The Global Financial Crisis: An Optimistic View

Professor Ajit SinghProfessor Ajit Singh

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This contribution differs from most commentaries on the current crisis and its evolution. It presents an optimistic view of these issues and the policies adopted to resolve it. I shall argue here that because of these policies, this is likely to be a short, albeit a deepish recession, with the world economy recovering reasonably quickly.

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Scenario

Credit to Policy Makers and triumph of Keynesian Economics

On the basis of the current facts and in analytical terms this is as plausible a scenario as any other, if not more so. I would further like to suggest that in retrospect this crisis episode will not only be regarded as a triumph for Keynesian economics but will also bring credit to the policymakers including Barack Obama, Ben Bernanke, Larry Summers and Gordon Brown, yes, Gordon Brown.

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Financial variables and financial globalization

Most analyses of the crises normally focus on financial variables and financial globalization as the root causes of the current turmoil. Indeed, some very uncomfortable facts emerge from analyzing these variables.

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Sub-prime Mortgages and Stock market capitalization

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Consider, for example, losses due to the collapse of sub-prime mortgages – estimated to be $250 to 400 billion. Due to this the consequential loss in the world‘s stock market capitalisation over a 12 month period is estimated to be higher than $26 trillion – 50 to 100 times larger!

Financial system and the real world economy

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The analysis of the financial variables needs to be supplemented by an analysis of the real economy. The essential purpose of a financial system is to make the real economy work better. This arguably, was being done for the world economy as a whole during 2000 to 2007.

Performance of the real economy 2000 to 2007

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1. In this period, the world real economy performed well and for some years world gross product grew at a rate of almost 4% a year, almost 5% if measured in terms of purchasing power parity.

2. Developing countries expanded at twice the rate of the developed countries

3. Among developing countries, stellar performance by China and India

4. Among developed countries, outstanding performance by USA

5. Poverty reduction – for the first time – absolute number of people fell below one billion

World economic growth, imbalances and sustainability

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Yet this success was accompanied by severe imbalances, most importantly the ever increasing current account deficits of the US economy and the dependence of the world economy on the high consumption of the American consumer who was becoming heavily indebted. IN addition, capital was moving from poor to rich countries rather than the other way round.

Credit Crunch

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Faced with the credit crunch and the loss of confidence in the financial system the nations of the world have for once acted decisively and in concert. The huge Keynesian stimulus for the world economy was agreed upon and, though not without uncertainties, is stemming deflationary forces.

G20 and International Economic Co-operation

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1. The G20 agreement of last April is historically unprecedented.

2. Nations agreed to deficit spending even when some of them were already running big budget deficits.

3. Despite evident disagreement on the basic model of how a modern economy operates (for example Germany vs. US) countries agreed to co-ordinate cuts in interest rates.

4. They also agreed to expand resources for developing countries by the IMF to increase the issuance of SDR.

Criticism of G20

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There are of course well-founded criticism of aspects of the stimulus package as well as questions regarding the legitimacy of the exclusive G20 group. Nevertheless this collective action by leading economies of the world appears to be working positively for the rehabilitation of the world economy. Although this is an ongoing story and all the evidence is not yet in, as I have indicated earlier, most observers would accept that the measure taken by G20 policymakers have worked – at least in saving the financial system from collapse. There are also signs of real economic recovery.

Second chief ground for optimism

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This remarkable collaboration between countries is the second chief ground for optimism in relation to the present crisis. Although its desirability is unquestioned, its feasibility in the next few years raises important questions that need to be addressed. These I will take up in a few minutes after the next point about the third and most important reason for optimism about the present crisis. This is the outstanding performance of India, China and some other developing countries in the world economy.

Prospects for further collective action

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It might be argued that the collective action is due entirely to the adverse circumstances in which most countries found themselves. Once the world economy recovers, there will be no adversary, and no collective action. The alternative scenario is that having seen the success of collective action, nation states will be encouraged to take collaboration further to resolve their difficulties. These questions I will take up soon.

Third chief ground of optimism

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This brings me to the third and most important structural reason for optimism about the current economic crisis. This is the role of India and China and some other developing countries in contributing to the recovery.

