Global financial crisis and corporate governance

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The Global Financial Crisis and the Developing World: Impact on and Implications for the Manufacturing Sector UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATIONAbstract The paper analyses the impact of the global economic crisis of 2007-2010 on the manufacturing sector of a sample of 11 low and middle income economies, and examines in detail its impact on three manufacturing sub-sectors – textiles and garments, the automotive industry and agro- industries. Within the context of globalisation, the evolution of the financial crisis is outlined and its impact on the global economy identified, and the main transmission mechanisms by which the crisis spread to the developing world discussed. The macroeconomic impact of the crisis and an overview of its impact on the manufacturing sector in general, along with government and corporate responses, are then examined. The lessons that can be learned from the country case studies, and in particular the future role of industrial policy, are then identified. Economic data are still incomplete, provisional and ambiguous, so care must be exercised in reaching conclusions. In general, the impact of the crisis has been highly uneven, but it can be tentatively concluded that the more integrated into the global economy is the individual economy, through previous policies of financial sector and trade liberalization and through the promotion of export oriented industrialization, the more vulnerable is the economy to external shocks. The most successful export-led industrializers have been most adversely affected by the fall in the rate of growth of manufactured exports. The crisis also impacted on countries already facing major economic problems prior to its onset, and in particular a number of countries were facing major problems in their manufacturing sectors – poor infrastructure, high import dependence, shortages of skilled labour, lack of competitiveness and limited indigenous technological capabilities, for example. Small and medium sized enterprises (SMEs) appear to have been hardest hit by the fall in credit availability. The macroeconomic impact of the crisis on the manufacturing sector is of significance because of the impact on prices (the interest rate, the nominal and real exchange rate and the real wage rate), the narrowing of policy space in a liberalized economy (the policy trilemma), and the need for new regulatory structures and institutions. What stands out from the country case studies (as of mid-2009) is the lack of an imaginative and positive response to the impact of the crisis on the manufacturing sector. The paper reiterates the centrality of industrialization to development and the importance of productivity growth as the major determinant of competitiveness. It re-emphasises the necessity for a so-called offensive or pro-active strategic response at both the level of the enterprise and the government, and the need for the latter to deal effectively with recognised market failures and to create the capabilities, v institutions and incentives (to use the late Sanjaya Lall’s terminology) to promote successful industrialization. The paper summarises a number of UNIDO commissioned studies which examine the possibilities for so-called “green growth” and analyse the potential for the development of renewable energy, in particular the wind power industry, and the development of the organic recycling industry. There is no reason in principle why developing economies cannot pursue “green industrialization”, by developing and using green technologies, creating new markets and creating a virtuous circle between environmental protection and economic growth. vi 1 Introduction The global economic crisis of 2007–2010 has been unprecedented since the Great Depression of 1929-1932 (UNIDO/South Centre, 2009). The crisis originated in the US mortgage market and quickly spread to a number of other countries, including the UK, Spain and Ireland. By the time of the bankruptcy of Lehman Brothers in September 2008, the financial crisis had become a more general banking crisis which in turn rapidly impacted on the real economy and turned into a global recession. This paper focuses on five key issues:  What were the transmission mechanisms that spread the crisis to the developing world?  What economic factors determined the initial impact of the crisis on individual developing countries?  What is the impact of the crisis on the manufacturing sectors of affected countries?  What policies have affected countries implemented to offset the adverse effects of the crisis?  What lessons can be learned from the crisis and how can future industrial policy take these lessons into account? 2 Globalisation and the Financial Crisis Globalisation is a multi-dimensional process of economic and structural transformation that has a variety of meanings and interpretations. It generally refers to both the increasing flows of capital, goods and resources and knowledge across national boundaries and to the emergence of a complementary set of organisational structures to manage the expanding network of international economic activity and transactions. However defined, globalisation has led to the greater integration of national economies through trade liberalisation, financial sector deregulation and capital account liberalisation, and flows of Foreign direct investment (FDI) by transnational corporations (TNCs). Globalisation has opened up new opportunities to low and middle income countries, through improved market access, increased flows of FDI, often integrating them into global value chains (GVCs) or global production networks (GPNs) and accelerated technology transfer, both product and process technologies. Although