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The Effect of Financial Crisis on International Security

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 The Effect of Financial Crisis on International Security

Muhumed Mohamed Muhumed

Department of Political Science and International Relation, Istanbul Aydin University. Istanbul,

Turkey.

December 2016

Abstract

In twenty-first century threats are no longer limited to military threats and the state is not the sole

source of threat anymore. In this concise article, the effect of financial crisis on international

security has been examined. Due to globalization, countries across the world became

interdependent politically, economically, socially and culturally. Thus, crisis started in specific

sector of specific country can easily and rapidly spread to many countries. Financial crises lead to

declining defense and law enforcement budget; regime collapse; growing nationalism, and

prolonged unemployment and widespread poverty, resulting radical and violent movements.

Keywords: international security, threat, financial/economic crisis, globalization.

Introduction

Defining financial crisis may not be easy for various reasons. It is not easy to determine a moment

of financial crisis using single measurement of indicators. The main reason is that financial crisis

come to being through different forms. It may originate from diverse areas in finance or financial

markets. Throughout the history, most of the previous financial crisis experienced by the world

had different origins and had to do with certain issues. Some were related to currency; others

mortgages; others debt; others fiscal issues, so on and so forth. Crisis prevail in a situation whereby

substantial changes occur and may lead to unstable or dangerous situations. Financial crisis has to
do with either considerable change in asset prices, currency value, credit volume, money supply

and banking activities, balance sheets of firms, banks, households etc.

Claessens and Kose (2013) classify four types of financial crisis: currency crisis, sudden stop, debt

crisis and systematic banking crisis. Currency crisis prevails when currency speculation leads to

the devaluation or depreciation of the currency. In a situation like this, governments are obliged to

defend their currencies. Governments may defend their currencies in different ways, and the

government approach is normally governed by the nature of the problem. Governments may

impose capital controls, spend huge amount of foreign reserves or increase interest rates. A sudden

stop is crisis associated with the balance of payments, particularly the capital account. In this type

of crisis, considerable, unexpected amount of capital inflows are visible. This can be explained

balance of payments deficits in other words. Debt crisis comprises both foreign debt crisis and

domestic debt crisis. A country experiences foreign debt crisis when it cannot service or pay debts

from foreign countries, banks, International Monetary Fund, World Bank etc. Domestic debt crisis

exists when a country cannot pay its debts from local banks and the public through bonds. When

countries go into default, debt crisis prevails. Finally, a systematic banking crisis is that crisis

resulted from banks’ failures to convert liabilities. When banks run out of required reserves or

deposits in general, they fail to pay interests, repay their debts or pay cash to the depositors. This

compels governments to interfere and provide capital assistance or bailout.

Financial crises are not necessarily limited to the above-elaborated types, but those are the four

major categories of financial crisis. We have a couple of examples for these types. The Asian

financial crisis in 1997 was initially started from the change of the value of the currency of

Thailand, followed by the currency of other Asian countries. Likewise, the crisis of Greece started

when Greece went to default and could not service its debts.
In this concise article, I am going to examine the effect of financial crisis on international security.

Financial crisis is therefore our independent variable while international security is our dependent

variable. The study employs qualitative research design, analyzing and reviewing available

literature addressing about this topic. Textbooks, journal articles, reports and policy documents

will be analyzed throughout the study to figure out the impact of financial crisis on international

security. It is obvious to many that financial crisis is among the main threats to international

security in twenty-first century and negatively contributes to it. We therefore attempt to find out

the extent of the influence compared to other threats. As we defined and explained financial crisis

in the previous paragraphs, let us now focus on international security.

The concept of international security evolved over time and took different meaning and

explanation in twenty-first century. Historically, military threat was the main threat in the political

realm, always generated by states. Therefore, security studies could be defined as analyzing the

sources and control of military threats. However, that is not the case in twenty-first century. Threats

are not limited to military threats and the state is not the sole source of threat anymore. Threats are

coming from financial crisis and economic mismanagement, terrorism, mass destructive weapons,

refugees, poverty and hanger, ethnic polarization, criminal gangs, epidemics, over-population,

climate change so on and so forth. The globe is under threat and thus there is a growing awareness

of how to save it through collaboration of states, international organizations, communities etc.

