Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)

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Globalization and the unleashing of the financial crisis

Policymakers should consider a broad array of options, including devolving some of the bank's functions to new institutions or redistributing them to existing ones.

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The effects of the financial crisis on economic globalization

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Below, we will analyze the leading external indicators of the globalization process, and will then analyze the three motors mentioned above. The economic deceleration caused by the recent implosion of the global financial system has led to an abrupt fall in international trade. Moreover, this reduction in economic activity has provoked a significant excess in the capacity of some sectors of the economy and a consequent increase in unemployment. Over the last twelve months, the automotive industry in Europe and the United States has experienced the largest drop in sales in various decades.

Other sectors, including steel or capital goods, have experienced equally serious drops. Consequently, the financial crisis has not only prompted a global economic recession, it has also brought out some of the weaknesses and structural risks of economic globalization: greater dependence on international trade, greater exposure of domestic industry to excesses of capacity when economic activity drops abruptly, and indirectly, an incorrect but latent and manifest perception in the most advanced economies that globalization has weakened their countries due to outsourcing of industrial activities.

Once again, the deindustrialization of countries like Great Britain is lamented when, in recent years, the shift to a tertiary economy had begun to seem natural and almost desirable. Dropping demand and increased unemployment efficiently spur new calls for economic protectionism. Until now, the governments of countries with the greatest economic weight have resisted the temptations of protectionism rather well. Nevertheless, while trade flows parry the thrust of protectionism, commercial interdependence among countries can also help to more rapidly propagate economic recovery.

Emerging countries are also major clients of companies in the most advanced countries. If the latter increase their exports it will improve economic growth, the need to import capital goods or sophisticated intermediate goods and also investments in public infrastructure. All of these tendencies are good news for multinational corporations.

Consequently, just as commercial interdependence has worsened the international repercussions of the crisis, it also means the possible recovery by the most relevant economic countries will have a more rapid effect on the world economy. We can thus see that, as a process, globalization can have a variety of effects on the world economy, and they are not always foreseeable or predetermined. The impact of the financial crisis on capital flows has been direct, immediate and enormous. First, the liquidity problems that initially affected US banks and investors rapidly affected all countries belonging to the international economy.

Liquidity problems quickly turned into credit restrictions, which especially affected those companies with the highest debt levels. In spring , a growing perception that liquidity problems could be long-lasting and could possibly turn into problems of solvency provoked a flight of capital from emerging markets to more developed economies. This may be because the unstoppable liquidity crisis of the first months of turned into a financial panic at the possible collapse of the world banking system, leading investors to opt for US Treasury debt rather than assets on emerging markets.

Direct investments in emerging countries also dropped drastically as a result of growing uncertainty about global demand and demand in the countries receiving those investments, as well as the credit restrictions of investment firms in their countries of origin and the fact that investments in emerging countries became less attractive with the changing economic scenario. The recent restructuring of the banking sector, mainly in the United States and Great Britain, is provoking a greater concentration—as banks in crisis are absorbed by more solid banks—as well as a reduction in size of some of the major banks with international operations.

In this case, two phenomena converge. First, strict indications by US financial regulators that banks in receipt of public recovery aid must improve the efficiency of their operations. And second, that in numerous banks, the restructuring of international operations is a clear field for improvement. In the case of European banks, such as those in England, Holland, and Germany, the smaller number of international operations is the result of an explicit decision by the top directors of those very banks to optimize the management of resources and reduce the degree of geographic diversification of their operations.

Underlying these decisions by banking institutions is the need to sell assets to reduce debt, the greater demands of capitalization, an awareness that some international operations have been characterized by deficient risk management, and the need to divest themselves of international operations that were not very efficient in some cases.

This is an interesting phenomenon. We find that one of the most dynamically internationalizing sectors, banking, faces a drop in its international operations as a result of the financial crisis. Moreover, the difficulty of regulating banks with international operations due to their greater complexity has led to public debate about whether it would be preferable for banks, as regulated institutions, to have a smaller geographic area of operations.

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Unless the debate on public policies in Europe changes radically, it seems unlikely that this debate will mark a turning point for international banking operations. Nevertheless, the fact that this debate has arisen is a clear indication of the degree to which the financial globalization process is now being questioned.

Finally, mergers and acquisitions—another important motor in the globalization process in recent years—have also dwindled as a result of the financial crisis.

