Frank Stilwell
We are now facing the most severe economic crisis since the Great Depression began in 1929. The crash in share market values has sent shock waves though the global economy. An economic recession now seems inevitable in Australia and many other nations. How deep and how long it will be depends on how we and our governments respond.
The warning signs of a coming crash became evident during the emergence of the sub-prime crisis in the United States in 2007. The egregious business practices of a range of financial institutions were the immediate cause of the problem. The financial institutions had been making loans to low income people wishing to buy houses, knowing that they would be committing their customers to rising interest rates and creating a high probability of default. Both borrowers and lenders became losers when the US housing price bubble burst a couple of years ago and prices started to fall.
A devastating transmission process ensued. The problem of mortgage defaults spread because the debts had been repackaged as securities called 'collateralised debt obligations'. Other banks, companies and governments bought the securities, believing them to be less risky than proved to be the case. The false confidence was partly because inappropriate reassurances were given by the big credit ratings agencies Moody's and Standard and Poors.
When the extent of the actual risks was revealed financial institutions became less willing to continue holding these mortgage-backed securities. As in any market, when there are lots of sellers but few buyers, prices inevitably fall. The stock market values of the institutions themselves also fell because they were holding securities that were worth less (if not completely worthless). With the collapse of some of these major financial institutions, particularly in the US and the UK, a general financial crisis emerged.
So what originated as a sub-prime crisis of largely US origin became generalised as a global financial crash. The long period of debt-fuelled growth has shuddered to an end, as it inevitably had to sooner or later. The economic growth of the 1990s and early 2000s was based on debt-fuelled consumerism, speculation and the quest for unlimited capital gains, rather than sound finance and sustainable economic production.
Not even government bailouts have been able to restore the confidence necessary for failing financial institutions to resume normal trading with each other. The downturn has now spread from speculative financial markets to the 'real' economy in which goods and services are produced, leading to the prospect of a severe and prolonged global recession.
This is a deeply troubling situation. Job losses seem inevitable as the crisis impacts adversely on productive capital investment, consumer spending and labour markets.
The Australian economy cannot be immune from this economic calamity. Until recently it has been propped up by the high value of minerals dug up and exported to the rapidly expanding economies in Asia, particularly China. But now Chinese growth is slowing sharply and the value of our commodity exports has plunged. The federal government is already forecasting significant job losses over the months ahead. As a society we cannot afford to have unemployment diminish, divide and demoralise us.
Responding effectively to the crisis requires the rejection of neoliberal economic ideas and policies. Free markets are manifestly not delivering good outcomes. Economic instability is rife. Fiscal restraint and deregulated markets cannot remain the basis for government economic policy.
But what can governments realistically do? They can regulate the behaviour of financial institutions more comprehensively. They can implement public ownership, as governments in the UK and USA have done where large financial enterprises have been facing imminent collapse. They can directly create jobs by increasing their own current spending and long term investment, thereby preventing further economic downturn. They can steer economic development into new directions.
Kevin Rudd has recognised that 'extreme capitalism' no long works. The alternative that he and other government leaders like Barrack Obama and Gordon Brown are grasping has its roots in Keynesian economics. This was the orthodoxy in the 1950s and 1960s before the onset of rapid inflation and growing unemployment led to its displacement by monetarism and neoliberal policies. Now that neoliberalism has failed it is not surprising that Keynesianism is resurgent.
To his credit, Rudd perceived the need to respond quickly to the economic crisis. His government's decision last November to add $10 billion to its own budgeted expenditure and its more recent commitment to another $42 billion signals a strong Keynesian economic stimulus. More government spending pumped into the economy can offset the tendency towards recession. Making many of the payments directly to households is also clearly motivated by the wish to boost consumer spending as quickly as possible.
Are these policies enough? The government gets more credit for speed than for the specific policy details. For example, seeking to boost spending on housing by increasing the first home buyers' subsidy in the first stimulus package will keep house prices higher than they would otherwise be. Spending on public housing is a better way of directly creating building jobs and making housing more affordable.
The government's $900 handouts are being welcomed by people on low and middle incomes, but there are concerns about fairness. Unemployed people don't qualify for the payments but some households can get multiple payments under other eligibility categories. The boost to spending is also uncertain. People who think that the government's policy package signals very difficult times ahead may respond by saving their handouts. That is good for them but it reduces the overall economic stimulus. Similarly, if the extra spending is on imported goods not be many local jobs will be generated.
A comprehensive policy response to the crisis needs to go beyond short-term measures. More long-term investment is needed to put the economy on a sounder footing for the future. Therein lies the opportunity to link redress of the current financial crisis with other policies to create more stable, secure and ecologically sustainable economic arrangements. The extra spending on schools and transport infrastructure that the Rudd government has announced is welcome and overdue. Improving our social services makes much more sense that the tax cuts that the Liberals are advocating. But how the money is spent is crucial. We need new train lines for commuters not coal companies.
The Greens were successful in the Senate in getting the government to put more emphasis on investments in energy-efficiency. But more needs to be done to encourage economic restructuring and sustainability. Key focal points could be steering superannuation funds into public infrastructure projects, improving land and water management practices and investing in the provision of green energy.
Strident voices from the business community will predictably argue that we cannot 'afford' to pursue environmental objectives until the economic situation improves. In fact the embrace of a job-creating green agenda could not be more timely. We need a 'green new deal' that simultaneously addresses the economic crisis, social needs and environmental concerns.
Frank Stilwell is Professor of Political Economy in the School of Economics and Political Science at the University of Sydney and an executive member of the Evatt Foundation.
Suggested citation
Stilwell, Frank, 'The financial & economic crisis', Evatt Journal, Vol. 9, No. 1, March 2009.<https://evatt.org.au/the-financial-economic-crisis>