1 WORLD ECONOMIC CRISIS, DEFLATION, RECESSION AND THE COMING SHIFT IN THE BALANCE OF GLOBAL ECONOMIC POWER

OUTLINE Nature of crisis Sources of crisis Actual and future policy responses Prospects for the advanced countries Prospects for the developing countries

NATURE OF CRISIS

General Nature of the Crisis Financial EconomicEconomic Global

Financial crisis Bursting of housing bubble Liquidity crunch – shortage of cash Credit crunch – lending activity ceases Global crash of stock markets* Collapse of major financial institutions

Beginnings of an Economic Crisis and Recession Fall in Industrial Production and GDP Rise in unemployment Collapse in consumer and business confidence

US Industrial Production, Jan 1989 – Sept 2008

SOURCES OF CRISIS

Perceived Sources Of Problems Burst housing bubble (sub-prime mortgages) which spilt over into other sectors Greedy bankers and speculators (short- traders) Misguided policy makers

The Actual Sources Long business cycle increases and falls –Long period increases and falls in economic growth, employment and inflation alongside rises and falls in profits, real wages, and interest rates technological –….resulting from major changes in the technological base of production Shift in global power

LONG WAVE

Source: Goldstein 1988 (modified) LONG CYCLE DATING

What Happens in The DOWNWAVE – i.e., 1980-Present Rise of Neo-liberal/Neo-classical type ideology Fall in inflation* Fall in growth rates of advanced economies* Fall in interest rates Rise of financial sector and speculative activity – repeated “asset bubbles” (1)(2)* IllusionIllusion of prosperity

US Inflation Period Averages

US Long-Cycle Average Growth Rates: Official vs Williams

US TOTAL Debt as % of GDP Source: US Federal Reserve and Financiële Strategie In % of GDP 264% 330%

Derivatives Growth Outstanding derivatives contracts $75 trillion$600 trillion As percentage of World GDP 250%1100% Source: Bank for International Settlements

Relative Decline of The US Economy Using Published Data

INTO THE NEXT LONG UPSWING?

What Is Needed For The Upswing To Start And Progress? A major crisis and a shift in global economic power Destruction of debt (1) Elimination of excess capacity Restoration of productive profit rates from; –Lower costs of capital –Relocation of production to lower cost areas –Less competitive environment Change in dominant economic thinking and policy making (towards Keynesianism) (2) More transparency in and regulation of the financial system Recognition and elimination (or at least reduction) of fraud in economic data computations (3) New international financial system New international trading system

ACTUAL AND FUTURE POLICY RESPONSES

Actual responses Fixing the financial sector –Injections of liquidity (money) into the system (1) –Bail-outs of banks Purchase of “toxic assets” (2) Nationalisations and capital infusions Guarantees of deposits –Talk about tightening financial regulation Sharp reductions in interest rates

Proposed Responses More interest rate cuts Massive increases in budget deficits (1)(2) Bail-outs of certain sectors “Nuclear option” (3) - Economist

PROSPECTS FOR THE ADVANCED COUNTRIES

Short-term (1-2 years) More turmoil in the financial system – insurance companies and pension funds Bankruptcies in the productive and non-financial service sector (1) Fall in GDP to zero or below zero* Rise in unemployment Threat of deflation (2)*

World Growth Forecasts

Deflation Coming – Economist primary Commodity and Metals index, Jan end Oct 2008

Longer-term (1) Stagflation (2) or Depression (3)

PROSPECTS FOR THE DEVELOPING COUNTRIES (1)

Short-term Balance of paymentsexchange rateBalance of payments and exchange rate weakness problems inflationExchange rate/inflation vicious cycle economic growthSharp falls in economic growth Neo-liberal ideologyWorst affected will be those countries where Neo-liberal ideology still dominates policy making (1-3)

Balance of Payments and US Dollar (and Yen) Shortage Problems Current account problems(1) 80 developing countries have current account deficits of more than 5% of GDP Turkey (-6.4%), Pakistan (-8.7%), South Africa (-7.7%), Bulgaria (-25%) Ukraine (-10%), Hungary (-5.5%), Poland (-4.9%), Baltic states (-6% to -15%) Swap facilities with US (2) Brazil, South Korea, Singapore and Mexico Yen debt problems Affecting South-East Asian countries that borrowed in Yen – so-called “carry trades”

…..Possible Short-term Silver Linings Benefit from expansionary policies in the advanced countries and richer developing countries Relocation of capital from the advanced countries and high cost developing countries Lower international borrowing costs

The Long-term – Shift in Economic Power to The Non-OECD Countries Non-OECD countries have more flexible production bases Many developing countries will benefit from increases in primary product prices Relocation of capital from advanced to developing countries Increasing South-South cooperation The rise of Asia and the advent of an Asian currency bloc Hypocrisy of Neo-liberal development and stabilisation policy prescriptions become apparent

The Long-term – The Potential Dangers Policy makers still steeped in Neo- liberal/Neo-classical thinking or jumping into Keynesian follies (1) New development policy thinking – poverty alleviation and Aid-based infrastructure development EPAs, Doha Multi-lateral trading round and Breton Woods II