Message to Policymakers: The Crisis Offers Opportunities

 Our system has come to an end

The deepening dual crisis – of financial markets and the real economy – is threatening to endanger much progress that has been made in the wellbeing of the global population during the past years.

This statement needs to be qualified, insofar as the huge economic progress, as measured by per-capital GDP growth has been hugely uneven – both between countries and within countries income distribution has worsened significantly, and has come at high environmental costs and a reduction in non-market public services. Thus, while some countries and within them, some persons increased their wealth significantly, the well-being of many others was reduced, both in terms of monetary income and access to non-monetary resources.

Policymakers all over the world are rather clueless how to combat this crisis, both of  effective demand and of confidence (mainly into the financial system). As a result, they heap previously unheard-of sums of liquidity on banks and the economy. The projected budget deficits e.g. of the U.S. and the U.K. are unheard of in times of peace. While all kinds of lags are still operating, it is (still) unclear whether all these efforts have stabilizing effects or are just wasted – with significant costs to future taxpayers.

We all have to learn the hard way that “the market” is not self-correcting, that the dismantling of regulatory instruments reining in the inherently unstable financial markets in the name of self-regulation was wrong, that the economic system is much more influenced by psychology (in this case “loss of confidence”) than the  policymakers of the last decade had thought. While the U.S. President is doing his considerable best to influence his voters’ psyche in a positive way, little of that (verbal) leadership is visible in Europe. This may also explain why so far at least the European efforts to jump-start the economy lag behind the American ones.


Task One: Get Liquidity Flowing, Reinstate Confidence

John-Stuart Mill and David Hume famously developed the Quantity Equation of Financial Transactions, M x V = P x Q where M is the money supply, v the “velocity of money (i.e. the rate of turnover), P the price level and Q the quantity of goods supplied by an economy in a year. During the present crisis V has come to a standstill; policymakers are increasing M, in order to enable the financing of a higher national product. So far V has remained frozen at close to zero, thus the increases in M have not stabilized PQ. The reason is the basic distrust of financial institutions in each others’ balance sheets and ability to repay loans. Instead of lending the additional liquidity injected into the economy to businesses and consumers, banks are putting this money into (badly remunerated) over-night facilities in their central banks – and take it out again to hoard the next day. One way to make this even less profitable would be to charge negative interest rates for such “pyjama parties”. Still, it would not solve the psychological problem. However, if suddenly velocity jump-started again, together with the increase in the money supply, this could cause very large inflation – unless liquidity is withdrawn quickly and effectively by the central banks.


Task Two: Increase Public Consumption and Investment

A number of countries have undertaken tax reductions as stimulus, in order to put more money into the hands of consumers and businesses, with the aim to increase demand. However, in such uncertain situations, consumers rather save than spend and businesses, sitting on full inventories, have better to do than to invest in new capacity.

A much better way would be to use this stimulus to boost investment in public consumption, i.e. in material and immaterial infrastructure, improvements into social services and health care, education and research and development, as well as into climate-change-mitigating measures. In the face of increasing poverty in the world, both in rich and especially in poor countries, major attention and funds should be directed into short and long-term poverty alleviation measures.

Especially for less developed countries and emerging countries, efforts to increase consumer spending fall in deaf ears in the current situation. Which consumer would spend extra tax savings, in the fact of looming unemployment, of lacking social services, of no pension system, no universal healthcare (that provision was abolished in China in 1979 and has since lead to a halt in increases in life expectancy)? It is especially such countries which should put all their efforts to counter the lack of export demand into quickly setting up some sort of general welfare state systems. Only when citizens feel no existential threat will they be willing to spend more on personal consumption.


Task Three: Increase the Costs of Global Trade

While the general benefits of free trade are (nearly) universally recognized, some of the damages caused to countries (as a result of unequal trade relations) and the global environment have become glaringly apparent. We also see that the crisis which started in the US has destroyed export demand in large parts of the world. Individual “beggar-thy-neigbor” strategies, where one country attempts to gain competitiveness at the expense of other countries, cannot work globally.. On the contrary, they will lead to the protectionist spiral which exacerbated the Great Depression during the first third of the last century. Full-cost pricing of transport, which includes the environmental and social costs will slow demand. As a result, in the future trade growth and thus GDP growth will be slower. Countries and regions will have to develop more strongly their domestic demand, and trade less globally and more regionally, thus reducing the high environmental costs associated with world-wide trade. This is not a plea for self-sufficiency, but rather one for a return to a more sensible trade pattern.


Task Four: International Solidarity

Most less developed and emerging countries (with the exception of  China and oil exporting countries) so far have not had the means to create significant stimulus packages of their own. They will need help from the international community, because for them generating large public debt is not an option, since they will be crowded out of financial markets. While OECD governments still have obligations to fulfil their development aid targets (for the EU countries at least .51% of GDP by 2010 and .7% by 2015), under the given political and budget restrictions it is rather doubtful that this will be achieved – even though the necessary sums appear to be peanuts relative to the banking and stimulus packages enacted. In this situation, it will be up to the IMF to help these countries with cheap loans. The recent call to increase the IMF’s resources, be it via increases in the New Arrangement to Borrrow, an increase in Special Drawing Rights allocation, or a selective or general quota increase. Such help, supplemented at the project and programme level by the international development banks may be able to mitigate mass poverty-driven emigration, more drug-trafficking and smuggling and thus a more peaceful world. In addition, such budgetary and balance-of-payments help must be supplemented by a global trade agreement which makes for “fairer” trade, respects the different levels of development of participants (including quasi “infant-industry” arguments) in order to be sustainable in the medium term.


