The IMF recently estimated that for the first time in 60 years the world economy in 2009 is very likely to shrink. Some commentators, however, especially in the US, rejoice already about “green shoots” of a recovery. While stock prices have rallied (as they have frequently in the past), I think this hope is premature. We face a very deep, protracted crisis where many of the excesses of the past still need to be undone, especially in Europe. The fiscal stimulus programs and the much larger monetary easing in the developed countries still have to work their ways through the economies before confidence returns. And that will not automatically imply growth recovery.
This green-shoot-talk is dangerous, because it is frequently coupled with the hope that after this episode the world economy will go back to the status quo ante: high growth with high debt and large economic imbalances. Since this growth pattern has brought us into the deepest crisis in 80 years, it is neither probable nor desirable to go back to the previous model – even if vested interests are lobbying strongly for that (viz. many bankers’ reticence to accept the new realities, let alone responsibility; viz. many predators hoping to increase their market share on the cheap). Politicians beware!!
When thinking about a new economic model, it makes sense to differentiate by country type. Doing this we will have to accept the fact that global growth and potential growth during the coming ten years at least will be significantly below the 5% rate of the past years. This implies that much harder choices about what to spend (public and private) money on will have to be made. Citizens who with higher taxes will have to pay for the present stimuli will demand much more accountability from their elected governments:
a) Rich (current account) deficit countries, e.g. USA, UK fuelled their recent growth by debt-financed consumer demand, while extensive debt-financed mergers and acquisitions reduced competition; the crisis has caused consumer demand collapse, caused significant negative equity and leads to increases in precautionary savings, still below average levels. It will take years for consumer demand to return. Maybe future consumers will also realize that “shopping” is not the epitome of life’s fulfilment, that less built-in obsolescence and higher quality in products provides higher satisfaction. In the short and medium run, effective demand will have to come from government spending, both to provide existential security (health, unemployment, pensions, anti-poverty programs) and to secure a better future (material infrastructure, education, training, R&D) with a cleaner environment and less damage to the climate. Only when these are adequate will households once again be willing to spend, once they have rebuilt some personal savings and so collective needs fulfilled. The public will have to make hard choices on what to spend public money, what the future economy will look like, what the growth drivers will be when the accounting contribution of an overboarding financial sector will have disappeared (memo: remember the “de-industrialization” debate in Britain in the late 70’s).
b) For rich surplus countries, e.g. Germany, Japan, their export orientation has produced high productivity gains and falling unit labor costs, thus increasing their external competitiveness – at the expense of domestic demand, because household real incomes have stagnated or even fallen, despite high growth.
The rich surplus countries (with the exception of Japan) can afford to incur higher budget deficits and should do so: spend on infrastructure, on better education, on immigration integration programs, on – yes also in Germany – on effective poverty alleviation.
c) Emerging surplus countries, like China and many other Asian countries have feverishly accumulated foreign currency reserves by a ruthless export orientation, with the purpose to shield themselves from IMF conditionality in case they needed financial bail-outs. This is the legacy of the IMF’s ill-begotten strategy during the Asian crisis of 12 years ago when surplus generation by cutting social expenditures, low wages and undervalued exchange rates threw millions into additional poverty. The endemic high savings rates of these countries have prevented the countries from taking up the “slack” in US consumer demand, since in these countries the lack of existential social welfare conditions, high private health-care and school fees and the lack of old/age and unemployment insurance leads citizens to excessive precautionary savings. In addition, significant infrastructure needs plus high environmental costs require large public investment, as does the need to alleviate widespread poverty. These countries have started to recognize this and are engaging in social welfare and infrastructure spending. Much will need to be done before private consumption will emerge as a strong growth driver.
