Global Financial Crisis: Causes, Effects and Lessons

This article discusses the causes, effects and lessons learned from the Global Financial Crisis. It also explores the impact of the crisis on developing countries, with a focus on Pakistan.

INTRODUCTION
GFC and Global Financial Crisis refer to a situation of extreme depression in overall financial market. The
year 2007-2008 was known to be the year of worldwide crisis and is considered to be the worst financial
crisis by many economist since the depression which occurred in the year 1930’s.The main reason
behind the global financial crisis was the crash in the US housing market that spread like a fire from the
United States to rest all over the world. Banking sector all over the world incurred huge losses and
depends on the country government support in order to avoid indebtness.Many lost the jobs in this
severe recession and the recovery from this recession was very slow as compared to past recession.
(Reserve Bank of Australia, 2019)
POSSIBLE CAUSES OF FINANCIAL CRISIS
It is very difficult to analyze the main possible causes of the financial crisis. However, the experts and
analyst believed that combination of several factors have lead to the explosion in the market of US and
afterwards to the rest of the world. Few main causes, which can be described below for the contribution
of financial crisis, are as follows:
 World Trade Imbalance: After joining the World Trade Organization in 2001 by china, it has
benefitted a lot. China has fully utilized the advantage of the global market. China spread its
product worldwide with very cheap prices and has flooded the world with very cheap exports.
The exchange rate of Chinese currency Yuan was also kept very low so to make the trade very
competitive and able to attract all the country worldwide. This also helped china to accumulate
huge foreign earning and to do trading in vast scale and increase its trade surplus while rest of
the countries in the world expecially the United States ,trade deficit was increased. For instance
the trade deficit of the country US has tripled from the year 1999 to year 2007.Gradually the
production of the consumer goods has also declined sharply in the United States and gradually
US economy shifted to a service economy. (ResearchGate, 2019)
 United States Consumption Pattern: The economy of United States did not adjust itself
regarding the trade deficit and trade imbalance. Due to high imports and less export to another
country lead to trade imbalance. All deficits in trade balance were mainly outsourced from
external borrowings. The external borrowing was mainly from china, the surplus received from
the United States was reinvested in buying the Treasury bill and bonds of US. This continuous
process of trade deficit worsened the economy and the trade deficit can be witness in the public
budget as well. (ResearchGate, 2019)
 Financial Markets Deregulation: The liberalization in financial market since 1980 as the market
was completely deregulated and the monitoring of market by government and FED was

completely relaxed. This also allowed the United States to expand its role in providing financial
services and become a major player in providing the services. As a result, US introduced many
derivatives and products .And as a result involvement of many investment bankers and market
mortgagers is an example of deregulation .All the liberalization and deregulation created a
situation that lead to the burst in the credit market. (ResearchGate, 2019)
 Increases borrowing by banks and investors: The bankers and other investors started
borrowing from outside in huge scale in order to increase their purchasing power and expand
their lending operations. Borrowing money in order to finance the asset increases the profit at
the same time leads to losses too. When the house prices started declining, banks and investors
was the first who had incurred huge losses because of their huge borrowing from outside
market. (Reserve Bank of Australia, 2019)
Sometimes banks and other borrows used to borrow money for a very short span of time like
just for an overnight in order to purchase an asset and which cannot be quickly sold
off .Accordingly the bankers became dependent on other bank and lenders in order to finance
their new short term loan as existing loan were not repaid.
Will it happen Again?
The Global Financial Crisis worldwide taught huge lessons to the investors, some of which can be
highlighted as well:
 The investment and economic cycle is alive and very well.
 More the risk, more the return.
 True diversification importance.
 Importance of Asset allocation.
 Too much gearing should be avoided, and any wrong gearing also should be avoided.
 Return to normal parameter after financial crisis can take huge time.
 Monetary and fiscal policy generally works.
No one can judge and state whether there will be global financial crisis in future or not but of course,
the recession and crisis specifics will be different which might occur next time. (Oliver, 2017)

Global debt has grown to an all-time high relative to global GDP.
(Oliver, 2017)
However, a higher debt does not mean that there is a financial crisis, which is surrounding us. Post
Global Financial Crisis the debt nature is generally public in nature and the interest burden is very
low .The other signal of financial crisis that create the scene of recessions and depression are not
present now. Low inflation rate, hardly tightening of monetary policy. Moreover, there is also great