(Heurlin and Kristensen).

The article is organized as follows: section one is the introduction. Section two examines the role

of globalization on the extent of the effect of financial crisis, while section three explores the role

of international economic/financial organizations – IMF and World Bank in particular. Section

four offers and overview of two recent, major financial crises namely, the Asian Crisis of 1997-98
and the Global Financial Crisis of 2008 to understand how big is the impact of financial crisis in a

globalized world. Section five, which is the core of this study, elaborates how financial crisis affect

international security and the possible implications of this effect. Finally, section six concludes the

study.

The role of globalization

Why crisis started in specific sector from specific country spread rapidly across other countries?

What makes the spreading of financial crisis easier? Why the economies or financial markets of

different countries are closely interconnected? A very simple answer of all these questions is

because of economic globalization, economic integration or globalization in general. Let us go

each of these concepts into detail.

Globalization is the interconnectedness or the interdependence of the global states and populations

led by increasing movements of people, capital, information, ideas and goods across nations and

national borders. World populations are interrelated in terms of politics, economy, social and

culture. This interconnectedness is driven by various factors, mainly technology. Economic

globalization is the amalgamation or integration of national economies into the international

economy through capital movements or foreign investment, trade, and labor mobility. It is

determined by trade, capital flows, and migration (Schreier 2010).

Financial globalization and financial integration are basically dissimilar concepts. Financial

globalization associates with increasing global connections through financial flows across borders.

On the contrary, financial integration refers to the connections of single country to the global

financial markets (Prasad et. al. 2003).

Economic or financial globalization can sometimes directly contribute to the economic growth of

the country by fostering investment through the flow of capital and minimizing trade barriers. It

also provides larger market for the production and exports. It also enhances technology of

production. Since different economies are open to one another, they not only exchange goods,

money, and people but also ideas, knowledge and technology. The competition in the international

market also motivates governments to improve their product quality, specialize in certain

commodities, and also enhance the efficiency and effectiveness of the local institutions. In

contrast, globalization costs are considerable. Economies become vulnerable to external shocks.

They also lose their sovereignty and economic freedom in the sense that they become subject to

external policies from the international institutions. These policies may not always match the local

economic features (Prasad et. al. 2003).

The role of the World Bank and International Monetary Fund (IMF)

The World Bank and IMF were created in a meeting held in Bretton Woods, New Hampshire in

1944, and for this reason they are famously known as “Bretton Woods Institutions”.

The World Bank aims at assisting the development of developing countries by providing technical

and financial assistance (World Bank 2016). Likewise, IMF aims to enhance economic growth and

stability by providing technical support and financing to member countries with economic

difficulties (International Monetary Fund 2016). Having similar structure and membership, they

attempt to provide more stability and certainty for the globalized economy (Gerber 2014). Since

globalization influences the developing economies through trade in goods, flows of capital and

migration of people (Collier 2007), the World Bank and IMF are heavily involved in the second

process.
The IMF as well as World Bank loans retard the economic growth (Przeworski and Vreeland 2000;

Barro and Lee 2003), and widen the gap between the rich and the poor (Gilbert & Unger 2009).

These insitutions also many times lead to global economic instability. IMF and World Bank

conditioned loans also weaken the economic freedom and sovereignty of the recepient countries

by imposing policies against their will (O’Driscoll et. al. 2003; Stiglitz 2006).

