Monthly Archives: March 2009

By Alan Greenspan

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Global economic policymakers are currently confronted with their most daunting challenge since the 1930s. There is considerable fear in the marketplace that the unprecedented set of stimulus programmes and efforts to recapitalise banks with sovereign credits will fall short of success. It is thus useful to contemplate alternatives to that distressing outcome.

Over the past two centuries, global capitalism has experienced similar crises and, up until now, has always recovered and proceeded to achieve ever higher levels of material prosperity. What would today’s world look like if, instead of the vast government policy efforts to stem the onset of crisis, we had allowed market mechanisms and automatic stabilisers, currently built into most of our economies, to function without any additional assistance? Counterfactual scenarios are highly problematic to say the least. But there are intriguing possibilities that offer comfort that, if all else fails, the global economy is not on a track towards years of stagnation or worse.

In one credible scenario, behind the unprecedented loss of wealth during the last year and a half, lie the seeds of recovery. Stock markets across the globe have to be close to a turning point. Even if a stock market recovery is quite modest, as I suspect it will be, the turnround may well have large (and positive) economic consequences.

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By Alan Greenspan

Pinn illustration









The extraordinary risk-management discipline that developed out of the writings of the University of Chicago’s Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators.

But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions. For generations, that premise appeared incontestable but, in the summer of 2007, it failed. It is clear that the levels of complexity to which market practitioners, at the height of their euphoria, carried risk-management techniques and risk-product design were too much for even the most sophisticated market players to handle prudently.

Even with the breakdown of self-regulation, the financial system would have held together had the second bulwark against crisis – our regulatory system – functioned effectively. But, under crisis pressure, it too failed. Only a year earlier, the Federal Deposit Insurance Corporation had noted that “more than 99 per cent of all insured institutions met or exceeded the requirements of the highest regulatory capital standards”. US banks are extensively regulated and, even though our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still took on toxic assets that brought them to their knees. The UK’s heavily praised Financial Services Authority was unable to anticipate and prevent the bank run that threatened Northern Rock. The Basel Committee, representing regulatory authorities from the world’s major financial systems, promulgated a set of capital rules that failed to foresee the need that arose in August 2007 for large capital buffers.

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By Karl-Theodor zu Guttenberg

T he current financial and econ­omic crisis is apparently sweeping aside many established ideas of how societies should run their economies. In Germany, the crisis has ballooned into the worst recession in postwar history. By way of diagnosis, some say we are observing the end of the financial world as we know it. Not so long ago some had heralded the era of Alan Greenspan, former US Federal Reserve chairman, as the realisation of a new economic paradigm. By way of therapy, some have called for the renaissance of state-monopoly capitalism, sometimes labelled “new capitalism”. The crisis should have a cathartic impact on the financial sector but there is a risk that responses to it will overshoot.

We already have the conceptual approach we need to set up intelligent rules to which all market actors have to adhere and that will foster transparency, credibility and trust. We know how to pursue stability-orientated monetary policies. We need to revive a culture of stability and responsibility in business. Individual incentives should reward long-term success, prevent short-termist excesses and punish inordinate risk-taking. We know that sticking to rules on competition, state aid and trade shelters the long-term gains from competition and trade from short-term protectionist and interventionist reflexes. Our social systems should shield market participants from the consequences of market upheaval – but not at the expense of market flexibility. These principles are the leitmotifs of the social market economy model on which Germany’s economic rise after the second world war was built.

For both short-term crisis management and long-term decisions, it is imperative that policymakers, bankers, investors and voters understand clearly what went wrong with the world economy. Some elements of the build-up of the housing and financial bubbles have been clearly identified: loose monetary policy; the wrong kind of incentive in the housing markets; a lack of regulation of financial institutions, which allowed the creation of a shadow banking system; inadequate incentive and risk-management systems within banks; and a failure of rating agencies and of financial market supervision.

