By Pedro Sousa
* The first in a series of three articles
Major consequences of the global financial crisis remain evident eight years after the G20’s first meeting following the collapse of Lehman Brothers. World leaders acting collectively on international macroeconomic issues is the medicine that the global economy requires, and yet this is not what we are witnessing. The current state of the global economy is worrying. This period of ‘secular stagnation’ is characterized by stubborn and sluggish growth, with a lack of attractive investment opportunities encouraging saving over spending. Low expected returns on investment have driven down real interest rates worldwide. The high degree of leverage makes additional investment unattractive and global demand for investment remains stagnant. Even more worrying is the lack of leadership that is allowing the world to go into a regressive and counterproductive path.
It seems clear that the global financial crisis inflicted a massive wound on the world economy, one that is still damaging for growth, given the build-up of debt on government balance sheets and the slow pace of post-crisis deleveraging. World trade has fallen as a proportion of global gross domestic product (GDP), reversing the historical pattern of trade growth exceeding global output growth. China’s structural transition from an economy that is dependent on manufacturing, exports and fixed-asset investment to one which is focused on services and domestic consumer demand has also contributed to slower growth. The annual rate of real GDP growth in China has already declined from a high of 10.6 per cent in 2010 to 6.9 percent in 2015, a 25-year low. This has a spillover effect on countries whose exports depend on Chinese demand, on supply chains dependent on Chinese industrial growth, and investors seeking higher returns in China. A prolonged period of weak demand and investment has the potential to become a self-fulfilling cycle. Lower supply and demand expectations further slow growth, meaning investors become less optimistic about the investment environment. This in turn leads to low wage growth. Combined with rising inequality, this creates weaker demand and frustration with the system.
A number of recent studies show that high inequality is dangerous not only for low earners, but for the sustainability and health of a country’s economy. Research by the OECD estimates that the rise in inequality observed between 1985 and 2005 in 19 OECD countries knocked around five percentage points off cumulative growth between 1990 and 2010. French economist Thomas Piketty used historical data to show how wealth has grown faster than GDP in his much talked about publication Capital in the Twenty-First Century.
It’s no wonder that there are a growing number of people like Warren Buffett who call for a tax on the ‘super rich’ and Wall Streeters who have thrown their support behind US presidential candidates like Bernie Sanders. Workers in developed economies have had to tolerate weak income growth and a decline in their purchasing power for decades, even at a time economic growth was doing quite well. As OECD’s Chief Economist, Catherine Mann, writes: “Since 1990, the income of the top 10% has grown 1.2% per year. Contrast this with an annual income growth of 0.6% for the bottom 40% and an even more dismal 0.3% for the bottom 10%.”
With income inequality comes inequality of opportunities in accessing better jobs, education, training and healthcare. Redistribution through taxes and transfers may have worked in the 1990s but it hasn’t offset the rise in labour income inequality in the 2000s. The fruits of growth have gone primarily to the highest earners, and flowed far less to median and lower earners.
No surprise therefore that anger and protests have increased demonstrably across Europe and the US. These social and political costs emphasise the need for prompt policy action by the G20. Addressing high and often rising inequality is also vital to sustain economic growth. To achieve stronger inclusive economic growth and better jobs, tackling inequality must be a priority. Anemic growth maintains a lack of job creation and weaknesses in the quality of jobs, wages and income, and will continue to have negative effects on consumption, living standards, investment and government revenues. Joblessness and underemployment place downward pressure on wages and contribute to increased inequality. With youth unemployment, underemployment and job insecurity at record levels, a substantial number of young people find themselves unable to contribute to economic activity. The long-term outlook is also affected as this lack of job security has adverse consequences for that generation’s ability to consume, causing them to put off large purchases such as a house or car. This means lower global aggregate demand. Add into the mix the labour market disruption caused by the digital economy and the fourth Industrial Revolution, which is potentially leaving some workers behind and in turn putting strain on social protection systems and weakening intergenerational equity. The fear is that new digital technologies, artificial intelligence, and robotics will create widespread technological non-employment.
The sluggish growth we are experiencing has a lot to do with what has happened in the finance and banking sectors. And much of the anger and frustration we see in the world targets the originators of the financial crisis and the Great Recession. In recent years, news stories that included terms such as ‘too big to fail’, ‘hedge fund billionaires’, and ‘Panama Papers’, fortified the perception of a system that is rigged. Indeed, the financial sector’s wage premium and ‘too big to fail’ status increases inequality. And some companies are sitting on cash because their war chests are overseas; using it to invest would mean paying substantial taxes.
Banks have also been saddled with bad loans since the financial crisis. It is clear that there needs to be urgent action to de-risk financial systems, build defences against volatile capital flows, and tackle growing asset bubbles. Capital markets have created a way of enriching themselves without serving or being productive to Main Street, through highly complex algorithms and technological advancements. No doubt, finance is key to the functioning of modern economies. But too much finance may hamper economic growth and worsen income inequality. A deep reform of the financial system is required, at a global level. Not just to prevent it from being harmful, but also to push banks and other financial institutions to perform their main job, which is to take savings and funnel those into productive new enterprises, matching long-term savings to investment needs, which create jobs and wealth and ultimately, economic growth. Tackling inequalities and achieving inclusive growth has a lot to do with reforming and ensuring the economy has a healthy finance and banking sector. Without this, our societal system goes into a path of slower growth, higher inequality, market fragility and social unrest.
Dangerous situation for the global economy
Rising inequality, high unemployment and weak demand has left the global economy struggling to make progress. In order to solve this dangerous situation, collective macroeconomic policy reaction is needed. Markets are not able to restore prosperity alone. Central bankers have done their best with monetary policy in order to muddle through and remain accommodative in the face of deflationary pressures. However more must be done in order to overcome stagnation. Sluggish growth and less potential to grow in future makes it harder for governments to deliver on their promises of creating an environment favourable for the creation of more and better jobs and opportunities.
And yet, some governments refuse to take action. A “race to the bottom” attitude is only creating economic, political, and social risks. Collective government policies are needed. In a globalized and interconnected economic world, agreement on fiscal stimulus can only be achieved if everyone participates. A potential agreement on monetary and fiscal stimulus can lift aggregate demand, output, job growth, private activity, and innovation. Public investment in infrastructure, research, and education is a pillar of economic progress. If the global economy is to have a resilient international monetary and financial system, it is essential to cooperate in enhancing the global financial safety net and the global regulatory regime. The threat of a synchronized slowdown, the increase in already significant downside risks, and restricted policy space in many economies calls for bold multilateral actions to boost growth and contain risks at this critical stage of global recovery. It demands a renewed focus on fiscal policy and public investment. It demands strong, 21st century, positive, visionary leaders, who sadly the world has not seen for years. The global financial crisis, the Great Recession and all its very real and harmful negative consequences happened under their watch. And now they are allowing the global economy to sleepwalk towards disaster. This disaster is the risk of having anger channeled into the ballot box, putting in power leaders who will do more harm than good.