Economic Crisis and Rule Reconstruction

Deming Chen

• Publisher: WSPC
• Year: 2016
• eBook ISBN: 9789814740968
• Topic: Economía
• Subtopic: Negocios en general

-->

The 2008 global economic crisis resulted in many new changes in global economic governance, multilateral trading system, the Group20 major economies, regional economic cooperation and other international governance platforms. Coun

Chapter 1

Economic Crisis in the Era of Globalization

On September 15, 2008, America’s fourth-largest investment bank, the 158-year-old Lehman Brothers announced it would file for bankruptcy protection with the US Bankruptcy Court for the Southern District of New York according to Chapter 11 of the American Bankruptcy Act. The global financial giant with a total of USD693 billion worth of assets and USD613 billion of debt had survived the turmoil of the 19th century railroad company closure, the Great Depression of the 1930s, the collapse of the capital management market at the turn of the century, and numerous other trials, yet came tumbling down in this sudden crisis, becoming the largest case of financial bankruptcy in the US history. This triggered another wave of economic trouble in the US subprime mortgage market with the fall of Bear Stearns in the summer of 2007. Following this, America’s third-largest investment bank Merrill Lynch, was acquired by the Bank of America, the world’s largest insurance company, and American International Group was brought to the brink of bankruptcy. This series of events raised the curtain on the new century’s global economic crisis.

In comparison with several other economic crises in history, this meltdown was unique in its background, epicenter, degree of impact, evolution, and other aspects. The depth and breadth of its impact continues to exceed everyone’s expectations. What is particularly noteworthy is that the crisis not only triggered intense philosophical and ideological debates, it also exposed the long-standing abuse of institutional structures and operational collaborations, and their respective regulations in the post-World War II global economic governance system, sparking off the search for new global governance platforms and reconstruction of trade rules. As globalization has developed in the past five years, many major changes have occurred in its dominant forces, manifestations, promotion platforms, trade patterns and other aspects. Some trends have begun to emerge as various old and new, multilateral, bilateral and regional platforms, as well as the economic powers supporting them, debate, negotiate and strategize vigorously to revise, adjust and improve upon existing global rules governing finance, trade, investment, intellectual property rights, development assistance as well as environment, labor, competitive neutrality and some new areas of economic and trade-related fields.

1 Outbreak of the Crisis

The 2008 economic crisis will be noted as one of the major historical events in the 21st century. Taking place just a few months after the US subprime mortgage crisis, it quickly evolved from a financial crisis into a global economic catastrophe and triggered a new round of European sovereign debt crisis with the rippling effect, and emerging economies also facing new challenges. Since the outbreak, the world’s economy has plummeted, global rescue measures have shown unprecedented strength, and all parties have placed high hopes in new governance platforms. Yet, just as the global economy is showing signs of recovery, there appears to be policy differences and awkward coordination among the major economies and the progress of recovery has become uncertain. The disparate and perplexing economic phenomena reveals some of the unique characteristics of this crisis.

1.1 Onset of the crisis

Figures show that before the outbreak of the crisis in 2007, the world economy seemed to still be in the most robust period of growth since the 1970s. According to statistics from international agencies, the annual growth rate of the global economy from 2003 to 2007 was 4.9%; during that time, the growth rate of world trade volume was much higher than this, reaching an average of 7.9% per annum; transnational investment also increased from USD557.87 billion in 2003 to USD1.83 trillion in 2007, an average annual growth rate of 34.5%.¹

Behind the “prosperous” figures, the US financial and real estate markets had already been showing symptoms of turmoil since 2007. On February 13 2007, the second-largest subprime mortgage² company in America, New Century Financial Corporation, announced a profit warning for the fourth quarter of 2006. Eventually on April 2, the company filed for bankruptcy, retrenched 54% of its staff, and became the biggest mortgage lender in the US to go bust in the real estate downturn. Following that, as enterprises and investment institutions successively reported their earnings, more problems in the subprime mortgage market came to light. Two credit rating agencies, Standard & Poor’s and Moody’s Investors Service reduced the credit ratings of hundreds of mortgage bonds respectively and the risk gradually began to spread. On August 3, Standard and Poor’s lowered the debt ratings of the famous investment bank Bear Stearns. On August 8, Bear Stearns, America’s fifth-largest investment bank, announced the closing of two of its funds and subsequently, several subprime-related financial institutions went bankrupt. From then on, the downturn of the real estate market and the collapse of the subprime mortgage market triggered a comprehensive credit crisis that hit and shook the entire global financial system.

