GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
Obstacles on the road to economic recovery
, February 21, 2009
The benefits of any economic stimulus will be limited, says Colin Teese, because there is little manufacturing industry left in Australia to stimulate.The global financial crisis has so far cost the world 20 per cent more, in today's dollars, than the United States spent on fighting World War II, according to banking giant Goldman Sachs. And we haven't seen the end of it yet.
However, rather than rake over the ashes of the financial crisis, I want to consider how we all might emerge from it.
Long before the crisis started, we had been able to observe the division of the world's economies into saving and spending nations. This created a fundamental imbalance. One group of countries made things; another group bought the output. The first group saved and invested their profits. The second borrowed money to buy what others made.
Among other things this imbalance destabilised the world's financial markets: the West's banks flooded their economies with cheap money, which was lent out indiscriminately.
The Great Depression of the 1930s lasted so long, and had such devastating effects, because, in the beginning, policy-makers of the time at first insisted on sticking with remedies rooted in prevailing economic orthodoxies.
Excessive spending had supposedly landed us in trouble. The cure was to cut public spending, balance the government budget and moreover cut wages and prices. The results were disastrous. Business activity contracted all over the world, banks collapsed and unemployment reached unprecedented levels.
Today's crisis is not quite the same. Back in the 1930s, governments made some efforts to develop infrastructure and prop up manufacturing businesses and employment within the United States.
Now, it is different. Most of the spending economies - of which the US and Australia are notable examples - don't have significant manufacturing industries any more; they've been exported.
Restarting the West's real economies is certainly a first step. And it could give us the breathing space needed to create an enduring world economic framework. However, today's policy-makers seem unwilling to think longer-term.
Some commentators have warned us - correctly - about the dangers of blaming greed or venality on the part of practitioners in the finance sector. Sensibly, we should assume they would behave that way. Those same commentators insist that the fault lies with the central banks which have failed to acknowledge the possibility of bad behaviour by the financial sector.
They have a point. Central bankers, like the rest of our current economic elite, have been trained to believe in the purity and integrity of the free market and its supposedly self-correcting capacity. Nothing in their training has prepared them to recognise, let alone seek to contain, asset bubbles and high levels of personal and business indebtedness. They have been taught to concentrate all their efforts in dealing with short-term goods inflation - as have business leaders and most of the West's policy-makers and advisers.
Central bankers should be identified - and criticised - where appropriate, but we can't really say they alone created the problem. No sins of commission or omission by central bankers created the imbalance between savings and spending economies. Misguided policies - mainly a blind commitment to the ideas of globalisation, free trade and deregulation - led us into that.
These sorts of ideas were embodied in the so-called Washington Consensus, developed by the US Treasury and the International Monetary Fund (IMF) in the early 1990s at the time the Soviet empire collapsed.
The philosophy behind the Washington Consensus was probably well-meaning. After the Cold War, it was thought that it would be better if the world economies could be brought together within an economic and political framework modelled on the US idea of liberal capitalist democracy. This approach was, however, conceptually and economically flawed.
The particular focus was on the emerging economies of Asia. Some of these, notably Japan, South Korea, Taiwan and Singapore, had already settled comfortably into the Western camp. All of these attained economic prosperity (though not necessarily power) by means of being granted privileged access to the US market.
But the two most populous (and therefore potentially powerful) countries in the region - Communist China and the then socialist and "non-aligned" India - were outside the orbit of the West.Two giants
The thinking behind the Washington Consensus was that political and economic stability in the world could be far better served if these two giants were enticed into the Western fold.
The central economic pillars of the plan were globalisation, free markets, and deregulationist economics. The West (notably the US) would grant targeted countries opportunities to export to Western markets, as a demonstration of good intentions. The West, through the World Trade Organization (WTO), would then embrace the idea of free trade and deregulation of financial markets. This the West did to a greater or lesser degree after the WTO was formed.
A side benefit for this new, liberalised West was that India and China, with their cheap labour costs, would be able to supply cheap products to the West and so help it to contain goods inflation which had come to be the West's enduring economic obsession.
