What the credit crunch means for development

Although there’s no consensus on whether we’re heading for a 2-3 year recession or a much longer period of deflation a la Japan in the 1990s (c.f. Nouriel Roubini on V, U and L shaped recessions), four implications for development are already clear.

First, donor countries are going to be facing a dramatically different situation in their public sector budgets from next year. With the US Treasury’s $700 billion bailout plan now approved by Congress, the incoming US Administration will face a budget deficit of up to a trillion dollars next year, rather than $300 bn as planned.  Other donors will find their budgets constrained too – by falling growth, lower tax revenues and probably also higher public debt.  In the UK, for example, public borrowing next year is likely to have to rise from an expected £43 bn to £100 bn or more.

All this means that governments will have less to spend – so we should start worrying now about what that means for development assistance.  While it remains to be seen whether those governments that have committed to spending 0.7% of national income on aid will row back on those commitments, it now looks much likelier that for example climate adaptation costs will come out of aid budgets, rather than being additional to 0.7% – as they should be.

This shift will be compounded by the second implication of the credit crunch: change in public attitudes.  So far, the full impacts of the financial crisis have yet to hit the real economy in developed countries.  But when they do, they will accelerate a switch that we can already see, towards more priority on issues that are ‘close to home’, and less on global issues like development and climate change.

Third, the financial crisis will obviously hit growth in developing countries.  Monday’s stock market falls hit developing country exchanges hardest: the benchmark MSCI emerging markets index, for example, fell 11% as investors fled for safety.  Meanwhile, the debate about whether developing countries in Asia and Africa have ‘decoupled’ from developed countries seems to be ending, with the conclusion that developing country growth is not immune from a downturn in the wider global economy.

And fourth, a reduction in commodity prices for the duration of the global downturn (however long that may be) as demand for them falls.  As I’ve mentioned, futures prices for grain crops are already falling; we can expect that trend to be supported by falling energy prices, which will reduce some of the pressure on food that’s come via fertiliser prices, transport costs and demand for crops as biofuels.

That said, let’s be clear: the fall in commodity prices due to a global downturn does not mean that we’re out of the woods for good on high food and fuel prices. As Javier Blas notes in the FT today, the downturn also means that necessary investment in increasing supply will be put off.  As soon as we’re out of the dowturn and demand starts going up again, we’ll discover that there’s been no shift in the underlying supply fundamentals – and hence that the stagflation drivers we were all worrying about until the credit crunch really began in earnest are just waiting where we left them.  Let’s hope policymakers use the current easing as a moment of opportunity to start getting long term policy frameworks in place to manage high commodity prices a bit better than we did over the last two years.