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.

66 thoughts on “The global spread of the financial crisis

  1. Jack#47
    Finance and fiscal alone wont deal with the problems Australia has that have been incrementally accummulating since the 1970s.
    What point is assessing JHs government as good fiscal or financial managers (hello? Am I hearing you right? We have just had the biggest GFC and the financial sector has been decimated. I dont care where the problem started – what exactly did Howard do to reign in the financial gambling that went on here over the last decade? To my recollection he praised it as evidence of individual entrepreneurrial success stories whilst the greed abd excess built to a crescendo and smashed the financial markets into a brick wall).

    In short he had his foot right off the brakes and I dont see how that makes for good financial management. As for the fiscal side of things – he starved the states and local governments when we had surpluses (leaving the mess of public hospitals and transport failings for the ordinary person to bear), he starved welfare where it was needed and gave it where it wasnt and he did not invest adequately in long term infrastructure because he was so ideologically driven to strip public ownership (and Telstra is a disaster of the first order).

    He was a dogged short term man with a dogged short term miserly view.

    I can barely imagine that people in here would be fool enough to consider JH either a good financial or fiscal manager.

  2. But having created an asset bubble…

    he said nonchalantly, as if Mr Nobody was to blame… Sorry I couldn’t resist.

    Any fall in house values will need to be modest, not severe, unless we want more economic damage elsewhere.

    Yes that is the paradox we’re in. High housing prices will only encourage inflation as those who can work will attempt to recoup the costs. As far as I see it there are only two ways this could end. Deflation or inflation. Either way, those who thought they could fund their retirements off the housing bubble may get a rude shock. And I’m betting on deflation, no matter how hard the government or RE industry try to fight it.

  3. Peter Whitehead#23
    said (and thankyou for the info)

    “Using a 50% of median income poverty line, the poverty rate in 2005 for Australian households with children was around 10-12% (depending on the equivalence scales used) with around 40% of these being headed by lone parents (male and female).

    Parenting payments for lone parents were increased substantially in real terms under the Howard government, because of the increases in both the Family Tax Benefit Part A and Part B, with Part B going to single income families including lone parents. The Parenting Payment Single was also indexed to wages for the first time.”

    My reply;

    The male and female is still in the vast majority female Peter. It depends on the equivalence scale – correct. However I would add that Centrelink offers very little assistance to chase up income hiding (often self employed) males to contribute their proper responsibilities.

    I also think that I would rather have the attitudes of the past prevail when it comes to the social benefits of raising children…Menzies noted it as form of national service and so it is. What too many of those who measure success by employment dont count is the productive contribution of childraising (not even getting a mention in GDP) and the detrimental effect of parental absence and even exhaustion due to the burden being primarily carried by a sole parent.

    Some respect for the role of raising children (and the sheer effort and time involved) would not go astray by social policy makers. In addition burdening sole parents with a choice between extreme hardship or poorly paid employment is not tackling the problem as they do in European Countries. You can achieve a very high participation rate in sole parents by providing government run and heavily subsidised childcare (Now this would be a useful fiscal stimulus as well) and instead we leave childcare to the typical Australian scoundrels like Eddy Groves and let sole mothers (and I will say mostly mothers because that is the way it is) battle under extreme hardship.

    Where is the debate on this? At least make it easier for sole parents to get to work knowing their kids are being looked after. Childcare in exchange for national service. Its more than fair but there is not even any recognition of positive initiatives like this – just put the boot in and force them to work or live in poverty no matter the effect on kids.

    Even 40% means sole parents are over represented in the poverty stats.

  4. Peter# 23
    Even if the rate of sole parents living in poverty is 40% of 12% = 5% of all families with children, and given that sole parent families are now about 30% of all families with children – that still means 1 in 6 sole parent families are living in poverty. Still too high. According to Elspeth McInnes (see below) 8.5 in ten children live with their mothers. House prices have risen from 4 times the average wage to 7 times over the decade to 2007 which has pushed up rents whilst federal funds have been directed to rent relief as subsidy to landlords and public housing has declined. 70.7% of single parents have an income in the two lowest quintiles compared to 25% of other families with children.45,000 families with children accessed homelessness services in Australia in 2006. The number of families with children seeking assistance has increased by 30% over the past 5 years (St Vincent de Paul 2007).


    The link is here

    I dont think John Howard did much of any use at all in this area whatsoever and more than that, I think “welfare to work” for sole parents was a neo liberal jack boot approach whilst he splashed our taxes around on people who really didnt need it (middle class welfare). The government could do much more that would be productive, respectful and beneficial (like decent childcare) if it was so inclined and even though we had the boom to pay for these initiatives – the coalition with its old (selfish) white male’s policies chose to ignore need and reward greed.

  5. Alanna @ 41 Said;

    “arising from their joint decision to have children.”

    No Alanna in todays society it is always the womans prerogative to have a child or not.

