Fin­ish­ing the post-cri­sis job

Financial Mirror (Cyprus) - - FRONT PAGE -

Au­gust 9 was the tenth an­niver­sary of the de­ci­sion by the French bank BNP Paribas to freeze some $2.2 bln worth of money-mar­ket funds. Those of us who were ac­tive in fi­nan­cial mar­kets at the time re­mem­ber that event as the begin­ning of the worst global fi­nan­cial cri­sis since the Great De­pres­sion.

Many econ­o­mists and fi­nan­cial ob­servers ar­gue that we are still liv­ing with the con­se­quences of that cri­sis, and with the forces that in­cited it. This is partly true. Many de­vel­oped economies still have in place un­con­ven­tional mone­tary poli­cies such as quan­ti­ta­tive eas­ing, and both pro­duc­tiv­ity and real (in­fla­tion-ad­justed) wage growth ap­pear to be mostly stag­nant.

But it is im­por­tant to put these devel­op­ments in per­spec­tive. Many peo­ple, in­clud­ing the Queen of Eng­land in Novem­ber 2008, still ask: “Why did no one see it com­ing?” In fact, many fi­nan­cial ob­servers did warn that hous­ing prices in the United States were ris­ing un­ten­ably, es­pe­cially given the lack of do­mes­tic per­sonal sav­ings among US con­sumers.

As Chief Econ­o­mist of Gold­man Sachs at the time, I had writ­ten three dif­fer­ent pa­pers over a num­ber of years show­ing that the US cur­rent-ac­count deficit was un­sus­tain­able. Un­for­tu­nately, these find­ings largely fell on deaf ears, and the firm’s for­eign-ex­change sales­peo­ple prob­a­bly got bored pass­ing on yet more of the same pieces to their clients.

At one point in 2007, the US cur­rentac­count deficit was re­ported to be 6-7% of GDP (it has since been re­vised down to around 5% for the full year). This high fig­ure re­flected the fact that the US trade bal­ance had been steadily de­te­ri­o­rat­ing since the 1990s. In the ab­sence of ob­vi­ous neg­a­tive con­se­quences, how­ever, com­pla­cency had set in, and the US con­tin­ued to spend more than it saved.

Mean­while, China had spent the 1990s ex­port­ing low-value-added prod­ucts to the rest of the world, not least to US con­sumers. In 2007, its cur­rent-ac­count sur­plus was around 10% of GDP – the mir­ror image of the US. Whereas the lat­ter was sav­ing too lit­tle, China was sav­ing too much.

For some ob­servers, this huge in­ter­na­tional im­bal­ance was the source of the cri­sis. In the years lead­ing up to the crash, they ar­gued that the global fi­nan­cial sys­tem was sim­ply do­ing its job, by find­ing in­creas­ingly clever ways to re­cy­cle the sur­pluses. Of course, we now know that it per­formed that job rather poorly.

Much has changed in the in­ter­ven­ing decade. In 2017, China will run a cur­rentac­count sur­plus of 1.5-2% of GDP, and the US will most likely run a deficit of around 2% – but pos­si­bly as high as 3% – of GDP. This is a vast im­prove­ment for the world’s two

any largest economies.

Still, other coun­tries have built up ev­er­larger cur­rent-ac­count im­bal­ances over the past decade. Chief among them is Ger­many, whose ex­ter­nal sur­plus now ex­ceeds 8% of GDP. Ger­many’s cur­rent ac­count sug­gests that there are deep im­bal­ances that could lead to a new cri­sis if pol­i­cy­mak­ing is not well co­or­di­nated. The last thing that Europe needs is an­other sud­den re­ver­sal, as we saw at the height of the Greek debt cri­sis.

The United King­dom, for its part, will have a cur­rent-ac­count deficit above 3% of GDP this year, which is nearly three times what it was ten years ago. But that is not to say that the UK’s trade bal­ance has sig­nif­i­cantly de­te­ri­o­rated. Rather, it re­flects the fact that the UK is a ma­jor fi­nan­cial cen­tre, and that in­vest­ment re­turns have shifted more in the UK than else­where.

All told, the global econ­omy to­day is much health­ier than it was ten years ago. Many are dis­ap­pointed that real global GDP growth since the cri­sis has un­der­shot per­for­mance in the pre­vi­ous decade. But since 2009 – the worst year of the re­ces­sion – the global econ­omy has grown at an av­er­age rate of 3.3%, just as it did in the 1980s and 1990s.

Of course, this is largely ow­ing to China, the only BRIC coun­try (Brazil, Rus­sia, In­dia, China) that has met my growth ex­pec­ta­tions for the decade (al­though In­dia is not too far be­hind). The size of China’s econ­omy has more than tre­bled in nom­i­nal terms since 2007, with GDP ris­ing from $3.5 trln to around $12 trln. As a re­sult, the ag­gre­gate size of the BRIC economies is now around $18 trln, which is larger than the Euro­pean Union and al­most as big as the US.

There will in­evitably be an­other fi­nan­cial bubble, so it is worth ask­ing where it might oc­cur. In my view, it is un­likely to emerge di­rectly from the bank­ing sec­tor, which is now heav­ily reg­u­lated. The big­ger concern is that many lead­ing com­pa­nies across dif­fer­ent in­dus­tries have con­tin­ued to fo­cus ex­ces­sively on quar­terly prof­its, be­cause that de­ter­mines how ex­ec­u­tives are re­mu­ner­ated.

Pol­i­cy­mak­ers should take a hard look at the role of share buy­backs in this process. To her credit, in the Con­ser­va­tive Party’s 2017 elec­tion man­i­festo, Bri­tish Prime Min­is­ter Theresa May an­nounced that her gov­ern­ment would do this. One hopes that May’s gov­ern­ment fol­lows through. Do­ing so could strike a sym­bolic blow against the un­der­ly­ing malaise of post-cri­sis eco­nomic life. The West needs real in­vest­ments and higher pro­duc­tiv­ity and wage growth – not more eco­nom­i­cally un­jus­ti­fi­able prof­its.

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