by Don Alexander, MBA
Associate, RSD Solutions Inc.
www.RSDsolutions.com
info@RSDsolutions.com
Raghuram Rajan wrote an interesting article in the current issues of Foreign Affairs (May/June 2012) called The True Lessons of the Recession: The West Can’t Borrow and Spend Its Way to Recovery. The article has a number of interesting observations on the limited policy options available to advanced countries, but also for risk management and the potential increase of financial market vulnerability to systemic risks.
The conventional interpretation of the global economic recession is that growth has stagnated due to the massive amount of debt accumulated by the government and private sector in the West. A number of policymakers have attributed the anemic recovery to lack of sufficient fiscal stimulus or inadequate demand. However, households and governments cannot borrow the funds to spend for growth as investors are concerned about rising debt levels.
Rajan suggests the problem is caused not just by inadequate demand, but by a distorted supply side. Western countries need to address the underlying flaws in the economy and avoid the quick, politically expedient fix such as financial deregulation.
The post WWII economic expansion was driven by several factors: postwar reconstruction, resurgence of trade, better educated workforces, and effective use of new technologies. As the boom ended with high oil prices in the 1970s, western governments’ quick fixes such as deficit spending, deregulation and low rates produced mixed results and did not address long-term problems. In addition, productivity growth remained weak in many countries that did not attempt to implement necessary structural reforms.
Rather, these policies produced economic distortions such as concentrated job creation, financial excesses, a distorted tax system and a growing income disparity. Politicians tended to focus on their short-term goals and ignored worker training and education. Currently, the educational gap between job skills required and education achievement is creating further dislocations in a number of countries. Recent economic growth has been distorted by misguided policies and governments have limited options to restore demand quickly.
The way out of the crisis cannot be still more spending and borrowing. Politicians can no longer opt for the easiest answer, but must be held accountable for making the necessary decisions. A return to the status quo is not the answer.
The best short-term policy response is to focus on long-term sustainable growth. Fiscal austerity will not be painless and reforms should be phased in gradually over time. Financial excess pushed the global economy into a crisis, but a return to excessive regulation is not the optimal alternative. Finance needs to be vibrant to encourage entrepreneurship and innovation.
Industrial countries should treat the crisis as a wake-up call and deal with structural issues papered over by politicians in the last few decades. Otherwise, the West will be exposed to a long period of anemic growth.
The lesson for risk management is that the lack structural reforms and a system of quick fixes will leave financial markets more vulnerable to systemic risk as seen with the euro and deficit gridlock in Washington.
For more on this, follow the link: http://tinyurl.com/8y5qo2k