    When my daughter goes out on a date I tell her to treat it like a job interview, otherwise she won’t know what she could end up with.

  6. Your last comment seems to suggest Tony that in your opinion, when the father walks away from a relationship leaving women to fend for themselves and their children, hiding income in some (too many) cases so as to avoid their responsibilities, then it is the woman’s fault.

  7. 55# Tony
    I would gave guessed the advice you give your daughter when she goes out on a date is all wrong (and my guess is she knows it!). When she goes out on a date tell her to treat it like hiring a potential employee.

  8. That’s right Alanna,

    If she is going to be in a position of HAVING to indenture someone’s service for 18 plus years, not withstanding the risks of death, disappearance or insolvency, she should conduct a reasonable due diligence to ascertain if the counter party is up to the task before she commits.

    If there is any doubt and she still wants to rear children, she should do it on the basis of being able to maintain her independence.

  9. Tony#59
    And there should be insurance for unforseen marital events after the children have arrived! I dont see that offered anywhere – do you?

  10. “[insurance] I dont see that offered anywhere – do you?”

    Alanna, have you stumbled on a business opportunity?

    On a more serious note, as you know at the best of times it is hard to raise children, let alone having to do it as a single parent. Unfortunately, I don’t see that changing any time soon, but we can live in hope. In the scheme of things we only get to borrow children for a short time and then they are gone, enjoy them while they are there.

  11. There are endless explanations of the causes of the GFC and myriad proposed solutions. The analysis that has made the greatest sense to me comes from Mary Kaldor of the LSE. In particular, I like her paradigm (drawn from the work of Carlota Perez) of the long waves in the history of capitalism that are a consequence of the bunching together of technological innovations. The current crisis is the end of the frenzy phase of installation of the latest surge of technological development – our own era of the age of information and telecommunications technologies.

    Kaldor says the resulting mismatch between our social and political institutions and the profound changes in society wrought by the so-called `new economy’ require a solution that goes well beyond a bank bail-out and some Keynesian pump priming.

    “The new Keynes has to be a Neo-Schumpeterian. Neo-Schumpeterianism is both supply side and demand side; it is about matching the social and institutional framework to the techno-economic paradigm. Keynes thought it was enough to dig holes within a national context if that would stimulate the economy and, indeed, that was the solution in a mass production era. But in the current era, any stimulus has to be directed towards structural sustainability on a global basis. This is Keynsian in the sense of stimulating demand but it is neo-Schumpeterian in so far as it matters how money is spent, in the insistence that any stimulus must provide a sustainable outlet for the extraordinary gains in technological know-how of the last thirty years.”

    Read the full article at and I’d be really interested to see your responses.

  12. Tony#61
    Yes I may have stumbled on a business idea Tony (insurance for unforseen marital events after children have arrived) – however Im reluctant to offer it the idea to the insurance companies or they may lobby governments for legislation requiring wedding liability insurance up front!! Be careful what you wish for.

  13. Regarding the above mentioned poverty measurements that anyone who is on less than 50% of median income is living in poverty, measuring poverty solely in terms of income inequality is pretty meaningless.

    If you had a country with an average income of $1000 a year, then anyone on more than $500 a year would be deemed not living in poverty. If you had a country with an average income of $50,000 a year, then anyone on less than $25,000 a year would be deemed to be living in poverty.

    If a rich person gains income, then the official poverty rate rises because the average income rises. If a rich person loses income, the official poverty rate falls because the average income falls.

    Moroever, there are many reasons why income inequality tends to exaggerate the extent of real material inequality in society:
    – people’s incomes often vary across time, including short-term and long-term fluctuations. Many people spend part of their lives in higher and lower-income brackets. My income varies heavily week-to-week. Does that make me a rich capitalist pig last week, but a poor oppressed individual this week?
    – in addition, most people’s standard-of-living doesn’t vary as much as their income across time. That is because people usually do things like making major purchases or paying off a house during times of greatest earning potential, while reducing their outlays during times of lower earnings. Or people save money when their earnings are high, and draw down when their earnings are lower.
    – it also ignores a whole range of non-income social transfers, like concessions, price discrimination, charitable redistributions, expenditure on services for the poor, public housing, etc. etc.

    Measuring poverty solely in terms of income inequality is pretty useless. A more credible method of measuring poverty is to look at what percentage of people suffer multiple hardships over meeting basic needs within a short period of time (like medical care, food, housing, clothing).

    But it’s pointless debating poverty unless there is a half-way credible method of measuring it.

  14. Tony with inequality measures all those things you mention can be examined – but what really matters is key indicators within the measures over time (and that means decades in many cases)…..such as the rise in the p90/10 ratios which show the ratio of the top decile income earners to the lowest decile income earners…and also the number who are excluded from the measures completely (earn under the tax reporting threshold for example). Amazing things were done with newly separated females in the 1980s – disappeared from the if anything it was likely understated in that decade.

