What’s hold­ing back the world econ­omy?

Financial Mirror (Cyprus) - - FRONT PAGE -

Seven years af­ter the global fi­nan­cial cri­sis erupted in 2008, the world econ­omy con­tin­ued to stum­ble in 2015. Ac­cord­ing to the United Na­tions’ re­port World Eco­nomic Sit­u­a­tion and Prospects 2016, the av­er­age growth rate in de­vel­oped economies has de­clined by more than 54% since the cri­sis. An es­ti­mated 44 mil­lion peo­ple are un­em­ployed in de­vel­oped coun­tries, about 12 mil­lion more than in 2007, while in­fla­tion has reached its low­est level since the cri­sis.

More wor­ry­ingly, ad­vanced coun­tries’ growth rates have also be­come more volatile. This is sur­pris­ing, be­cause, as de­vel­oped economies with fully open cap­i­tal ac­counts, they should have ben­e­fited from the free flow of cap­i­tal and in­ter­na­tional risk shar­ing – and thus ex­pe­ri­enced lit­tle macroe­co­nomic volatil­ity. Fur­ther­more, so­cial trans­fers, in­clud­ing un­em­ploy­ment ben­e­fits, should have al­lowed house­holds to sta­bilise their con­sump­tion.

But the dom­i­nant poli­cies dur­ing the post-cri­sis pe­riod – fis­cal re­trench­ment and quan­ti­ta­tive eas­ing (QE) by ma­jor cen­tral banks – have of­fered lit­tle sup­port to stim­u­late house­hold con­sump­tion, in­vest­ment, and growth. On the con­trary, they have tended to make mat­ters worse.

In the US, quan­ti­ta­tive eas­ing did not boost con­sump­tion and in­vest­ment partly be­cause most of the ad­di­tional liq­uid­ity re­turned to cen­tral banks’ cof­fers in the form of ex­cess re­serves. The Fi­nan­cial Ser­vices Reg­u­la­tory Re­lief Act of 2006, which au­tho­rised the Fed­eral Re­serve to pay in­ter­est on re­quired and ex­cess re­serves, thus un­der­mined the key ob­jec­tive of QE.

In­deed, with the US fi­nan­cial sec­tor on the brink of col­lapse, the Emer­gency Eco­nomic Sta­bil­i­sa­tion Act of 2008 moved up the ef­fec­tive date for of­fer­ing in­ter­est on re­serves by three years, to Oc­to­ber 1, 2008. As a re­sult, ex­cess re­serves held at the Fed soared, from an av­er­age of $200 bil­lion dur­ing 2000-2008 to $1.6 tril­lion dur­ing 2009-2015. Fi­nan­cial in­sti­tu­tions chose to keep their money with the Fed in­stead of lend­ing to the real econ­omy, earn­ing nearly $30 bil­lion – com­pletely risk-free – dur­ing the last five years.

This amounts to a gen­er­ous – and largely hid­den – sub­sidy from the Fed to the fi­nan­cial sec­tor. And, as a con­se­quence of the Fed’s in­ter­est-rate hike last month, the sub­sidy will in­crease by $13 bil­lion this year.

Per­verse in­cen­tives are only one rea­son that many of the hoped-for ben­e­fits of low in­ter­est rates did not ma­te­ri­alise. Given that QE man­aged to sus­tain near-zero in­ter­est rates for al­most seven years, it should have en­cour­aged gov­ern­ments in de­vel­oped coun­tries to bor­row and in­vest in in­fra­struc­ture, education, and so­cial sec­tors. In­creas­ing so­cial trans­fers dur­ing the post-cri­sis pe­riod would have boosted ag­gre­gate de­mand and smoothed out con­sump­tion pat­terns.

More­over, the UN re­port clearly shows that, through­out the de­vel­oped world, pri­vate in­vest­ment did not grow as one might have ex­pected, given ul­tra-low in­ter­est rates. In 17 of the 20 largest de­vel­oped economies, in­vest­ment growth re­mained lower dur­ing the post-2008 pe­riod than in the years prior to the cri­sis; five ex­pe­ri­enced a de­cline in in­vest­ment dur­ing 2010-2015.

