Transcript International Financial Crisis

International Financial Crisis
The Aftermath
Global Risks and Opportunities
Joseph E. Stiglitz
Trinidad and Tobago
September 9, 2011
The big questions
 Where are we now, four years after the breaking
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of the bubble, and almost three years after the
collapse of Lehman Brothers?
How did we get here?
What are the choices we have?
What are the choices that are likely to be made—
and what will they imply?
What does all of this imply for emerging markets
and developing countries, including the
Caribbean?
A divided world
 Global growth reasonably good—for 2011, projected to be about
4.4%
 Slightly lower than 2010
 But much better than 2009, when it shrank .5%
 Continuing weakness in US and Europe
 Europe 2011 projected to be only around 1.6%
 But large differences within Europe—Germany 2.5%
 Strong growth in emerging markets, especially Asia
 China projected to grow at slightly less than 10%
 Though government is trying to cool economy
 Developing Asia projected to grow at 8.4%
 Sub-Saharan Africa projected to grow at 5.5%
Prospects for US and Europe:
A Japanese-style malaise
 Continuing weaknesses in Europe and the U.S.
 Some chances of a much deeper downturn (double-
dip)
 Growth too slow to create enough jobs to bring
down unemployment
 Official US unemployment rate 9%
 Teen unemployment 23%
 African-American teen unemployment 40%
 Still, almost 1 out of 6 of those who would like a job
can’t get one
 Jobs deficit almost 25 million
 More than 40% of the jobless are long-term
unemployed
Fundamental problem
 Lack of aggregate demand
 Before crisis, US economy (and much of the world) was
fueled by unsustainable housing bubble
 Savings rate plummeted to zero
 Bubble hid underlying problem
 Structural transformation—
 successes in increasing manufacturing productivity meant
fewer jobs
 Changing global comparative advantage
 Growing inequality
 Those whose incomes were stagnant and declining told to
continue consuming
 Not sustainable
 Reserve build-up in emerging markets
 Precautionary savings
 Export led growth
Why prospects of US recovery are so
dim
 Breaking of bubble left in its wake a legacy of excess capacity in real
estate and debt—exacerbating fundamental problems
 Solving financial crisis by itself would not resolve underlying
problems
 But we have not fully addressed problems in financial sector
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Continuing problems of lack of transparency
Continuing problems of excess risk taking
Continuing problems of undercapitalization
Problems of too-big-to fail worsened
 Haven’t fixed problems in housing market
 Prices continue to fall, foreclosures continue at rapid rate
 Haven’t done anything to address underlying economic problems
 Again, in some areas, they have become worse
 Countries with large reserves did better—incentive to build up reserves further
 High unemployment is contributing to increasing inequality
Why prospects of US recovery are so
dim
• Consumption likely to remain weak, given overhang of debt,
high unemployment, weak wages
• And it would be bad for long-run prospects if US returned to
profligate consumption pattern
• Investment likely to remain weak, given excess capacity,
overhang from excess investment in real estate during boom
years
– Small businesses cannot get access to credit
• Source of job creation
• Banking system—especially the part engaged in lending—
remains weak
• Most borrowing is collateral based; collateral real estate; real
estate prices down markedly
• Exports uncertain, given weaknesses in global economy
• US lost capacity for exporting in many industries
Weak prospects for US
 Government, rather than offsetting weaknesses
in private sector, is exacerbating them
 End of stimulus implies fiscal contraction
◦ Stimulus worked, but was too small and not well
designed
◦ Administration underestimated depth and duration of
downturn
 Thought that the underlying problem was just a banking crisis;
repair the banks and the economy will be repaired
 Even if banks were working perfectly, economy would be weak
 Exacerbated by declines in state revenues
◦ States have balanced budget frameworks
◦ Responses of states—cutting expenditures rather than
raising taxes—bad for short-run stability
◦ Problems exacerbated by federal aid cutbacks
What US needs –
and what it is likely to get
 Needed: large second round of stimulus
 Aimed at high return investments (in education,
infrastructure, technology)
 Stimulating the economy today
 And providing basis for long-term growth
 Helping address some of US long term problems
 Aid to states, to prevent further cutbacks (total government
employment now less than in 2008)
 Can the U.S. afford stimulus?
 Can’t afford not to
 Long-term fiscal position will be improved if government spends
on investments
 “Balanced budget” multiplier also large
 But Congress unlikely to agree to large increases in revenues
What US needs –
and what it is likely to get
 Actually getting:
 Two-year extension of Bush tax cuts
 Likely to stimulate economy only a little
 But will probably increase deficit substantially: low bang for
buck
 One-year extension of payroll tax
 Will have some positive effect
 But what happens January?