To cope with the volatility and liquidity issues brought about by the financial markets, the US Federal Reserve and European Central Bank began joint “rescue” efforts. In early 2008, the major financial institutions in America reported severe losses, the real economy showed significant signs of decline, so the Federal Reserve continued and intensified its efforts to reduce interest rates. Despite their efforts, the ripple effect quickly spread. From the beginning of March 2008, subprime loan and debt losses extended to derivative securities, superior debt, credit cards and other areas, further triggering a credit crunch, short-term corporate financing difficulties, the plunging of loans and bond prices, and a large number of commercial banks were also struck by the “domino” effect. In July 2008, “Fannie Mae” and “Freddie Mac” faced severe financial difficulties due to heavy losses, forcing the Federal Reserve and Treasury to intervene and bail them out. From the onset of the subprime decline through its spread across the entire financial chain to this point, a systemic crisis had, in fact, developed in the US financial system.

1.2 Development of the crisis

Before September 14, 2008, the global impact of the subprime mortgage crisis was essentially limited to direct losses associated with the subprime market. However, when Lehman Brothers filed for bankruptcy, Merrill Lynch was acquired by the Bank of America and another relevant series of events took place, the myth that financial giants were “too big to fail” was busted and investor confidence was greatly hit. This was the last straw for global stock and property markets, and the world was suddenly confronted with the huge risk of financial crisis.

In the financial sector, as global financial markets are closely linked and intertwined, financial institutions in Europe, Asia and other continents quickly felt the impact. British and Swiss financial institutions suffered heavy losses; the banking and financial industries of India, the Republic of Korea (hereinafter referred to as Korea) and others in Asia were also seriously affected. From September 15 to September 17, 2008, after the Lehman Brothers’ bankruptcy, the three major stock indexes in the US experienced the greatest plummet since September 11, impelling sharp dives in the European and Asia-Pacific stock markets. In 2008, the global stock market incurred losses of up to USD17 trillion.³ The already sluggish global housing market worsened and further declined. The combination of all these factors dragged more countries into the crisis. The monetary and financial markets of many emerging economies such as Russia, Korea, India, Brazil became increasingly volatile. Some countries such as Iceland even faced the risk of national bankruptcy.

The crisis also spread rapidly in the real economy. In December 2008, JP Morgan’s global Purchasing Managers’ Index (PMI) indicated that manufacturing had dropped to its lowest point since the beginning of the investigation 11 years ago. At the same time, almost all commodity prices saw dramatic plunges and further triggered the decline of the shipping and other production and services industries. The Baltic Dry Index (BDI) plummeted sharply from its highest recorded 11,793 points on May 20, 2008 to less than 1,000 points at the end of 2008. Indicators such as containers, port traffic, freight rates and others were broadly low. As these factors interplayed and continued brewing, the steady continual growth of national economies was disrupted, business confidence was severely set back, international demand fell significantly, global product networks were affected, trade financing deteriorated and protectionism began to rise. By then, the crisis had rapidly spread from the financial sector to the real economy, and moved from developed economies to developing economies, turning into a rare and dire international economic crisis with wide-ranging effects and implications.

1.3 Extension of the crisis — triggering the European debt crisis

After the crisis broke out, the international community launched large-scale rescue measures rarely seen in history so as to curb panic in the market and stabilize confidence. However, in the latter half of 2009, just as all thought the worst part of the crisis was over, a new “storm center” emerged in the world economy — Greece was the representative case of the European sovereign debt crisis.⁴

Actually, as early as in October 2008, during the initial stage of the Wall Street financial turmoil, Northern European Iceland’s sovereign debt issues had already surfaced before the debt crisis broke out in Central and Eastern Europe. However, as these were generally small national economies and there was prompt international aid, many problems were not fully exposed, thus larger global financial turbulence did not occur. It was only once the new Greek government came to power in 2009 when the fiscal deficit was significantly increased from the expected 6% to 12.7%, way higher than the 3% ceiling provisioned in the “Stability and Growth Pact”,⁵ and major credit rating agencies quickly downgraded Greece’s sovereign debt ratings that the “tinderbox” was re-ignited. Due to the serious sovereign debt problems prevalent among the member of the Eurozone, the market began questioning Ireland, Spain, Portugal, Italy and other heavily indebted countries, bringing about the rapid spread of the debt crisis and global financial upheaval was set off once again.