not as significant as global capital mobility, the international migration of 1 labour has led to reciprocal flows of remittances which have become a major income source for many developing countries. Increased economic interdependence between national economies leads inevitably to greater vulnerability to global economic shocks which are beyond the control of individual countries. Developing countries run the danger of becoming “locked in” to the business cycle, financial sector conditions and the vagaries of policy making in the larger, more powerful developed market (capitalist) economies and, many would argue, this growing integration of national economies has not been accompanied by the appropriate mechanisms and institutions of global economic governance that would correct imbalances, address market failures, anticipate disequilibria and co-ordinate and regulate international flows of goods, services and capital, both FDI and portfolio flows. In the second half of 2007, the world economy began to face acute financial turmoil. It was becoming clear that serious losses were accruing in the United State’s sub-prime mortgage market and as a result of the fall in US house prices. The increase in mortgage defaults led to further corrections in housing prices, leading to further defaults, rising interest rates to cover bank losses and eventually to the insolvency of the lending institutions themselves. Much of the initial funding for mortgages had been obtained from the inter-bank money market and thus other financial institutions were compromised and failed, or had to be bailed out, leading to a liquidity and credit crunch in the inter-bank money markets. The development of an essentially unregulated ‘shadow banking system’ (the term used by Cable, 2010, Chapter 2, in an accessible, non-technical discussion of the evolution of the crisis) led to a loss of confidence, fuelled as the extent of toxicity of many assets became more widely known. Banks cut back on short term lending to those institutions or markets that were seen as excessively risky. The sub-prime debacle was not confined to the US housing market since sub-prime mortgages were repackaged as structured credit products, such as collaterized debt obligations (CDOs) or special purpose vehicles (SPVs) or other innovative financial instruments, through multi-layered securitizations of underlying assets (Nissanke, 2009). These were traded globally through integrated but poorly regulated financial markets, and financial institutions opted for excessive risk-taking, with high leverage ratios. Cable (2009, Chapter 2) argues that the crisis was largely owing to non-traditional lending outside the banking system, centring on securitization: “Through securitization, loans once held on the books of banks were repackaged and sold. The scale and 2 complexity of this repackaging increased many times in the rapidly growing pool of debt-based products created by investment banks. The genius of securitization is also its central weakness. Debt is so widely and skilfully diffused that it becomes impossible to trace it. No one really owns the loans” (Cable, 2010, p.35). This in turn means that institutions find it difficult to determine what their assets are actually worth and how much has to be written down. In March 2008, the US Federal Reserve Bank had to rescue Bear Stearns; in July 2008 the Federal Government had to support the Federal Home Loan Mortgage Corporation (‘Freddie Mac’) and the Federal National Mortgage Corporation (‘Fannie Mae’), judged to be ‘too big to fail’. In September 2008, the fourth-largest investment bank in the USA, Lehman Brothers, was allowed to go bankrupt, although the state choose to rescue the world’s largest insurance company, AIG, with an 85 billion loan and effectively nationalised the company. Banks in a number of other countries, including the UK, Germany, Ireland and Switzerland revealed massive toxic debts, falling share prices, loss of confidence and further falls in lending. The financial crisis rapidly spread to the real economy. The construction sector was affected first as new house building fell. The manufacturing sector saw falls in demand for commodities, particularly those purchased with loans, such as automobiles. With the growth in unemployment and increasing job insecurity, reductions in consumer spending led to falls in aggregate demand. Falls in business confidence and reduced access to credit may well have delayed investment, further accelerating the downward spiral leading to recession. Governments in the developed market economies have intervened in a variety of ways, through measures aimed both at specific sectors or activities, to more general stimulus packages aimed at keeping financial institutions afloat, supporting enterprises in various productive sectors where deemed necessary and attempting to maintain consumer confidence and expenditure. Such measures have re-ignited a number of controversies relating to the role of the state. Should governments intervene as lender of last resort, to protect financial enterprises ‘too big to fail’ and risk moral hazard? Should the financial sector be radically restructured, separating retail banking from so-called ‘casino’ banking? Should the financial sector be more strictly and effectively regulated to lower the risk of a similar crisis happening again? How quickly, and in what ways, should governments begin to deal with the large budget deficits that have been incurred as a result of the rescue packages implemented? Is the recession now (March 2010) over, or does the risk of 3 a ‘double dip’ recession still remain if stimulus packages are reversed too soon and the private sector does not compensate with increased investment, output and employment? To understand the origins and