David Parkinson and Barrie McKenna
report on the cost of saving the global economy
It’s apparent that saving the world came at a price. The global economy, although better and healthier, has still not returned to its normal state as business investment, wage growth and employment continue to lag
In mid-September of 2008, as Henry Paulson stood face-to-face with one of the most dangerous financial meltdowns in history, his days were so hectic that he didn’t have time to fear he might screw it all up.
But at night, the U.S. treasury secretary would lie awake, stare into the darkness and become overwhelmed with doubt.
“In the night, little problems seem big, and big problems seem insurmountable,” Mr. Paulson recalled this week in Washington, during a panel discussion commemorating the 10th anniversary of the collapse of U.S. investment bank Lehman Brothers. “I would look into the abyss and see food lines, see another Great Depression.”
The crisis had been building since 2007, but Lehman’s bankruptcy filing on Sept. 15, 2008, was a pivotal event – the domino that toppled so many others. Within hours, failing investment bank Merrill Lynch was purchased in a fire sale by Bank of America, failing insurance giant American International Group was saved by a massive government rescue plan, and fears mounted about just how deeply and widely the financial system was infected with toxic assets.
Markets went into freefall, and investors barred up their doors. Authorities around the world raced against time to stanch the bleeding, halt the spread and get fresh money flowing through a financial system that was in real danger of seizing up entirely.
Mr. Paulson looks pretty relaxed talking about it now. Sitting in an easy chair alongside two other key players in U.S. economic policy a decade ago – former Federal Reserve chairman Ben Bernanke and Tim Geithner, who was head of the powerful New York Federal Reserve when the crisis began and President Barack Obama’s treasury secretary when it ended – Mr. Paulson can live comfortably in the knowledge that he and his colleagues succeeded where and when it mattered most.
The crisis was certainly painful: In the ensuing months, stock markets lost half their value, central banks cut their interest rates to near zero, the North American auto industry required a government bailout and almost half a million Canadians and six million Americans lost their jobs. But the consensus is that the fiscal, monetary and regulatory policy moves made in the United States, Canada, Europe and elsewhere saved the world from an all-out collapse of the financial system – and a second Great Depression.
But a decade after the Lehman tipping point, it’s apparent that saving the world came at a price. The global economy, though healthier, has still not returned to normal.
Growth has been frustratingly slow. The global economy has never recovered all that it lost – has never gotten back on the trajectory it was on prior to the crisis. Growth in wages has been stubbornly weak.
Business investment and trade growth have failed to recover.
Interest rates set by central banks remain far lower than historical norms, which has encouraged excessive risk-taking in capital markets and has fuelled record global debts.
Some of these are old problems that proved hard to resolve, or returned as the economy and financial markets clawed their way out of the deep hole dug by the recession.
Other issues were exacerbated by the crisis. But some of the world’s current set of economic ills can be linked to the unprecedented policy actions – fiscal, monetary and regulatory – taken to stave off total disaster during the crisis.
“When you’re in a crisis, by necessity you have to shorten your horizon. You don’t have the luxury of thinking about long-term structural consequences. The first priority was to stabilize the financial system,” says Tiff Macklem, dean of the University of Toronto’s Rotman School of Management, who, as second-in-command at the Bank of Canada a decade ago, played a key role in erecting Canada’s own crisis defence strategy.
“There’s no doubt that it has had some unintended consequences.
“The crisis has cast a very long shadow.”
The current recovery is one of the longest on record – but also one of the weakest. In the decade leading up to the crisis, Canada’s economy was growing an average of almost 3 per cent a year. Between 2009 and 2017, growth averaged just 1.7 per cent a year.
The global economy has similarly slowed, growing an average of 2.9 per cent a year since the crisis, down from 3.3 per cent a year from 1999 to 2008.
The crisis has also left deep wounds – affecting companies, workers and, more broadly, confidence. “One of the lasting legacies of the financial crisis is psychological scarring,” says Craig Alexander, senior vice-president and chief economist at Deloitte Canada. “Even though it’s been 10 years, people still remember what a bad recession looks like.”
Companies, in particular, remain extraordinarily risk-averse, and that is still weighing heavily on their decisions. Corporate profits bounced back after the crisis, but companies are still reluctant to spend and deplete their cash reserves. Canadian businesses have not been spending enough to replace old machinery and equipment, let alone make new investments.
“All these companies are behaving rationally,” Mr. Alexander explains. “But when all those businesses act in the same cautious, risk-averse way, you end up with an economy that is under-investing.”
The slow pace of the recovery is typical of the aftermath of a financial crisis, says McGill University economist Christopher Ragan, a member of Finance Minister Bill Morneau’s Advisory Council on Economic Growth.
The combination of rattled business confidence and the deleveraging of financial institutions is like a double whammy for the economy.
“It’s an unusually slow recovery if this had been a normal recession, but it’s a normal recovery from a financial crisis,” he says.
The crisis isn’t entirely to blame for slower economic growth. Demographics are also at play. In 2011, the first members of the massive baby boom generation began hitting 65 and retiring in droves. With each passing year, more leave the work force, slowing the growth of the labour market, which is a key driver of growth.
On the surface, the job market appears to have recovered strongly in North America: Unemployment in Canada recently dropped to its lowest rate since 2007, while U.S. unemployment recently dipped to its lowest since 2000.
But the labour force has yet to get back to its pre-crisis state – and it may never. Many workers, particularly in manufacturing, lost jobs that no longer exist, either due to automation or because factories moved elsewhere. Canada’s labour force participation rate – the share of the working-age population that is employed or actively looking for work – remains lower today than it was in August, 2008, at 65.4 per cent versus 67.4 per cent – the equivalent of about 590,000 fewer people in the labour force.
The Great Recession also put a dent in global demand for many of the commodities that Canada exports, sending the price of oil and other resources plunging. Prices for many of these commodities remain below pre-crisis levels.
The popular perception is that governments bailed out bankers in the crisis while leaving people on Main Street to fend for themselves. To an extent, it’s true.
No doubt the crisis would have been much worse without the extraordinary injection of cheap money into the global economy by central banks. But the benefits of all that liquidity have not been spread equally across society, widening the gap between the middle class and the very wealthy, particularly in the United States.
That’s because low interest rates created a property and stock market boom, which boosted the wealth and power of shareholders. But they also punished savers, including pension funds and their beneficiaries.
“Low interest rates stimulate asset price inflation, and that’s where the one per cent live,” explains economist Dan Ciuriak, former deputy chief economist at Global Affairs Canada. “We’ve come out of the crisis with more or less full employment, but we have depressed wages, elevated corporate profits and distorted income distribution.”
Low interest rates have also affected the relative value of machines versus people in the minds of employers, according to Mr. Ciuriak. And that’s holding back wage growth.
“Why pay for labour if you can buy a machine with cheap money?”
Wages in the world’s wealthiest countries are now growing at a meagre 1.2 per cent a year, after factoring in inflation, according to the Organization for Economic Cooperation and Development’s recently released annual employment outlook. That’s down from 2.2 per cent before the financial crisis.