These corporate operations have an important cyclical component, so it is natural for them to diminish in parallel to economic deceleration. And yet, at this point in the economic cycle, the drop in the number and volume of such operations is related to the loss of attractiveness of certain key markets, poorer expectations of the stock market, general uncertainty about the future of globalization, and reduced credit facilities for undertaking acquisitions financed with debt.

Nevertheless, the financial crisis has also shown how important it is for the international financial system to have a high degree of integration. The enormous imbalances in the US budget and balance of payments have been financed with foreign savings, which would have been more difficult just a few decades ago. This is the second positive dimension of financial globalization worth noting: international capital flows have not completely disappeared during the financial crisis.

As a result, the absence of liquidity in certain markets has not led to a generalized rise in interest rates. And last, the crisis has revealed the enormous impact of public policies, particularly monetary policies applied by major central banks to combat the perverse effects of the financial crisis.

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A coordinated effort by central banks to inject liquidity, rein in the panic, and maintain nominal interest rates at a very low level has clearly kept the financial crisis from turning into a great depression. In that sense, the crisis has proven the efficiency of the circuits through which financial globalization runs, even when the imprudence of certain banks and the lack of regulation in keeping with the new realities could have provoked an even greater disaster.

Likewise, central banks have shown that even when circumstances are very adverse—as they were in and —the financial globalization process allowed adjustments that might have been more costly and less efficient in other circumstances. As we emphasized above, the financial crisis has raised numerous questions about the future of the economic globalization process. At the base of this hypothesis is a set of convictions about public policies necessary to guarantee the proper functioning of an economy. The first of these convictions is that deregulated markets function better than regulated markets except in certain cases, such as monopolies.

The second is that financial markets tend towards efficiency, which signifies that share prices adequately reflect all available information on companies. Experience shows that the first, less presence by the public sector, has generally been a good one. The decision toward less regulation, however, has been ill advised in some cases, principally in the financial sector. One of the main effects of the financial crisis is the reconsideration of those basic aspects of market economies and of the need for greater regulation of financial activity.

This phenomenon will have some consequences on globalization. The first is that a re-regulation of the financial sector will make international expansion by banks more difficult and will generally limit, and increase the cost of, international capital flows. The second is that in a period of lesser economic growth a greater presence of the public sector as a regulatory agent of the financial sector could lead it to intervene in other areas of the economy beyond those needed to guarantee desirable levels of social protection. The return of state regulation could have implications for greater economic protectionism, which could include the shameless defense of so-called national champions in strategic sectors.

This would be bad news for the proper functioning of economies and would have a negative impact on globalization. In recent decades, partially as a result of the ideas described in the previous section, which have inspired economic policies in numerous countries, another opinion has become widespread: the idea that specific aspects of social life—or of society as a whole—should behave in a manner similar to the marketplace, with the corresponding incentives.

This idea reached its peak in the moments of greatest growth during the s and reappeared in the present decade before the summer of With this notion, a sensible approach—the idea that the organization of economic activity in competitive markets is generally the most efficient solution—has been transformed into the argument that social life should be centered on the market. Logically, the financial crisis has brought out the weak functioning of certain markets—especially financial markets—and has revealed the need for reasonable regulation. It has also debunked the myth that society mirrors the market.

In other words, the market has limits.

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Moreover, there are other personal and social realities for which the market offers no reasonable explanation. The satisfaction of personal objectives and interests has been particularly eloquent in financial institutions, especially investment banks and collective investment institutions, some of which have disappeared with the financial crisis.

The current financial crisis has provoked a wave of distrust of the market that is not logical, just as there is nothing reasonable about how, until very recently, the market economy was praised as a successful paradigm. In the corporate world, the maximization of market value for shareholders—a new criterion that has replaced the notion of maximum profit—has become the central paradigm of business management, even when, for top management, maximization is neither an operative criterion nor the result of decisions they can make.

Clearly, in this case we tended to replace a real market of clients, products, people, efficiency, and economic results with a market based on expectations—the stock market—under the hypothesis that the prices in the latter would reflect all available information.

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Payment of top management is a complex challenge, but that challenge turns into nonsense when the referential indicators are short-term rather than long-term results. Short-term results generate perverse incentives to take risks with the expectation of high short-term returns, without any concern for the company in the long term.

Neither a stable economic system nor human society can rest on foundations of self-interest. If they did, the social edifice would suffer from considerable structural weakness.

Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies) Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)
Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies) Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)
Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies) Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)
Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies) Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)
Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies) Challenges to Enterprise Performance in the Face of the Financial Crisis (World Bank Studies)

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