regulation in financial market as banking sector is required to have higher capital ratio and can find
themselves a great source of money from its depositors. (Oliver, 2017)
AFFECT OF GFC IN DEVELOPING COUNTRIES?
Global financial crisis arouse mainly in developed countries ,but the effects of crisis was not restricted
only to developed countries but it also spread worldwide and the effect also occurred in developing
nation as well. Reduction in foreign investment and in trade created a major impact on the economies of
the worlds developing and poorest countries. The growing trade deficit, devaluations of currency, higher
rate of inflation, high rate of inflation, increase in public debt and foreign currency reserve dwindling.
The developing countries were much affected by the financial crisis as by the year-end 2010; mostly all
developing countries had lost US $2.6 trillion in output.GDP growth also witnesses a sharp fall from 8.3
percent in 2008 to 6.1 percent in 2008 and just 2.4 percent in 2009.
The downturn in economy, growth in population leads to drop in per capita income by 20 percent. The
crisis grew so vast in number that 89 million to the number of people living in less than $1.25 a day.
Estimation by International Labour Organization in terms of unemployment in developing countries to
be near around 50 million by the year-end 2009.Despite many efforts to solve the issue, all developing
countries are still feeling the effect of the crisis. (Pham, 2017)
When demand of the product fall simultaneously the price and volume of the product fall too. The huge
fall in growth of China and India, also lead to a fall in demand for energy and minerals from other
countries. In past years before financial crisis, African economy’s growth was growing at a very fast
speed as an increase in the prices of commodity. The sudden slump in import demand with a
simultaneously fall in prices of the commodity also had a bad effect on the energy and the metal
exporting countries in Africa. (Pham, 2017)
In the first half of 2009, the 49 poorest countries saw their export income decreased by 43.8 percent.
The higher GDP and debt ratios further weakened the prospects of growth.
At the same time, international loan from bank and foreign direct investment declined which also lead
to a sharp fall in the net capital flow.
The investors diverted their money in safe investment hands like US Treasury bills.
The flow of resources to developing countries declined lead to downturn in economic condition of the
country. The domestic uncertainty in Europe and America, the people were less likely to send their
money abroad. The survey and the report of the world bank says the remittances has been decreased 6
percent from 2008 to 2009.But the survey report of world bank is understated as many transfer to
other country is unofficial through other means. In addition, in many developing countries remittance
from other country form part of income and comprises a large portion of Gross domestic Product.

The remittance effect varies from country to country. Asia and Eastern part of Europe experienced a
major drop in percentage i.e -20.7 percentages followed by other Latin America and Caribbean region i.e
-12.3 percent. The country which mainly relied on remittances are Morocco and Tunisia as the
remittances from abroad contributed to 2 percent of Gross Domestic Product. (Pham, 2017)
Seeing the financial crisis IMF has also changed its policies and given support to low-level countries
whose economy is very low and provided financial support to them.
Government started following using various methods and policies to develop their financial system in
developing countries. Because of many policy and fiscal measures, Uganda government started spending
in infrastructure and development projects. The recovery from the financial crisis was very slow but the
investment in development projects, energy and infrastructure lead to recover from the crisis. The
remittance from other country in Zambia has also allowed the country to increase its expenditure in
agriculture, education, health, infrastructure that was very slow in financial crisis time. (Pham, 2017)
Effect on Pakistan
There was a huge financial crisis in pakistan too. Before the onset of financial crisis, the country Pakistan
was also suffering from serious macroeconomic imbalance. The financial crisis affected Pakistan in
numerous ways as if the GD of the country came down, deficit in fiscal and current account. Inflation
also affected Pakistan in a very serious mode. There was huge drastic fall in GDP growth rate as it
declined from 6.8% in 2007 to 4.1% in year 2008. (All Answers Ltd, 2019)
The financial crisis also hampered the economic growth rate of Pakistan. Due to Financial crisis the
foreign Direct Investment also witnessed a sharp decline from $5410 million in 2008 to $3720 million in
2009.Trade gap also widened and the trade deficit rose to 12.8% of GDP in 2008.Adoption of tight
monetary policy by the government in order to control the inflation was also considered to be the
remarkable policy followed b the government of Pakistan. It was a major challenge for the Pakistan
government in order to achieve the macroeconomic stability and to put the whole economy back in
track. Both Fiscal and monetary policy carried a huge importance and to need to study the effectiveness
of both policy is very important in order to study the importance of it and stabilizing the Global Financial
Crisis. (All Answers Ltd, 2019)
The Global Financial Crisis has bought many issues and concern towards the nation and the attention,
which is required to be followed when such issues crop up, is very vital and important. The need for
reformation is required after the crisis. Lot of improvement and betterment is required in the financial
system of the world so that whenever in future there is a crisis the whole world economy does not get
distressed and the whole world does not suffer such a huge loss. (All Answers Ltd, 2019)
References:

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crisis-on-pakistan.php
[Accessed 20 January 2019].
Oliver, S., 2017. GFC lessons 10 years on: can it happen again?. [Online]
Available at: https://www.nabtrade.com.au/investor/insights/latest-news/news/2017/09/
gfc_lessons_10_years
[Accessed 20 January 2019].
Pham, J., 2017. How did the GFC affect developing countries?. [Online]
Available at: http://economicstudents.com/2017/05/gfc-affect-developing-countries/
[Accessed 20 January 2018].
ResearchGate, 2019. The Global Financial Crisis: Causes and Solutions. [Online]
Available at:
https://www.researchgate.net/publication/265235519_The_Global_Financial_Crisis_Causes_and_Soluti
ons
[Accessed 20 January 2019].
Reserve Bank of Australia, 2019. The Global Financial Crisis. [Online]
Available at: https://www.rba.gov.au/education/resources/explainers/the-global-financial-crisis.html
[Accessed 20 January 2019].
Reserve Bank of Australia, 2019. The Global Financial Crisis. [Online]
Available at: https://www.rba.gov.au/education/resources/explainers/the-global-financial-crisis.html
[Accessed 20 January 2019].