When the US Sneezes…

January 15, 2009

It’s the cold and flu season in London: my son has been battling a cough and related ailments for what seems like the entire winter, on and off.  It’s also cold and flu season in the international economy, and the US credit crisis is contagious.

As I’ve written before, the claims that contagion is a thing of the past – that economies have “decoupled” or that international investors had become more sophisticated and would not pull their investments from unrelated developing economies at the first sign of a sniffle elsewhere –  is unrealistic.  The old maxim, “when the US sneezes, the world gets a cold,” is looking even more true now than it did in January 2008.  The credit crisis has created debt and exchange rate concerns for a number of countries in developed and developing economies: Iceland, Hungary, Argentina and Brazil in addition to the UK and other Western European states.

That contagion is still with us is the bad news.  The worse news is that there are new transmission mechanisms between developed and developing countries to spread the economic malaise. In the past decade, remittances – money sent by workers in one country back to their home countries – have become an increasingly important part of flows of development finance.  Mexico, for example, received $20 billion dollars of remittances in 2005.  That was more than the total inflows of foreign direct investment in the economy by some margin (the World Bank reports that in 2003, remittances were 125% of FDI).   In 2008, remittances were Mexico’s second largest foreign exchange earner (after exports of oil).  While development specialists have argued about whether remittances are pro-developmental (i.e. whether the money goes to the poorest and is used to improve livelihoods), the fact is that they have became a major source of income for people living in developing countries with high levels of emigration.

But as the US economy slows down, so does the flow of remittances.  The Mexican Central Bank announced this week that remittances fell by 2.0% last year, the first fall ever recorded, and expectations are that remittances will fall another 2.5% in 2009.    Declines in remittances from low-skilled / semi-skilled immigrants might be even higher than the average as many of the industries in which they work will be strongly affected by the crisis: domestic service (people cut back on nannies, cleaners and other additional staff when times get bad), restaurants, construction, etc.   As low-skilled immigrants are likely to have left the poorest families back home, this is doubly bad for development.

The FT reports an interesting series of knock-on effects in the state of Michoacán, Mexico: the use of traditional medicine has increased as people have less money to pay for Western-style health care.  While this might not help to cure the contagiousness of the credit crisis, it could be of some use in curing my son’s cold…

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