evolution of the crisis, and its impact on developing countries, we have to locate our analysis within a broader global context. Financial sector instability is largely, but not solely, the result of over two decades of liberalisation and deregulation which began in the 1980s under the Reagan and Thatcher administrations and which has been a fundamental component of the neo-liberal, market fundamentalist Washington Consensus since then. Global economic instability is in part related to the emergence of the huge US government budget and current account deficits, funded by the current account surplus and net capital export economies, namely China, other East and South East Asian current account surplus economies and the large net oil exporters. A further source of global instability is the volatility of oil and commodity prices. Having reached record levels in April–June 2008, commodity prices fell sharply over the remainder of the year, especially oil, a number of metals (nickel, zinc and copper) and a number of foodstuffs (wheat, rice, vegetable oilseeds and tropical beverages) (Nissanke, 2009, p.25). Obviously the economic impact of commodity price fluctuations depends on the structure and composition of production and trade of individual developing countries. Net commodity exporters in general benefit from rising prices and suffer when prices decline. Economies that are heavily dependent on imported oil and foodstuffs, other things being equal, will benefit from falling commodity prices (Nissanke, 2009, discusses commodity price issues in greater detail). 3 The Impact of the Crisis on the Global Economy The causes of the financial crisis are complex, and are not the prime concern of this paper, but we need to understand its recessionary impact on the global economy. Data on output, trade, employment and financial flows have improved (March 2011) but are still subject to revision. Thus, the discussion of the global impact must thus be qualified and data used cautiously. According to the IMF (2010, 2011), world output grew by 3 per cent in 2008, fell by -0.6 per cent in 2009, and grew again by 5 per cent in 2010. It is projected to grow by 4.4 per cent in 2011 and 4.5 per cent in 2012; a clear sign for global recovery. For the advanced economies, output grew by 0.5 per cent in 2008, fell by -3.4 per cent in 2009, and grew by 3 per cent in 2010. It is 4 projected to grow by 2.5 and 2.5 per cent for the years 2011 and 2012, respectively. The difference between world output and advanced country output figures is largely accounted for by the Emerging and developing economies group of countries and Developing Asia (China, India, Asean-5 – Indonesia, Malaysia, the Philippines, Thailand and Viet Nam) in particular. The Developing Asia group of countries grew by 7.9 per cent in 2008, 7 per cent in 2009, and 9.3 per cent in 2010. It is projected to grow by 8.4 per cent in 2011 and 8.4 per cent in 2012; hence making it the powerhouse of the global recovery. The IMF (2011) presents upward revisions to the projections presented in IMF (2009, 2010), is optimistic about the strength of the global recovery in 2011 and 2012 and as indicated above, focuses the emerging and developing economies where “activity is expected to be relatively vigorous, largely driven by buoyant internal demand (IMF, 2010).” Furthermore, and most “notably, growth in sub-Saharan Africa – projected at 5.5 per cent in 2011 and 5.8 per cent in 2012- is expected to exceed growth in all other regions except developing Asia (IMF 2011).” It was not until September 2008 that the impact of the financial crisis on international trade became evident (WTO, 2009). The rate of trade growth had already slowed from 6.4 per cent in 2007 to 2.1 per cent in 2008, but the 12.2 per cent contraction in 2009 was without precedent in recent history (WTO 2010). The full impact of the crisis was felt across all regions of the global economy by the fourth quarter of 2008, with Europe experiencing a fall of 16 per cent in the fourth quarter and Asia recording a fall of 5 per cent in exports in the same period. In the first quarter of 2009, there was a much steeper decline in merchandise trade, with falling commodity prices largely to blame (WTO, 2009). The IMF (2010, 2011) gives data for world trade volume (goods and services) for 2008, 2009 and 2010. World trade volume grew by 2.8 per cent in 2008, fell by -10.7 percent in 2009 and grew by 12 per cent again in 2010. It is projected to grow by 7.1 per cent and 6.8 per cent for the years 2011 and 2012, respectively. For the Emerging and Developing Countries sub-group, imports fell by -8 per cent in 2009 and exports fell by -7.5 per cent for the same year. Grow recovered for 2010 by 13.8 per cent for imports and 12.8 per cent for exports. World GDP and world merchandise exports move in tandem. The rate of growth in international trade is greater than the rate of growth of GDP (trade data count intermediate goods every time they cross a border while GDP data include value added only), but the same relationship holds when GDP or its rate of growth falls. The income elasticity of manufactured exports is greater than that for total merchandise exports. Therefore trade in manufactured exports responds more 5 than merchandise exports to changes in income. The WTO (2009) estimates average income elasticity for total merchandise exports of 1.7 for the period 1960-2008; for manufactured goods for the same period, the average income elasticity was 2.1. Other things being equal, countries more heavily dependent on manufactured goods exports should experience a greater fall in total exports than those economies less dependent on manufactured goods. Between 2007 and 2008, China experienced a fall of 9 percentage points in its exports; the figure for Chile was a fall