Global economic shocks portend a Winter of Discontent in all four corners of the Earth, with myriad challenges arising for nation states, intergovernmental organizations, NGOs, and individual citizens in the Global North and Global South. In this analysis, Christopher McNulty examines the factors which are driving these economic headwinds and sets out the potential short and long-term consequences, using case studies from recent history.
The Global Impact of a Regional Recession
As the world enters a winter characterized by energy price shocks and an uncertain economic future, much attention has been focused on the movements of the United States and the European Union. Constant discussion includes whether or not the United States will finally enter a recession. For Europe, a recession, fueled by rising inflation and energy prices, is a certainty; the question that remains is when most of Europe enters one. For both entities, the fight against inflation has been especially salient, with central banks across the world raising interest rates to combat increasing costs.
While many of these policies are necessary from a domestic standpoint, the combination of rising interest rates and a recessionary environment will have major impacts across the international stage. As an aside, the continual dynamic-COVID-19 policies of Xi Jingping have also contributed to this uncertain economic situation, with supply lines still facing disruptions. What is perhaps lost in these discussions are the economic ramifications this situation will have on developing economies. Many countries are still recovering from the economic catastrophe of the COVID-19 pandemic and uncertainties from the war in Ukraine. Now, these states are forced to contend with the fallout of economic decline in both the United States and European Union. Therefore, this article seeks to assess the different ways developing nations may be impacted.
Rising Interest Rates Increase the Cost of Imports
As the United States contends with high inflation, the Federal Reserve has implemented a number of hikes to the interest rate. Chairman Jerome Powell has signaled that additional increases are likely in the near future. It is widely accepted that such interest rate hikes have significant impacts on global markets; as interest rates rise, the USD strengthens while other currencies weaken. One key effect of this appears in the world of global trade. A weakened currency increases the costs of imports. This is due to the fact that a vast majority of imports for many countries are paid in USD.
For resource-poor countries, a rising USD can have disastrous impacts. The Kingdom of Jordan is one key example. The country’s agricultural output is negligible and it imports large amounts of wheat and rice. The government continues to support a wheat subsidy, meaning that there is a sharp clash between prices on the international market and that of the domestic. Jordan faced substantial pressures on such commodity prices from the war in Ukraine, with food and fuel skyrocketing in value. The United States, the largest supplier of rice to Jordan, has seen agricultural exports increase by 10.4 percent from October 2021 to October 2022. With Jordan set to increase its wheat reserves from 12 to 18 months, it is clear that the country will face increased financial pressures to secure these precious food resources. Indeed, Jordanian ministers revealed that such global economic factors played a role in the development of Jordan’s 2023 budget.
Rising Interest Rates Impacts International Borrowing
As the United States and European Union increase their interest rates, investments in those particular countries become more lucrative as well. As economic uncertainty becomes more and more uncertain, investors will likely pull their money out of riskier countries and put into more financially stable ones. At the same time, such policies will increase the strength of the USD and EUR; other currencies will become weaker. Both of these factors can result in the same consequence. General investment in these developing economies decreases substantially. International investors will move assets to American and European-based instruments to weather the potential financial storm; meanwhile, emerging economies may increase their own rates to prevent significant currency devaluation, which in turn decreases aggregate domestic borrowing. As a result, these countries will be left with limited investment funds to use for economic growth, public service spending, and other needs. The United Nations Conference on Trade and Development warned that American interest rate hikes were set to cut around $360 billion in potential income for developing countries.
The direct impact of this investment decline can be found in sub-Saharan Africa, where rising interest rates in the United States resulted in “reduced capital inflows.” Ghana is a particularly salient example here. Building on strong oil reserves and a relatively stable political atmosphere, Ghana positioned itself as a major area for foreign investment. In 2020, Ghana received around $429 million from the United States in direct foreign investment. However, COVID-19 and poor spending decisions forced the country to increase deficit spending and borrowing. A number of economic pressures, including increased borrowing costs derived from American interest rate hikes, led to a major exodus of investors. The country was beset by significant inflation and investors became unconvinced that the country could pay back on its loans; around $28.4 billion of which came from international lenders (and much of that originated from the United States).