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By Kemal Dervis

We are talking about the end of the economic crisis while it deepens. Economic projections have had to be continuously revised downward. Yet a relatively quick economic recovery is possible, provided four things happen.

First, public authorities must restructure and rewrite balance sheets in the financial sector, when necessary by taking over banks, instead of waiting any longer. Second, public expenditure must replace faltering private demand to reverse the downward spiral before it becomes a rout. Third, this must be done with international co-operation so that the global current account imbalances that contributed to the crisis will diminish rather than increase. Fourth, there must be aid to the most vulnerable so that they will not be pushed into destructive despair.

Will politics allow all this to be accomplished in time to avoid a catastrophe? If so, growth may resume some time in 2010. Even under this optimistic scenario, however, the world will have changed irreversibly.

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By Gary Becker and Kevin Murphy

Ingram Pinn illustration










Capitalism has been wounded by the global recession, which unfortunately will get worse before it gets better. As governments continue to determine how many restrictions to place on markets, especially financial markets, the destruction of wealth from the recession should be placed in the context of the enormous creation of wealth and improved well-being during the past three decades. Financial and other reforms must not risk destroying the source of these gains in prosperity.

Consider the following extraordinary statistics about the performance of the world economy since 1980. World real gross domestic product grew by about 145 per cent from 1980 to 2007, or by an average of roughly 3.4 per cent a year. The so-called capitalist greed that motivated business people and ambitious workers helped hundreds of millions to climb out of grinding poverty. The role of capitalism in creating wealth is seen in the sharp rise in Chinese and Indian incomes after they introduced market-based reforms (China in the late 1970s and India in 1991). Global health, as measured by life expectancy at different ages, has also risen rapidly, especially in lower-income countries.

Of course, the performance of capitalism must include this recession and other recessions along with the glory decades. Even if the recession is entirely blamed on capitalism, and it deserves a good share of the blame, the recession-induced losses pale in comparison with the great accomplishments of prior decades. Suppose, for example, that the recession turns into a depression, where world GDP falls in 2008-10 by 10 per cent, a pessimistic assumption. Then the net growth in world GDP from 1980 to 2010 would amount to 120 per cent, or about 2.7 per cent a year over this 30-year period. This allowed real per capita incomes to rise by almost 40 per cent even though world population grew by roughly 1.6 per cent a year over the same period.

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By Kishore Mahbubani

Asian elites have always looked at the world differently from western elites. And after this crisis is over, the gap in perspectives will widen. Asians will naturally view with caution any western advice on economics, particularly because most Asians believe that the crisis has only vindicated the Asian approach to capitalism.

To be accurate, there is more than one Asian approach. China’s economy is managed differently from India’s. Yet neither China nor India has lost faith in capitalism, because both have elites who well remember living with the alternatives. The Chinese well remember the disasters that followed from the Maoist centrally planned economy. The Indians well remember the slow “Hindu rate of growth” under Nehruvian socialism.

The benefits of the free market to Asia have been enormous: increased labour productivity, efficient use and deployment of national resources, a tremendous increase in economic wealth and, most importantly, hundreds of millions have been lifted out of absolute poverty. Just look at Chinese history through Chinese eyes. From 1842 to 1979, the Chinese experienced foreign occupation, civil wars, a Japanese invasion, a cultural revolution. But after Deng Xiaoping gradually instituted free market reforms, the Chinese people experienced the fastest increase so far in their standard of living.

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By Henry Paulson










In the midst of the market turmoil, the pressing priority for US and global policymakers is to repair the financial system and restore the economy. Just as important, however, will be addressing the serious flaws exposed by this crisis. This process of reflection and reform will be critical to restoring confidence and enabling market-based capitalism to rebuild our economies. We must recognise the real possibility that because the crisis is not behind us, there may be lessons to learn and problems to address that are not now obvious. Yet many lessons are obvious and I take confidence from the commitment of world leaders – in the US, Europe, China and elsewhere – to pursue comprehensive regulatory reform and co-ordinate internationally.

