The Shifts and the Shocks
The central debate about the economic outlook among economists and investment managers is the extent to which economies have recovered from the financial crisis. Strong growth in gross domestic campaign has finally appeared in the United Kingdom after a severe downturn, for example, and stock markets have surged from their lows a few years ago. However, the worry is that things have not really changed and that the recovery will not last. Despite recent growth, developed economies such as the UK are much smaller than the pre-crisis trends in growth rates imply they should be. Political leaders have largely ducked implementing radical reforms after the financial crisis, despite its scale. Does that mean such reform was unnecessary? Martin Wolf’s answer in The Shifts and the Shocks is a resounding ‘no’. He warns that if we do not take further action, further crises are inevitable and will even risk eroding the fabric of our society.
Wolf is the chief economic commentator at the Financial Times. Throughout the financial crisis and since he has brought insightful analysis into the economic debate, disarming alternative views by outlining the evidence of what has been happening. He adopts the same approach in this book but in greater depth. As with his articles, this is not a book that can be read in a hurry but it does reward the patient reader.
Wolf examines the causes of the financial crisis which began in 2007 and reviews the various explanations. These include risk-taking by banks, poor regulation, a savings glut (or investment dearth), persistent current account surpluses by some countries, and inequality in developed economies. He reviews the world’s initial, Keynesian, response in 2009 and the depressing (in more than one sense) return of the old economic orthodoxy which prescribed an urgent return to balanced budgets, with its ‘bashing of innocent beneficiaries of public spending’, together with a reliance on ‘a few regulatory changes’. A member of the Independent Commission on Banking, he is particularly scathing of the basic business model behind banking, seeing it as doomed to failure.
The author focuses on the nuts and bolts of an economy – its sectoral balances. Balances in the household, business, government, and foreign (net flows into or out of a country) sectors always sum to zero. The financial crisis sent households and businesses from deficit to surplus as they struggled to recover. For countries with a current account deficit (flows out of the country), governments had to run large annual deficits. Had they chosen not to do so, they would have forced households and businesses into larger surpluses. That would have required people to cut back on consumption in favour of paying down debt even more than they did, turning a deep recession into a depression on the scale of the 1930s. Austerity measures reduce government deficits but have been applied too soon. The result in the UK is that the recovery is being driven in large part by increasing household debt, particularly while business investment remains low. The situation for eurozone countries other than Germany is worse because there is no floating exchange rate to rebalance their economies; they have to do it internally through deeper recessions with resulting high unemployment.
Wolf believes reform must go beyond the ‘new orthodoxy’. He argues that fiscal stimulus is still necessary and highly unlikely to be inflationary given economies are operating below capacity. Among other reforms, he believes inequality must be tackled and that government must intervene to promote higher growth in the long run. Ideally, banking would be reinvented essentially as a government provision. The alternative to reform, he maintains, is a series of further crises at shorter intervals than the past but with damaging effects on economies and societies as people continue to suffer.
The evidence and arguments in this book are in sharp contrast to the complacency of governments and the quality of political debate about the economy. We need determined and visionary reformers if we are to recover our economic potential and protect the vulnerable from future economic disasters.
This article was first published by Progress on 18 September 2014.