Financial Volatility
Financial Volatility

One of the first major economic crises in a more globalized economy was the turmoil that struck East Asia beginning in 1997. Although the crisis was rooted in broader international economic developments, such as the severe and lengthy downturn in the Japanese economy, and weakness in bank supervision and loan practices in several East Asian countries, the presence of large amounts of short-term foreign portfolio investment exacerbated what might have otherwise been a relatively small downturn in one region. The flight of that short-term capital out of South Korea and Thailand helped produce a collapse in those economies and several of their neighbors.

A recent study by the Bank for International Settlements quantified the economic impact of the volatility of this short-term investment capital, noting, “In many emerging markets, financial cycles have been particularly pronounced, typically being reinforced by large swings in the flow of international capital. The cost of these cycles has been high, with the direct cost of resolving bank crises often exceeding 10 per cent of gross domestic product and the indirect costs in terms of lost output higher still.”

Another major economic crisis is the global financial and economic crisis of 2007-2009.  The main cause of this crisis can be sourced to a credit boom.  After the information technology bubble between the mid-1990s to early 2000s and its ensuing burst,(Galbraith, Hale, 2007) the US Federal Reserve kept interest rates at the lowest levels in history—close to one percent  in 2003 and 2004—in an attempt to offset the subsequent decline in stock prices; but that only fueled the real estate bubble (Sachs, 2008). 

By the time that bubble had burst, the entire financial system had already become weak due to “the transfer of assets from the balance sheets of banks to the markets, the creation of complex and opaque assets, the failure of ratings agencies to properly assess the risk of such assets, and the application of fair value accounting [as well as the] failure of regulators and supervisors in spotting and correcting the emerging weaknesses” (Fratianni, Marchionne, 2009). 

Low-quality (or subprime) mortgages are not necessarily the direct cause of the crisis (a popular notion), although they did make its effects more widespread.  While the world is still feeling the overall effects of the crisis, Robert Zoellick, president of the World Bank, has prognosticated that the global financial system reached a “tipping point [which] will trigger business failures and possibly banking emergencies.  Some countries will slip toward balance-of-payment crises.” (Cho, Appelbaum, 2008) 

Specifically, with regard to global foreign direct investment, the crisis has had an effect, as well.  Prior to the crisis, from 2003-2007, global foreign direct investment generally increased, culminating in record levels in 2007 (United Nations Conference on Trade and Development Investment Brief, 2009).  But as the US subprime crisis began in the summer of 2007, “various indicators during the first half of 2008 already suggested a decline in world growth prospects as well as in investors’ confidence” (United Nations Conference on Trade and Development, 2009).  Indeed, FDI flows had already begun to decline by the middle of 2008 (United Nations Conference on Trade and Development Investment Brief, 2009).  By late 2008, the crisis had worsened as non-financial sectors of the economy suffered and some nations were turning to the IMF for assistance. Now in 2012, several economies are still experiencing a recession, or at the very least low levels of growth.

 By late 2008, the crisis had worsened as non-financial sectors of the economy suffered and some nations were turning to the International Monetary Fund (IMF) for assistance. Now in 2013, several economies are still experiencing a recession, or at the very least low levels of growth.

Developed economies are experiencing more of a decline in foreign direct investment than transition or developing economies (see table below).  This is because the crisis originated in, and therefore more directly affects, the developed world (United Nations Conference on Trade and Development, 2009).  Developing and transition economies are seeing a slowdown in FDI inflow growth, although growth rates will still remain positive (see table below). Europe, Japan and West Asia will suffer the greatest decline in FDI, (see tables below).

(UNCTAD World Investment Report 2013 Global Value Chains: Investment and Trade for Development, 2013)


(UNCTAD World Investment Report 2013 Global Value Chains: Investment and Trade for Development, 2013)

Due to declining profits and increasingly difficult access to credit, as well as bad short-term economic growth prospects, transnational companies are cutting down on foreign direct investment.  However, the situation could improve in the future as financial and economic crises provide opportunities for firms to purchase foreign assets at relatively low prices.  Firms also seem to be committed to longer-term investments in foreign nations; although FDI flows have decreased, FDI stocks have not (United Nations Conference on Trade and Development, 2009). 

Firms, from “emerging economies and countries that are well-endowed with natural resources, are becoming a growing source of FDI,” too (United Nations Conference on Trade and Development, 2009).  Lastly, specific industries might be well-suited for escaping from the crisis.  According to UNCTAD, these include industries in life sciences, agro-food, transport equipment, business services, personal services, information and communication technologies and energy, chemistry and environmental conservation (United Nations Conference on Trade and Development, 2009). 

 

 

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