of 17 percentage points. For Africa, on the other hand, exports rose by 10 percentage points over the period 2007-2008 (WTO, 2009). As far as the impact of the crisis on employment is concerned, the latest ILO (2010, 2011) data indicate that the largest falls in employment were in the manufacturing sectors in all regions of the global economy, but were greater in the developed economies. In the latter group of economies, the fall in employment is estimated to be 6 million jobs, as opposed to approximately 2 million jobs lost in developing economies. There were also significant, but smaller, falls in employment in the construction and wholesale and retail trade sectors in all economies. For selected economies, the ILO (2011, Annex 1, p.32) presents quarterly employment data for 2008 to 2009 and 2009 to 2010. For the manufacturing sector (Table 1 below) the quarterly comparisons show significant job losses for the period form 2008 to 2009. Comparing Q1 2009 to 2010 and Q2 2009 to 2010 shows a reduction in experienced job losses by -3.1% and -1.1% respectively, in sharp contrast to the average losses in 2008 to 2009 of -7.2%. The ILO (2010) notes that it expects employment to continue to fall even after the recession is formally over, that is, the recovery in economic activities and a positive rate of GDP growth will not initially be accompanied by growing employment opportunities. Table 1 Manufacturing Employment, Selected Economies, Quarterly Change Q1-Q3 2008-2009 Average Change Change Q1 Change Q2 2008 to 2009 2009 to 2010 2009 to 2010 Change in Level of employment (in -7,373.5 -3,011.3 -1,093.5 thousands) Percentage change -7.2% -3.1% -1.1% Source: ILO (2011), Annex 1, p. 32 6 As far as capital flows are concerned, UNCTAD (2010, 2011) estimates that global inflows of foreign direct investment (FDI) fell by 39 per cent from US1.7 trillion in 2008 to US1.1 trillion in 2009. Global FDI flows rose marginally by 1% and remained almost stagnant in 2010 at an estimated US1.1 trillion. For 2011, UNCTAD estimates FDI flows to be between US1.3 trillion and US 1.5 trillion (UNCTAD 2011). Individual economy falls over this period varied widely, from -2.6 per cent in the case of China, to -66.6 per cent in the case of Malaysia and -56.6 per cent in the case of Morocco. All components of FDI – equity capital, reinvested earnings and other capital flows (mainly intra-company loans) - were affected by the economic downturn, but the decrease was especially marked for equity capital flows, which are most directly related to transnational corporations’ longer-term investment strategies (UNCTAD, 2010). Concerns have been expressed about the possible negative effects of the crisis on Official Development Assistance (ODA) flows to developing countries (as the governments of the major donor countries struggle to bring their public sector budget deficits under control). OECD DAC data (DCD-DAC, 2010, 2011) shows that ODA Net Disbursements (in US million) rose from US 107 102 million in 2007 to US126 656 million in 2008 to 131 272 in 2009, which marks an increase of 14.1 per cent from 2007 to 2008 and 3.6 per cent from 2008 to 2009, respectively. Over the period 2007-2008, ODA Commitments rose from US127 266 million to US153 400 million, an increase in real terms of 11.7 per cent. In the period from 2008 to 2009 ODA commitments rose to US 163 435 by 6.5 per cent. This tells us nothing about the real value or the geographical distribution of ODA in the future, but a number of large donors (for example, the United Kingdom Government) have promised to “ring fence” ODA and meet the targets previously agreed. Of more concern and relevance to this paper is the declining share of ODA that is directed at Industry, Mining and Construction. From an already low value of 8 per cent of total sector- allocable ODA in 1990, the share had fallen to approximately 2 per cent in 2007 (DCD-DAC, 2010, Table 1.3.7, p.13). On the same basis, the share of Agriculture, Forestry and Fishing fell from approximately 18 per cent in 1990 to approximately 7-8 per cent in 2007 (ibid). Given the need to develop the productive sectors of developing countries, both in general developmental terms and specifically in the aftermath of the economic crisis, a task that cannot be left solely to the private sector, if for no other reason than the existence of extensive market failures in developing countries, a reconsideration of donor country priorities would appear to be in order. 7 4 Transmission Mechanisms From the discussion in Section 3 of the impact of the financial crisis on the global economy, the identification of transmission mechanisms by which the crisis rapidly spread to the developing world is fairly straightforward. There is general agreement that the major transmission mechanisms are:  The impact of the crisis on the rate of growth of international trade;  The impact of the crisis on oil and other commodity prices;  The impact of the crisis on remittance flows to those economies dependent on such flows;  The impact of the crisis on financial flows to developing countries, including portfolio capital flows, bank lending, trade finance and ODA;  The impact of the crisis on foreign direct investment flows;  As a consequence of all the above, we need also to consider the impact of the crisis on the macroeconomic environment and the balance of payments situation of the affected countries. Before we attempt to evaluate the impact of the crisis specifically on the manufacturing sector of developing countries in more detail, we must attempt to identify those characteristics that make developing countries vulnerable to global shocks or conversely, give them a certain degree of protection, relatively speaking. The relevant characteristics are both structural and policy induced and they