(UNDP) – Over the past few decades the world has suffered deeper and more frequent financial crises that have spread rapidly to other economic sectors, creating uncertainty, affecting livelihoods and threatening social stability. In the most recent crisis global unemployment increased by nearly 30 million between 2007 and 2009, while current unemployment estimates remain far above pre-crisis levels. Economic shocks can have long-term negative consequences, especially if they trigger a vicious cycle of low human development and conflict. Natural disasters and political shocks—such as droughts and coups d’état—usually have strong negative impacts on human development. But financial shocks—such as banking crises—are the most probable trigger of HDI downturns. The number of countries affected by banking crises appears to be higher in periods of high international capital mobility. Between 1950 and 1980, when capital controls were common, few countries had banking crises. But after capital flows were liberalized and financial markets further integrated, the incidence of banking crises soared (figure 2.9). The Nordic banking crisis in the early 1990s, the Asian financial crisis in 1997 and the recent global financial crisis exemplify this growing instability.
Although the poorest countries were more insulated from the initial financial shock—due to their limited integration in global capital markets—they were extremely vulnerable to secondary transmission channels, such as declining external demand for their exports and lower foreign investment. Developing countries traditionally are less able to cope with large economic shocks and usually take longer to recover from crises. For instance, the volatility of GDP growth is often higher in the poorest countries—except in recent years— and the proportion of years spent in deep recession is also higher for them, due partly to their undiversified economic structures and limited policy space.
Economic crises often generate unemployment and hardship, but economic booms can enhance inequality—which may contribute to the next crisis. Indeed, inequality can be both a cause and a consequence of macroeconomic instability. A more equitable distribution of income can boost economic growth and promote greater social and political stability. Low income inequality has been associated with longer growth spells and thus greater economic sustainability.