1 Current Debt Crisis: Causes in Historical Perspective Mah-Hui LIM South Centre Eurodad – Glopolis International Conference 2013 Debt, Finance and Economic Crisis Prague June 3 – 5, 2013

Three Levels of Causes of Crisis  Flaws in Theory & Method of Macro Economics &Finance-Market Efficiency Theory & Fallacy of Composition  Deregulation, Practices and Malpractices of Financial Industry  Macro-economic structural causes – Current account imbalance Financial vs Real Economy imbalance Income/Wealth Imbalance 2

Economic Crisis and a Crisis of Economics  P Krugman in 2009 Lionel Robins Memorial Lecture at LSE:  Much of mainstream macroeconomic theory in the past three decades have been “useless at best and harmful at worst” 3

Financial Industry- Minsky  Financial fragility is determined by margin of safety (banks’ ability to meet liquidity demands) & ability of borrowers to repay from cashflow  As banks have moved from hedge financing to speculative & Ponzi financing – financial fragility & instability increases 4

Frequency of Banking Crises – 1880s to

Focus on 2 Structural Causes – Financialization & Inequality  Key to understanding long term structural causes of Global Financial Crisis is to examine the link between: financialization, debt and inequality Not an ordinary banking crisis 6

7 Inequality Preceded Great Depression and GFC

Why Inequality related to recent financial crisis  2 measures of inequality: Gini index Wage share of GDP (vs capital share) 8

Declining Wage Share of GDP – 1970 to 2010  Source: UNCTAD, TDR 2012 & CEIC 9

Globalization and Increasing Inequality  Growth has been accompanied by growing inequality in most countries  In 4 largest economies – US, Europe, China, Japan - common phenomenon of unrelenting pressure on labor income despite rising productivity 10

Productivity Growth vs Wage Growth 11

U.S. - Wages lagged behind productivity 12

Wages – play two functions  A cost component of production  Also a component of aggregate demand  With neo-liberalism – labor flexibility > labor loss of bargaining power, rise of temporary – casual labor, wage suppression > wage growth lagged behind productivity and wage share of GDP declining 13

Inequality & Under- consumption  Decline of wage should suppress household consumption, i.e., under- consumption (as in China)  Under-consumption or drop in aggregate demand can be counter acted in 2 ways Increase in debt (as in the US) Increase in exports (as in China) 14

Enter Monsieur & Madam Finance - Financialization  US became a debt driven economy  US GDP rose 27x Total debt rose 64x to 350% of GDP Household debt rose 64x to reach 100% of GDP in 2007, while real wages stagnated or declined  Debt bubble built up 15

U.S. - Growth of GDP (27x) and Debt (64x) btw 1960 &

17 Composition of USD total debt GDP rose - 27x Total Debt - 64x Financial -490x Household- 64x Non Financial Corp – 53x Govt- 24x

Excess Savings of Rich Invested in Risky Financial Products  Most of income gains accrued to top 1% of households  Propensity to consume of rich much lower than the poor  Excess savings chasing for high yields and invested in risky assets (financial innovation) > asset bubble  BOTH BUBBLES IMPLODED

Conclusion & Policy Implications  Wage Repression + Financialization a toxic mix results in financial crisis  Policy Implications:  Need finance to serve real economy but NOT financialization which drives speculation and bubbles  Finance needs to be better regulated because finance is an industry with high negative externalities 19

Financial Regulation & Functional Income redistribution  Studies on contribution of finance to growth is mixed – probably it’s a inverted U shape – positive effect up to a point and then becomes negative  Need to address problem of inequality  Can be ex-ante or ex-post  Ex-ante – wages tied to productivity growth over long run – cannot be less or more without causing instability 20

Income redistribution  Ex-post – government must have fiscal policies to redistribute income and enhance social safety nets  Civil societies must push for all the above 21

References  Michael Lim Mah-Hui and Khor Hoe Ee, “Inequality and Financial Crisis: From Marx to Morgan Stanley” in Development and Change, Volume 42 (1) January  Michael Lim Mah-Hui & Lim Chin, Nowhere to Hide: Great Financial Crisis & Challenges for Asia, Inst of SEAsian Studies, Singapore 22

IMF Working Paper 10/268 23

 THANK YOU 24