The current economic crisis has brought forward some changes that were inevitable or were already taking place at a slower pace. The credit boom in western countries, that was fuelled by Chinese savings, was an anaesthetic that prevented the symptoms of underlying difficulties from emerging. We need to redesign global capitalism so that it faces up to long term problems of the kind the credit boom shielded from our view

In that sense, we would have been better off if the crisis had occurred sooner, because we would then have been forced to deal with the underlying problems sooner.
The underlying problems, which the credit crunch has laid bare are
the ageing of our societies,
the failure of some of our education systems,
the chronic vulnerability of our western patterns on energy and food consumption
the distorted allocation of resources by capital markets,
and our inadequate means of supervising flows of capital across borders.
The fact that people are living longer has meant that the pension systems of most western countries are unviable. People are living too long, and qualifying for pensions too long, to be supported in retirement by the contributions they made during their working lives. This was made worse by mistaken “early retirement “ schemes introduced to create jobs for younger people, or to solve short term public finance difficulties.
The ageing of societies has also contributed, along with law cases and incentives to over use of drugs and tests, to an explosion in health costs. David Walker. Former Comptroller of the United States, says
“If there is one thing that could bankrupt the United States, it is out of control health costs”.
The United States is the worst case here, but other countries are heading in the same direction.
While the US Federal debt $13 trillion, unfunded commitments under entitlement programmes related to ageing come to $55 trillion.
All these problems were known during the credit boom, but there was no apparent necessity to do anything about them, because money was artificially plentiful. Indeed it was nearly impossible to do anything because the availability of revenues made anyone who proposed unpopular changes appear to be heartless, or politically unrealistic. All that has changed now.
Education systems have also been failing to respond to challenges. A significant proportion of students continue to drop out of school with few or no qualifications. This is the case all over the western world. One of the reasons for this is that our educational systems have been designed for those with academic aptitudes, but not to nurture other forms of intelligence. It is too easy to drop to the back of the class. Extra help needs to be given when children are still very young, if it is not to be too late . The only jobs some of those leaving school without a qualification are able to do were ones that can be done more cheaply in Vietnam or China.
Young unqualified males were particularly vulnerable. 75% of the recently unemployed in the US are male. Young females could find jobs locally in traditional female occupations in the service sector, but the jobs that unskilled males did were either in sectors that migrated to the Far East or in volatile sectors like construction.
Income inequality has risen, especially in English speaking countries. In 1965, American CEOs earned 24 times the average employee. In 2007 they earned 275 times as much. Since 1970, productivity in the US has risen five times as fast as wages have.
Long term unemployment is on the increase, and the longer people are unemployed, the more their skills and aptitudes for work deteriorate. The new jobs are not being created in the sectors for which many of the unemployed are able to qualify.
The underlying failure in all these developments was a failure of education to prepare people for economic reality, but the social consequences make people angry and unwilling to accept leadership when it is most needed.
The financial crisis has also laid bare the fundamental unsustainability of our patterns of energy and food consumption in the western world.
There is not enough oil, nor enough fertile land, nor enough unpolluted atmosphere, in the world to cater for a situation in which Indians, Chinese and Brazilians consumed oil, coal, and livestock products at the rate we do in Europe and America. It take far more acres to produce food off the back of an animal than if it is consumed straight from the ground.
The legacy of colonial intervention in China and India held those countries back for two centuries. That era is now over. They will look for the same meat and dairy intensive diets we take for granted. Energy and food prices will inevitably rise because of increased demand for energy and for meat intensive lifestyles by the growing middle class of the emerging economies. It is the same with energy. On present trends, China’s oil imports will double in the next twenty years.
We have only been able to maintain the present patterns of consumption because there was less competition for these resources than there will be in the future and because,in the past , we controlled the rules of the economic game. We were able to write world trade and intellectual property rules in our interests.
The United States, with its vast coal reserves and fertile lands, can resist the effect of these trends longer than Europe can. But even the United States will have to adjust. If US oil consumption per head was reduced to average European levels, the saving would be equivalent to China’s entire present oil consumption. The money that is spent in Europe and America on subsidizing energy extraction needs to be diverted to research into energy conservation.