Crisis Response and New Growth Model Go Hand-in-Hand

Many argue that first the immediate effects of the crisis must be mitigated by increasing effective demand, especially by consumers. Only then should and need the “new growth model” or a new economic system be contemplated. While rapid crisis response is necessary, the short term and the medium term need to be tackled simultaneously. We cannot go back to the status quo ante, because the “old system” has proven to be unstable and crisis-prone. We must now take the opportunity to create a more sustainable system. To this end, we have learned the hard way that ideology is a bad guide to economic and social policy. We need to recognize that in our modern European economies around ½ of all activity is produced outside the “market”, that we need to strengthen the collective system of solidarity and find a pragmatic way to rein in the destructive forces of markets when left to their own devices. One important facet of this thinking is that we have to tackle financial market regulation right away: both all instruments, all institutions and all jurisdictions need to be regulated; both individual and systemic risks need to be assessed and  monitored. A number of suggestions to that effect have been made recently. They need to be expanded and enlarged and implemented on a world-wide scale.


A number of very difficult tasks lie ahead of policymakers. Getting from the “old” model to a “new” socio-economic system will require wisdom and strong leadership: many, politically very powerful vested interests will offer resistance. Many banks and enterprises will have to fail, many fortunes will be lost. However, policymakers should not be concerned about the rich few, but rather about the many poor and many “regular” citizens. To devise programs that they are not thrown into destitution, that they can learn new skills, that they can work to improve the environment and see each other not as enemies, but in solidarity, is the overriding task. The present crisis is harsh, but offers opportunities to turn around. The previous system was not sustainable, the future one should be better.



Filed under Crisis Response

3 responses to “Message to Policymakers: The Crisis Offers Opportunities

  1. Bernd Berghuber

    Kurt, thats a good point: of course it is up to the shareholders to change the policy of the fund. But, given that mojorities change in favor of developing countries, do you think it is likely that (please forgive me my prejudice) conservative central bankers, would agree on a reform of the international monetary and, what is more, would acknowledge that monetary policy has an influence on long-term growth strategies (e.g. via exchange rate policy)? Having in mind that in recent years more and more central banks have switched to the sine-qua-non of mainstream monetary policy, complete indepence and a strict inflation targeting regime (which of course has its benefits in certain respects!), I have doubts.

  2. Bernd Berghuber

    Dear Kurt,

    I fully agree with the four tasks you presented and I also agree that we need to use the political momentum of the crisis to switch to a more sustainable growth model. But I see an important difference between the model of the crisis and a sustainable long-term growth model. There is, as you pointed out, a need these days for huge public demand because neither consumers nor companies are eager to spend or invest. However, I think in the long run growth dynamics should be driven by private consumption (having an eye on sustainable lending of course) and (preferably green) investment with the public sector providing a stabilizing anchor for confidence and expectations (social security and other non-market activities, financial market regulation) and having a steering role for the economic pattern of a country (e.g. distributional, environmental and industrial policy).

    Talking about a long-term growth model you should as well take into account that not only countries’ currency regimes and export strategies shape international trade relations, but that IFIs, especially the IMF, have been influencing these strategies or have provoked reactions to those attempts (early redemption, build up of currency reserves as a self-insurance, sovereign wealth funds). I am afraid that international solidarity in the form of a propping up IMF fire-power is necessary to fight upcoming currency crises, but will not help to achieve the growth model we are talking about (or have you heard of an IMF conditionality, for example, requesting a broadening of the tax base to allow for an increase of public expenditure?). Reforming the IMFs policy regime as well as the international monetary system (UNCTAD, for example, proposed a system of a few leading and several satellite currencies to improve real exchange rate stability) are necessary to rebalance global economic forces. This is important to create disincentives for the distortionary, competitive use of exchange rate policies. For in the end, stability of the system is a prerequisite for sustainable national growth models.

    • kurtbayer

      Bernd: thanks, I agree almost compeletly; especially on your first point we mainly have a difference in sequencing: at present I do believe in increasing public consumption and investment, especially in the surplus countries, both as a means to stabilize demand and to build future welfare-enhancing material and immaterial infrastructure; in the longer run, part of this demand should revert to private consumption and investment for well-being in a sustainable manner.
      On the second point, referring to the international institutions, I do believe – and it has been my experience – that they or their secretariats are not “hanging in the air”, they are not independent from their shareholders. Thus they essentially express their shareholders (majority) will. For this reason, we need much more balanced influence and voting power by emerging and developing countries in the future, such that more “balanced” decisions will be made by them. In this way, I have also come out against the present G-20 group as the optimal role model for global economic governance, because it lacks participation by the poorest countries. It is quite absurd, that both Spain and the Netherlands weaseled their way into this group (condoned by G. Brown), increasing the rich countries’ participation – but that not a single IDA country is present. At least one poor country from each continent should have been included. As it is, the poor countries which in this crisis are not at all to be blamed, are once more at the mercy of their “wellmeaning” rich global neighbors.

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