In the long run …

What impact will the banking crisis and subsequent stock market collapse have on the developing countries of South Asia? According to one economist, not much. According to Michael Clemens at the Center for Global Development, no economic crisis has been very consequential in the medium to long term:

In historical perspective, many of the most worrisome recent crises are small bumps on a very long road. The entire effect of the 1994 so-called “Tequila” Crisis on per-capita real income of the average Mexican… was erased in exactly three years. In Thailand, epicenter of the 1997 Asian Financial Crisis, it took all of six years. In Indonesia, the poverty rate in the population was back to its pre-crisis level within just three years. Even the big, bad 1982 Latin American debt crisis … [had no long term effect]

Bad years are typically followed by offsetting good years, and good years by bad. The good years get smaller headlines, or none at all. The point is that in the long march of development, some financial crises amount to rounding error relative to the real economy, and the real economy affects welfare. [Link]

Clemens claims this is even true about the mother of all financial crisies, the Great Depression. Even this seemingly cataclysmic event, he argues, had no real impact on long term American growth.

Other economists disagree quite strongly. One of them says that the such shocks can kill the worst off of the poorest, removing them from the population altogether so they don’t show up the next time per capital income figures are calculated:

A doubling of poverty, even if only for a year or two, has an impact on infant and child mortality, on schooling rates, and other welfare variables that have long-run consequences. I once calculated that the elasticity of mortality rates with respect to real rice prices (in Sri Lanka and Bangladesh) is about 0.1; that is, if rice prices rise by 10 percent, the mortality rate rises by 1 percent. It’s not hard to understand why: poor people die more frequently when their already diminished nutrient intake gets cut back. They “exit” the population, and thus do not show up in the calculated per capita income a decade later. [Link]

This is just a small taste of the ongoing debate. You can read the entire series of posts here (note, they’re mixed in with posts on other development subjects).

6 thoughts on “In the long run …

  1. the Great Depression. This seemingly cataclysmic event, he argues, had no real impact on long term American growth:

    but it changed the world. Bretton woods came about through that – and that shaped how the globe helps out the basketcases (IMF), supports the relatively well to do (WB) and brings down trade barriers (WTO). Before this the world operated as separate economic fiefdoms.

    the equivalent of 1944′s Bretton Woods as a distinct possibility in november – when a new economic world order will be shaped – this time with the BRIC. Prez GWB has nixed the possibility but Brown, Merkel and Sarkozy are keen on it. Bretton woods I led to the IMF, WTO and WB. things are so serious that the status quo needs to be shaken up. Despite the drop of over 40% in the stock markets for BRIC, the world looks to them for growth – currently their growth rate is expected to exceed 6% annually even as the developing world trudges around at sub 1% growth Y2Y. one of the outcomes has to be an active engagement of the BRIC.

  2. That remains to be seen. The BRIC countries are still not that wealthy, and more importantly, they don’t have a lot of cash to spare. Russia has it’s own economic problems and with the price of oil going down, may not have much leverage in the future. Brazil and especially China may well have a bigger role to play.

  3. unfair for me to post excerpts. it’s a rich article. you might find this good reading. it explains the impact of the us financial trouble on bric, their ability to weather the storm and even to carry the load by being the pacemaker for a sluggish global economy.

  4. It’s remarkable to me that the discussions around economic catastrophe keep trending towards “but it works out over time.” Of course it works out over time. But, as Keynes said, in the long-run we’re all dead. Perhaps because the Great Depression generation is slowly dying out people don’t remember or recall how devastating that period of history was to people’s survival.

    I don’t think things will be as bad as the Great Depression this time, but I think we’re naive if we think the fall-out won’t a) hurt, and b) have a disproportionate impact on the survival of those at the bottom of the income spectrum.

  5. Let’s not forget the deflationary effects of a sustained lack of demand in the overall economy that a true depression brings with it. In all the advanced economies (US, UK, France, Germany, etc), for example, the 1930s were a deflationary period. From sources who lived through the period (Camille note) I have strong anecdotal basis for claiming that something similar also happened in India. The CPI Numbers for India during the same period also probably exist and will hopefully bear this out more broadly.

    In the US, for example, on a 1929 = 100 base, the CPI index in 1933 was 73, and in 1940 was still just 81.

    There was a further period of enforced price stability during the War, which had a clear impact during 1943-45, after mild inflation during 1941 and 1942. It wasn’t till 1946 that prices caught up to pre-1929 levels, and 1947 was high inflation (relatively speaking) in the US – 15% ! (Anecdotally, something similar happened in India, complicated by Independence). 1950s were even more stable price-wise in the US than the 1940s had been, though that is another story.

    So in estimating the impact of a depression on the very poorest people, perhaps lack of income will negate any positive impact that a decline in prices has on purchasing power. This could kill them off. But for the middle class, and people on fixed incomes, the deflationary impact can be a good thing, provided they don’t have fixed interest debts.

    Just thought I’d throw that in.

  6. Of interest – Africa is demanding a spot on the table at Bretton Woods II. The news article is from the Francophonie summit being held here in Canada. The point is well taken – why are there billions for bankers but nothing for the hungry?

    “Africa must be present,” said Senegalese President Abdoulaye Wade. He said most African countries were ignored colonial outposts when the Bretton Woods system of monetary management, the International Monetary Fund and the World Bank were created. “We keep inventing mechanisms to deal with new problems without fundamentally changing systems. Now that we are talking about fundamental change, we must be present,” Mr. Wade said.