Seven years after the Global Financial Crisis the world economy is in a worrying state of stagnation and fragility that shows no sign of improving unless decisive action is taken. One issue at the heart of the problem, says Geneva-based researcher Dr Diana Barrowclough, is an international financial architecture that has become increasingly divorced from the needs of national economies and fails to support productive investment, trade, or sustainable economic growth.
“The rising price of assets is interlinked with a global financial system that has become excessively focused on speculative investment and short-term profits. Ironically, this has resulted in a situation where there are record levels of liquidity and low interest rates but no parallel increase in productive investments or capital formation,” says Dr Barrowclough, a senior economist at the United Nations Conference on Trade and Development (UNCTAD). She says long-term productive investments are failing to find finance while banks and corporations sit on large cash holdings and many countries hoard record levels of foreign reserves.
Barrowclough is co-author of the United Nations’ newly released Trade and Development Report 2015 which examines what it calls the “speculative biases” of global financial markets and the inadequate attempts to reduce the risks of future crises in the wake of the Global Financial Crisis.
The report notes that excessive financial liberalisation in both developed and developing countries over the past 30 years has resulted in unprecedented cross-border capital flows. By 2008 global finance had grown to become nine times greater than global trade, with the worldwide stock of financial assets exceeding US$200 trillion. At the same time, emerging financial institutions and a flood of complex financial products overwhelmed the capabilities of regulators. The new system was more liberal with credit, more innovative at managing risk and better able to absorb small shocks.
“However, it turned out to be much less capable of identifying systemic stresses and weaknesses and anticipating bigger shocks (from the Mexican peso crisis to the Great Recession) or mitigating the resultant damage. The burden of such crises has, instead, fallen squarely on the balance sheet of the public sector, and indeed, on citizens at large,” say the report’s authors.
They add that sluggish job and productivity growth, faltering investment, and stagnating wages have been accompanied by rebounding property and stock markets, exacerbating the imbalance between returns to capital and to labour, and increasing inequality. Debt levels have also continued to rise, with some US$57 trillion added to global debt since 2007.
“In today’s financialised world, the main stimulus used are mounting private debts and asset bubbles. Thus countries may be facing a trade-off between prolonged subdued growth on the one hand and financial instability on the other.”
Market forces are powerful and do some things well, says Barrowclough, but they shouldn’t be the master of a nation’s economy. The risks of leaving financial systems to market forces alone have been clearly shown in the years leading up to, and following, the GFC. Taking the example of exchange-rate mechanisms, she says it makes little sense for a small, open economy like New Zealand to choose a market-driven system dominated by large and rapidly fluctuating external forces that have nothing to do with its economic fundamentals.
“One needn’t have the actions of investors, exporters, or entrepreneurs in an open island economy dependent on unrelated and unpredictable issues, such as whether the United States interest rate goes up or down by a fraction of a per cent. The magnitude of capital flows is so immense, and they can reverse so abruptly, that most countries need a system that is more robust and better reflects the fundamentals of their economy.”
She says the notion of banks being too big to fail also remains a major issue.
“The fact that the share of assets of the five largest banks in each of the world’s major economies have increased in the past five years reflects a missed opportunity to slow their growth. Their size puts a massive burden on an economy and, in the last resort, holds governments to ransom because the failure of banks brings down many innocent bystanders.”
The UN report says that countries are not condemned to remain powerless in the face of global financialisation, but should instead embrace the wide menu of policy options available.
“It is not a question of markets or governments – both have essential roles to play. In the present context, what is needed is for the public sector to intervene when uncertainty and stagnation dampen private sector activity. Then, when the private sector is functioning effectively, governments can step back. It is a cyclical dance.”
Ultimately, however, given the interlinked nature of the global economy, she says some problems are best solved at the multilateral level – for example, by replacing the dollar standard with a system comprising a range of international currencies such as the dollar, the euro, and the renminbi; or by enhancing the scale and role of the International Monetary Fund’s supplementary foreign exchange reserve assets. Similarly, the role of the international credit rating agencies may need multilateral coordination to create public institutions, or at least to move from a “issuer pays” to a “subscriber pays” business model to curb conflicts of interest and the contagious effects of group think.
Dr Diana Barrowclough, a Business School alumna, discussed the findings of UNCTED’s Trade and Development Report 2015 at the University of Auckland in November 2015.
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