Costas Lapavitsas is Professor in Economics at the School of Oriental and African Studies of the University of London and specialised in the theory of banking and finance.*

The crisis of 2007-2009 arose after the burst of an enormous bubble in real estate in the USA and the UK. But the underlying trends that led to it are characteristic of financialisation in developed countries. The crisis also drew in a range of developing countries via the mechanisms of global trade and finance. It became clear that financialisation has also made significant advances in developing countries in recent years.

Financialisation has several meanings in social science literature. In this article the term is used to indicate structural transformation of capitalist economies. In a nutshell, the sphere of finance has grown enormously in mature countries during the last three decades, spurred by technological advance and the lifting of regulations. In contrast, production in mature countries has continued to face problems of profitability and productivity.

As the financial sphere has expanded, large industrial enterprises have become proficient at raising external finance in open financial markets. Big business has acquired independent financial functions and lessened its reliance on banks. Consequently, banks have sought new fields of profitability, including, first, investment banking in open markets and, second, lending to individual workers.

The turn of banks toward households has been facilitated by gradual withdrawal of public provision in housing, health, education, pensions, and so on. Financial institutions have become social mediators of consumption and other personal spending.

In short, these changes have amounted to the ‘financialisation’ of productive enterprises, banks and households. Needless to say, the institutions of monetary and credit policy have also changed greatly, particularly central banks. Furthermore, governance of corporate enterprises has been transformed, with strong emphasis on ‘shareholder value’, share prices and short-term results.

Financialisation has also had distributional, ethical and moral repercussions across society. Nonetheless, the characteristic features of financialisation across developed countries are not homogeneous and reflect institutional, historical and political factors, including norms of business and personal income expenditure.

Financialisation has also had an integral international aspect. International financialisation is a complex issue, ranging from the accounting standards of global financial transactions, to the altered role of international organisations, including the IMF, the World Bank and the WTO, to exchange rate policy and adoption of inflation targeting across the developing world, to the functioning of the dollar as quasi-world-money. The current crisis has touched upon all these dimensions of international financialisation.

A striking feature of the crisis, however, is that it has revealed new links between domestic financialisation in developed countries and international financialisation affecting developing countries. These links have derived in large part from the international capital flows between developed and developing countries. Capital flows were important to sustaining the bubble in developed countries particularly during 2004-2007, while providing an effective subsidy to the USA as main provider of world means of payment.

Moreover, international capital flows appear to have induced domestic financialisation in several developing countries, led by expansion of domestic bond markets and entry of foreign banks. By the same token, capital flows and domestic financialisation have contributed to the emergence of crisis across a range of developing countries.

Financialisation in developing countries is, in the first instance, a phenomenon of international transactions. Liberalisation of capital flows has integrated developing countries more closely into world capital markets since the early 1990s, FDI being the most stable component of capital flows from rich to poor. The flows of FDI were sustained during and after the Asian crisis of 1997-8, but the overall character of capital flows has become significantly different in the 2000s. Developing countries have been obliged to hoard international means of payment – primarily dollars – as a result of participating in international capital transactions. The unprecedented extent of such hoarding has resulted in negative flows of capital on a net basis.

During the 2000s, poor countries have been effectively financing rich countries, mainly the USA. Capital has been ‘flowing uphill’ in the financialised global economy. This is one of the most paradoxical, as well as pathological, outcomes of international financialisation.

The form taken by negative capital flows has resulted from the need to sterilise inflows into developing countries, thus leading to the acquisition of foreign exchange reserves. Sterilisation was also spurred by the pressures of inflation targeting, which has been widely adopted across the developing world, and has created a secure terrain for foreign capital to flow into developing countries. The safest way to sterilise and accumulate reserves is, of course, to acquire public debt issued by mature countries, primarily the USA. In effect, the monetary authorities of developing countries have been lending directly to the state in the US and other mature countries.

Consequently, international financialisation has meant substantial costs for developing countries. Interest rates on public debt issued by the USA have typically been lower than interest rates on either international borrowing, or on domestic public securities in developing countries. Put differently, developing countries have been paying an implicit subsidy to the USA as issuer of the pre-eminent form of international means of payment.

International financialisation has also acted as a spur for accelerated domestic financialisation, particularly in middle income countries. Sterilisation has encouraged growth of domestic bond markets, thus providing scope for expansion of domestic financial institutions. During the same period large-scale entry of foreign banks has led to adoption of practices common in financialised developed countries. In particular, lending to individuals for mortgages and consumption has become prominent in several developing countries, resulting in rapid growth of personal debt. Domestic banks have also entered this field. The development results of directing credit toward personal income are unlikely to be positive.