include:  What can broadly be referred to as the level of development and the productive structure, specifically the extent and depth of industrialisation, of the individual economy;  The state of the economy at the time of the impact of the crisis; was the economy growing? Was the macroeconomic environment stable (specifically, was the budget deficit under control? Was the current account deficit financed by stable and dependable capital inflows? Was the exchange rate stable and roughly in equilibrium? Was the price level relatively stable?);  The dependence on, and commodity composition of international trade, will be largely determined by the first point; the extent to which the economy has followed the path of export-led industrialisation, with a focus on the export of low to medium technology, labour intensive manufactured goods, which are subject to intensive competition from other low-wage developing countries and vulnerable to protectionist barriers (for example, anti-dumping measures) in the major developed market economies, is of significance; 8  The extent to, and the manner in which, the developing economy is integrated into the world economy through trade (as above) but also through capital flows, especially flows of FDI, and the extent to which the economy is specifically integrated into the global economy though global value chains or global production networks, which will make the economy very vulnerable to fluctuations in global demand;  What can be broadly defined as the technological capacity of the economy will in large part determine its flexibility, that is its ability to respond to the crisis through the reallocation of productive resources, the development of new products and markets and the exploitation of new opportunities in, for example, the service sector;  A very important policy-induced characteristic is the extent to which the economy has liberalised short term capital account transactions (portfolio capital flows) which, other things being equal and depending on the exchange rate regime in place, may introduce a high degree of instability to the macroeconomic environment and weaken the use of monetary policy as a counter cyclical instrument;  The above characteristics, along with a number of key, non-economic variables (the developmental nature of the less developed country state, for example) determine the “policy space” (Wade, 2003) that the individual economy has available and can make use of. Clearly policy space is not completely absent, but membership of the World Trade Organization (WTO), Economic Partnership Agreements with the European Union (EU), and the aid “dependency” of the economy (a dependency on both bilateral and multilateral agencies) will all tend to narrow that space and restrict the policy options that the developing economy will have available. The complexity of the interaction between these variables makes generalisation hazardous. Not all developing countries will have been equally, and in similar ways, affected by the global economic crisis, and it is quite possible that some of them will have been hardly affected at all. The least developed countries (LDCs) are, in principle, the most vulnerable to external shocks, because of their relatively lows levels of development and extensive and deep rooted poverty. Although they are not a homogenous group, the LDCs are marginal participants in international trade (from a global perspective), particularly as far as the trade in manufactured goods is concerned; they suffer from fundamental structural weaknesses, and balance of payments and fiscal constraints; they are highly indebted and aid dependent and because of their limited industrialisation, they are dependent on the production and export of primary commodities, with a 9 commodity composition of output and exports that in some cases has hardly changed over the past 50 years. The boom in primary commodity prices of 2003-2008 led to higher rates of growth of GDP and manufacturing value added, along with increased savings and investment, in many LDCs. Unfortunately the boom was followed by a “bust”, with detrimental impacts on their long term development and industrialisation prospects. Fuel and food importing LDCs in particular suffered from both the boom and the bust, in the sense that the emergence of the global economic crisis occurred at the time they were facing high international prices of foodstuffs and fuel. However, although non-oil commodity prices fell by over 36 per cent from the peak to the trough, food prices did not fall as much as the prices of other commodities and have picked up faster after they reached their trough in December 2008 (UNIDO/South Centre, 2009). Nissanke (2009) argues that it is the Asian economies, not the LDCs, which have been most vulnerable to the recessionary impact of the financial crisis, as global trade fell heavily in the fourth quarter of 2008, because of their heavy reliance on the production and export of manufactured goods, especially consumer durable such as automobiles, electronics and capital goods, as well as low technology commodities such as footwear and garments. But it is not only Asian economies that have been severely affected. Latin America (Mexico, Argentina, Brazil and Peru) and a number of transitional emerging economies in Eastern Europe have been severely affected. The sectors experiencing the most severe contractions in output indicate that the effects of the crisis have been felt throughout a wide range of industrial activities, irrespective of their nature and size of operations. As argued already, there are obviously variations across countries, reflecting country-specific conditions, structural features and varying financial conditions and arrangements (the importance of FDI, the integration of the financial sector into global financial markets). For example, export industries specific to countries, such as the processing and preserving of fish and fish products or fruit and vegetables (Chile), textiles and leather products (Czech Republic) and electrical machinery and electrical products (Singapore) have all be severely affected by weakened export demand (Nissanke, 2009). But common patterns can also be identified. Motor vehicles and transport equipment, basic metals and steel, chemicals and chemical products, rubber products and construction materials appear in the list of affected sectors across most countries (Nissanke, 2009). 