    There are many different and completely credible forms of inequality measures Tony – they do not ignore social transfers or even housing costs or other items you mentioned depending on the criteria used. The Social Policy Research centre at UNInsw and NATSEM at Canberra cover most measurements with considerable expertise and contribute to social welfare policy as they should (that is, if balanced governments choose to listen (by that I mean non ideologically driven systematically and dogmatically anti redistribution prone) – unfortunately balanced government has been a bit thin on the ground over the last decade or two in Australia.

    Redistribution policy is mainstream in Australia or we would not have progressive tax rates and social welfare and further it has been thus for many many decades and well accepted by both Labor and Liberal governments. Anti redistribution ideologies are fringe element economics in my opinion (yes the extended right view culminating in the most recent Coalition government).

    Apart from Quadrant I cant think of anyone else that wants to abandon social welfare redistribution and tax policies and Quadrant could hardly be called a big outfit even if they are excessively noisy. Oh apart from that there are the extreme right liberals who have hijacked the common sense, ethics and balance in the party.

  15. Australian Bears, reconstructed and unreconstructed

    Over most of the noughties I, like Pr Q, was predicting some sort of financial melt-down and industrial recession based on unsustainable trends in the:

    – consumption of imported current goods, with implications of trade deficit-driven currency market collapses
    – speculation with inflowed capital funds, with implication of bad-debt driven property market collapses;

    However, despite AUS’s high-risk in these areas, the GFC has stubbornly refused to go through the formality of ruining our economy. It appears that, like Pr Q, I:

    over-estimated the severity of risk in AUS’s case
    under-estimated the severity of risk in the RoWs case.

    SO, since Jan-Feb 2009, I have curbed my inner bear. I have been predicting that AUS will not have a bad recession or a bad property price crash. Over the past couple of weeks off-line I revised my prediction that over the next 12 months:

    – unemployment rate < 8%
    – metro property prices falls < 10% off their 2006 peak

    That does not rule out a mild recession. Something like 2001. Not nearly as bad as 1991 or 1983 though.

    The signs still look pretty good. Melbourne especially hardly appears to have skipped a beat. The rate of mass sackings is relatively low. Not counting the shut down of manafacturing companies which, regrettably, had numbered days in any case. Banks are still lending at high rates. Auction clearance rates are quite high.

    Now I see this report in the style section of the Age:

    It’s been six months and a credit crisis since Australia’s most expensive facial was launched but still the ladies are booking $800 sessions of pampering at Melbourne’s Crown Spa.

    Thats not too shabby.

    I try, in the interests of intellectual honesty and transparency, to always admit when my hypotheses have been refuted or at least bruised by evidence. I am interested to know if Pr Q has formally revised his generally bearish forecasts about the AUS economy, this one as recently as mid-2008.

    [un?]sustainability of the economic model pursued by the whole English-speaking world for the last couple of decades with large trade and current account deficits and low to zero rates of household savings in traditional terms, offset by capital gains on housing and equity investments.

    Australia has followed this model even more enthusiastically than the US in some respects, and so far has not suffered any serious consequences. But a sudden loss of confidence in the US could easily spread here. I’d be a lot happier if our current account deficit was declining as a result of the mining boom. Instead, it’s now at record levels.

    There is still a glut of Asian capital swaming the worlds security markets, putting downward pressure on interest rates. Most of which would only be too glad to find a home invested in AUS’s relatively blue-chip mortgages.

    THis ocean of cheap credit is bound to shore up our banks balance sheets, which now look pretty good by comparison to RoW standards. Which means we avoid the stumbling block sending the RoWs economies down the toilet. (With the exception of PRC which I remain bullish on, both economically and politically.)

    And if so, does it not logically follow that Pr Q must revise his disdainful rating of the economic ministry of Howard-Costello? (And soften his contemptuous dismissal of Costello.)

    In 1964, Donald Horne described Australia as ‘a lucky country, run by second-rate people who share its luck’. This epigram could be applied, with equal or greater justice, to the Howard government and its term in office, particularly as regards economic policy. Sooner or later, however, this kind of luck will run out.

    I suggest it would be fairer to say that Howard-Costello had reasonable macro-eco policy settings given the national high demand for property and global low interest rates on capital. We have had:

    – higher quality providers of capital, given stricter financial regulation curbed the appearance of gigantic holes for commercial property in most CBDs.

    – higher quality servicers of capital, given lots of high-IQ immigrant eager to rent baby boomers empty nests investment properties

    AUS is in distinctly different situation from the US case, where both providers and servicers of capital essentially were of lower quality and went on a free-for-all. A “debtquity and diversity” recession, as I call it. (Which is why I am so uneager to slavishily imitate Californian trends.)

    Or are we, as Dirty Harry might put it, “still lucky, punk?”

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