From crisis to growth

A decade on from the global financial crisis, most economies still show their scars. Has the global economy recovered, and how well equipped is it to attain the SDGs and inclusive growth?

19th June 2019

A Gilet Jaune or Yellow Vest walks past a mural to the cause in Paris, France. The recession and austerity programmes that followed the 2009 financial crisis have spawned numerous protest movements worldwide. © Kiran Ridley/Getty Images

From crisis to growth

A decade on from the global financial crisis, most economies still show their scars. Has the global economy recovered, and how well equipped is it to attain the SDGs and inclusive growth?

By Valerie Cerra, Assistant Director, Institute for Capacity Development, International Monetary Fund (IMF)

Ten years have elapsed since the global financial crisis rocked the world, sending more than half of countries into recession and dragging down global economic growth for the past decade. The crisis had lasting effects in most countries even after their recessions ended. A decade later, the level of output remains far below the pre-crisis trajectory by an average of around 10 percentage points.

The crisis left other scars too. Debt and inequality rose in many affected countries, and trust in institutions eroded. The aftermath of the crisis witnessed rising political polarisation and populist pressure for policy changes such as trade protectionism that inadvertently further reduced growth and social welfare.

The scarring pattern of the global crisis is very similar to earlier episodes of crises and recessions, from countries as diverse as Japan and Sweden to those that went through the Asian crisis. In fact, historical data shows that following recessions and crises, countries do not fully recover to their pre-crisis trends.

Stability for development
Developing and emerging economies have had more frequent and severe crises and recessions than advanced economies. The permanent output loss associated with these adverse events sharply deterred long-term growth, knocking the countries back from their development path and weakening their ability to achieve development goals. In fact, it is a major reason why these countries historically have not been able to converge to the income levels of advanced economies.

Sustained economic growth is critical for meeting many of the Sustainable Development Goals (SDGs). High growth, especially in China and India, has helped lift more than a billion people out of poverty since 1990 (related to SDGs 1 and 8). Improvements in material living standards are also directly associated with advances in health and education and can provide the basis for productive work (SDG 8).

Higher output also increases the economic base for raising tax revenue from which governments can finance spending to build resilient infrastructure (SDG 9). This includes ensuring the availability of water and sanitation (SDG 6), affordable clean energy (SDG 7) and resilient and sustainable cities (SDG 11). Public resources are also required to provide social services that ensure nutrition, health and education (SDGs 2, 3 and 4). Therefore, to achieve the 2030 SDG targets, countries need to be mindful of the role of macroeconomic and financial stability in avoiding major economic distress that can permanently set them back from this path.

Financial fault lines
The financial sector is an integral part of a modern economy, channelling household savings into loans that enable firms to invest in socially beneficial projects. Financial inclusion can create opportunities for everyone to take a stake in improving the future.

The global financial crisis demonstrated the importance of maintaining a healthy, stable financial system. Financial innovation brought a proliferation of complex financial instruments in advanced economies, and credit grew rapidly prior to the crisis. Risks were distributed across the financial sector in non-transparent ways that were difficult to assess. This contributed to a breakdown of trust among financial institutions and amplified the general public’s mistrust in the economic order.

Over a decade of reform, new regulatory standards and supervisory practices have strengthened financial systems, reducing leverage, curtailing shadow banking and raising capital cushions and liquidity. Going forward, financial regulation needs to strike the right balance in promoting a vibrant financial sector that will fund projects with uncertain returns, while preventing excessive risk-taking that leads to financial distress.

Policies matter
The good news is that policies can help. Evidence shows that macroeconomic policies can influence the speed of economic recovery, helping to regain some of the lost ground from recessions and financial crises. Monetary and fiscal stimulus, real depreciation, foreign aid and more flexible exchange rate regimes can spur a rebound. In advanced countries suffering from recessions associated with banking crises, fiscal policy has been particularly effective in boosting growth during the recovery.

During the 2008 crisis, advanced-country policymakers reacted very quickly to shore up the financial system. They introduced unconventional monetary policy and undertook unprecedented financial operations with domestic and foreign financial institutions, along with discretionary fiscal stimulus. This policy reaction was able to stop the bleeding and prevent a deeper depression.

In addition, emerging and developing countries had improved their policy space prior to the financial crisis. They had reduced their debt levels and introduced stronger frameworks for macroeconomic management. This enabled them to create buffers against the
adverse financial and trade spillovers hitting them from the crisis originating in advanced economies.

Most countries inevitably are susceptible to external events from which they have no control, such as fluctuations in commodity and other international trade prices or a slowdown in global trade. But the lesson is that countries can help protect themselves by building policy buffers and resilience during good times. That allows them to act swiftly to address financial and economic distress as soon as it arises.

Current indicators and outlook
Looking ahead, the growth forecasts for many countries have weakened. The IMF’s April 2019 World Economic Outlook projects growth of the global economy to decline to 3.3 per cent in 2019 from a recent peak of close to 4 per cent in 2017. Downside risks abound, particularly related to mounting trade tensions and heightened uncertainty, and could further lower incentives to invest.

Analysis in the IMF’s Fiscal Monitor shows that public and private debt has increased to near historical peaks in many advanced, emerging and developing economies. In some cases, this is raising concerns over fiscal sustainability and pushing up borrowing costs. According to the latest IMF Global Financial Stability Report, financial vulnerabilities have continued to build in several systemically important countries in the sovereign, corporate and non-bank financial sectors, raising medium-term risks.

Higher debt levels and financial vulnerabilities may weaken the ability of public and private sectors to weather the impact of any future adverse shocks. These growing vulnerabilities also limit the space for fiscal and monetary policy to respond to any materialisation of the downside risks.

What needs to be done?
History, including the experience of the global financial crisis, taught us that robust, steady growth is needed to advance well on a development path. Countries should aim to rein back the rise in public and private financial vulnerabilities to ensure a stable macroeconomic environment. Given the elevated risks to the outlook, they should restore fiscal, financial and foreign reserve buffers to respond to any spillovers from an increasingly interconnected world.

Governments should foster higher and more inclusive growth and identify sustainable ways of financing their key development goals, including through improved revenue collection. They should gradually reduce debt to create space to respond to the next downturn. Spending can be better targeted to promote social inclusion and environmental sustainability, such as by reallocating resources from environmentally unfriendly energy subsidies to priority investments in infrastructure and public services. Countries should also promote deeper and more inclusive financial markets while safeguarding financial stability.

Strong institutions can boost investor confidence and public trust and improve policies for economic stability and growth. Thus, countries should build capacity of their economic institutions, improve governance, and enhance coordination with global partners. These efforts could help countries progress towards the SDGs with strong, inclusive growth.

The views expressed in this paper are those of the author and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.