Epic falls? Economic Crisis and Household’s Welfare

“Do not judge me by my success, judge me by how many times I fell down and got back up again.” Nelson Mandela

Resilience, as emphasized in a previous #GraphForThought, is the ability to return to a predetermined path of development in the shortest time possible after suffering from an adverse shock. At the macro level, a country’s resilience depends on its ability and willingness to adopt policy measures to smooth consumption during times of shocks that impact GDP and, ultimately, individual wellbeing.

Consider the world economic crisis which was set off by the collapse of Lehman Brothers in September 2008. As a result of this crisis that trickled down from Wall Street to the rest of the world, the GDP flow (the total value of the products and services traded in one year or, equivalently, the sum of everyone’s income) of most countries fell. In Latin America, this halted the steady growth path that many LAC countries had experiencedin previous years due to the “commodities boom” and it’s extremely favorable terms of trade (the price of a country’s exports relative to its imports.)

In this context, one way we can think about measuring a country’s macro resilience is by counting the number of quarters in which GDP level was below that of the previous quarter (i.e. negative growth) after the 2008 crisis. This #GraphForThought shows how this number evolves for a sample of LAC countries from the beginning of the crisis in 2008 through the end of 2015 (a total of 31 quarters). The results show that on average in LAC, countries spent 13 out of the 31 quarters in negative growth. This means that on average they experienced negative growth for close to half of the period. However, the results are very diverse across the region. On one extreme, Argentina spent 21 quarters with negative growth (around two-thirds of the period). On the other extreme, Guatemala and Venezuela spent only 7 quarters with negative growth (less than a third of the period).

Why is macro resilience relevant for outcomes at the household level? Because when an economic crisis takes place, households and governments may react by reducing investments in key areas such as health or schooling. This may be the case if households are unable to smooth their consumption (for example, by drawing on their stock of savings during periods of economic hardship) or if governments do not have the necessary counter-cyclical fiscal policies in place (for example, which allow them to draw on savings or debt to spend more during times of recession).Consequently, welfare-related aspects of people’s lives may worsen. Even when levels of health or education return to their pre-crisis paths, it is important to remember there may be more permanent effects for certain groups (or cohorts) within the population that were uniquely affected by the shock. For example, a study on health impacts of the 1980 economic crisis in Peru estimates that there was a 2.5 percentage point increase in infant mortality rates for children born during the crisis (meaning that 17,000 more children died than would have in the absence of the crisis). Similarly, a study on unemployment shocks in Brazil estimates that an unemployment shock to the male head of a household significantly increases the chances that a child will have to enter the labor force and will have poorer schooling outcomes (dropping out or failing to advance).

While it might be too soon to draw conclusions on the effects of the 2008 crisis on household’s well-being, the lessons from past crises still apply: policies which support governments in minimizing the impact of macro shocks on micro variables, such as health or education, are critical to strengthening resilience. In particular on a macro-level, counter-cyclical policies can play an important role in helping countries to recover quickly. Two examples from the region’s experience during the crisis of 2008 are worth mentioning. In the case of Colombia, the central bank had enough room to lower interest rates (that were high because of the country’s high inflation at the time) which allowed them to apply a strong monetary policy (similar to what the U.S. did). In the case of Chile, the country had a fiscal rule that allowed the government to spend strongly in periods of crisis (and forced it to save during booms) which allowed the country to quickly recover through fiscal policy.

However, it is important to remember that policies, such as the fiscal balance rules mentioned here, are not enough on their own to build resilience. Effective governance is a necessary precondition to ensure that countries can commit to these types of long-term goals in practice. Consider, for example, the difference between Chile and Mongolia (a comparison studied in the World Development Report 2017). While both countries introduced similar fiscal rules in order to manage fluctuations in the price of their natural resources (which account roughly for 8 and 30 percent of their fiscal revenues, respectively), in practice only Chile’s expenditure patterns are countercyclical. Therefore, the sole adoption of policies that have proven effective elsewhere does not guarantee anything: they have to be implemented by actors willing to accept and follow the rules in order to be credible and successful.