By conscious acts of policy on the part of the West, these two economies were unleashed to flourish, as it were, at the West's expense.
India and China were, by far, the most populous nations on earth. And each in its different way was uniquely placed to take full advantage of the opportunities the West presented - cheap consumer goods (in the case of China) and cheap services (in the case of India).
Nobody then was prepared to acknowledge how imperfectly basic trade theory works in the real world. Theory tells us that, as a nation's exports increase, so the accruing economic gains inflate the value of its currency, thereby making its exports dearer. The value of its exports, compared with imports, should diminish. According to theory, this correcting mechanism makes it impossible for any country to keep on accumulating trade surpluses.
But if an exporting country decides to hold down the value of its currency by design, then the theory doesn't work. Japan, over the last 30 years, has been a master of this policy. China and India have been good pupils.
The West, especially the English-speaking West, went along with this policy. It got what it wanted most - cheap goods and services. But there were drawbacks, not immediately apparent. The cheap imports came at a price. Effectively, the West was required to export jobs, investment and national income to enable the cheap goods to be made offshore.
Western countries, such as the United States and Australia, particularly welcomed the flood of cheap Chinese imports, and chose to pay for them with offshore borrowings.
Thus, Western economies actually exported manufacturing capacity (and employment) to the new producing countries that began to accumulate huge export surpluses. These ever-expanding sums, maintained by juggling exchange rates, were thereupon lent back to those buying their exports.
Thus, the surge in imports was funded by offshore borrowing, both by importers and consumers in the Western importing countries. And the borrowings came mostly from the export surpluses of the manufacturing economies of Asia.
Consumers in the many Western economies accumulated unsustainable debt obligations. Excessive credit card lending financed much of the consumer spending. Loose lending by banks sustained this and also funded overspending on housing and share-purchasing, creating an asset price bubble.
Certainly, cheap imports of consumer goods helped the West contain goods inflation; but excessive credit availability encouraged borrowing to the point where inflation attached itself to assets - for example, housing and shares. Central bankers, steeped in economic orthodoxy, were incapable of recognising this as a problem.
The West's bad policies, with the help of its unregulated financial institutions, unthinkingly constructed and delivered to the world a financial time-bomb. The result has been shrinking demand among low-income earners, worldwide. They have over-committed themselves to credit card debt in paying for consumer goods, and are further burdened with repayments on overpriced housing. They can afford no further consumption. As in the 1930s, the demand underpinnings of the economy are crumbling.
The realisation of all this seemed to have hit home in late 2007. It was first manifested in the form of a credit crisis that hit at the same time, but the two events are inter-connected. The immediate direct cause of the credit crisis was the imprudent sub-prime lending for house purchase and other massive consumer spending in the United States.
The consequences of that have infected the entire world. But that could not have happened if consumers had not been encouraged to borrow beyond the level they could afford to repay.
This means that now, according to celebrated American economist Joseph Stiglitz, low-income US consumers are not buying because they have no money to spend. And those with money, he adds, are choosing not to spend.
Neither do other spending Western economies have the money to buy, nor are they in a position to borrow from the saving countries. The saving economies have the money and the manufacturing capacity, but now lack customers. This combination may drive the world into a 1930s-style depression.
Economic stimulus packages may not work any more for those Western, mainly English-speaking countries, which have exported their manufacturing industries and jobs to saving countries.Sustainable jobs
In the end, restarting the US economy comes down to creating new, well-paid and sustainable jobs for US workers. Without an industry base to absorb the unemployed, spending in the West will only create offshore jobs and output which, in turn, won't be able to find buyers. And, without jobs and incomes, US consumers can't buy.
This is bad news for Australia too, as our commodity exports fuel the output of the saving economies' factories. Under the influence of globalisation and free market economics, we have unwisely chosen to put most of our economic eggs into the commodity exports basket.
One thing is sure: the economic philosophy behind the Washington Consensus - globalisation, deregulation, self-regulating markets and free trade - has probably run it course.- Colin Teese is a former deputy secretary of the Department of Trade.