The effect of the crisis on developing countries has varied according to the mode and extent of integration of each in world trade and capital flows. Developing countries were hit by a combination of worsening current account and sudden reversal of short-term capital flows. The impact of the blow depended on the size of foreign exchange reserves. Countries with substantial reserves were afforded a measure of protection from sudden reversal of capital flows, and some even attracted fresh flows as financial conditions in mature countries became worse.

The impact of has also depended on entry by foreign banks and the extent of domestic financialisation in particular developing countries. Central and Eastern Europe represented a particularly acute combination of these pressures.

The crisis has reopened the issue of reforming the international financial system. Developing countries were hit by a storm that was not of their own making. This was after undertaking policies throughout the 2000s that had resulted in capital flowing from poor to rich, on a net basis, thus imposing substantial costs on the poor. Meanwhile, the domestic economy in several developing countries has become increasingly financialised and credit has been direct toward consumption. The crisis has posed again the issue of alternative institutions and mechanisms to regulate international flows of capital.

*Prof. Lapavitsas is member of Research on Money and Finance, a network of political economists that have a track record in researching money and finance. It aims to generate analytical work on the development of the monetary and the financial system in recent years. A further aim is to produce synthetic work on the transformation of the capitalist economy, the rise of financialisation and the resulting intensification of crises.

Sanoussi Bilal is head of Economic and Trade Cooperation Programme, at the European Centre for Development Policy Management (ECDPM), Maastricht and Brussels

The financial crisis, though having its origin in developed countries, has generated a global recession that has severe consequences for developing countries, including in Africa, in terms of their prospects for economic growth and development, notably through a decline of trade and investment flows, lower remittances, some lower commodity prices with a greater volatility, which appears to already lead to a reduction of employment opportunities and an increase in poverty and malnutrition for the most vulnerable people.

With more pessimistic growth expectations, most African, Caribbean and Pacific (ACP) governments, in particular in Africa, will be facing serious budgetary constraints and forced to make difficult choices for the future of their economies. In this context, it is worth asking what role EPAs can play, or should not play? Knowing that the situation of African economies vary from country to country, it is unlikely that a one-size-fits-all or a tailored-made approach would be suitable, however broadly two opposite options can be identified.

At one extreme stand the “EPA enthusiasts”, who believe EPAs can effectively contribute to address some of the systemic impediments to economic development in ACP countries. Combined with strong commitments on social, labour and environmental rules and accompanied by appropriate levels of development cooperation, as repeatedly pledged by the EU, EPAs could become an antidote to the global crisis and a credible guarantee against future backlashes and policy reversals that would erode the prospects for domestic growth. Or at least so goes the argument. The direct consequence for the negotiation process is that all interim EPAs should be signed and that regional full and comprehensive EPAs should be concluded with the remaining African (and Pacific) ACP regions concerned as soon as possible.

At the other end of the policy spectrum stand the ‘EPA fearful’ or ‘EPA sceptics’, who tend to view EPAs as another attempt by developed countries, in this case Europe, to impose an obsolete model of development based on too rigid neo-classical recipes. In a nutshell, some critics claim that EPAs, with their liberal agenda forced upon Africa will exacerbate, rather than alleviate the negative effects of the crisis and institute a new policy and regulatory framework that will ultimately undermine the African ACP countries ability to respond to similar crises in the future.

In particular, they argue that opening up local markets to international competition from EU products will further contribute to put domestic production under pressure at a time when international export market opportunities are dwindling and food security is under threat. In addition, the removal of custom duties from EU imports will exacerbate further problems of tightened budgetary constraints experienced by many developing and ACP countries as a result of the global crisis.

What do we know? In the short run, an EPA is unlikely to make much of a difference. EPA main commitments cover a period up to about 15 years, and implementation will be gradual. So, if EPAs can help address some of the fundamentals of African ACP economies, their effects will not be felt immediately. In this sense, EPAs are no quick fix for the global crisis. On the other hand, commitments under EPAs have to be made in a period of economic hardship. While most of the potential benefits of EPA reforms will be reaped in the longer term, adjustment costs - in terms of market opening, productive adjustments, infrastructure development, fiscal reforms, etc. – are likely to be borne in the short and medium term.

The challenges of facing adjustment costs could be partly addressed through the adoption and delivery of appropriate accompanying measures to EPAs, discussed with the EU in parallel to the EPA negotiations. But as the crisis is affecting mainly developed countries, donors will be increasingly at pain to deliver on their ODA commitments or beyond, raising doubts as to their ability to meet some African countries need for greater reliance on development assistance.

Beyond the loss of custom revenues by African ACP countries as a result of the general collapse of global trade, fall of trade flows with the EU could also have an effect on the liberalisation schedules to be negotiated in EPAs. Some products may become (temporarily) more sensitive and other less, depending on how they are affected by the crisis.

