The global spread of the financial crisis
Jim Henley asks a lot of good questions
There’s an awful lot of right/conservative/soft-libertarian economics I consider well and truly refuted by events. That said, I haven’t seen progressive thinkers grappling with the global nature of the current downturn, which seems to be falling on the social democracies and neoliberal regimes and post-mercantile states alike. What does it mean that pretty much all national economies are in a tailspin, regardless of model? Are the safety-net features of the social democracies successfully blunting the impact on their citizens? In ways that can be sustained through another year, say, of recession? Is the protectionism of post-mercantile states in East Asia protecting their industries more than the less protectionist regimes of the neoliberal countries?
I’ll try and answer these, with more confidence on some points than others.
Looking at the global impact of the financial crisis proper, it’s evident that the investment banking business (pre-crisis) was so globalised that, even though the immediate problem started with defaults on US mortgages, US and international banks suffered about equally. So the magnitude of the impact on any given country depended mostly on the ratio of banking sector assets and liabilities to national income, and this was not closely correlated with social democracy/neoliberalism. Iceland was the extreme example, a social democracy which nonetheless was ranked near the top on measures of “economic freedom” thanks to massive financial deregulation in the 1990s. The ratio of bank debts to income was so high that even the immediate nationalisation of the major banks, when they hit trouble back in October, did no good.
The severity of the immediate financial crisis depended both on the magnitude of the impact and on the capacity of governments to respond. The big losers here have been countries like the Baltic states, which relied heavily on capital inflows and have failed to build up the capacity to raise government revenue (it’s not so long ago, that the governments of these states were being lionized for their adoption of a flat tax system). By contrast, most of the richest countries have been able to finance bailouts of various kinds. It’s arguable that the US, which already had chronic deficit problems going into the crisis, would have suffered more if it weren’t, like Citigroup, too big too fail (and maybe too big to rescue also). Countries that suffered little immediate impact included Australia (we had a big banking crisis in the early 1990s, so regulators were more cautious, though thye were unable to stop a housing bubble that may yet burst ) and India where pressure for financial liberalisation was successfully resisted.
As the financial crisis translates into sharp falls in consumption and investment demand, all countries have been affected to a greater or lesser extent. Given the rapid and near-universal conversion to Keynesianism, it’s going to be hard to draw lessons about the relative performance of economic systems from cross-country comparisons of the severity of the recession, but I suppose the very universality of the shift is indicative of something.
Finally, there’s the question of the extent to which social democratic systems will soften the impact of the crisis on households. This impact has two parts: direct effects associated with the financial crisis, and indirect effects of recession, rising unemployment and so on. Both appear to be worse in countries which have pursued economic liberalism rather than social democracy. On the first point, the pattern of expanding credit, low or negative household savings and asset price bubbles characterized most of the English-speaking countries (Iceland and Spain as well, but the pattern was most evident in the Anglosphere). The collapse of this bubble is being reflected in high rates of foreclosure and bankruptcy, with the associated dislocation for the households involved.
As regards the recession, we have yet to see the impact, but there’s already evidence to suggest that the US social welfare system (including unemployment insurance, TANF and other measures) is unable to handle the load. The same is true, with more dramatic effects, in the Baltic states and other formerly Communist countries that have embraced economic liberalism, or simply failed to develop an effective social welfare system to replace the employment-based system that collapsed with the end of Communism. In my view, the difficulties of countries with weak social welfare systems are only going to get sharper in the next couple of years.
Finally, I doubt that mercantilism, at least in the export-oriented form common in East Asia is going to be much of a protection. China is already suffering from a big drop in US export demand and the same will be true elsewhere.