International Financial Crisis

Global Risks and OpportunitiesInternational Financial CrisisThe AftermathJoseph E. StiglitzTrinidad and TobagoSeptember 9, 20111The big questionsWhere are we now, four years after the breaking 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 madeand what will they imply?What does all of this imply for emerging markets and developing countries, including the Caribbean?2A divided worldGlobal growth reasonably goodfor 2011, projected to be about 4.4%Slightly lower than 2010But much better than 2009, when it shrank .5%

Continuing weakness in US and EuropeEurope 2011 projected to be only around 1.6%But large differences within EuropeGermany 2.5%

Strong growth in emerging markets, especially AsiaChina projected to grow at slightly less than 10%Though government is trying to cool economyDeveloping Asia projected to grow at 8.4%Sub-Saharan Africa projected to grow at 5.5%

3Prospects for US and Europe: A Japanese-style malaiseContinuing 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 unemploymentOfficial 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 cant get oneJobs deficit almost 25 millionMore than 40% of the jobless are long-term unemployed

4Fundamental problemLack of aggregate demandBefore crisis, US economy (and much of the world) was fueled by unsustainable housing bubbleSavings rate plummeted to zeroBubble hid underlying problemStructural transformationsuccesses in increasing manufacturing productivity meant fewer jobsChanging global comparative advantageGrowing inequalityThose whose incomes were stagnant and declining told to continue consumingNot sustainableReserve build-up in emerging marketsPrecautionary savingsExport led growth

5Why prospects of US recovery are so dimBreaking of bubble left in its wake a legacy of excess capacity in real estate and debtexacerbating fundamental problemsSolving financial crisis by itself would not resolve underlying problemsBut we have not fully addressed problems in financial sectorContinuing problems of lack of transparencyContinuing problems of excess risk takingContinuing problems of undercapitalizationProblems of too-big-to fail worsenedHavent fixed problems in housing marketPrices continue to fall, foreclosures continue at rapid rateHavent done anything to address underlying economic problemsAgain, in some areas, they have become worseCountries with large reserves did betterincentive to build up reserves furtherHigh unemployment is contributing to increasing inequality6Why prospects of US recovery are so dimConsumption likely to remain weak, given overhang of debt, high unemployment, weak wagesAnd it would be bad for long-run prospects if US returned to profligate consumption patternInvestment likely to remain weak, given excess capacity, overhang from excess investment in real estate during boom yearsSmall businesses cannot get access to creditSource of job creationBanking systemespecially the part engaged in lendingremains weakMost borrowing is collateral based; collateral real estate; real estate prices down markedlyExports uncertain, given weaknesses in global economyUS lost capacity for exporting in many industries7Weak prospects for USGovernment, rather than offsetting weaknesses in private sector, is exacerbating themEnd of stimulus implies fiscal contractionStimulus worked, but was too small and not well designedAdministration underestimated depth and duration of downturnThought that the underlying problem was just a banking crisis; repair the banks and the economy will be repairedEven if banks were working perfectly, economy would be weakExacerbated by declines in state revenuesStates have balanced budget frameworksResponses of statescutting expenditures rather than raising taxesbad for short-run stabilityProblems exacerbated by federal aid cutbacks

8What US needs and what it is likely to getNeeded: large second round of stimulusAimed at high return investments (in education, infrastructure, technology) Stimulating the economy todayAnd providing basis for long-term growthHelping address some of US long term problemsAid to states, to prevent further cutbacks (total government employment now less than in 2008)Can the U.S. afford stimulus?Cant afford not toLong-term fiscal position will be improved if government spends on investmentsBalanced budget multiplier also largeBut Congress unlikely to agree to large increases in revenues

9What US needs and what it is likely to getActually getting:Two-year extension of Bush tax cutsLikely to stimulate economy only a littleBut will probably increase deficit substantially: low bang for buckOne-year extension of payroll taxWill have some positive effectBut what happens January?Dose of austerityWeakening the economy furtheroverwhelming evidence that austerity is wrong medicine, deficit reduction will not restore confidence in economyBudget compromise entailed only small dose of austerity

10Monetary Policy will continue to be ineffectivePlayed an important role in creating crisisBut much less effective in helping economy get out of crisisLow interest rates have not workedLow interest rates are not likely to workeven with commitment to keep them lowExcess capacity SME lending still restrictedhavent fully fixed banking sectorLarge firms flush with moneycredit is not the problemLow interest rates contributing to jobless recoveryInducing firms to substitute low cost capital for labor

11QE II did not workMoney goes where returns are highestemerging markets, not USIt goes where its not needed, not where it is neededConsequence of global capital marketsMay contribute to increase in commodity prices (inflation)Responses of emerging markets contributing to fragmentation of global capital marketsMay have had slight benefit in competitive devaluationAnd in temporary increase in equity prices12Europe is equally frailSome countries in particularly bad fiscal positionBut even those that are not (such as UK) are engaging in austerityWe were all Keynesians, but for a momentAusterity will slow growth markedlyUncertainty in euro areaTook away interest rate and exchange rate mechanisms for adjustment, put nothing in placeProblem is not a surprisepredicted at the onset

13From bank bailouts to sovereign bailoutsBank bailouts meant socializing losses (Ireland)Bad economics, bad politicsHard to ask ordinary citizens to bear consequences for mistakes of private bankerswhen they walked off with so much moneyEven without bailouts, though, crisis caused by financial sector has weakened fiscal positionsBut with the potential of future bailouts, bank balance sheets and governments are intertwinedFuture bank losses likely to be borne by publicIncluding those arising from real estate (Ireland) or sovereigns

