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Current Debt Crisis: Causes in Historical Perspective

Mah-Hui LIMSouth Centre

Eurodad – Glopolis International Conference 2013

Debt, Finance and Economic CrisisPrague

June 3 – 5, 2013

Three Levels of Causes of Crisis

Flaws in Theory & Method of Macro Economics &Finance-Market Efficiency Theory & Fallacy of Composition

Deregulation, Practices and Malpractices of Financial Industry

Macro-economic structural causes – Current account imbalance Financial vs Real Economy imbalance Income/Wealth Imbalance

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Economic Crisis and a Crisis of Economics

P Krugman in 2009 Lionel Robins Memorial Lecture at LSE:

Much of mainstream macroeconomic theory in the past three decades have been “useless at best and harmful at worst”

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Financial Industry- Minsky

Financial fragility is determined by margin of safety (banks’ ability to meet liquidity demands) & ability of borrowers to repay from cashflow

As banks have moved from hedge financing to speculative & Ponzi financing – financial fragility & instability increases

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Frequency of Banking Crises – 1880s to 2009

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Focus on 2 Structural Causes – Financialization & Inequality

Key to understanding long term structural causes of Global Financial Crisis is to examine the link between:

financialization, debt and inequalityNot an ordinary banking crisis

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Inequality Preceded Great Depression and GFC

Why Inequality related to recent financial crisis

2 measures of inequality: Gini index Wage share of GDP (vs capital share)

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Declining Wage Share of GDP – 1970 to 2010

Source: UNCTAD, TDR 2012 & CEIC

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Globalization and Increasing Inequality

Growth has been accompanied by growing inequality in most countries

In 4 largest economies – US, Europe, China, Japan - common phenomenon of unrelenting pressure on labor income despite rising productivity

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Productivity Growth vs Wage Growth

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U.S. - Wages lagged behind productivity

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Wages – play two functions

A cost component of production Also a component of aggregate

demand With neo-liberalism – labor flexibility

> labor loss of bargaining power, rise of temporary – casual labor, wage suppression > wage growth lagged behind productivity and wage share of GDP declining

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Inequality & Under-consumption

Decline of wage should suppress household consumption, i.e., under-consumption (as in China)

Under-consumption or drop in aggregate demand can be counter acted in 2 ways Increase in debt (as in the US) Increase in exports (as in China)

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Enter Monsieur & Madam Finance - Financialization

US became a debt driven economy 1960-2007

US GDP rose 27x Total debt rose 64x to 350% of GDP Household debt rose 64x to reach 100%

of GDP in 2007, while real wages stagnated or declined

Debt bubble built up

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U.S. - Growth of GDP (27x) and Debt (64x) btw 1960 & 2007

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Composition of USD total debtGDP rose - 27x

Total Debt - 64x

Financial -490x

Household- 64x

Non Financial Corp – 53x

Govt- 24x

Excess Savings of Rich Invested in Risky Financial Products

Most of income gains accrued to top 1% of households

Propensity to consume of rich much lower than the poor

Excess savings chasing for high yields and invested in risky assets (financial innovation) > asset bubble

BOTH BUBBLES IMPLODED 2007

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Conclusion & Policy Implications

Wage Repression + Financialization a toxic mix results in financial crisis

Policy Implications: Need finance to serve real economy

but NOT financialization which drives speculation and bubbles

Finance needs to be better regulated because finance is an industry with high negative externalities

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Financial Regulation & Functional Income redistribution

Studies on contribution of finance to growth is mixed – probably it’s a inverted U shape – positive effect up to a point and then becomes negative

Need to address problem of inequality Can be ex-ante or ex-post Ex-ante – wages tied to productivity

growth over long run – cannot be less or more without causing instability

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Income redistribution

Ex-post – government must have fiscal policies to redistribute income and enhance social safety nets

Civil societies must push for all the above

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References

Michael Lim Mah-Hui and Khor Hoe Ee, “Inequality and Financial Crisis: From Marx to Morgan Stanley” in Development and Change, Volume 42 (1) January 2011.

Michael Lim Mah-Hui & Lim Chin, Nowhere to Hide: Great Financial Crisis & Challenges for Asia, 2010. Inst of SEAsian Studies, Singapore

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IMF Working Paper 10/268

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THANK YOU

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