10 In many low income economies, remittances constitute a major source of income and a major credit item in the balance of payments accounts. In 2008, for example, remittances as a percentage of GDP reached over 27 per cent in the case of Lesotho, 18 per cent in the case of Haiti, and 17.8 per cent and 11 per cent in the cases of Nepal and Bangladesh respectively (UNIDO/South Centre, 2009). Countries in Central and South America are also highly dependent on remittances from family members living in the USA. By reducing employment, particularly of migrant workers who are often the first to be affected, the slowing down of growth in OECD economies will substantially reduce remittance flows. Remittance flows from oil-rich countries are also falling as output falls and new projects postponed. Remittance flows were predicted to fall by 20 per cent in 2009. 5 The Macroeconomic Impact of the Crisis Although this paper focuses on the manufacturing sector, we have to examine the macroeconomic impact of the crisis because it is the macroeconomic policy environment that determines key prices – the exchange rate, the interest rate and the wage rate – that are important determinants of manufacturing sector performance and enterprise competitiveness. Macroeconomic performance, and the confidence (or lack of) that it generates, is also an important determinant of private sector investment in the economy which has important implications for growth of output, labour productivity and competitiveness in the future. The two key ex ante macroeconomic constraints are the budget deficit and the current account deficit. Ex post of course, they must both be financed, but governments will find it increasingly difficult and costly to finance growing budget deficits, with higher interest rates and the possible crowding out of private investment. Many developing economy governments have implemented stimulus packages to maintain levels of economic activity. While mitigating the impact of the crisis, such measures are essentially short term and their size is constrained by what governments can borrow. Such programmes must eventually be phased out, and it is too early to judge how effective they have been. With respect to the behaviour of the current account deficit during the recession, much will depend on the structure of production and trade and the nature of the integration of the individual economy into the global economy. Economies may be hit by a combination of falling export revenue (partially offset by lower imports if exported manufactured goods are dependent on 11 imported intermediate goods), lower inflows of remittances, less FDI and stagnant or falling ODA. A worsening balance of payments position may lead to a depreciation of the nominal exchange rate, depending on the exchange rate regime, but the fall in the nominal rate may be offset by rising domestic prices and the country experiences an appreciating real exchange rate, which other things being equal, will reduce the competitiveness of the export sector. We have already noted the negative impact on employment of the crisis. Although there may well be a fall in employment in the manufacturing sector in the short run, the longer run problem relates to the employment elasticity of growth. That is, for any given growth rate of employment, the required growth rate of output is higher. Falling export growth rates, and reduced investment levels impact on the rate of growth of output, which is unlikely to be high enough to absorb both those already unemployed and new entrants to the labour force. Falls in the rate of growth of employment will in turn impact on poverty. The World Bank (2010) estimated that an extra 64 million people could be trapped in poverty as economic growth slowed around the world, on top of the 130-155 million estimated to be pushed into poverty in 2008 because of rising food and fuel prices. It is estimated that 94 out of 116 developing countries will have experienced slow downs in economic growth. The IMF (2009) predicted that the global crisis would have a major impact on low-income countries, especially in sub-Saharan Africa. The IMF uses a concept of vulnerability that is based on a country’s overall level of exposure (defined by a situation where the initial level of poverty was a problem before the crisis and where an adverse impact on economic growth is expected) to argue that the crisis is exposing households in virtually all developing countries to increased risks of poverty and hardship. 6 The Impact on the Manufacturing Sector: Overview The growth of global manufacturing production slowed substantially in 2008, especially in the last quarter of the year. The rate of growth of China’s industrial output decelerated in the last quarter of 2008 whereas manufacturing production in Argentina, India and Tunisia actually fell over the same period. However, world manufacturing activity has been on the way of recovery since the first quarter of 2009, where production reached a minimum (see Figure 1). 