The financial crisis: five years and counting

It is five years since the financial crisis broke.  In July and August of 2007 the interbank markets froze over, and it became evident that the boom years were over.  Five years on and the world economy still looks in deep trouble.  Each of the major developed economies is in a mess, especially if you treat the Eurozone as a single economy.  This is a remarkable fact in itself – we are used to economic crises taking a much shorter time to resolve.  It is worth trying to take a long view on it.

Looking back at what I was writing in 2007 (when I was in the third year of my economics degree at UCL), I am struck by how much denial there was in the air then.  There was clearly a crisis in finance. but this was all about a few loans to poor people in the US – and would not affect the “real” economy by much, so many thought.  Share prices held up, and superficially things seemed to be holding together.  In the autumn of 2007 the small British bank Northern Rock fell apart.  All hell did not let loose until the autumn of 2008, when Lehman collapsed, threatening to take much of the world’s financial system with it.  Even so, the press regularly articles from people saying, backed by statistics from previous crises, that things would be back to “normal” soon.  Alas, those who were comparing the crisis to Japan’s “lost decade” of the 1990s were closer to the mark.  What happened?

At first sight the crises affecting the US, the Eurozone, Japan and the UK all look quite different – and it is very easy to focus on just one of these (as I usually do about the UK) as if the crisis in the rest of the world was something else.  But the fact that they are all going wrong at the same time suggests a global pattern underlying all the local variations.

In the developed world, across the board, there has been a collapse in domestic demand – private consumption and business investment.  This collapse has been compensated by an increase in net government expenditure (spending less taxes), to varying degrees in each economy.  This has stopped, or mitigated, a sort of doom loop in which diminishing demand feeds on itself to reduce demand further.  But private sector demand has been slow to revive.  This is what is perplexing people.

Here the world is divided – and depending which side you are on, your views on how to tackle the crisis will differ.  The optimists suggest that the problem is a temporary loss of confidence which is suppressing business investment and consumer demand.  Revive this (some say by government stimulus, others by business friendly polices like cutting taxes) and we can get to something like where we were before, with more employment and rising living standards.  The there will be a multiplier effect whereby growth feeds on itself.

I am not an optimist in this sense.  I think that behind the crisis lie some big developments in the world economy:

  1. The developed world’s demographics are changing.  People are living longer;  the post war baby boom is moving into retirement.  The proportion of the working age population is shrinking.  Many older people want to stop work to retire.  It is important to see this in perspective.  Many talk of a demographic crisis and of the threat to the wider economy.  But it is quite rational to want to experience the benefits of a modern, highly productive economy through increased leisure, rather than through an endless treadmill of work and consumption.  And quite rational to take this leisure as retirement rather than a shorter working week, say.
  2. Technological advance is changing the shape of the economy in the developed world.  Manufacturing is now so efficient that it requires few people employed in it to satisfy all of our needs.  As a result a growing proportion of jobs are in services.  It is not so obvious how increased productivity, as conventionally viewed, applies in many services.  Too often this comes at the expense of the personal contact we value so much.  Another problem is that so often the jobs created by the new economy aren’t matched to the skills that a large proportion of the population has.
  3. The developing world is catching up with the developed world.  This can be counted as the biggest success of the global economy, but it is putting pressure on some scarce global resources – such as oil – and forcing their relative prices up in all economies.
  4. And as if that wasn’t bad enough, the amount of carbon the world is pumping into the atmosphere is causing global warming, with the prospect of increasingly disruptive effect across the world – and an imperative to change our ways to reverse it.

The sum of these trends it to suggest two things: that the developed world economy before the crisis was unsustainable so that we can’t return to it; that the prospects for economic growth, as conventionally measured, in the developing world are weak.

That means that the world after the crisis will be a very different place to the one before it.  It is one where people in the developing world escape the tyranny of poverty, and where in the developed world people consume less but enjoy life more.  But to get there means resolving some awkward tensions:

  • It’s all very well to say that we should be less focused on economic growth and consumption, and more on wellbeing.  Except that so much of what we expect from a modern society depends on the state, and on taxes to fund it.  Taxes are driven by the conventional economy.  We have to reduce our expectations of what the state can provide.
  • As growth in the economy as a whole slows, tackling poverty and deprivation through growth alone won’t work.  Distribution of wealth grows in importance.  That leads to a dense thicket of economic problems and challenges to social values.
  • At a global level we are hardly beginning to understand how to reconcile tackling poverty in the developing world with the need to reverse carbon emissions.  While this battle continues, the developed world has to lead from the front and reduce its own net emissions to less than zero.

And here we are. 1,000 words on the economic crisis and I have mentioned debt and globalisation, or even the problems of currency unions – factors which have dominated discussion of the crisis since it began.  But debt, trade and currency are the tactics, not the strategy.  We won’t solve these mammoth problems without a clear understanding of strategy.  as the crisis drags on though, people will perhaps realise that the problems are a bit deeper that a bit of stimulus here and there will fix.