The price paid for letting carbon go off into the atmosphere is too low to make carbon capture at coal plants economically worthwhile. It must be increased. Decarbonising transport will be even more difficult. Perhaps the US deficit could be bridged in its entirety by gradually increasing gasoline taxes to European levels. Perhaps that will be one of the ideas the bipartisan Deficit Reduction Commission will come up with when it presents its report in December.
But we need long term solutions too. We must find radically more efficient ways to transform the energy the sun sends our way every day, into food on our tables, and fuel in our motor vehicles.
Reducing our dependence on oil would bring big long term political benefits as well. It would reduce our vulnerability to blackmail of the kind that OPEC imposed in the 1970’s. By 2030, OPEC will produce 52% of the available oil, as against 42% today.
The capital markets have not covered themselves in glory in recent years.
Thanks to financial innovations, shares in companies could be bought and sold again with much greater frequency than ever before. Hostile takeovers became easier to mount. This meant that companies were judged, and executives rewarded, on the basis of short term movements of share prices.
The scale and speed of capital movements around the world also overwhelmed those trying to keep track of it in the public interest. Foreign investment was 20% of global GDP in 1980, by 2000 it was 100%. Foreign Exchange reserves went from 5% of global GDP in 1995 to 11% in 2008.
Failure to monitor the consequences of these rapid movements had its most devastating effect in banking, but it infected the rest of the economy too. The freeing up of global capital markets has outdistanced the supervisory capacity, and even the understanding, of national financial regulators.

It fuelled a housing bubble. It allowed banks to be runs as “workers cooperatives” wherein the short term financial interests of senior employees were given preference over the longer term interests of shareholders.
The frequency with which shares changed hands increased dramatically. Individual shareholders were replaced by institutions, who bundled portfolios of share together, and whose executives were often rewarded on the basis of short term results. Quick productivity gains were thus preferred to longer term innovations. The human capital of companies was often valued less than it should be.
We have not even begun to consider the remedy to this problem. One suggestion, to give preference to longer term perspectives, might be to enhance the voting share of shareholders that hold their shares for a longer period. Another might be to impose a small fee to slow down foreign exchange transactions a little, to give time to supervisors to see where the trend is leading.
This has led to the build up of unhealthy imbalances in the world. Half of the debt of the United States is now held by foreigners, particularly by the Chinese central bank. The Chinese have bought these dollar denominated assets in order to keep the value of their own currency artificially low. Meanwhile the US is printing more dollars through Quantitative Easing. The Carnegie Foundation said last month
“The United States should cease pursuing what is increasingly seen as a policy of currency depreciation against the rest of the world”
The net effect of these political decisions is that both the Chinese and American currencies are now being artificially devalued against other currencies like the euro. That is unsustainable.
It introduces a lot more uncertainty and tension, into a world that is already uncertain and tense. It is reminiscent of the behaviour of nations during the 1930s.
Politically created problems need political solutions. The venue in which these political solutions should be found is the G20. But it has not yet found its feet, and is governed by a rotating Presidency, a system the EU has found to be unsatisfactory.
Anatole Kaletsky, in his recent book, “Capitalism 4.0”, says
“International coordination of economic policies will be inevitable if the world economy is not to degenerate into a new financial crisis”.
To sum up, if free movement of capital across borders is to continue, the world probably needs to institute, what the EU itself is trying to grope its way towards for the euro, a system of cross border economic governance that highlights imbalances and distortions long before they become bubbles about to burst
Any system of global economic governance will, of course, mean a pooling of sovereignty, something that both the United States and China would be very reluctant to agree to. But is one is to preserve complete free movement of capital across the world, you have to have a global rule maker and enforcer. Capitalism only works when there are rules that are enforced. That applies within nations. It also applies between nations.
If complete freedom from rules was the answer, Somalia would be the richest capitalist country in the world!
Fines and penalties may not be necessary. So long as information is shared and published in a timely way, markets will discipline delinquent behaviour. The job of supra national supervisors is to ensure that the information is obtained and published in good time and is interpreted intelligently and courageously. The IMF can do this work, so long as it is allowed to. It should be given the full range of supervisory functions over all countries, including the United States and China. If disputes arise, we already have, in the WTO panels, a system of adjudication.
The crisis has created the sense of urgency. It is for political leaders now to come up with the vision.
Print Entry