12 Figure 1: Quarterly IIP, World Manufacturing, base year 2005 Source: UNIDO (2011) After moderate growth rates in the last three quarters of 2009, manufacturing production jumped 7.1 per cent in the first quarter of 2010 relative to the previous quarter, led by industrializing countries (see Figure 2). However, preliminary estimates show signs of deceleration of growth in the second quarter of 2010 at 1.6 per cent relative to the first quarter. Production levels in the first two quarters of 2010 are however 11 per cent higher relative to the same quarters in 2009, revealing some regain of vitality in the manufacturing sector. Figure 2: Growth rate of manufacturing production Source: UNIDO (2011) While the global economy, in particular manufacturing, has started to recover, figures in the second quarter of 2010 call for caution. This crisis has led to mass layoffs and a scale down of production in factories, and recovery is still too weak to curb unemployment rates (see ILO 2010, 13 2011 data). As a result, transfer payments such as welfare or unemployment benefits are on the rise while tax revenues are declining. Industrializing countries have alternated periods of expansion and contraction of the manufacturing production. A decline in the last two quarters of 2008 was followed by positive growth in the first two quarters of 2009. Industrial production stagnated in the last two quarters of 2009 (0.2 and -0.2 per cent growth respectively), before rebounded in the beginning of 2010 with growth reaching 13.2 per cent relative to the previous quarter. However, the second quarter of 2010 is showing signs of slowdown as growth rate decreased to 5.6 per cent (all figure 2). Industrialized countries have experienced positive growth rates since the beginning of 2009. In the first quarter of 2010, they recorded a growth rate of 3.5 per cent, but the second quarter revealed the feebleness of recovery as production growth turned negative at -0.3 per cent. The largest industrialized countries have experienced however positive growth rates in 2010. US manufacturing has expanded 1 and 1.2 per cent in the first and second quarters of 2010 respectively. Germany’s industrial production increased 2.3 per cent in the first quarter of 2010, and at an accelerated pace in the second quarter at 5.9 per cent. The UK and France also registered growth for two consecutive quarters at 1.8 and 1.5 per cent in the first quarter, and 1.9 and 1 per cent in the second quarter. In Asia, Japan’s production grew 8.3 per cent in the first quarter of 2010, but weakened in the second quarter at 0.5 per cent. Among industrializing countries, it is China and India that are leading the manufacturing recovery, having grown 14.4 and 13.6 per cent respectively in the first quarter of 2010. Growth decelerated however to 7.3 in China in the second quarter of 2010. Brazil registered a higher growth rate in the first quarter relative to the second (6.9 and 1.2 respectively). Mexico’s production stagnated in the first quarter, with 0.2 per cent growth but is showing more vitality in the second quarter with growth at 3.7 per cent. After two quarters of growth in the second half of 2009, industrial production contracted in South Africa by 4.5 and 3.8 per cent in 2010 first and second quarters. Likewise, Tunisia’s industrial production growth has been in the negative for the first two quarters of 2010. Manufacturing industry investment in some developing countries fell abruptly towards the end of 2008. The Argentine case study (Sercovich, 2009) reports the postponement of a US524 million investment in the steel sector in November 2008 because the investor saw a drop of 75 per cent in 14 its New York stock market value. In Cameroon (Monkam, 2009), investment projects in cobalt, copper and aluminium have been deferred until market conditions improve. In China (Dexiang, 2009), export-oriented as well as recycling industries are facing cuts in investment. Monthly manufacturing FDI halved in China, to an average of US5.9 billion in December 2008. Banks are contributing further to the reduction in manufacturing investment by extending loan evaluation periods and demanding more stringent financial analysis and guarantees. One of the paradoxes of falling property prices is that companies can provide less collateral. In countries such as Tanzania (Wangwe and Charle, 2009), Tunisia (Amara, 2009) and Viet Nam (Vu Thanh Tu Anh, 2009), investment was still growing in 2007– 2008. Foreign investment in manufacturing in Tanzania more then trebled between 2007-2008, with the number of projects increasing by more than 15 per cent. Tunisia had a 32 per cent increase in manufacturing FDI in 2008. Projections for manufacturing investment in developing countries for 2009 are not available and the trend is unclear. It should be noted however that current investment was based on decisions made some time ago, and that underlying economic conditions have changed dramatically since then. The operating environment for most manufacturing firms in most industrial sectors is becoming more restricted. Levels of unused installed capacity are high, with some companies in Cameroon using administrative and maintenance workers to keep factories open until demand recovers. There is a danger than machinery and equipment will deteriorate if factories remain closed, and working capital tied up with increasing inventories of raw materials and/or final products. Energy prices are rising in a number of countries, including Argentina, China and Vietnam, as governments attempt to reduce transport and electricity subsidies. Business finance conditions are becoming more difficult. Trade credit has become scarcer and some foreign suppliers are requesting advance payment for inputs and spare parts, while foreign and domestic suppliers want to reduce account payment deadlines from between 90 and 180 days to 30 days. Enterprises in many countries have to cut costs to survive. The range of