Perhaps for the first time, a major international financial institution has said that politics is not only holding back the world economy’s recovery from the crisis, it has also led to a rise in risk and uncertainty. The International Monetary Fund’s latest Global Financial Stability Report, out on Tuesday, says that “the crisis—now in its fifth year—has moved into a new, more political phase.”
The reference is to the wrangling between political leaders of the European countries, the domestic political compulsions of politicians from the European core countries that severely limit what they can do to bail out the nations of the periphery and to the protests in Greece and other countries against the austerity measures. The report also talks about the lack of agreement in the US on a long-term fiscal policy and the political grandstanding and brinkmanship that culminated in a credit downgrade. Markets have become much more aware of this political risk and are questioning the ability of politicians to take the measures needed for a full recovery.
By Shyamal Banerjee/Mint
It isn’t only in the US and Europe that the markets are disenchanted with politicians. Japan practically has a revolving door for its prime ministers. In India, the government has been under attack for doing nothing to further reforms. Social unrest in China, although immediately suppressed, appears to be growing.
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The classical economists were well aware of the close relation between economics and politics, which is why economics used to be called “political economy”. Karl Marx had long ago pointed out that in a market economy, the social relation between people assumes “the fantastic form of a relation between things”.
There has been a revival of interest in Marx after the crisis, not so much for his economic theories as for his insistence on the close links between economics and politics. In a recent note, UBS economist George Magnus said, “We have had a gathering crisis of political economy this year, which is partly about economic growth and jobs, but also and importantly, about a malaise in politics and policymaking, in which governments are seen as unwilling, unable, divided or ineffective when it comes to economic management and stability. It’s this resistance or backlash against the political order that runs through the propagation of the political economy convulsions around the world, including, in extremis, the uprisings through North Africa and the Middle East.”
New York University professor Nouriel Roubini, celebrated for predicting the US housing crash and the global financial crisis, recently said that Marx was right and you cannot keep on shifting income from labour to capital without having excess capacity and a lack of aggregate demand. He was referring to the US economy, where the share of wages in national income has fallen to the lowest level in modern history. Indeed, according to data from the US Census Bureau, real income fell between 1973 and 2010 for full-time workers in the US.
But rhetoric aside, there are structural reasons why the share of labour has declined in the advanced economies. One of them is globalization. The opening up of the Chinese, Indian and East European economies has led to a huge rise in the labour force participating in the global economy. Jobs have migrated overseas and this has put pressure on the working class in the developed nations. Recent technology advances too have been more capital-intensive.
An IMF study by Anastasia Guscina pointed out that “technological progress has been capital augmenting during the globalization era. Although before the mid-1980s productivity growth increased labour’s share, since 1985 productivity gains have tended to boost profits. Openness to trade and the increasing trade with developing countries had a negative effect on the labour share in industrial countries.”
Faced with these structural issues, the response by policymakers in the advanced economies was to increase consumer debt, so that higher borrowing would substitute for higher wages. But now that such high debt levels are no longer viable, what then is the way out? The Western world’s first reaction was to substitute government debt for private debt. But public debt levels have reached unprecedented levels in the West. The Global Financial Stability Report points out that Europe’s sovereign risks are higher now than after the Lehman collapse, as seen from CDS (credit defalt swaps) spreads. CDS spreads for banks in the Euro area are also higher than they were after Lehman.
But could the inability of Western governments to tackle these issues also be structural? Could the high wages and social security safety nets built up earlier be no longer viable in an era of globalization? Won’t a so-called new normal of lower growth exacerbate social tensions in these economies? Will this lead to more protectionism or currency wars? Could the collapse of the overleveraged financial system be a signal that the global economic system has changed fundamentally and the old familiar rules no longer work? And how painful will this be for the export-oriented economies of Asia? These are some of the many uncomfortable questions that have been raised by the crisis. The world is still groping for the answers.
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com