NAZIM TUGRUL YEGEN

BU-532 INTERNATIONAL ECONOMICS – REPORT 1

NAZIMTUGRUL YEGEN

BU532 International Economics

Online- Spring 2016

6/5/2016

Everycountry has the mandate to get ready for any crisis. In the recentpast, the world has been experiencing a financial crisis. The globalfinancial crisis has found many nations both developed anddeveloping, unprepared to handle it. It is in the public domain thatmany countries still hold the notion that economic recessions areunpredictable and that is the reason they fail to make themselvesready for any crisis that may arise. However, the article “Thecrisis and economic recovery in Baltic Countries”, by GediminasMacys, indicate that countries are able to predict the financialcrises and reduce their impact if they can get ready for it. Thearticle authored by Gediminas Macys and printed in the year 2012 inthe InternationalJournal of Humanities and Social Science hasa lot of facts that states can emulate and learn on how to preparefor any disaster.Many countries prepare in advance by reducing their debts and forminga special fund for pre-crisis (Macys, 2012). In addition, businessesthat view the financial crisis as a creative destruction are able toinvest in innovative projects and adapt to new structural changes. Inthis paper, I will provide a point of view regarding the ideaspresented by Macys (2012), assess how the article deals with theeconomic theory, and determine whether more relevant facts are neededto support the issues raised by the authors. Global marketsbegan realizing the effects of economic and financial crisis afterthe collapse of Lehman Brothers in September 2008. This sent an alarmto all global financial markets leading to a consequential breakdownin inter-bank lending systems. As a result, premium risks shot up byabout 5%. Other banks literally froze such activities as an act ofcushioning themselves against this crisis. Economic activities in thecorporate markets saw a sharp drop since premium risks for corporatebonds rose by about 6%. Developed economies were exposed to highlevels of recession due to fallouts for trade in the global sphereleading to dramatic decrease in volumes and trends of goods andservices traded. This economic effect did not spare any economy. Itseffects were evident on economies of all nature, ranging from therich to the poor and big to small economies. According to Jicking(2010), this crisis came in varied forms and magnitudes and evolvedperiodically into other forms which spread into the other sectors ofthe global economy. Financial institutions and other governmentalsectors were brought together to look into the means through whichimmediate fiscal policies and responses could be formulated to cutits effects. Unlike economic crises experienced in earliertimes, the period 2008-9 saw most of the world’s economies unitefor social protection leading to decreased levels and periods ofunemployment. There were high levels of anti-cyclical measures inmonetary systems and positively inclusive fiscal programs beingadopted all over the world leading to progressive retardation on theeffects brought by this crisis within this period. Despite theeffects brought about by this menace, global economies have remainedmyopic on tackling the factors that led to this crisis (Bartkowiak,2015). Issues such as efficient regulation of financial systems andlack of balance in the global economy which is as a result of skewedand inefficient distribution of global income have not been addressedto the fullest.

Analysisof the article

Apersonal point of view The main argument presented in thearticle is that countries (such as Estonia) managed to pass throughthe 2008 financial crisis and with minimum loses because they hadmade adequate preparations. I agree with this view because the use ofeffective economic models can help countries to determine theprobability of a financial crisis occurring, which allows them toprepare in advance. For example, the IMF identified that financialinterconnectedness between countries is a warning sign of a financialcrisis (Minoiu, Kang, Berea &amp Subramanian, 2013). The Balticnations would have discovered that the interconnectedness betweentheir financial institutions with the Scandinavian financial sector,which created a bubble in the real estate industry, was an earlywarning sign. The authors present an idea that changing investmentstrategies to focus more on market diversification and innovation canhelp organizations overcome economic challenges that they face duringthe global economic crisis. Although this idea is still disputed, Iagree with the authors because financial crisis leads to the closureof obsolete firms, while more diversified and innovative firms tendto survive (Alfranseder &amp Dzhamalova, 2014). Therefore, most ofthe views presented in the article are logical.