First, this will be a big, multi-year undertaking. The crisis has exposed serious flaws in many aspects of our financial system. There will be proposals for more effective regulations in areas ranging from over-the-counter derivatives and short selling, to the practices of financial institutions, investors, mortgage originators and credit rating agencies. We will need to reflect on the long-held premise that sophisticated investors have the wherewithal to look out for themselves and require minimal, if any, supervision. In these areas and others, regulations must be crafted to foster market stability while maintaining the fundamental tenet of capitalism: if investors are to reap the rewards of taking risks they must also bear the negative results of their risk-taking.

Yet updating our regulations and market practices will not be enough. We must also fundamentally reform and modernise our regulatory architecture and authorities. While regulators have co-operated in addressing this turmoil, it is clear that their overlapping jurisdictions, gaps in jurisdictions and authorities, uneven capabilities and competition among themselves created the environment in which excesses throughout the markets could thrive. Consequently, to focus only on new regulation would fall short: we must also modernise the regulatory system and authorities in the US.

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By Trevor Manuel

Can Ulysses bind himself again to the deck, having succumbed for so long to the sirens’ allure?

Global growth has slumped and its financing is in disarray. Once again the limits to institutional rationality are self-evident. It is not that we were not warned. The historical record repeats itself: confidence gives way to exuberance, panic is followed by decline, retrenchment precedes reconstruction. From Adam Smith’s defence of moral sentiment before economic self-interest to Debreu’s algebraic articulation of the informational requirements for a welfare-maximising equilibrium, economists have been clear that markets are incomplete and cannot be left to themselves.

Political economists since Thomas Hobbes and Adam Smith have understood that capitalism relies on state power to impose instrumental checks on greed and abuse of influence.

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By Nigel Lawson

That capitalism has been shown, in practice, to be endemically flawed should come as no surprise. That is the nature of mankind. What is more important is that history, notably the history of the world after the second world war, has demonstrated beyond dispute that every other system of economic organisation is far worse. So capitalism both deserves to survive, and will survive, just as it did after the even greater economic disaster of the 1930s.

But there is another lesson of the 1930s. It is that although capitalism survives it is capable of retreating behind a protectionist shell, at great cost to global prosperity. This is a real danger today. The “Buy American” provisions in President Barack Obama’s fiscal boost are an ominous sign. The impulse to resort to protection when economic hardship suddenly strikes is, of course, always present. But there is today a dangerous new factor which magnifies the threat. The leaders of some of America’s largest corporations have already joined up with organised labour (the AFL-CIO) to urge Congress to impose tariffs against imports from countries (such as China, for example) which are understandably unwilling to bear the heavy costs of an obligation to curb their carbon dioxide emissions. There is considerable support in Europe, notably within the European Commission and in France, for a similar approach.

It is essential, both in the US and in Europe, that this is resolutely rejected. The first and most important requirement for the future of capitalism is the preservation of globalisation, and the massive benefits it confers on mankind, in particular in the developing world. There are, inevitably, costs of globalisation; but they are hugely outweighed by the benefits. So resistance to protection, whatever arguments may be used in its favour, must be rigorously maintained. Nor is this an exclusively economic argument. It is a moral imperative, as well. Moreover, a trade war with China could well have unpredictable, and potentially highly damaging, political consequences.

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By Paul Kennedy

Ingram Pinn illustration









US presidents, in confronting crises, have often let it be known that they are serious students of history and biography. George W. Bush, an unusually voracious late-night reader, devours books on the lives of Great Men, including his hero Winston Churchill, (who in turn liked to read about his illustrious ancestor, Marlborough). Barack Obama looks to biographies of Abraham Lincoln for inspiration.

Given the enormity of the banking, credit and trade crisis, might it be worth suggesting to Mr Obama and his fellow leaders that they study the writings of the greatest of the world’s political economists, instead? After all, we may be in such a grim economic condition that the clever direction of budgets is a greater attribute of leadership than the stout direction of battleships.

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