Now, Ghana plans to meet with the International Monetary Fund to stabilize the situation. The government has announced a number of austerity measures. For example, the country will implement a hiring freeze in the civil service, and the announced 2023 budget is focused on curbing its debt. Although the rise of US interest rates is only a component of the financial issues in Ghana, it is evident that increased rates helped push a number of investors out of the country, reducing the country’s ability to continue its deficit spending. Taking a wider view, many developing nations will face key downstream impacts on their ability to provide public services or further economic growth. Such nations often increase spending by sizeable degrees in an effort to spur such programs, resulting in a large accrual of international debts. Capital and investment flight can have a deleterious effect. As public services wilt and economic stability declines, many countries will potentially face decreased social cohesion, and increased citizen dissatisfaction, resentment, and anger will fuel civil unrest as economic growth slows.
A Recessionary Environment Decreases Aggregate Demand
Should the European Union or the United States enter a recession, it is possible that either entity might face declining aggregate demand for international goods and services. A recessionary environment will force countries and consumers to reduce spending; in some instances, countries such as France and Germany have signaled the potential for austerity measures. In turn, this leads to a reduced cash flow for developing nations, particularly those that are significant exporters. There are signs of this demand-side pullback, as shipping rates (which had previously reached high levels due to supply bottlenecks) are beginning to decline. As previously noted, this decrease can be attributed to a number of other factors, as many companies increased overall supply in the wake of supply chain issues and are now needing less product.
The potential trajectory of Vietnam provides an interesting case study of this possibility. In a 2022 report, the World Bank noted that Vietnam faces significant risks from slowdowns in its main export markets, which, in this case, includes the European Union and the United States. The World Bank further warned that, should this global pullback occur, many citizens would be subject to pressures from global inflation and high energy prices. Vietnamese officials have directly commented on this potential problem, as evidenced by statements made by the Ministry of Industry and Trade. High interest rates and a recession would reduce the appetite of many American and European consumers from purchasing Vietnamese goods, such as textiles. Indeed, East Asia is already experiencing an overall decline in factory output, and such trends are likely to continue as Europe is likely to enter a recession in the near future.
A Recession May Force Cut to International Aid
The final point of consideration is that a recessionary environment almost certainly leads to a reduction in crucial international aid. As governments enact austerity measures and put further focus on their domestic populations, money that is sent to support developing nations shrinks. In the wake of the 2008 economic crisis, for instance, there were substantial concerns over a pullback in aid to developing countries. Indeed, several trends indicate that international aid increases during periods of strong economic growth in these aid-providing countries. At the same time, the 2008 recession did not result in a major decline in foreign aid, and in some cases aid remained consistent or increased.
Although widespread decreases to foreign aid have not yet been implemented, there are some signs indicating this possible direction. Sweden intends to lower its contributions to foreign assistance. The United Kingdom, which faces major economic pressures across many sectors, also continues to decrease its aid spending. This has included lower contributions to war-torn countries such as Yemen and Syria, as well as reductions to multilateral contributions to organizations such as the World Bank. Many of the countries affected by aid reductions require obviously require these funds to support humanitarian initiatives. A sizeable decrease in spending will impact the availability of non-governmental health services and food services.
In an era of political uncertainty, the ramifications of macroeconomic chaos are endless. Inflationary pressures and recessionary environments will impact the livelihoods of ordinary individuals throughout the world, setting the stage for global stagflation. GDP growth will slow, unemployment may rise, and many states may take further drastic actions to increase their own security. However, these are not problems solely faced by advanced economies. Rather, it is clear that developing nations, resource suppliers, and industrial producers are all caught in the crossfire. Fuel protests in Jordan have turned violent. Sri Lanka witnessed intense political turmoil and continues to suffer from hyperinflation. Amid the ongoing chaos seen in Peru are economic undercurrents. Lower demand, less investment, and reduced global support can all further this period of uncertainty, placing the whole world at risk of ever greater unpredictability and instability.
Suggested books for in-depth reading on this topic:
- Political Risk: How Businesses and Organizations Can Anticipate Global Insecurity (Amy Zegart and Condoleezza Rice)
- Guide to Country Risk: How to identify, manage and mitigate the risks of doing business across borders (Mina Toksöz)
- The Money Illusion: Market Monetarism, the Great Recession, and the Future of Monetary Policy (Scott Sumner)
Additional geopolitical reading suggestions can be found on our 2023 reading list
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Christopher McNulty is a pen name used by multiple anonymous contributors to Encyclopedia Geopolitica, including an American security analyst based in Afghanistan, and a British insurgency analyst focusing on the Northern Ireland Troubles and the subsequent peace process.
Photo: “Calca Peru- crowd gathered outside building in protest“, Thayne Tuason