Global Financial Crisis

Global Impact and Solutions

Paolo Savona, Chiara Oldani, John J. Kirton

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317127802
• Edition: 1
• Topic: Business
• Subtopic: Financial Risk Management
• Index: Business

Out of the debate over the effectiveness of the policy responses to the 2008 global financial crisis as well as over the innovativeness of global governance comes this collection by leading academics and practitioners who explore the dynamics of economic crisis and impact. Edited by Paolo Savona, John J. Kirton, and Chiara Oldani Global Financial Crisis: Global Impact and Solutions examines the nature of the recent crisis, its consequences in major regions and countries, the innovations in the ideas, instruments and institutions that constitute national and regional policy responses, building on the G8's response at its L'Aquila Summit. Experts from Africa, North America, Asia and Europe examine the implications of those responses for international cooperation, coordination and institutional change in global economic governance, and identify ways to reform and even replace the architecture created in the mid 20th century in order to meet the global challenges of the 21st.

PART I
Introduction

Chapter 1
Introduction and Analysis

John J. Kirton, Chiara Oldani, and Paolo Savona

The Challenge

As 2010 unfolded and a new decade began, the global community remained scarred by the destructive grip of the worst global recession in 60 years. In the speed, scope, and scale of its impact, the financial and economic crisis—which began in America, then crossed the Atlantic before going global—far surpassed that of the Asian-turned-global one a decade before. Indeed, this crisis was worse than any since the one in the 1930s, whose haunting memory lives on vividly in the minds of policy makers and their citizens today. While the contemporary crisis clearly began in the mortgage markets of the United States and erupted through financial markets connecting America and key European countries, its complexity and surrounding uncertainty have meant there remains little convincing consensus on its causes, contagion mechanisms, and consequences for major countries and regions around the world. There is also ongoing debate on the effectiveness and innovativeness of the specific policy responses by leading governments, their international institutions, and major firms as well as the effectiveness and innovativeness of the global governance that international institutions offered as a global public good.

What is clear, however, is that the crisis, while deeply affecting all, had distinctive impacts on North America, Asia, Europe, the emerging countries of Brazil, Russia, India, and China (BRIC), and the developing world beyond. It thus evoked in each key country and region varying policy responses and innovations in the instruments and institutions employed to restore stability and growth and to reduce the chance of similar crises erupting again. These differences have compounded the challenge of forging international consensus on the innovations in global economic governance required of today’s globalized financial and economic system. At the same time, the unprecedented crisis provides the economic, social, and political demand and perhaps also the supply of political will to fundamentally alter the international economic institutional architecture first constructed in 1944–45.

Yet as the crisis recedes in reality and memory, more than two years after the collapse of Lehman Brothers in New York on 15 September 2008, it remains unclear what lies ahead. Will the aftermath resemble the collapse of the stock market in New York City in October 1929, when ensuing bouts of recovery and confidence proved brief while the real economy receded to new lows that led to social fragmentation, the death of democracy in leading countries, and world war? Or will it be more like the imminent collapse of a bankrupt New York in 1975, when the predicted global financial devastation was met by the leaders of the new G7 successfully convincing a reluctant American president to act in order prevent a destructive cycle of the new financial instability that already had the established economic powers in its grips?

The Purpose

This volume explores these dynamics of economic crisis and impact, policy response, and innovation in global governance. It examines the nature of the crisis, its consequences in major regions and countries, the innovations in the ideas, instruments, and institutions that constitute their national and regional policy responses—particularly in the context of the 2009 G8 L’Aquila Summit—and the implications of their responses for international cooperation, coordination, and institutional change in global economic governance. On this foundation, it identifies appropriate ways to reform and even replace the architecture created in the mid 20th century in order to meet the global challenges of the 21st.

The Framework

To guide this exploration, this book employs and develops a crisis-response-innovation framework first created to explore the way national governments and global governance institutions cope with acute crises in the field of health (Cooper et al. 2007; Cooper and Kirton 2009).

