Thursday, January 28, 2021

The social consequences of an economic crisis.

How does an economic crisis affect ordinary people? It is a difficult question to answer because it depends on many variables including the strength of the financial sector and the state of public finances. While it is difficult to draw exact parallels from other crises because initial conditions may have been different examining some of the broader channels through which a crisis me be transmitted is useful. An ADB paper on the Asian Financial crisis identifies five main channels of transmission; prices, labour markets, assets, credit and the government budget.

The initial blow tends to be on the currency and the sudden depreciation of the currency leads to price increases in imported goods or those locally produced that carry high import content although the degree of price inflation depends partly on the level of government intervention.

This disrupts trade and investment and leads to contraction of GDP, which translates to a lower demand for labour leading to increased unemployment and under employment. "Reduced demand for labor is reflected in business failures or retrenchment, wage cuts, shorter work hours, or fewer employee benefits."

"Besides reduced employment earnings, many households bear the loss of lifetime savings due to banking failures or of asset values owing to the collapse of stock and real estate markets. Diminished collateral for loans and high interest rates constrict access to credit for investment or consumption. This then forces household to resort to the informal credit market that imposes punitive interest rates".

Inflation also eats away the real value of savings, as the quantity of goods that a given sum of money can acquire diminishes.

The downturn also leads to lower government revenues while a good deal of public expenditure has to be devoted to restructuring financial institutions and debt servicing. "Normally efforts are made to maintain previous spending levels in such basic social services as education and health, but lower real spending in these areas is often inevitable".

Increases in poverty, malnutrition and hunger are possible. A paper by M Ramesh (on the impacts of the Asian Financial crisis) notes: 

"In Indonesia, underemployment rose from around one-third of the labor force in 1996 to around one-half in 1998. In Thailand, underemployment rose from 1.7% in 1998 to 3.6% in 1999" 

"The effects of the crisis were aggravated by increases in consumer prices, especially food prices. Indonesia was most affected, with food prices rising by 81% in 1998 and by 25% in the following year . In Malaysia and Thailand, food prices increased by 9% and 10% respectively in 1998, although there was little increase the following year. "

"The economic slowdown and increased unemployment were accompanied by increased poverty. Based on national poverty lines (which vary considerably in terms of how they are calculated and, hence, must be treated with care), between 1996 and 1998, the poverty rate nearly doubled in Indonesia (from 11.3 to 20.3%) and South Korea (from 9.6 to 19.2%; World Bank, 2000: 116). The increase was less dramatic in Malaysia (from 8.2 to 10.4%) and Thailand (from 11.4 to 12.9%) over the same period, but still significant."

Analysts and rating agencies have warned that a crisis may be approaching; a useful panel discussion on this is available here. It is not something that should be dismissed lightly.



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