The Global Economic Crisis and Failed States

Editor’s Note: Already precariously dependent on commodities before 2008, the world’s fragile states have been critically hit by the global financial crisis. In a recent article in Foreign Policy Magazine, Homi Kharas notes that a number of them are likely to suffer declines in real per capita income through 2010 as a result of the global recession and commodity price declines. He warns that the connection between economic instability and political turmoil is real and the world will be dealing with these repercussions for months to come. This was originally published under the title “The Whiplash Effect”.

It was only a matter of time before the global financial crisis—now ravishing developed economies—hit the world’s poorest. In April, the World Bank predicted that 50 million people could be driven into poverty in coming months. But the point of impact won’t be high-powered modern finance so much as old-fashioned commodities, just like in 2008. During the first half of last year, commodity prices jumped off the charts, rendering food and other necessities unaffordable. Then, beginning in the third quarter of 2008, many major commodities, including crude oil, aluminum, copper, nickel, and corn, took a nose dive, with the largest price decreases in percentage terms since 1970. The whiplash in prices left failed states reeling, and it might not be over yet.

Before 2008, the world’s fragile states were already precariously dependent on commodities. Some, like Sudan, are vulnerable because they have commodities to export, encouraging a corrosive pattern of bribery, corruption, and rent-seeking that rewards those in power. Others, like Bangladesh, are fragile because they lack commodities and must import food, oil, and minerals for the population at market prices. With weak institutions unable to cushion the blow, such states suffer tremendously from commodity-driven booms and busts.

For the exporting countries, early 2008 brought high revenues as commodity prices spiked. Oil and gas producers such as Azerbaijan, Nigeria, Turkmenistan, and Yemen enjoyed double-digit income gains. Food producers, like Burundi and Sierra Leone, also did well. Populist governments in Bolivia and Iran rapidly expanded social spending.

The party came to a painful end when oil prices collapsed; many producer countries faced massive budget shortfalls, and 2009 looks just as tough. Twenty fragile states (out of the 56 for which data exist) are likely to suffer declines in real per capita income through 2010 as a result of the global recession and commodity price declines. Oil-rich Equatorial Guinea and Nigeria could see drops of 13.5 percent and 9.5 percent, respectively.

Major commodity importers such as Bangladesh, Ethiopia, and Pakistan felt a pinch even before 2008 began. Some, including Pakistan, felt compelled to go hat in hand to the IMF. Luckily, the other side of the whiplash brought the economy back from the brink. Pakistan lost 1.8 percent of GDP from higher import prices in 2008, but in 2009, it stands to gain 2.4 percent of GDP in purchasing power, an amount that will allow the economy to expand 2.5 percent in real terms. Absent lower crude oil prices, Pakistan—and others like it—would be having a much rougher 2009.

The whiplash effect matters to failed states not just for their bottom lines. The connection between economic instability and political turmoil is real. Economist Paul Collier estimates that the risk of conflict goes up 1 percentage point for each percentage-point decline in economic growth rates. Countries that were stable thanks to commodity windfalls in 2007 and 2008 will become less stable, while importing countries will become more stable.

This is good news for strategically important countries such as Afghanistan and Pakistan, where global price changes will add an extra boost just as new U.S. policies are kicking in. Iran, now facing revenue shortfalls, might be more accommodating to dialogue as its economy weakens and discontent simmers. One notable exception is West Africa, where an oil-dependent and increasingly unstable Nigeria could spread its contagion. We’ll be treating these future whiplash victims for months to come.