Crisis

This framework begins, as its first component, with the crisis itself. Many still see the 2007–09 crisis and ensuing ‘great recession’ as unprecedented on most dimensions, since at least the stock market crash in 1929 and the subsequent Great Depression. Such novelty arises in the complex interplay of financial, economic, business practices, and government policies that created the crisis, in the speed and scope of its contagion, and its continuation in crisis sectors, notably its apparent epicentre in the housing market of the United States.

The framework thus starts by identifying the crisis catalysts and causes, ranging from long-term structural ones to more proximate ones in the policy and practices of business, professional communities, consumers, national governments, and international institutions. It next considers its characteristics, notably its depth and duration of the crisis. It then assesses its course, including its particular contagious spread and path across sectors, regions, and countries, and when it was contained and came to a close. It finally asks if this was primarily the latest instalment of financial crises that have regularly come during the many centuries in the past, or one that is genuinely novel, flowing from the complex adaptive system that the global economy has now become. If it is the latter, then the challenge for firms, governments, and international institutions will be much greater, requiring innovations on a scale never seen before in order to provide an appropriate, adequate, and effective response.

Consequences

The second component identifies the consequences, or impacts of the crisis, over the short, medium, and longer terms. From the start there was a debate about who would be hit hardest and fastest, as the former belief in the decoupling of major regions from America broke down. There was another debate, which still continues, about whether the road to recovery would resemble those of market meltdowns and recessions past, and which letter of the alphabet or symbol would best graph its course. It extended to who would recover soonest, to enjoy the greatest growth over the long term.

There was also a debate about the geopolitical impacts of the crisis on a hard-hit America soon sporting a popular new president, on a China with massive amounts of money to stimulate but with serious institutional, ecological, social, and political vulnerabilities, and on many other consequential countries and regions of the world. The crisis gave new life to the old and ongoing debates about America’s imperial decline, the emergence of Asia or the rise of the rest (Zakaria 2008; Joffe 2009; Arrighi and Silver 1999). But it added new dimensions, notably a power shift brought by a financial collapse rather than victory or defeat in a system-wide war, or one that reversed the long-term trend toward democratization and openness in the world, with the emerging democracies in Central and Eastern Europe, the recent democracies such as Spain, and the democratic pioneers in Britain, America, and France being hit hardest of all.

The assessment of consequences thus begins with the economy, at the levels of the firm, marketplace, national economies, and the global economy as a whole. But it extends to embrace the geopolitical changes that a crisis of the magnitude of the great meltdown and great recession of 2007–09 brought in its wake. It focuses on who won and who lost, and whether the different and common impacts provided the structural foundation for competition or collaboration among states.

Capabilities

The consequences of the crisis depended importantly on the capabilities and vulnerabilities that the relevant actors and institutions had at the time it arrived. In sharp contrast to the 1997–99 Asian-turned-global financial crisis, this time it was those with the greatest overall financial and economic capabilities that seemed most surprised by the crisis and were poorly equipped to cope, while those that had suffered most from the previous global financial crisis in 1997–99 and even poorer countries had the ability to endure at limited cost. It was America as the single superpower in the post-Cold War period, Anglo-American market capitalism as the model, and New York and London as the leading global financial centres that suffered most. In sharp contrast, the leading victims of the 1997–99 crisis—Korea, Indonesia, and Brazil—this time seemed to have the strengths to insulate them from the worst consequences, in large part because they had learned from the last time how to ensure that they would never again be consumed when the subsequent crises came. Yet even with this searing lesson and policy response from less than a decade earlier, they might have had lucky escapes with good insurance policies, rather than having been global leaders with capacities for prescience, prediction, and prevention. Indeed, few beyond the Bank for International Settlements (BIS) seemed able and willing clearly to predict and warn of the crisis to come.

The third component thus concentrates on the capabilities and vulnerabilities with which firms, countries, and international institutions started the crisis. It considers the size and capacity of the material resources these actors had, as well as their vulnerabilities and resilience. It also considers their predictive and policy capacities, asking how well actors foresaw the crisis and implemented preventive measures or insurance policies in response. It asks how and how well their capabilities were mobilized and deployed in response after the crisis struck. On this basis, it considers which capabilities count the most in the 21st-century world: the depth and sophistication of financial markets still concentrated in the G7 countries; governments’ foreign exchange reserves where China, Japan, and Russia led the pack; governments’ debt and deficit positions and resulting ability for long-term stimulus, policy, or regulatory sophistication; and other capabilities that can be brought to bear.