 Dose of austerity
 Weakening the economy further—overwhelming evidence
that austerity is wrong medicine, deficit reduction will not
restore confidence in economy
 Budget compromise entailed only small dose of austerity
Monetary Policy will continue to be
ineffective
 Played an important role in creating crisis
 But much less effective in helping economy get out
of crisis
 Low interest rates have not worked
 Low interest rates are not likely to work—even with
commitment to keep them low
 Excess capacity
 SME lending still restricted—haven’t fully fixed banking sector
 Large firms flush with money—credit is not the problem
 Low interest rates contributing to jobless recovery
 Inducing firms to substitute low cost capital for labor
QE II did not work
 Money goes where returns are highest—emerging
markets, not US
 It goes where it’s not needed, not where it is needed
 Consequence of global capital markets
 May contribute to increase in commodity prices
(inflation)
 Responses of emerging markets contributing to
fragmentation of global capital markets
 May have had slight benefit in competitive
devaluation
 And in temporary increase in equity prices
Europe is equally frail
 Some countries in particularly bad fiscal position
 But even those that are not (such as UK) are
engaging in austerity
 We were all Keynesians, but for a moment
 Austerity will slow growth markedly
 Uncertainty in euro area
 Took away interest rate and exchange rate
mechanisms for adjustment, put nothing in place
 Problem is not a surprise—predicted at the onset
From bank bailouts to sovereign
bailouts
 Bank bailouts meant socializing losses (Ireland)
 Bad economics, bad politics
 Hard to ask ordinary citizens to bear consequences
for mistakes of private bankers—when they walked
off with so much money
 Even without bailouts, though, crisis caused by financial
sector has weakened fiscal positions
 But with the potential of future bailouts, bank balance
sheets and governments are intertwined
 Future bank losses likely to be borne by public
 Including those arising from real estate (Ireland) or
sovereigns
The end of the euro?
 Bailout measures only temporary palliative—haven’t
changed basic economics
 Political issue: will they be able to create more permanent
institutions? (“solidarity fund for stabilization”)
 Or will they be even willing to roll over the debt?
 Austerity measures imposed on Greece will depress
economy, unlikely to produce hoped for improvement in
public finances
 Fire sale privatizations and further cutbacks are likely to
be politically unacceptable
 But will further assistance without still more measures be
acceptable to the rest of Europe?
 Without real assistance, default is inevitable
 But default (restructuring) may not be enough—will need
to devalue
 Argentina showed that there is life after default and
devaluation
The end of the euro?
 I believe European leaders are committed to preserving euro
 But strong opposition from voters in many countries for assistance to
Greece and other countries
 Process of reaching and implementing agreements very slow
 Too slow for changing market realities
 July agreement was a good one
 Recognized principle of private sector involvement, importance of
growth, need for assistance, interdependence of Europe
 But there have been significant problems in implementation
 Finish demand for collateral
 Slovak refusal to bring to parliament
 And even before implementation, events have shown not enough money
 Uncertainty will cast pallor over Europe and global economy
 Break up would have significant effects on global economy, banks
 Already contributing to credit tightening, banking problems
So what does this mean for
emerging economies?
Big questions for emerging economies
1. Can emerging economies have sustainable growth
even in the presence of weakness in the West?
Answer: Yes, on the strength of the growth of
domestic demand.
2. Is there a risk of the emerging markets
overheating—and then crashing?
Answer: Yes, but China, at least, is acting to limit
that risk.
Lessons from Asia: a changing global
economic landscape
• Unprecedented growth in Asia
– Rapid convergence
• China already 2nd largest economy
• On the way to being largest economy
• Already largest source of savings
• “Correcting” a two-century-long aberration
– Economic model markedly different from American-
style capitalism (especially in East Asia)
• Larger role for government
• More government controls
• Especially in financial markets
Asian economic model has worked
 Not only to promote unprecedented growth
 But also for stability
 Avoided the excesses of the US
 And even to manage the instability foisted on them
After the crisis
 Recognized that excessive deregulation was
responsible for the crisis
 And financial and capital market liberalization may
have contributed to the rapid spread of crisis around
the world
 Countries that had maintained regulations
(including on cross-border capital flows) fared better
 But US Treasury does not seem to have fully learned
the lesson
A new global economic order:
1. New Governance
• Rules governing global economic system
have largely been written by advanced
industrial countries, for advanced industrial
countries—or for special interests within
those countries
– Based on “free market” ideology
– But justified in terms of “economic principles”
• Similarly, for international institutions
governing globalization
– Marked by flawed governance
A new global economic order:
2. New Balance of economic power
 Rapid growth in emerging markets, continued slow
growth in advanced industrial countries
 High savings in emerging markets
 Why should they rely on the flawed financial markets of
advanced industrial countries to manage their finances?
