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Eurozone Crisis Could Spill Over into Developing World

Thalif Deen

UNITED NATIONS, Aug 15 2011 (IPS) - When the global economy was hit by a severe recession in 2008- 2009, the negative fallout impacted heavily on the world’s developing nations, hindering the U.N.’s key development goals, including plans for the elimination of extreme poverty and hunger worldwide by 2015.

The current sovereign debt crisis, spreading mostly across the Eurozone (EZ) and threatening the economies of several Western nations, including Portugal, Ireland, Greece and possibly Spain and Italy, will sooner or later undermine the developing world, warn economic analysts and academics.

Shrinking markets and potential cuts in development aid, which followed the 2008 crisis, could repeat themselves.

Mauro Guillen, director of the Lauder Institute at the Wharton School of Business at the University of Pennsylvania, told IPS the EZ crisis would affect developing countries in several ways.

First, he pointed out, the EZ is a huge market, so anybody exporting manufactured goods or commodities would suffer.

“The EZ is also a big investor. If European companies feel less confident, they could delay investments,” he said.

And, finally, a structural/existential crisis in the EZ would provoke turmoil in global financial markets, which would hurt developing countries as well, said Guillen, a management professor and an international expert on global economic affairs.

The current crisis, according to economists, is focused not on consumer debt but on government debt.

The most drastic measure would be to force countries such as Portugal and Greece to voluntarily leave the EZ to avoid a major calamity to the common European currency, the euro.

The euro is used by over 332 million people in 17 of the 27 member countries of the European Union (EU).

With the exception of Germany, most Western nations are being dragged into an economic quagmire even as the EU tries to bail out the defaulters.

Besides a possible recession in Europe, the EZ crisis is also threatening to destabilise stock markets in the United States.

Dean Baker, co-director of the Washington-based Center for Economic and Policy Research (CEPR) told IPS, “There is, of course, the obvious – the self-imposed austerity spreading across the Eurozone limiting the market the region represents to the developing world.”

Rob Vos, director of the Development Policy and Analysis Division at the U.N.’s Department of Economic and Social Affairs (UN-DESA), told IPS the present nervousness in financial markets comes on top of existing uncertainties primarily caused by the weakness of the recovery in Europe, Japan and the United States and volatility in commodity markets.

“So it is not just the downgrading of the U.S. sovereign debt or the debt crisis in Southern Europe that we should look at,” Vos said.

The weakness of the recovery in the advanced economies is reflected in persistent high unemployment and fragility in the banking sectors which are holding back private demand, and financial investors now fear further economic setbacks as governments try to deal with their deficits and debts.

Vos pointed out that severe austerity measures will further hold back the European and U.S. economies and this in turn will make fiscal adjustment and debt reduction the more difficult.

“So should we really be concerned with a possible default of the U.S. or one of the Southern European countries?” he asked.

Policymakers have made clear they will not allow it to happen, Vos added.

During the last global financial turmoil, U.N. Secretary-General Ban Ki-moon warned that the resolution of the crisis must not come at the expense of solving other critical problems, such as hunger, the food crisis and climate change.

He said there is a need to recognise the fierce urgency of protecting the livelihoods of millions around the world.

Asked how it would impact on developing countries, Vos told IPS it is also the weakening of the economic recovery in the advanced countries that worries developing countries the most, as they remain highly dependent for their exports on demand in the advanced countries.

Continued financial turmoil also will not do them good, he said.

Attracted by higher returns, capital flows have returned to emerging market economies over the past year and a half, but also kept the promise of being volatile, Vos said.

A prolonged selloff in equity markets in the U.S. and Europe could lead to a fast withdrawal of much of that money and cause further adjustment problems.

A double-dip recession will also put further downward pressure on aid flows, which would particularly affect the world’s least developed countries (LDCs), described as the poorest of the poor.

“In this sense, the international community should take further measures to strengthen global liquidity mechanisms (especially those managed by the International Monetary Fund) to avoid further volatility in capital and commodity markets to cause payments crises in the developing world,” he noted.

A joint report by the U.N. Conference on Trade and Development (UNCTAD) and the U.N. Development Programme (UNDP) released last year said the 2008 crisis provoked a reality check, calling for a more effective global governance system in which emerging countries are no longer outsiders.

“As global demand sharply contracted in the most advanced countries, the fast growing developing nations performed relatively better, surviving the crisis with less damage,” said the study titled “Creative Economy”.

The study also said that South-South regional trade and investments were vital in mitigating the effects of the global recession.

Vos said the European Central Bank (ECB) has come up with a belated but yet in principle workable short-term plan that should ease fears of any imminent default.

In the U.S., politics has complicated fiscal adjustment, but in the end all parties moved to avoid default and technically the country is not facing problems in honouring its obligations.

“So can things still go wrong? Yes, they could,” he said.

The risk of a self-fulfilling crisis is still present, that is, a situation where the fear of a default will precisely lead to default.