The reliability of IMF’s reports, and its predictions on economic performances have been under

fire. Both investors and lending-countries often use IMF reports and policy documents as

foundation of their decisions. Several times before the Asian crisis, IMF failed to predict problems

or even worse, its predictions were misleading. The policy advice and technical assistance

provided by IMF during crisis are sometimes painful and exacerbate the situation of those

countries struggling with crisis. During the Asian crisis, for instance, Malaysia survived the crisis

earlier after rejecting IMF’s conditioned loans, policies and imposing capital control. that put

restrictions on movement of both currencies and capital (Sundaram 2015).

The Asian crisis (1997-98) and the Global Financial Crisis (2008) at a glance

Since 1950s, some Asian economies were rapidly flourishing and their models became example

for many other states in different parts of the world. These successful economies were the Dragons

(Singapore, Taiwan, South Korea and Hong Kong) and Tigers (Malaysia, Indonesia, Philippines

and Thailand). However, in 1997 the storyline, all of a sudden diverted to another direction. The

well-documented Asian crisis started when the Thai government abandoned defending its currency

due to continuous pressure. This resulted the Thai Baht to lose around 15 percent of its value.
Other neighboring countries then experienced this currency crisis and its effect spread far and wide

(Allen and Gale 2007).

Apart from that, currency crisis were the starting point of the Asian crisis, it evolved over time and

took different faces and shapes. The causes of Asian crisis can be summarized as: the governments’

failure to defend their currencies; huge investment funded by superfluous borrowing; weak and

ineffective financial regulation; government-infiltrated banking systems; absence of transparency;

and wage rigidities in labor markets (Kim 1998). The crisis severely affected the region, whereby

numerous banks, other financial institutions, industries and firms went bankrupt. The outcome was

substantial decline of output which lead to higher unemployment (Allen and Gale 2007).

As we can all recall, the financial meltdown of 2008 appeared initially in the housing and mortgage

sector in United States. Apart from giving mortgages to unqualified borrowers and easing

conditions, the housing prices started to rapidly fall between 2006 and 2009. During this period,

the housing price index of US fell around 31 percent. This was accompanied by a sharp increase

of oil and other commodities prices. This exposed a danger of insolvency to many financial

institutions. Among these institutions were investment banks. Risk premium of all kinds of lending

increased and the loss of the stock market value was considerable (Jones 2009).

Financial crisis and international security

As we have mentioned earlier, security in the twenty-first century is not only dealing with military

issues and states are no longer the main sources of threat. Threats are originating from diverse

sources whereby international organizations and non-state actors could be a vital reason of

international security to deteriorate. The principal threats to international security in twenty-first

century include but not limited to financial crisis and economic mismanagement, terrorism,
weapons of mass destruction, refugees, poverty and hanger, ethnic polarization, criminal gangs,

epidemics, over-population, climate change, water crisis, and globalization per se.

Crisis are natural feature of globalization. Due to globalization, different economies and markets

are interconnected. Certain markets hence react to changes taking place in other foreign markets

or international markets. Net capital flows to emerging markets, for instance, are positively

correlated to US economic fluctuations. This correlation results emerging economies to be

susceptible to financial, economic and all other external factors. These external factors affect their

financial markets, domestic production as well as trade and capital flows between them and other

countries including US. Composition of capital inflows and maturity structure of external debt,

according to empirical evidences, lead emerging economies to be highly vulnerable to risks of

financial crisis (Prasad et. al. 2003).

Financial crisis cause substantial fall of economic growth. During the 2008 financial crisis, Asian

emerging economies experienced decrease in private investment which contributed to the growth

negatively. As a result, foreign trade and net exports declined, followed by lower levels of

consumption. In addition, majority of East Asian economies faced extensive currency depreciation

against US Dollars (Goldstein and Xie 2009).

Financial crisis leads to increasing security threats both nationally and internationally. The reason

is that budgets for defense and law enforcement institutions are regularly falling as well as applying

strict saving measures. As a result of financial crisis, numerous countries suffered from lower or

negative economic growth, higher levels of unemployment, budget deficits, deteriorating balance

of payments and other negative effects. In order to survive from these drawbacks and lessen the

consequences of crisis, many countries should apply not only monetary and fiscal but also
legislative and political measures. Paying more attention to improving economic conditions may

cause the government to be too weak to protect the society from potential threats (Ivancik 2011).

