labor from immigrants than from residents. The other significant assumption was that the actions of an individual firm have little impact on the whole market because individual actors were insignificantly small and that every one behaves in the same way. In today’s free market economies, individual firms have amassed so much financial power that their individual actions have a bearing on the rest of the market. For instance, one of the largest players in the developed world, Wal-Mart, wields so much power that they dictate prices on their suppliers. This drives down their prices so much such that competitors cannot compete with them on a level playing ground. Such employers continue to attract immigrant workers because due to their huge operations, they can dictate wages to residents. Immigrant workers however are more willing to seek such jobs because the wages offered are rational to them based on their lifestyles back home as opposed to US residents. Conclusion It is apparent that there is a need to relook at free market economics. The models which continue to guide the modern day economies are built on unrealistic assumptions that cannot assure the necessary stability. The recent economic crisis is one such example where the ideals of free market economics have been tested and the results are disappointing. There are no early warning system theories that can detect a crisis early enough as was witnessed. The call for non-government interference in the market did not hold. Many governments especially in US and Europe had to bail it private organizations from collapse. The current movement of labour cannot be allowed to function under the ideas of free market theory. If the free market theory was to hold, a number of economies would have utterly collapsed during the recession or even after the recession as locals lose jobs to immigrants. For this reason, there is need for higher government involvement in regulating markets including the labour market through stricter control measures. . References Colander, C, Follmer, H, Hass, A., Goldberg, M., Juselius, K.Kirman, A., Lux, T. & Sloth, B. (2009). The financial crisis and the systemic failure of academic economics, Kiel working paper, No. 1489, In: Kiel Inst. for the World Economy, Kiel (Ed.) Crotty, James (2008) : Structural causes of the global financial crisis: A critical assessment of the "New financial architecture", Working Paper, University of Massachusetts, Department of Economics, No. 2008-14 Department of immigration (2013). 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