Home > Global Crisis, Global Imbalances, Inequality > The Real Structural Reforms

The Real Structural Reforms

I just published an editorial on the Italian daily il Corriere Della Sera (in Italian), that summarizes my views on the causes of the crisis and of global imbalances. It is a reprise of one of my first posts, written with Jean-Paul Fitoussi. It is useful to summarize and refresh the argument:

  • The crisis was triggered by trouble in financial markets (subprimes, financial engineering, and the like). But the roots of it are structural
  • Global imbalances, notably excess savings in some parts of the planet (e.g. China, Germany) , and excess demand in other parts (e.g. the US, the eurozone periphery), are the source of speculative flows that perturbed financial markets, and inflated bubble after bubble.
  • Paradoxically both excess savings and excess demand have the same source, i.e. increasing inequality that exerted downward pressure on aggregate demand (transfering wealth to the rich decreases the average propensity to consume).
  • Countries where institutions, culture, policies allowed debt were able to substitute consumption out of income with consumption out of debt. Typically the US, but also Spain, the UK, etc. This resulted in high but ultimately unsustainable growth.
  • Countries where debt did not increase suffered from the compression of demand, and either relied on exports (the core eurozone economies), or had disappointing economic performances (Italy).
  • The conclusion is obvious: Unless the trend towards increasing inequality is reversed, we will keep being trapped between the alternative of high and unsustainable growth versus soft growth. Only a more equitable distribution may guarantee sustainable growth.
  • The measures to reverse the trend are also rather straightforward:
    • Increase the progressivity of the tax system, that has constantly been decreasing in the past three decades
    • Stop the slow erosion of automatic stabilization, that constitutes a powerful insurance for low income workers/consumers
    • Renew emphasis on the provision of public goods, that guarantee once again the provision of safety nets and sustain aggregate demand

In a sentence: Simply do the opposite of what has been done in the past thirty years. These are the real structural reforms that we should be discussing.

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  1. April 14, 2012 at 11:33 pm | #1

    Hang on a second. I can agree that inequality played a role in the sub-prime crisis. For your overall argument to work, I think you need to establish that inequality was indeed the only cause. If it was, then reversing the only cause, all else equal, will presumably stabilize growth. To the best of my knowledge, I am not sure that it was the only cause.

    Between inequality and crises lie several players whose decisions determine whether or not a crisis will occur. If the payoffs of any of these players can be altered in a way such that they make certain decisions instead of others, then perhaps inequality could indeed coexist with the absence of crises. AIG FS could have been less bullish. Loan originators could have been better regulated. Democrats could have decided not to guarantee certain types of debt. All of these things would have the effect that people would indeed have probably felt significantly poorer than they did in, say, 2006. There would indeed have been other consequences, but sub-prime debt would never have taken off, and we would not probably be where we are today.

    Again, I am not trying to argue that inequality is a good thing. My concern is only with the logical/economic construction of your argument.

    • April 15, 2012 at 4:39 pm | #2

      Javaad, the point I am trying to make is precisely that while the contingent causes may be debated, the economy entered the crisis fragilized by global imbalances. And that in turn global imbalances and the mass of savings looking for investment opportunities, were made easy(er) by inequality and redistribution. There is never a single cause of the crisis. And of course minor events may cumulate in strongly different macro outcomes. Precisely for this, rather than focusing only on regulating financial markets, we should also and above all address the underlying fragility of the economy, I.e. reverse the trend in inequality. Otherwise there will be another crisis; triggered by what, we cannot say, but there will be one for sure. Thanks for commenting!

      • April 15, 2012 at 6:00 pm | #3

        Okay, so, if I understand this correctly, global imbalances are the cause, and fixing inequality is the/a solution. I guess that makes sense.

        On a global level, I am not sure I understand why global imbalances should necessarily be a cause of crises. Ultimately, the imbalance to which we are referring is simply a matter of supply of, and demand for, savings. If the savings rate in, say, Texas is significantly higher than the savings rate in, say, New Mexico, then we do not immediately infer the existence of some kind of instability. But if the savings rate in Texas is significantly higher than the one across the border in Mexico, we call that an imbalance.

        I realize this is a stupid question, but, honestly, why should imbalances be inherently destabilizing? Aren’t imbalances (of endowments, preferences, etc.) fundamentally the reason why we have markets in the first place?

        I understand the “fault lines” argument that frictions across legal and contract systems make global imbalances a problem. But I would think that fixing contract mechanisms would neutralize the problem. The whole world could, for example, just adopt the clearly superior model of the American legal system wholesale. That would make life considerably easier for all of us.

        The example of Greece and Germany would seem to argue against the above point. I would argue that the problem there was simply that the ECB accepted government paper as collateral at par value. If they didn’t, then, even if the legal frameworks were technically the same under EU law, then I imagine the Greek crisis would not have been possible.

        At this point, I am rambling. I realize the question here is a dumb one, and that I should probably do my own research instead of just wondering out loud about the universe and its crazy ways. I guess I had better read that paper of yours. But seriously, why should imbalances be inherently bad? If someone in Germany wants to lend me money to buy a German car, why is that worse than someone in Michigan lending me money to buy an American car?

        Wow sorry for the super long post.

      • April 15, 2012 at 9:16 pm | #4

        Okay so my last response was admittedly rather long. The main point was to raise the following questions. How, why, and to what extent does the domiciliation of savings necessarily lead to economic instability and crises?

        If savings fall in one country and rise in another, then the total stock of global savings remains unchanged, which means the amount of money chasing yield does not change. If so, then the argument that imbalances cause crises reduces to the argument that excess savings cause crises. The latter argument, I think, would be a rather interesting one to hear/read.

        (Maybe, for example, there exists a global golden rule of savings, and maybe we have pushed past it or something.)

  1. September 28, 2012 at 3:32 pm | #1

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