d) Least Developed Countries (LLDC) are in many cases plagues by current account deficits, on account of their need to import goods for their catching-up process; but at the advice of Western countries, of the Bretton Woods institutions, of their Western-trained elites, their growth strategies have also been focussed on export orientation. Some, especially raw materials and oil and gas producers had a spell of significant export surpluses. This has led in many cases to neglecting diversifying economies out of raw materials or other commodities and cash crops – and has driven wages down, while at the same time privatizations of public utilities have increased basic household costs for the poorest, since inadequate attention was given to affordability considerations. While many LLDC are too small to live on domestic demand alone, their export orientation (frequently nearly exclusively directed towards rich countries) should be geared towards neighboring countries, thus promoting regional complementarities and saving transport costs and thus negative climate effects. These countries are most strongly affected by the crisis – even though they had no role whatsoever in causing it. Estimates point to the fact that private financial flows (FDI, financial investments and loans) from rich to poor countries this year might amount to only 20% of their 2007 peak level of around 1 trill $. In addition, ODA will fall, by 6 bill $ alone from EU countries because of the fall in EU GDP (and the ODA target being defined as .56% of GDP by 2010). A small part of the financing gap can be filled by International Financial Institutions (IMF and development banks), but they come with conditions (frequently still requiring the obsolete previous model features to be followed), but growth will fall drastically, if LLDC need to finance their own requirements out of own resources. Bringing parts of the informal economy into the formal sector, stepping up the fight against corruption, distributing the proceeds from (now cheaper) raw materials among the many – and building up sizeable welfare systems (health, education, pension systems, poverty alleviation) – each country using its own culturally and contextually appropriate model – will be necessary.
e) At the global level, several significant steps forward are necessary:
– The G-20 format must be transformed into a word global socio-economic governing body, regulating macroeconomic, competition, health and safety, environmental and the fight against illegal activities, at a minimum. Membership must be changed to include some of the small and poorest countries, at the expense of some EU countries.
– Global standards for financial regulation must reduce the financial sector from domination to utility standard. Common principles and rules of enforcement are necessary, especially for those parts of the financial sector which does cross-border business. This includes the fight against tax havens, transfer pricing and shell companies, but also within otherwise complying countries. Financial transaction taxes might reduce some of the non-value creating trading activities, detrimental incentive structures for risk-taking and compensation must be effectively forbidden.
– Global incentive structures need to be developed to sanction both persistent current account deficit and surplus accumulation. These include the formation of regional currency regimes, of creating currency baskets for world trade and accounting, as well as binding rules on global money supply policy.
-Crisis alleviation must go hand in hand with more global attention to combating the effects of climate change. All countries must be drawn into this fight, the advanced countries must lead with technological and economic instruments for mitigation and adaptation, the less advanced countries need to develop their own instruments, in order to avoid inflicting similar damage as did the advanced countries. Mechanisms to share the costs according to polluter-pays-principles must be implemented world-wide.
– Development of institutions at the global level which tie economic policy decisions into a social and environmental framework. In this respect, special attention to global income distribution is necessary, ie. a renewal of commitments towards a balanced global development. As more policy attention at the national level needs to be directed to income distribution, the same is necessary at the global level. Social unrest, the uneven effects of climate change, droughts, pressure to migrate from impoverished home countries are a threat to world peace.
The era of the financial sector determining the welfare of the global citizenry is over. Its role as a growth driver for developed and emerging countries has come to a halt. The financial sector needs to return to its utility role of serving the “real” sector and the citizens. Deleveraging the global economy will be painful for many years to come. It will hurt all citizens in all countries, but mostly the most vulnerable. Policymakers must make sure that these costs do not fall exclusively on middle-class taxpayers and the poor. The financial sector of the future will be smaller, so bankruptcies will be necessary, both in the financial industry as in the real economy where massive overcapacity has been allowed to develop (e.g. the automobile industry). What the financing of the gigantic stimulus packages rich country governments are engaging in (both the US and the UK will run deficits in excess of 10% of GDP) will do to financial markets is unclear. In the short and medium run, public consumption and investment will have to bear the burden of restoring effective demand. These expenditures should prioritize to alleviate poverty, build social sectors for existential safeguarding and the material and immaterial infrastructure for the future society. Citizens will have to pay off these increased debt levels for many years. The situation is serious enough that it warrants to slaughter some of the “holy cows” of yesteryear: wasteful doubling of competencies, inadequate incentives for fiscal federalism, investments in armaments, politicians’ prestige projects, lavish international summits, etc. In all economic policy decisions social and environmental aspects and effects must be taken into account much more prominently than during the past decades. In the rich countries, we have wasted environmental and human capital, in the poor countries the effects of the predominance of business considerations over societal ones are being felt especially strongly.
Both the domination of the financial sector and of the US dollar need to come to an end. It is massively destabilizing if one sector runs wild with self-serving effects and infects the global economy with contagious risk. The same is true if the world’s largest debtor can absorb ¾ of global savings without effect on its currency. This system has led to the present crisis, it needs to evolve into a more sustainable one. Societal wellbeing has to trump sectoral and personal gain. If politicians do not act on this soon, the public will make them hear it with a loud voice.