cost cutting measures includes: fewer working hours, lay-offs and temporary plant closures; increasing efficiency including better use of raw materials and energy and improving quality of output; reducing sub- contracting and increasing production in-house; cut backs in overheads and non-urgent expenditures. A more novel approach has been to diversify output. Rather than closing down, some companies are seeking new productive activities. A Cameroonian mechanical engineering 15 company, for example, has switched from the production of truck tanks and bodies to barges, piping and steel plants. Indian auto-component manufacturers are shifting to the production of oil, gas and railway equipment or manufacturing agro-engines and electrical appliances. In some cases, product diversification is accompanied by market diversification. Small and medium sized enterprises (SMEs) linked to the export sector appear to be bearing the brunt of the crisis. Firms with access to credit and good foreign sources of funding are better able to survive the crisis. Large domestic and foreign enterprises, with good overseas linkages, often in Original Equipment Manufacture (OEM) relationships, are internalizing production and reducing sub-contracting to other enterprises and SMEs. Companies have increasingly turned towards the domestic market, either attempting to identify new market niches or developing repair and maintenance functions. Failure to obtain credit, especially for SMEs, remains a major problem. From a UNIDO sample of countries, it is clear that the crisis has impacted most severely on export-oriented manufacturing industries. Clothing and textiles, leather and footwear, timber and furniture, steel and aluminium, transport equipment and electronics have all had the largest falls in output in a number of countries, including Argentina, Cameroon, China, India, Nicaragua, Tanzania, Tunisia and Viet Nam. The steel and aluminium industries have suffered from reductions in construction and the demand for automobiles from developed economies. The fall in demand for metallurgical products has had a negative impact on the price of metals such as iron, bauxite and copper. 6.1 Textiles and Garments The textiles and garments (T&G) sector has been particularly hard hit by the crisis. The global crisis hit the sector at a time when it was already in the throes of a massive readjustment (Thoburn, 2009), following the abolition of the Multi-Fibre Arrangement (MFA)/ the Agreement on Textiles and Clothing (ATC) in 2005. With the abolition of MFA export quotas, it was widely predicted that China would be the major beneficiary, at the expense of other producers. China’s share of world textiles exports rose from 10.3 per cent in 2000 to 23.5 per cent in 2007, and from 18.2 per cent to 33.4 per cent for garments over the same period (Thoburn, 2009). India’s share of world garments exports fell between 2000 and 2007 and its share of the world textiles market rose only marginally compared to China’s significant rise. Some other Asian economies, for example, 16 Viet Nam, Bangladesh and Cambodia were doing well in particular export markets prior to the start of the recession (Thoburn, 2009). Thoburn (2009) analyses T&G import data for the USA, EU-27 and Japan. For the USA, there was a drop in total import value of 3-4 per cent for 2007-2008, with a more marked fall for the period May 2008 to May 2009, with falls in unit values. Taking only the five months to May 2009, compared to the same period in 2008, garment imports fell by 12 per cent and textiles by 20 per cent in total import value. For the EU-27, the recession’s impact on imports appears to have been experienced later than in the USA, with significant falls for nearly all items in terms of the four months to April 2009 compared to April 2008. For Japan, it is clear that the recession was already biting in 2008 and continued into the first six months of 2009. There were falls in unit values for almost all major suppliers in 2008, generally worsening into 2009. The trends shown by the USA and EU import statistics indicate that Mexico and Turkey have lost out in competition with China, and China has maintained its dominant position in the Japanese apparel market. But there have been factory closures and loss of jobs in China, with the return of workers from urban to rural areas and women and unskilled workers have been particularly affected by rising unemployment. India has suffered from falls in export revenue during the recession and half a million jobs have been lost in India’s export industries (gems and jewellery, automobiles and textiles). Cambodia has lost jobs in garments and Viet Nam has suffered a slowdown in its rate of T&G export growth. Even though Bangladesh raised its T&G exports by 15.4 per cent in the fiscal year to June 2009, there are reports of job losses in the recession (Thoburn, 2009). Two case studies – Cambodia and Lao People’s Democratic Republic (Lao PDR or Laos) (Rasiah, 2009) and Bangladesh (Sodhi, 2009) – illustrate the specificity of the impact of the crisis on the sector. For Cambodia and Lao PDR, the abolition of the MFA in 2005 and the preferential access agreements made available under the Generalised System of Preferences (GSP), the Bilateral Trading Arrangements with the USA introduced in 1999 (the Technical Agreement on Textiles and Apparel – TATA), and the “everything but arms” clause introduced by the EU in 2001, opened up opportunities for export oriented, quota utilising FDI and the development of local subcontractors in the garments sector. Garment manufacturing was spearheaded by foreign firms, with garment exports peaking in 2007. FDI in both countries peaked in the mid-1990s and again in 2007. FDI fell in 2008 with a further decline reported for 2009 (Rasiah, 2009). A 17