Response

Crises and their consequences create the conditions for actors, with their particular configuration of capabilities, to recalculate their preferences and strategies or even redefine their interests and identities in potentially transformational ways. But crises merely create an opportunity that can be wasted, rather than dictate the details and degree of the response (Finnemore and Sikkink 1998). Indeed, by 2010, as the crisis receded in reality and thus in memory, many felt that the old ways were returning, that the opportunity had been lost, that the window for transformational change was rapidly closing, or that some had seized the moment much better than many had.

The fourth component of the framework thus deals with the policy response, primarily from national governments but also from firms, international institutions, and other actors. It identifies how timely and well tailored the policy response was, and how well it matched the particular content, course, causes, and consequences of the crisis, whether or not these were well understood. This component of the book charts the repertories of standard responses deployed, and assesses how well they worked, behind the rediscovery, new respectability, and deployment of Keynesian monetary and policy stimulus. It explores the causes of these responses and their consequences in making the crisis better or worse. It identifies whether these crisis-bred responses were divergent or convergent, unilateral or coordinated, and whether they were appropriate in each case. It asks whether and why policy choices were made for competition or cooperation, in the short and longer terms.

Innovation

The fifth component addresses innovation. It focuses on the new instruments, ideas, and institutions that were invented in response to the crisis, from quantitative easing in monetary policy through direct financial support to endangered sectors on to detailed regulations during peacetime of how much firms could pay senior staff. It considers how effective they were in comprehending and containing the crisis, its harmful consequences, and the likelihood that such a crisis would erupt again. It further asks how the repertoire of old and new instruments, ideas, and institutions helped bring the crisis to a conclusion, in a way that created the structural conditions for a better economy, society, and policy for the years ahead. In short, was the opportunity for innovation that the crisis opened wasted or not?

Governance

The sixth component is governance, at the global level above all. Just as the crisis of the Great Depression helped create and shape the pillars of the old international financial architecture and order—based on the Bretton Woods bodies founded largely on the classic formula for intergovernmental organizations—so the 2007–09 crisis inspired calls for a new Bretton Woods order, with strong, supernational new multilateral organizations to preside authoritatively over the sovereign states of old (Ikenberry 2001). While such calls were not taken up in the short run, the crisis did lead to stronger powers, resources, and reform of the old institutions, notably the International Monetary Fund (IMF) and the European Union. It also catalysed the creation of several new, innovative plurilateral institutions—the G20 summit, the Financial Stability Board (FSB), and even BRIC summits. How well these were designed and operated is an important cause of how well the crisis has been dealt with and how the global geo-economic and geopolitical order will unfold in the years ahead.

Recommendations

The seventh and final component consists of policy recommendations, aimed at firms, national governments, and international institutions alike. It considers the adequacy, given the characteristics of the crisis and its consequences, of the existing responses, innovations, and governance arrangements. On this basis it offers policy recommendations, ranging from feasible ones for the short term aimed at critical components through to fundamental changes required over the long term for the global system as a whole.

The Contributions

Part II of the book, ‘Solutions in America and Asia’, begins the examination of how individual regions and countries have created the crisis, contributed to it, and tried to cure it. It begins with its epicentre in America and extends to the closely connected Asian region, with a focus on Japan.

In Chapter 2, ‘Crisis, Response and Innovation in America and Abroad’, Robert Fauver examines the financial and broader economic crisis confronting the global community, suffering from the first synchronized recession since the first oil shock of 1973–74. In the big three countries outside of Europe, the macroeconomic responses to the crisis have been a combination of classic policy moves and a few new, innovative ideas. All three countries have relied heavily on monetary policy easing. On the fiscal front some new ideas are being tried. Clearly the macroeconomic situation requires a large-scale global stimulus that is transferred from the domestic to the international economy.

