Roots of the world economic crisis

From John Boothman.

IN his recent column (JEP, 25 January) Alan Le Breton poses four questions about the current global economic crisis. Mr Le Breton modestly describes himself as ‘an economics dunce’ but his questions are good ones, so I thought I would have a stab at answering them.

Firstly, he asks why the loans made to heavily indebted euro-zone countries are not simply written off, as has been done in recent years for some developing countries. There are, I think, two reasons for this. One is that there is an understandable reluctance to exempt profligate borrowers from the consequences of their actions, especially if this encourages others to do the same. Many of us would be happy to borrow money if we thought we would never have to pay it back.

More importantly, the overall debts accumulated by some of the Mediterranean countries are now so great that either a major default or far-reaching ‘forgiveness’ would place creditor countries, and especially their banks, in serious trouble. While it seems unlikely that the whole debt will ever be repaid, for now the pretence has to be kept up that at least a substantial part of it is recoverable, to avoid another meltdown in financial markets, a corresponding collapse in business confidence and the onset of a fresh recession.

Mr Le Breton is however quite right in his assumption that one way or another, creditor countries (and their tax-payers) will end up sharing in the pain experienced by debtors. It is the equivalent of the old joke that if you owe the bank £1,000 you have a problem, but if you owe the bank £1,000,000 the bank has a problem. Simply add an improbable number of noughts to bring the analogy up to date.

Moving on to his second question, Mr Le Breton asks why overseas aid commitments are being maintained, and even increased, at a time of domestic stringency. This is a tough one to answer but perhaps the best explanation is that the recession has affected many countries, rich and poor.

While the inhabitants of richer countries can tighten their belts to some extent, poor countries depending on shrinking markets for their goods have much narrower margins between viability and destitution. Therefore there is a strong moral case for helping such countries through the current troubled conditions. But even if one accepts this, it is clear that donor governments must be more diligent than in the past to prevent unscrupulous potentates siphoning off aid for their personal benefit.

Thirdly, Mr Le Breton wonders why the credit rating agencies, with their poor record of predicting the 2008 crisis, now wield such influence in financial markets. He is right to question their credibility, though I suspect their influence is now less than it was. With or without credit rating changes, potential lenders and investors are themselves now in a state of heightened risk awareness as a result of past lapses; which is not to say bad lending decisions will not be taken again in the future.

With all their shortcomings, the agencies’ analyses do at least help to highlight movements in relative creditworthiness, which can of course include improvements as well as downgrades. That is one tool – but only one – in moving investment decisions away from the ‘irrational exuberance’ of past years to a more sober appraisal of which borrowers can be relied upon to honour their debts, and which cannot.

Finally, Mr Le Breton asks why economic growth is regarded as ‘the Holy Grail’. The answer, I accept, depends on one’s political views as much as on economics. But historically GDP growth is the way in which global wealth is increased and poverty diminished. Air travel aside, the very wealthy today probably lead lives not much different from the very wealthy of 100 years ago, but for most other people living standards have risen dramatically since 1912. This applies with even greater force to developing countries where escaping from poverty, in the absence of growth, is a near impossibility.

Of course growth carries costs too, both social and environmental. And there is plenty of room for debate about how evenly the fruits of growth should be shared. But long periods of stagnation or contraction have historically caused widespread anxiety and hardship.

Following many decades of impressive expansion the Jersey economy has achieved no net growth since the turn of the century – a state of affairs exemplified by job losses and pay freezes. Recovery implies a return to growth. A deliberate policy of zero economic growth might appeal to some climate-change diehards, but would surely be a recipe for electoral disaster.