China and US interactions: the negative popular image

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One must unfortunately start with the negative view which pervades much popular comment. In this view China is regarded as a main perpetrator of misery on the American workers, leading to their job losses, factory closures and deindustrialization. The low value impulses from China and India in other countries are thought to be a major factor in the observed worsening of income distribution in the United States.

China and US interactions: the negative popular image

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1. And yet I am going to argue briefly against this negative popular image of China’s impact on the US economy and suggest that in the present circumstances, China and India are major contributors to world economic recovery. China and India are too small a proportion of the world economy to drag the advanced countries into recovery, but they can make an important difference.

2. This is not the time and place for a full discussion of the negative points concerning China’s economic interactions with the US. Suffice is it to say that the impact of China on the US economy manifests itself in many different ways, including the availability of cheap manufactured products, reducing the rate of inflation and adding to the level of world aggregate demand. I have no doubt that the positives in this relationship between the two countries far outweigh the negatives. I shall be developing this point more fully in another lecture on Monday.

Proposals for Pay Co-ordination or Income Policies

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Although the growth path for the world economy for the period 2000-2007 was ultimately unsustainable, it certainly took the global economy a long way forward. An important issue is, what will determine the outcome for the real world economy in the next decade or two? Will there be a new growth pattern after the crisis and will it be more or less satisfactory than the previous one?

Proposals for Income Policies

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Apart from greater macro prudential and micro prudential regulation, it is in my opinion important to have prior agreement on internationally compatible income policies, particularly in developed countries

Rationale for Income Policies

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The rationale for these policies is provided by the Government demonstrating that it has a credible anti-inflationary policy, when and if the need arises. People would be worried that governments may attempt to inflate their way out of too high a level of debt. This would raise interest rates which may set back an incipient recovery. Having an income policy in place is a signal to everyone that the government means to contain inflation.

Why income policies did not work in the past?

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Experience shows that income policies did not work in the past because they were often imposed on workers wages as emergency measures. In order to work efficiently, these policies should be applicable in normal times; also these policies should not only be concerned with the question of inflation, but equally importantly with the central issue of income distribution.

Incomes policies and equality

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Income policies should not take the existing income distribution to be given and regard it as un-alterable. Rather there should be social consensus about a secular reduction in income disparities over time. This is a major issue that exercises public sentiments in relation to the financial excesses of last two decades. Societies have to try to build social consensus along values of shared growth.

India and China in the optimistic scenario

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The role of India and China in this optimistic scenario is critical. It is socially imperative for these countries to grow at their high trend growth rates achieved during the recent period in order to provide jobs to the new entrants to the labour force in the case of India, and for both countries to shift low productivity labour force from agriculture to high productivity manufacturing and service sectors.

India and China in the optimistic scenario (cont’d)

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The question is whether the Indian economy would be able to maintain its new trend growth rates in a troubled world economy. Unlike the Chinese, the Indian Economy is much less open and therefore, easier to manage. So, in principle, growth in India should not falter. Through appropriate economic policies a balance of payment equilibrium can be attained at a high growth rate even with a world recession.

India and China in the optimistic scenario (cont’d)

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The Chinese economy is more exposed to the world economy and therefore will have greater difficulty in adjusting to slower growth rate of its net exports. But the Chinese have shown remarkable ability to restructure their economy through command. They should be able to restructure it again where domestic demand should replace foreign demand. Their most recent experience in this direction has been extremely positive. With the help of a large stimulus which preceded that of the United States, the Chinese had been able to return to their previous trend rate of growth.

India and China in the optimistic scenario (cont’d)

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It is the interest of the world economy that the Indian and Chinese growth is maintained. This is not only good for India and China but also very good for the world economy that these two countries provide a stable source of growth in world demand.

It is similarly in the interests of the Chinese and Indian economies that the co-operative approach which G20s and other countries are pursuing to increase world aggregate demand and restore world economic growth should succeed.

Conclusion

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To sum up, the central message of this contribution is that is both desirable and necessary to set a new growth pattern in terms of global co-operation in trade and investment matters, environment and energy, and a more equal distribution of income and wealth.

Far from being the end of capitalism the present crisis may mark a new stage in the establishment of a more collaborative, and ultimately a more humane capitalism, or at least one which provides space for a variety of capitalisms to co-exist.

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