ECONOMIC AFFAIRS: by Patrick J. ByrneNews Weekly
Still coming to grips with the global financial crisis
, October 15, 2011
World leaders have not yet come to grips with the causes, let alone the solutions, to the global financial crisis (GFC), which now threatens to evolve into a global depression.
Joseph Stiglitz, the Nobel Prize-winning economist and professor at Columbia University, has identified three fundamental problems that caused the financial crisis of 2008 (Project Syndicate, September 3, 2011).
First, rising productivity (output per worker) in manufacturing industries has meant that fewer workers are needed to supply consumer demand worldwide.
The fall in manufacturing’s share of the labour force is comparable to the decline in the farm labour force from around 40 per cent of the workforce early last century to about 3 per cent today. The problem in Western countries has been exacerbated by globalisation, which has seen much manufacturing shift to lower-wage nations in East Asia.
While labour can shift from manufacturing to service industries, on average workers’ pay is less in services.
Second, there is a growing disparity of wealth, partly within Western nations but also between those nations that spend (e.g., the US and the EU) and those that save a large slice of their trade revenue, particularly the oil-exporting nations.
Third, following the 1997-98 East Asian economic crisis, many emerging nations have built up huge foreign currency reserves, now estimated to be $7.6 trillion, as a buffer against volatile hot-money flows and sharp currency fluctuations, which can rapidly undermine a small economy.
These vast savings have also reduced global demand. Further, to achieve these savings, countries such as China have manipulated their exchange rates to keep their exports at competitively low prices.
The theory of globalisation held that as a country’s exports grew, its currency would appreciate, making its exports less competitive. Conversely, an importing nation would find its industries more competitive, reducing the demand for imports. This mechanism was supposed to balance out trade in the medium to long term. But this self-correcting mechanism is jammed, and has led to huge disparities in world trade, between the big-exporting and big-importing nations.
In turn, the banks have facilitated the transfer of these savings into property, stock and speculative financial markets. This process generated a vast speculative bubble, eventually bringing the financial system into crisis.
According to Stiglitz, US consumers are unlikely to return to their pre-crisis levels of consumer spending to kick-start the world economy. Not only are Americans suffering prolonged high unemployment, but before the crisis the bottom 80 per cent were spending 110 per cent of their annual income, living on debt. Now they are spending just 80 per cent of their incomes.
At the core of this crisis have been the major imbalances in world trade and the deregulation of the global financial system.
The solution will require new mechanisms to bring about not only a greater rebalancing of trade between nations but also comprehensive banking reform. Both will be difficult to achieve.
Power over trade resides largely with the Group of 20 (G20) bloc of nations. These nations are split between the big-surplus trading nations and the big-importing and debtor nations, as pointed out by British financial commentator Ambrose Evans-Pritchard (UK Telegraph, Oct 2, 2011).
Evans-Pritchard predicts that if a new world trading and currency system cannot be devised, then more countries will resort to protectionism, as occurred in the 1930s with disastrous consequences. He says that the risk is that the US could opt for a variant of Britain’s old Imperial Preference scheme, which was a “pro-growth bloc created behind tariff walls by the British Empire with Scandinavia, Argentina and other like-minded states in 1932”.
He imagines that this could start with the US first clampdown on dumping, then escalating its tariffs. This would allow the US to recover behind a protectionist wall.
This could force Mexico and Central America to form their own trading bloc, which could be broadened to include Mercosur (a customs union, founded in 1991, consisting of Argentina, Brazil, Paraguay and Uruguay). Other looser alliances such as BRIC (Brazil, Russia, India and China) would wither on the vine.
“Ultimately, America would get its way. Korea and the Asian Tigers would come knocking. The austerity brigade and mercantilists would be shut out until they capitulated. The rules of world trade system would be redrawn,” says Pritchard.
Meanwhile, other new policies will be needed at the level of the nation-state: jobs training, reductions in inequality, new sources of energy, rebuilding of industries and banking reform.
The recent UK Vickers Commission recommendations on banking reform are important. It recommended that the core activities of the banks — e.g., deposit-taking and lending to small-to-medium businesses for productive investment — should be “ringfenced” so that they operate regardless of other stresses on the banks.
Writing in the UK Financial Times (September 13, 2011), John Kay says that the assets and liabilities of the UK banks exceed £6,000 billion, four times the county’s income and 30 times the £200 billion loaned to British businesses.
The welfare system has mitigated the effects of the GFC. Keeping small-to-medium businesses functioning is equally important, particularly as solving the ultimate causes of the worsening GFC is still a long way in the future.