Economictheory The authors of the article used two economictheories to explain why the economic crisis occurred in 2008 andstrategies that the Baltic countries should have used to shield theireconomies. The authors used the economic theory of evolution toadvance the idea that economic crises play a critical role inintroducing a new phase of economic growth. This is accomplishedthrough the introduction of new products, new production processes,and an increase in investment in research and development (Macys,2012). This theory leads to a perception that the economic crisis isa normal part of the economic evolution that introduces structuralchanges to the national economy. In addition, the authorsused the “pit-stop” theory of recession to advance an idea thateconomic crisis force business to become more innovative. Duringrecessions, the opportunity cost of failing to innovate is lowercompared to the buoyant periods. This implies that many businessessee innovation as the most viable solution that can get them out thecrisis. The two economic theories used in the article support thenotion that the economic crises are unavoidable instances that playan important role of reforming the national economy (Bartkowiak,2015). Although the main ideas presented in the article aresupported by the two theories, it is evident that the authors couldhave used more sound economic theories to illustrate that themonetary crises could be foretold and their impacts minimizedeffectively. For example, the theory of imperfect information holdsthat markets fail to work as expected when the stakeholders lack theinformation needed to predict the next move that their competitorswill take (Bartkowiak, 2015). However, the stakeholders in Lithuaniawere aware of the excess inflow of cheap credit from theinternational financial institutions that funded the real estatecompanies in their domestic markets (Macys, 2012). This inflow wasresponsible for the real estate bubble that culminated in thefinancial crisis. Similarly, the Marxian and Keynesiantheories would have been more appropriate to explain the occurrenceof the 2008 crisis in Baltic countries. These theories hold thatfinancial crisis result from ineffective regulatory governance andfailure by the government to learn from the history (Vidal, Adler &ampDelbridge, 2015 and Andrews, 2012). Therefore, sound economictheories suggest that the Baltic nations had the opportunity topredict that any bubble in their economies would eventually burst andcause a crisis.

Needfor additional facts The authors of the article “Thecrisis and economic retrieval in Baltic Countries” made significantassertions about the occurrence and the impact of the 2008 financialcrisis on the Baltic nations, but failed to support the ideas withrelevant facts. For example, the authors claim that the financialcrisis should be considered as a process of “creative destruction”,which means that it provokes companies to revolutionize and come upwith new products (Macys, 2012). In the absence of more relevantfacts, this argument can be disputed since one would expect businessto reduce their investment during the economic crisis due to chronicfinancial distress that they face in such periods (Mazzucato, 2013and Jicking, 2010). In addition, the international economicinstitutions (such as the IMF) experience the challenge of lending tomany countries and institutions that are going through the crisis atthe same time, which means that businesses would find it difficult toinvest in innovative projects (Macys, 2012). In addition,the authors used the concept of “creative destruction” to suggestthat all businesses become more innovative as a result of thefinancial crisis, but there are no adequate facts to support thisnotion. A study conducted by Alfranseder &amp Dzhamalova (2014)indicated that the financial institution experience economic crisesas a result of financial innovation that tend to make the financialsystem more complex. Therefore, the use of more relevant facts wouldhave helped the authors inform the readers that there are instanceswhen innovation becomes the source of the financial crisis, insteadof motivating business to become more creative. Moreover, theauthors depict the financial crisis in the Baltic countries as aregional issue in a global economy, where the three Baltic nations(including Latvia, Estonia, and Lithuania) seek for help from thecentral banks of the countries forming the European Union. Theauthors state, “The stable means of EU structural support fundswere the positive factors in these countries” (2014). The conceptof states getting financial assistance from other nations needed morerelevant facts given that financial crisis affects many nations,which makes it difficult to find assistance from other states(Ksantini &amp Boujelbene, 2014 and Claessens &amp Horen, 2014). To have a clear understanding of economic recession, one has tobroaden his/her perspective to avoid the effect of being limited tonarrow national or regional boundaries. It is important to increasethe point of view to a global dimension to easily appreciate theunderlying ideas and facts around this issue.

Crisisin the Baltic Countries Baltic States share a similarity intheir political, natural and socio-economic developments in relationto their business environments. They previously experienced a steadygrowth in their economies until 2008 during the global financialcrisis. Hardly hit economies such as Latvia saw an adverse negativegrowth as its economy declined by about 17.5% in 2009. An analysis ofthe factors that led to a similar economic trend in all Balticcountries shows a similarity. Researchers have proven that issuessuch as reduction in internal consumption rates emanating from lowincome levels of the population and increased levels of unemployment(Alfranseder, &amp Dzhamalova, 2014). This resulted to a reductionin the levels of internal and foreign investments, public expenditureand deterioration of expectations by internal consumers. Despitethis, Baltic countries recovered from the recession at a faster rate.According to J. A Schumpeter in his theory of economic evolution,crises lead to formulation of structural changes which guide aneconomy to new phases of development with motivations from newprocedures of production and products. Affected economies can achievethis through investing in research and other entities of developmentsuch as public investment and investing in the requiredinfrastructure. Baltic countries ensured this by encouraging directforeign investments and efficient utilization of the support they gotfrom the European Union (EU) in preparation for the businesses thatexisted through a new phase of growth. Despite this, countries suchas Estonia developed mechanisms such as declaration of setting-upprinciples like keeping surplus national budgets which was recognizedby the European commission, a step that made Estonia to be includedin the membership of EU countries. These policies led to a decreasein the debt of the public sector and that of Baltic Countries. Duringthe crisis period, there was a worsening situation in the levels ofunemployment and issues such as nationalizing of the Latvian localcommercial bank “Parex” made its debt to rise to 44.6% of thenational GDP. As a way to curb this situation, Latvia embarked intoways of bringing its economy back to a significant state throughfinancial and structural reforms and other financial aids from IMFand the EU. Estonia on the other hand was not hit in an adverse wayin comparison to Latvia since it had set a special kitty long beforethis crisis. However, its public sector deficit rose to about 6.5% ofthe national GDP in 2010.