In Chapter 3, ‘Crisis, Response, and Innovation in Japan’, Naoki Tanaka notes that even though the economic and financial crisis originated in the U.S., because of the distinct integration of global markets, East Asian countries faced equal challenges in response. In Japan, the crisis revealed an inherent defect in the financial system—a lack of securitization in its credit market. In contrast to American and European markets, Japan’s securitization market remained underdeveloped due to credit default swaps not having been fully utilized and due to the procyclicality of the banking sector in general. The credibility of Japan’s financial institutions was questioned as non-performing loans increased and measures to maintain balance sheets often meant selling assets and contracting credit lines. Measures to ensure micro-level functionality have destabilized macroeconomic management, mainly because Japan’s economy is so tied to that of the United States. Japan holds the second highest amount of U.S. foreign exchange reserves in the world. This poses a structural constraint—in having to adapt to excessive American consumption—on achieving the right production factors in Japan’s domestic economy and the creation of new domestic markets. The global shortage of demand will continue unless countries such as Japan are able to activate the expansion mechanism of net payments effectively. A Japanese-tailored structural reform to increase government spending to improve the supply side is paramount in helping the country recover and maintain equilibrium. The Japanese labour force should be redistributed to emphasize high value-added productivity. In so doing, the Japanese government should work toward developing networks of goods and services conducive to global environmental objectives. In these ways, Japan can realize productive and sustainable growth.

In Chapter 4, ‘The Macroeconomics of the Global Financial and Economic Crisis’, Libero Monteforte looks beyond the American banking system and mortgage market to identify broader causes of the crisis. These include technical financial issues such as banking procyclicality, macroeconomic imbalances multiplied by insufficient governance in international finance, and policy mistakes resulting from fiscal and monetary policy designed to postpone the crisis. These causes can be combined in a common microeconomic framework that focuses on incentives for excessive risk taking. This structural reduction of risk aversion, due to government policy, summarizes the variety of causes of the crisis. Moreover, the technical difficulties in monitoring risk aversion in real time can explain the large errors and revisions in the forecasts released in the last quarter of 2008. Although the crisis started in the U.S., it was Germany and Japan that suffered the most, due to factors in both demand and supply. Commercial trade contracted much more than world gross domestic product (GDP), perhaps because of protectionism measures. In regard to economic policy, it is almost impossible to use fiscal policy to counter the cycle. An evaluation of the stimulus plans should therefore look at the medium-run effect. Innovative monetary policy such as quantitative easing, while important in the short term, risks fuelling inflation in the longer term. There are no unique indicators to signal when such dangers—and the necessary need for policy adjustment—will arise.

Part III, ‘Solutions in Europe’, turns to the European region. In Chapter 5, ‘Crisis, Response, and Innovation in Europe’, Paolo Savona and Chiara Oldani emphasize that the close economic connection between America and Europe and London’s status as a global financial and monetary centre spread the American-created crisis instantly to Europe, where it had very different effects on the countries within. Overall, the European banking and financial sectors were able to manage the shock from across the Atlantic, despite a decline in manufacturing and exports due to deflated demand. Savona and Oldani examine these impacts and discuss the ineffectiveness of Europe’s regionally uncoordinated and late policy response. The European Commission and parliament addressed the financial crisis by creating an ad hoc technical working group to analyse the roots of the meltdown and suggest the main modifications to the present financial architecture needed to restore confidence and to create the basis for stronger financial markets. However, the suggested modifications did not consider the limited rationality of investors and markets, which formed the basis of the crisis itself. New regulatory improvements are recommended to alter the present shape of the European financial system and its incentives, to the detriment of speculative operators.

In Chapter 6, ‘Europe: From One Crisis to the Other’, Paola Suba...

Table of contents

• Cover Page
• Half Title Page
• Global Finance Series
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• List of Contributors
• Preface
• List of Abbreviations and Acronyms
• Part I Introduction
• Part II Solutions in America and Asia
• Part III Solutions in Europe
• Part IV Impacts and Responses in the BRICs
• Part V Impacts and Responses in Developing Countries
• Part VI Innovation in Global Economic Governance
• Part VII From G8 to G20
• Part VIII Conclusion
• Index
• Global Finance Series