In view of the possible impact of the global crisis on the EPA approach, it is also worth considering that comprehensive EPAs aim at liberalising not only trade in goods, but also trade in services, possibly including the financial sector. If there is one general lesson from the financial crisis is that the financial sector needs careful and appropriate regulation. But the type of regulation required and the reforms needed are less clear.

Besides, while the creation of effective regional markets may contribute to foster development and thus partially alleviate some of the negative impacts of the global crisis, the EPA negotiation process has so far mainly contributed to strain regional integration processes in Africa, notably with the conclusion of interim EPAs with individual countries or groups of countries cutting across RECs.

Recommendations

With the global crisis having drastically changed the context under which EPA negotiations are conducted and under which EPAs are likely to be implemented, some adjustments to the current approach to EPAs are needed.

In spite of the potential merits of regional integration and EPAs in the medium and long term, they offer little prospects to address the immediate consequences of the crisis. In the short run, special attention should thus be given to the scope of commitments and their sequencing, to reflect the specific current conditions and development approaches of each country and region.

Perhaps even more important, all EPAs could include specific clauses providing for the possible revision of liberalisation schedules (as in the CARIFORUM-EU EPA), as well as better provisions to facilitate the adoption of safeguard measures, including for balance-of-payment purposes. To those African ACP countries interested in substantial liberalisation of services in an EPA, the EU should provide appropriate support to build regulatory capacity and make generous offers in response to requests, notably in sectors where these countries have a comparative advantage. Without such flexibility, EPAs may add to the pain of the crisis.

With the global crisis, there is an additional sense of urgency to respond to the need of the African ACP countries. Development assistance can be front loaded and its effectiveness improved, but the potential of such measures is limited. Nonetheless, such loadable efforts should be further encouraged and speedily implemented. Existing mechanisms should also be used - notably support through budget support or commodity funds to address price and exchange rate volatility – or adapted. In this respect, the proposal by the European Commission for ‘vulnerability FLEX’ should be carefully considered, with regards to its mechanism, funding and effective delivery.

Bilal, S., Draper, P. and D.W. te Velde. 2009. Global Financial and Economic Crisis: Analysis of and Implications for ACP-EU Economic Partnership Agreements (EPAs), ECDPM Discussion Paper 92

For related discussion see: Jones, E. and Martí, D. (ed). 2009. Updating Economic Partnership Agreements to today’s Global Challenges: Essays on the Future of Economic Partnership Agreements, GMF Economic Policy Paper Series 09

Astha Kapoor is studying for her Master of Arts degree in Development Studies at the Institute of Social Studies, The Hague, the Netherlands. Previously, she worked as a journalist for the Mail Today newspaper in New Delhi, India, and was a researcher for the Centre for Policy Alternatives in New Delhi.

There are very few people who know about India's involvement in the global diamond trade. South Africa, Antwerp and New York are usually the names that first come to mind, even though India polishes 11 out of 12 diamonds in the world today.

When the financial crash of 2008 settled in, the booming diamond industry in India was left in shambles. The industry is centred around the city of Surat, in Gujurat, where close to 800,000 workers are employed in the trade. With the descent of the crisis, over 400,000 were left unemployed.

The recession hit in November 2008, when the diamond polishing units did not reopen after the annual winter break. Workers were left out of work and did not know how to respond. They were given no early warning of this closure, nor were any institutional measures put in place to shield workers from what would become the worst economic crisis of our times.

The workers were forced to employ different means to cope with the crisis. The labour force consists of migrant workers and those who still had links with land in the villages chose to leave the city and cut their losses. Others were forced to rely on loans from extended family in the villages. Women came to the forefront to support their families. The men were laid off their jobs and the women, traditionally confined to the household, took up home-based work to contribute to the income of the household.

A peculiarity of the diamond industry in India is the significance of caste. Since the trade is largely based on trust, those employed usually belong to one caste. Caste affiliations extend to the smallest possible level of the industry. At the time of the crisis, it was believed that this social network, exploited for so long to hire people, came to the rescue of those who belong to the caste. However, this is not true; caste was largely absent from its role as a safety net.

Many workers diversified their income. They invested small sums of capital into less lucrative business opportunities, such as vegetable vending and tea stalls, swearing never to go back to the diamond industry because of the crisis. Interestingly, those belonging to the dominant caste did not diversify their trade because their belief in the diamond industry was still strong.

The city of Surat saw 80 suicides during November and December 2008, the toughest months of the crisis. These suicides were committed by diamond workers who were in debt – not those who could return to their villages, or the poorest of the poor, but the middle income diamond workers who had probably taken loans recently to build a new house.

The state, trade unions and support from employers are all absent from the diamond industry. It operates in the dust of informality and no amount of discussion around the issue ever sees results. There is a need for greater social security to make sure that those involved in the diamond industry, and other informal trades like it, have secure safety nets to rely upon.