Glob­ally, debt se­cu­ri­ties is­sued by non-fi­nan­cial cor­po­ra­tions – which are sup­posed to un­der­take fixed in­vest­ments – in­creased sig­nif­i­cantly dur­ing the same pe­riod. Con­sis­tent with other ev­i­dence, this im­plies that many non­fi­nan­cial cor­po­ra­tions bor­rowed, tak­ing ad­van­tage of the low in­ter­est rates. But, rather than in­vest­ing, they used the bor­rowed money to buy back their own eq­ui­ties or pur­chase other fi­nan­cial as­sets. QE thus stim­u­lated sharp in­creases in lev­er­age, mar­ket cap­i­tal­i­sa­tion, and fi­nan­cial-sec­tor prof­itabil­ity.

But, again, none of this was of much help to the real econ­omy. Clearly, keep­ing in­ter­est rates at the near zero level does not nec­es­sar­ily lead to higher lev­els of credit or in­vest­ment. When banks are given the free­dom to choose, they choose risk­less profit or even fi­nan­cial spec­u­la­tion over lend­ing that would sup­port the broader ob­jec­tive of eco­nomic growth.

By con­trast, when the World Bank or the In­ter­na­tional Mon­e­tary Fund lends cheap money to de­vel­op­ing coun­tries, it im­poses con­di­tions on what they can do with it. To have the de­sired ef­fect, QE should have been ac­com­pa­nied not only by of­fi­cial ef­forts to re­store im­paired lend­ing chan­nels (es­pe­cially those di­rected at small- and medium-size en­ter­prises), but also by spe­cific lend­ing tar­gets for banks. In­stead of ef­fec­tively en­cour­ag­ing banks not to lend, the Fed should have been pe­nal­is­ing banks for hold­ing ex­cess re­serves.

While ul­tra-low in­ter­est rates yielded few ben­e­fits for de­vel­oped coun­tries, they im­posed sig­nif­i­cant costs on de­vel­op­ing and emerg­ing-mar­ket economies. An un­in­tended, but not un­ex­pected, con­se­quence of mon­e­tary eas­ing has been sharp in­creases in cross-bor­der cap­i­tal flows. To­tal cap­i­tal in­flows to de­vel­op­ing coun­tries in­creased from about $20 bil­lion in 2008 to over $600 bil­lion in 2010.

At the time, many emerg­ing mar­kets had a hard time man­ag­ing the sud­den surge of cap­i­tal flows. Very lit­tle of it went to fixed in­vest­ment. In fact, in­vest­ment growth in de­vel­op­ing coun­tries slowed sig­nif­i­cantly dur­ing the post cri­sis pe­riod. This year, de­vel­op­ing coun­tries, taken to­gether, are ex­pected to record their first net cap­i­tal out­flow – to­tal­ing $615 bil­lion – since 2006.

Nei­ther mon­e­tary pol­icy nor the fi­nan­cial sec­tor is do­ing what it’s sup­posed to do. It ap­pears that the flood of liq­uid­ity has dis­pro­por­tion­ately gone to­ward cre­at­ing fi­nan­cial wealth and in­flat­ing as­set bub­bles, rather than strength­en­ing the real econ­omy. De­spite sharp de­clines in equity prices world­wide, mar­ket cap­i­tal­i­sa­tion as a share of world GDP re­mains high. The risk of an­other fi­nan­cial cri­sis can­not be ig­nored.

There are other poli­cies that hold out the prom­ise of restor­ing sus­tain­able and in­clu­sive growth. Th­ese be­gin with rewrit­ing the rules of the mar­ket econ­omy to en­sure greater equal­ity, more long-term think­ing, and rein­ing in the fi­nan­cial mar­ket with ef­fec­tive regulation and ap­pro­pri­ate in­cen­tive struc­tures.

But large in­creases in pub­lic in­vest­ment in in­fra­struc­ture, education, and tech­nol­ogy will also be needed. Th­ese will have to be fi­nanced, at least in part, by the im­po­si­tion of en­vi­ron­men­tal taxes, in­clud­ing car­bon taxes, and taxes on the mo­nop­oly and other rents that have be­come per­va­sive in the mar­ket econ­omy – and con­trib­ute enor­mously to in­equal­ity and slow growth.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.