 Closing the knowledge gap
 With many even becoming a source of innovation
 Growth enhances fiscal resources, giving government
more room to promote growth with equity
 US wastes large amounts on defense, costly wars
 Leaving less room for growth enhancing investment
 Most Americans worse off than they were a decade ago
A new global economic order:
3. New Ideas
 The end of market fundamentalism?
 Key lesson: need a balanced view of role of government
and market, civil society
 Not just size of each, but what each does and how they
interact
 Many models of market economy, some perform better
than others
 Scandinavian model has performed better than others
 On a broad range of indicators
 Key has been a larger role of government, more social cohesion,
low levels of inequality
 Markets on their own also do not “solve” other problems
 Role of government in education, technology, infrastructure,
social protection and promoting environment
Some implications for the Caribbean
and Trinidad and Tobago
 Close ties with US economy will have adverse effect
on growth
 Tourism likely to remain weak
 Except high-end tourism
 Persistence of /increase of inequality
 But the price of oil is likely to remain high
 Strong demand in China, other emerging markets likely
to offset weaknesses in advanced developing
countries
 But large increase in supply of gas in US likely to
moderate gas prices
 Latin America increasingly reorienting itself toward
Asia
 May be able to sustain growth
 For Caribbean (and others) obvious implications
 Diversification
 Reorientation
Some implications for financial
markets
 Equities (except for banks) may do better than one
might expect, given weaknesses in economy
 Low interest rates
 Low wages
 Cost-cutting measures
 But these responses are likely to contribute to ongoing
weaknesses in economy
 But high degree of uncertainty—episodic “mini-
crises” (e.g. associated with Europe’s problems) –
will ensure high volatility, overall “flight to safety”
 With some risk that one of these mini-crises becomes
a real crisis
 With center of crisis in Europe, euro may weaken,
hurting US exports, weakening US economy further
 Considerable uncertainty about US financial systems exposure
to Europe
 One of consequences of lack of transparency of financial
system
Concluding Remarks
 The policies that have been pursued by the US and
some countries in Europe failed to enhanced the
well-being of most their citizens and were not
sustainable
Measuring success
 GDP is not a good measure of success
 Objective of economic policies should be
sustainable, equitable, democratic development
 Trickle down economics doesn’t work: most
Americans are worse off today than they were a
decade ago
 Lower real incomes
 More insecurity
 Lower quality of life
 Need to look at how benefits of growth are being
shared
Sustainability
 Many dimensions: economic, political, social, and
environmental sustainability
 US economic policies before the crisis were not economically
sustainable—true for many other countries around the world
 Current patterns of growth are not environmentally
sustainable
 The planet will not survive if everyone aspires to America’s
profligate lifestyle
 For the world, increasing sustainable investments is key to
addressing the world’s short-run and long-run problems
 Could help US and Europe emerge from the malaise into which
they seem to be sliding
 Countries that adapt to the new reality sooner are more likely
to prosper
Managing Resources
 Resource wealth has to be carefully managed
 Countries like Chile that did so have weathered storm
better
 Maximizing value obtained
 Using new global competition to extract the maximum rents
 Making sure that resources are well used
 Transparency is key
 Macroeconomic management
 High level of volatility
 Risks of exchange rate appreciation (Dutch disease)
 Many countries have failed
 Low growth, high inequality
 But some have succeeded
 If wealth below ground is not reinvested above ground,
country is poorer
Final Remarks
 US, Europe, and the world are not likely to take the
policy actions that would ensure greater stability
going forward—or even a quick recovery for US and
Europe
 Smaller trade-dependent countries around the world
have to adapt to this unfortunate turn of events
 This makes it all the more imperative that they
design policies to buffer themselves against this
volatility and which promote growth, even when
there is limited scope for expansion of exports to
traditional markets
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Monetary and exchange policies
Fiscal policies
Industrial policies
Education and infrastructure
Social protection
 In doing so, they can achieve equitable and
inclusive, stable and sustainable growth