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.