There are few safeguards against a repeat of the “Great Recession” triggered ten years ago by the collapse of Lehman Brothers, writes Karl Aiginger. However, it will be different from the crisis of 2008 and there is a lot we can do to make it less likely and less severe, he argues.
Karl Aiginger is the director of the Policy Crossover Center: Vienna-Europe, and a professor at the Vienna University of Economics.
The 2008 crisis was triggered by the breakdown of financial units that tried to present double-digit dividends by bending the rules, hiding problems, and repackaging and shifting risks. Bonus schemes and collusion with regulators and rating agencies worked up to a moment in which a small event led to collapse.
The problems were deeper, the greatest being a lack of effective demand due to high savings and low investment opportunities in many countries. Incomes did not rise in parallel to GDP, and firms did not use high profits for investment.
Instead of attacking the root causes, governments raised debt and encouraged the financial sector to offer consumer credits without chance of repayment. Meanwhile, regulations had been dropped, as markets were declared to be self-correcting.
Short-term reaction, long-term consequences
The crisis had the potential of a Great Depression; in several months, output decreased faster than in the twenties. Yet economic advisors as well as policy leaders had learned the lessons of the Great Depression.
Monetary and fiscal policy was coordinated. Interest rates were reduced and fiscal deficits were increased. On top of this, countries promised to abstain from protectionism. Developing countries continued to grow, so that world output did not decline, even if it fell by 5% in industrialised countries. And short-term recovery set in quickly.
The longer-term consequences were heavier. Europe stagnated for nearly a full decade, surpassing pre-crisis output as late as 2016; the US performed better at the cost of a debt higher than GDP. Southern Europe needed support programs. Youth unemployment soared.
People lost confidence that their incomes would rise during their lifetimes and that an “ever deeper integration” would be positive. Rifts between the North and the South, as well as the West and the East, came up. Mainstream parties lost support, and nationalistic or xenophobic agendas made inroads.
Political system destabilised
The financial system has been made more stable. Credits are given with stricter rules, own asset requirements are higher, banking regulation has improved, a European Stabilisation Mechanism (ESM) now exists.
But common deposit insurance is not on track, and short-run speculative transactions are still not being taxed. Banks still make more money by trading with each other than with the real economy, bonus payments remain high, and some European banks are still weak.
New risks are arising in Argentina, Turkey and Russia. China has homemade problems but is spreading money worldwide, including investment in silk roads and resource grabbing. But all in all the financial system has become somewhat more stable.
The political system, however, has become more unstable. The US retreats from globalisation and multilateralism. It is accusing other countries of causing its trade deficit, decreased employment and the demise of manufacturing.
Trump has renounced international agreements, from NAFTA to Paris2015. In many European countries, populist parties favour protectionism. Migration is seen as danger, even if without it the population would be ageing and the workforce decreasing. Russia is doing everything it can to destabilise Europe and right-wing populists in Europe are admiring Putin.
A European strategy for crisis prevention
The preconditions for an anti-crisis policy have not yet been restored. Low interest rates are difficult to reduce. Public debt is still higher than in 2008. Together with political instability, small causes will have larger effects. A strategy could be based on the following pillars.
Boosting innovation and education. Economic dynamics should be increased through intangible investment. Technical progress should be redirected from labour saving towards resource and energy saving. This would allow higher employment for lower growth rates. This could be supported by emissions taxes and lowering taxes on labour.
Reducing inequality. High dispersion of income and wealth is no longer a problem for left-leaning politicians only, but also for economic growth and employment. It is one of the roots of the populist agenda and the loss of the support of citizens for European integration. Redistribution can be supported by the upgrading of skills, preschool training, and empowering workers to adapt to changing demand.
Preventing climate change as a turbo. Limiting global warming to “below two degrees,” as promised in the Paris2015, requires radical decarbonisation, investment in new energy and alternative mobility. This could counteract the investment trough and enable decent dividends in the real economy.
Partnerships with rising Africa. Europe has a potentially dynamic but politically unstable neighbourhood. A partnership strategy with the East and the South can boost exports. If Africa’s population doubles to 2 billion by 2050, this is a chance for Europe, provided it offers education and training. Europe needs net immigration to combat ageing, but it should be qualified labour and a large part of it should be circular, with some immigrants returning to their home countries as Europe’s ambassadors with new skills.
New actors and diversity: Young people, women, civil society and diversity in management and politics could improve governance. This could endorse the “European narrative” of peace-building and conflict-solving.
We have to finetune the regulation of the financial system. But the most important tasks are to stabilise the real economy and eliminate the root causes of populism. Without changes to the real economy, any small crisis may result in a larger one.
No crisis is like the last one, and nobody can predict its timing and depth, but there are possibilities for reducing its probability and facilitating a common political response.