As the debt crisis heated up, various short-term and long-term relief measures were subsequently launched. On May 2, 2010, the Eurozone kick-started the Greek rescue mechanism. Together with the IMF, the European Union (EU) and other Eurozone countries established a European Financial Stability Facility (EFSF) of up to 750 billion euros, to help those Eurozone member states in danger of falling into the debt crisis and prevent the spread of the Greek sovereign debt crisis. To further stabilize market confidence and strengthen fiscal discipline, after much deliberation, the EU also set up permanent mechanisms in response to the European sovereign debt crisis. They are mainly the European Stability Mechanism (ESM) and the Outright Monetary Transactions (OMT). Deterred by these measures and under pressure from the international community, EU members began to weigh up their “incentives” and “constraints”. Most of the countries with excessive fiscal deficits rolled out clear deficit reduction plans and the European sovereign debt crisis was finally alleviated.

1.4 Impact of the crisis and rescue measures

The impact of the global financial crisis which broke out in 2008 was the greatest the world had seen in 100 years. First was the severe recession of the global financial industry. In late 2008, global stock market capitalization had fallen to almost half that of its peak, the notional value of financial derivatives had shrunk by nearly USD25 trillion.⁶ Secondly, world trade and investment was severely hit. Global trade declined by 12.2% in 2009, with the decline of developed countries being particularly significant. In the same year, US exports fell by 17.9% while imports decreased 25.9%.⁷ The UNCTAD’s report also showed that cancellations of global M&A transactions increased year-on-year by 50% and transaction volume decreased by nearly a third in 2008, among which BHP Billiton gave up its USD147 billion acquisition of Rio Tinto, becoming the largest transaction revocation case in history; global Foreign Direct Investment (FDI) dropped from USD18.3 trillion in 2007 to USD12 trillion in 2009.⁸ The economic slowdown of various countries seemed to synchronize especially in 2009. That year, world economic growth fell from 1.3% in 2008 to -2.6% wherein developed economies dropped from zero growth to -4% and developing economies declined from 5.6% to 2.2%.⁹

The international community quickly launched a series of relief measures in response to the chain of negative effects brought on by the crisis. In the early onset of the crisis, the main response of the various countries was to inject liquidity into the market through measures such as bailing out the banks on the brink of bankruptcy to stabilize the financial markets and purchasing distressed debts to contain the negative impact. However, as the crisis broke out, the various assistance policies also shifted from the initial emergency and palliative measures targeting financial markets, to recovery and growth-oriented incentive measures to prevent...

Table of contents

• Cover
• Halftitle
• Title
• Copyright
• Foreword by Robert Azevedo
• Foreword by Pascal Lamy
• Foreword by Li Yining
• Contents
• Preface by Chen Deming
• About the Author
• Introduction
• Chapter 1 Economic Crisis in the Era of Globalization
• Chapter 2 G20 and New Developments of the Global Governance Platform
• Chapter 3 Difficulties and Prospects of the Multilateral Trading System
• Chapter 4 The Rise of Regional Economic Cooperation and Global Rule Reconstruction
• Chapter 5 International Rules of Finance
• Chapter 6 Rules of Trade Remedies
• Chapter 7 Global Value Chains and Trade in Value-Added
• Chapter 8 Rules of Trade in Services
• Chapter 9 Rules of Government Procurement
• Chapter 10 Rules of Intellectual Property
• Chapter 11 Rules of International Investment
• Chapter 12 Competitive Neutrality and State-Owned Enterprises
• Chapter 13 Rules of International Development Cooperation
• Chapter 14 Rules for Trade and Sustainable Development
• Chapter 15 Reconstruction and Prospects of Global Economic and Trade Rules
• Postscript
• Glossary