Crumley and Karon (2009) argue that financial crisis and economic recession cause three principal

security threats. Firstly, long-lasting economic recession accompanied with lower levels of

production, investment, consumption, government spending as well as higher levels of

unemployment and possibly inflation will lead to regime collapse. That vacuum and state failure

will therefore give chance to terrorists, pirates and other violent groups. Secondly, crisis is

associated with rising nationalism. This can be either rising anti-immigrant movements in

developed countries, or promoting protectionism policies in developing countries. This

disintegration between economies undermines the possibility of collaboration and economic

recovery. Thirdly, due to increasing unemployment, both activities and power of organized

criminal groups rises that deteriorates the security in national and international levels.

Rogers (2008) also have very close argument. Because of the absence of international-level

collective response, financial or economic crisis will remain the biggest threat to international

security. The reason is that these crises leave millions and hundreds of millions of people in

poverty. Consequently, violent and radical movements will spread among societies, facing strong

force from the government. The result will be widespread conflict.

The Global Risks Report of the World Economic Forum listed economic/financial crisis as the

greatest global risk in terms of impact in recent years. Asset price collapse was the greats global

risk in 2007, 2008,2009 and 2010. Fiscal crisis was the greatest global risk in 2011 and 2014.

Major systematic financial failure was also the greatest global risk in 2012 and 2013 (World

Economic Forum 2016). This implies that between 2007 and 2014, the world suffered from

financial crisis as the main threat to international security. Even though there were terrorism,
refugee crisis, health crisis and even military conflicts in certain regions, financial crisis affected

many parts of the world and hundreds of millions of people. The impact is therefore significant

globally, as the report demonstrates.

Conclusion

In this article, we investigated the impact of financial crisis on international security. Due to

globalization, military threat is not the sole source of global threat any more. Threats to

international security in twenty-first century include but not limited to financial crisis and

economic mismanagement, terrorism, weapons of mass destruction, refugees, poverty and hanger,

ethnic polarization, criminal gangs, epidemics, over-population, climate change, water crisis, and

globalization.

Globalization resulted countries across the world to be interdependent politically, economically,

socially and culturally. This permits the financial crisis started in specific sector in specific country

to easily and rapidly spread to many countries. For instance, currency crisis in Thailand resulted

the Asian Crisis 1997-98. Likewise, the mortgage crisis took place in California, US, caused the

Global Financial Crisis of 2008. Not only US but also countries as far as Iceland paid the highest

price of this crisis.

In the wake of financial crisis, countries reduce budgets for defense and law enforcement

institutions to deal with the consequences of crisis. The government then becomes too weak to

address threats to security. Financial crisis followed by persistent recession leads to regime

collapse. This results growing number of violent groups that may deteriorate the national security

and then possibly the international security. Growing nationalism in both developed and

developing countries also weakens the chance of global cooperation and recovery. Moreover,
widespread unemployment and poverty caused by the crisis will also trigger strong criminal,

radical movements and conflict. (Rogers 2008; Crumley and Karon 2009; Ivancik 2011)

Given that the world suffered from the largest crisis since the great depression of 1930s, the cause

of the current crisis is due to the weaknesses of neo-liberal model, which dominated the global

economic markets for decades. These weaknesses originated from failures of policies and unstrict

regulations in many developed countries. The costs of saving the economy from this crisis –

bailouts and recapitalization – are growing tremendously (Schreier 2010). However, these minor

efforts of government interference and trivial regulatory reforms are not sufficient when dealing

with global economic security. This could just avoid global financial meltdown or total collapse,

but would not ultimately solve the problem of repeated crisis. A paradigm shift is thus necessary.

This can be a new version of capitalism; a more environmentally and socially responsible system

or a system that approaches development by focusing more on productive investment (Dellios

2008).

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