14The end of the euro?Bailout measures only temporary palliativehavent changed basic economicsPolitical 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 financesFire sale privatizations and further cutbacks are likely to be politically unacceptableBut will further assistance without still more measures be acceptable to the rest of Europe?Without real assistance, default is inevitableBut default (restructuring) may not be enoughwill need to devalueArgentina showed that there is life after default and devaluation

15The end of the euro?I believe European leaders are committed to preserving euroBut strong opposition from voters in many countries for assistance to Greece and other countriesProcess of reaching and implementing agreements very slowToo slow for changing market realitiesJuly agreement was a good oneRecognized principle of private sector involvement, importance of growth, need for assistance, interdependence of EuropeBut there have been significant problems in implementationFinish demand for collateralSlovak refusal to bring to parliamentAnd even before implementation, events have shown not enough moneyUncertainty will cast pallor over Europe and global economyBreak up would have significant effects on global economy, banksAlready contributing to credit tightening, banking problems

16So what does this mean for emerging economies?17Big questions for emerging economiesCan 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.

Is there a risk of the emerging markets overheatingand then crashing?

Answer: Yes, but China, at least, is acting to limit that risk.

18Lessons from Asia: a changing global economic landscapeUnprecedented growth in AsiaRapid convergenceChina already 2nd largest economyOn the way to being largest economyAlready largest source of savingsCorrecting a two-century-long aberrationEconomic model markedly different from American-style capitalism (especially in East Asia)Larger role for governmentMore government controlsEspecially in financial markets19Asian economic model has workedNot only to promote unprecedented growthBut also for stabilityAvoided the excesses of the USAnd even to manage the instability foisted on them 20After the crisisRecognized that excessive deregulation was responsible for the crisisAnd financial and capital market liberalization may have contributed to the rapid spread of crisis around the worldCountries that had maintained regulations (including on cross-border capital flows) fared betterBut US Treasury does not seem to have fully learned the lesson 21A new global economic order:1. New GovernanceRules governing global economic system have largely been written by advanced industrial countries, for advanced industrial countriesor for special interests within those countriesBased on free market ideologyBut justified in terms of economic principlesSimilarly, for international institutions governing globalizationMarked by flawed governance22A new global economic order:2. New Balance of economic powerRapid growth in emerging markets, continued slow growth in advanced industrial countriesHigh savings in emerging marketsWhy should they rely on the flawed financial markets of advanced industrial countries to manage their finances?Closing the knowledge gapWith many even becoming a source of innovationGrowth enhances fiscal resources, giving government more room to promote growth with equityUS wastes large amounts on defense, costly warsLeaving less room for growth enhancing investmentMost Americans worse off than they were a decade ago23A new global economic order:3. New IdeasThe end of market fundamentalism?Key lesson: need a balanced view of role of government and market, civil societyNot just size of each, but what each does and how they interactMany models of market economy, some perform better than othersScandinavian model has performed better than othersOn a broad range of indicatorsKey has been a larger role of government, more social cohesion, low levels of inequalityMarkets on their own also do not solve other problemsRole of government in education, technology, infrastructure, social protection and promoting environment

24Some implications for the Caribbean and Trinidad and TobagoClose ties with US economy will have adverse effect on growthTourism likely to remain weakExcept high-end tourismPersistence of /increase of inequalityBut the price of oil is likely to remain highStrong demand in China, other emerging markets likely to offset weaknesses in advanced developing countriesBut large increase in supply of gas in US likely to moderate gas prices 25Latin America increasingly reorienting itself toward AsiaMay be able to sustain growthFor Caribbean (and others) obvious implicationsDiversificationReorientation

26Some implications for financial marketsEquities (except for banks) may do better than one might expect, given weaknesses in economyLow interest ratesLow wagesCost-cutting measuresBut these responses are likely to contribute to ongoing weaknesses in economy27But high degree of uncertaintyepisodic mini-crises (e.g. associated with Europes problems) will ensure high volatility, overall flight to safetyWith some risk that one of these mini-crises becomes a real crisisWith center of crisis in Europe, euro may weaken, hurting US exports, weakening US economy furtherConsiderable uncertainty about US financial systems exposure to EuropeOne of consequences of lack of transparency of financial system

28Concluding RemarksThe 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 sustainable29Measuring successGDP is not a good measure of successObjective of economic policies should be sustainable, equitable, democratic developmentTrickle down economics doesnt work: most Americans are worse off today than they were a decade agoLower real incomesMore insecurityLower quality of lifeNeed to look at how benefits of growth are being shared

30SustainabilityMany dimensions: economic, political, social, and environmental sustainabilityUS economic policies before the crisis were not economically sustainabletrue for many other countries around the worldCurrent patterns of growth are not environmentally sustainableThe planet will not survive if everyone aspires to Americas profligate lifestyleFor the world, increasing sustainable investments is key to addressing the worlds short-run and long-run problemsCould help US and Europe emerge from the malaise into which they seem to be slidingCountries that adapt to the new reality sooner are more likely to prosper

31Managing ResourcesResource wealth has to be carefully managedCountries like Chile that did so have weathered storm betterMaximizing value obtainedUsing new global competition to extract the maximum rentsMaking sure that resources are well usedTransparency is keyMacroeconomic managementHigh level of volatilityRisks of exchange rate appreciation (Dutch disease)Many countries have failedLow growth, high inequalityBut some have succeededIf wealth below ground is not reinvested above ground, country is poorer

32Final Remarks US, Europe, and the world are not likely to take the policy actions that would ensure greater stability going forwardor even a quick recovery for US and EuropeSmaller trade-dependent countries around the world have to adapt to this unfortunate turn of events

33This 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 marketsMonetary and exchange policiesFiscal policiesIndustrial policiesEducation and infrastructureSocial protectionIn doing so, they can achieve equitable and inclusive, stable and sustainable growth

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