Lessonsfrom this Crisis Before the financial turmoil of 2008-9,most economies had experienced an economic bubble in various sectors. Despite this, Baltic countries were not well protected from thedownfall. Andrews, (2012) argues that fiscal strains could have beenalleviated the pre-crisis economic growth to some extents throughreductions in the sizes of the debts which existed in the recessionperiod in relation to the sizes of these economies and making annualbudgets to include exceptional funds for calamities. It is essentialto embolden structural reforms which reinforce creation of jobs andgrowth sustainability. There is need for nations to structurepolicies that encourage competition and innovation to enable a speedyrestructuring of investments which will create businessopportunities. For creation of employment, requirements of increasein the flexibility of labor markets is necessary as it leads torestoration of competitiveness (Alfranseder, &amp Dzhamalova, 2014).The following lessons can be learnt from this crisis: First,economies such as Estonia and other Baltic countries had to adoptsuitable retrenchment strategies which involved decreases in costs ofoperation and divestment of assets considered to be non-core. This isa short term approach and uses approaches such as closure ofestablishments, decrease in employment levels, cut on expenditures,employee training and marketing. All Baltic countries have put thesemeasures into practice. Second, investment strategies which includespending on innovation and diversification of economic markets shouldbe reconsidered. This would have helped to a great extent in managingthrough the period of recession.

Conclusion Thispaper has provided a viewpoint regarding the ideas presented by Macys(2012). There is an assessment of how the article deals with theeconomic theory, and has determined whether more relevant facts areneeded to support the issues raised by the authors. Economic crisisaffects many nations at the same time, which makes it challenging foran individual country to find financial assistance from other states.However, the article authored by Macys (2012) indicates that nations(such as Estonia) that use relevant economic model are able topredict the occurrence of economic crisis, which helps them reducetheir debt burden and create special funds to increase their capacityto deal with emerging challenges. Businesses can also survive thefiscal crises by differentiating their markets, engaging in theinternational trade, and becoming more innovative. The authors depictthe financial crisis in the Baltic countries as a regional issue in aglobal economy, where the three Baltic nations (including Latvia,Estonia, and Lithuania) seek for help from the central banks of thecountries forming the European Union. According to Andrews (2012)periods of economic recession are regarded as “times for creativedestruction”. It is the time in which many established and thrivingbusinesses decline in a terminal way. Countries need to reduce theirvulnerability to such circumstances by being watchful on the carelessincrements in piling up of leveraged debt financing. Economies mustwork to ensure that if these debts go down beyond a low threshold, noforeign finances should be used to pay them. Growth strategies shouldbe re-oriented to ensure that there are low levels of externalfinancial inputs while working by all means to avoid debts.Researchers have proven that issues such as reduction in internalconsumption rates emanating from low income levels of the populationand increased levels of unemployment. The need for mindless urge forquick development should be avoided. Despite this, economies shouldembrace slow but qualitative growth strategies which encourage betterlevels of absorbing domestic resources while adding the requiredvalue to these products. Governments should put into practicepolicies that enhance innovation and increase their flexibility insupporting these ideas. According to Mazzucato (2013), adaptationssuch as market adjustments, training, pricing and R&ampD are vitalin economic recession times.

References

Alfranseder,E. &amp Dzhamalova, V. (2014). Innovationand growth: Evidence from technology research and development.Lund: Lund University.

Andrews,A. (2012). Perspectives on the global financial crisis. Journalof Critical Globalization Studies,5, 167-171.

Bartkowiak,R. (2015). The bank’s financial reporting and the downfall of thebanking sector. InternationalJournal of Financial Management and Science,8 (19), 7-101.

Claessens,S. &amp Horen, N. (2014). Theimpact of the global financial crisis on banking globalization.Washington, DC: International Monetary Fund.

Jicking,M. (2010). Causesof the financial crisis.Washington, DC: Congressional Research Service.

Ksantini,M. &amp Boujelbene, Y. (2014). Impact of financial crises on growthand investment: An analysis of panel data. Journalof International Economic Studies,7 (1), 32-57.

Macys,G. (2012). The crisis and economic recovery in Baltic countries.InternationalJournal of Humanities and Social Sciences,2 (19), 202-209.

Mazzucato,M. (2013). Financial innovation: Creative destruction versusdestructive creation. Industrialand Corporate Change,22 (4), 851-867.

Minoiu,C., Kang, C., Berea, A. &amp Subramanian, V. (2013). Doesfinancial connectedness predict crises?Washington, DC: International Monetary Fund.

Vidal,M., Adler, P., &amp Delbridge, R. (2015). When organizations studiesturn to societal problems: The contribution of Marxist theory.OrganizationalStudies,36 (4), 405-422.