Driving Forces Behind World Economy (Essay Sample)

DRIVING FORCES BEHIND EVENTS IN WORLD ECONOMY: CASE STUDY ON GLOBAL FINANCIAL CRISIS OF 2008 AND GREEK DEBT CRISIS [STUDENT NAME] [DATE] Question: The core question in IPE is what drives events in the world economy? A Case Study on the Global Financial Crisis of 2008 and the Greek debt crisis. Introduction The global economy of today is much different to the one that existed since the Cold War. With the financial systems which have been developed in the world, it is easy to see how the world economy has now become an amalgamation of the economic systems being seen all around the world. In order to understand international political economy and its relationship to the events that drive the world economy, it is important to know how globalization has been able to create interdependencies all over the world (Cable, 2009). As globalization has taken place, it has led to an integrated world economy from the economies of different economy. Globalization and digitization of the world economy can be considered as the driving force behind the engine which drives world events in the world economy. Due to this, an event in the US is expected to have an impact on the Japanese economy as they are interconnected and have an impact on each other. The global financial crisis of 2008 and the Greek debt crisis are two such instances where the world economy felt the shocks and tremors of these events. It can be seen that in the last two decades, the world economy has merged into one. With financial markers trading all over the world, the whole world has become a trading hub where financial markets are operating all day round. This could not be imagined during the Cold War when half of the world economy was behind the Iron Curtain. This has changed as now governments, institutions and individuals are all taking part in the world markets. Even though they make a subset of the world economy, it is still the driving force behind most of the activity taking place in the world economy. Global Financial Crisis of 2008 The global financial crisis of 2008 was centered in the US but the collapse of the financial markets saw an impact on the real economy as well. The crisis was caused by financial service companies selling Credit Default Swaps (CSD) on many of low quality Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs) which were rated as being of high quality. Many of the CDS were sold with little or no understanding of what was being packaged in the CDOs and CMOs. Once the debt instruments started to default, the CDS being sold on a premium had to payout the debt. It was expected that as the debt instruments were of high quality, no payouts would ever take place like a safe insurance policy (Gamble, 2009). However, as there was no understanding of the instruments, it was not known how likely it was that the payout would have to be made. Once the defaults started, there was a reassessment of the value of many of the assets and toxic assets that different companies had on their books. This led to the devaluation of the balance sheets and saw many of the companies stressed under the new circumstances. Companies like Lehmann Brothers had to go bankrupt while Bear Sterns had to sell their shares at a bargain. Seeing the massive crisis that was being faced by the financial industry, the American government had to step in and offer the industry a bail out. Impact on the World Economy The impact of the financial crisis can still be seen where the world economy is seeing economic stagnation and recession. 2009 proved to be a very difficult year for the world economy due to the global financial crisis taking place in 2008. The effects of the global financial crisis were still felt in terms of the economic downturn in the Western economies which took the world towards the brink of worst economic conditions since the end of the Second World War. International Monetary Fund released a report in 2008 on the World Economic Outlook which reflected on how fast the economies of the world were deteriorating. It revised the global real GDP growth of many of the countries for 2008-2009. The real GDP growth rate of 3.0% forecasted in October was downgraded to 2.2% as the IMF expected many of the advanced economies to contract by 0.25% on an annual basis. Similarly, downgrading was also carried out for developing economies which were expected to grow at 5.1% overall as compared to a previous estimate of 6.1%. Figure 1 shows a detailed analysis of how the IMF downgraded its forecasts in October 2008 and November 2008 in order to account for the impact of the Global Financial Crisis (Tett, 2009).  Greek Debt Crisis The Greek Sovereign Debt crisis of 2009 took place in the aftermath of the financial crisis which struck the world stage in 2008. The recession triggered by the global financial crisis led to the Greek crisis being triggered. This was due to the structural weaknesses which already existed in the Greek economy in addition to revelations of previous government data which had not been accounted for and government deficits which had been undercounted by the Government itself. With the global financial crisis taking place all over the world, these deficiencies were finally exposed in front of the whole world which led to the sovereign debt of the Greek government to be called into question. As the confidence fell in the sovereign debt of Greece, the bond yield spread widened and there was an increase in the premiums of the credit default swaps being offered on the Greek debt by different issuers (Sweeney, 2005). By 2012, the crisis had deepened further with the largest sovereign debt default being launched by Greece itself and 2015 saw the country default on its IMF debt payment which was a first for a developed country. Impact of the Global Financial Crisis on a World Event In order to understand how economic events have an impact on international political economy, it can be seen that as the global financial crisis took place, the effects of the recession were felt throughout Europe. As the global financial crisis led to a global recession, Wealthier countries of the European Union decreased their funding to the smaller countries like Greece as they could no longer sustain the same levels of funding. As the funding fell and reports of financial misstatements and deception of Greece came to the forefront, the borrowing costs of Greece increase which meant it could no longer fund its trade and budgetary deficits at an affordable cost. In normal circumstances, once the investment stops into a country, the country is able to depreciate its currency in order to pay back its debt. Greece could not do such a thing as it was trading in Euros and it did not have the control over the currency it desired. This led to deflation and a fall in wages and GDP of the country resulting in severe recession for the whole country. The cycle triggered a fall in tax revenue which further increases the debt-to-GDP ratio and started a cycle of recession and further economic deterioration. Driving Forces in the New World Economy The crises which have been discussed show that a structural change has taken place in the global system. Due to this one trend has emerged which can be held responsible for the world economic system becoming the way it has. The crises were caused due to the explosive nature of growth which has taken place in the financial system of the world. This growth has not been backed by the growth which has taken place in the manufacturing sector or the economies of the world either which has led to speculative behavior in the financial markets. Wealth accumulation has now become a function of speculation rather than actual production and value of the production which is being carried out. The current economic system which has been put into place is based on looking for profit and to try to accumulate as much capital as possible. This allows for the economy to be able to reap higher profits while leading to greater capital which can be further invested (Stiglitz, 2010). In fundamental terms, this is correct and this is how return should be in order to accumulate more capital in the future. The theory goes on a tangent to the real economic theory as the new theory is centered more on the rate of profit rather than absolute level of profits being earned. As the investments increases, economies are looking to maximize the return earned on that investment. The rate of return of investment is now becoming a better indicator of the economic performance of an economy and is used to judge the health of a particular country’s economy. The rate of return for most of the economies was stagnant since World War II as the rate of return was seen to be steady throughout 1940s, 1950s and early 1960s. This lead to a steady boom in the world economy as rising investment lead to rising profits all over the world. Due to the steady accumulation of capital and profit, this era is also known as the Golden Age of Capitalism (Gray, 2009). After the 1960s, there were two decades of falling rate of returns seen in the Western economies. As the rate of return and growth fell, so did the rate of real global GDP. Many countries experienced deep economic recessions through the 1970s and 1980s where growth slowed, the profits being earned fell and unemployment was on a rise throughout this time period. In order to counter this situation, the governments had to carry out different measures which have been termed as being called neoliberalism. These policies took different forms in different countries. In the US, these policies were termed as Reaganism while in Britain these were termed as Thatcherism. Other Western countries also carried out similar measures along the lines of neoliberalism. As developed countries and internat...