Revisiting the ‘GFC’: what went wrong?

One of my favourite bloggers, Oxford economist Simon Wren-Lewis, has drawn attention to a new book that revisits the ‘global financial crisis’ or GFC as it is widely known. There is, of course, a voluminous literature on the topic, but this contribution by Tamim Bayoumi – a senior IMF official – offers some fresh insights. A summary of his arguments can be found here, while a succinct review is available here.

To start with, Bayoumi gives the GFC a new name with a strong geographic complexion. Instead of the GFC, we now have ‘NAC’ – or the North Atlantic crisis. The idea is that the financial crisis that eventually paved the way for the Great Recession of 2008-2009 was not merely US-centric. Europe also played a significant role – a view that is not widely noted.

Bayoumi traces the NAC to ‘…serial but different regulatory mistakes in Europe and the US starting in 1980. By 2002 …the elements that drove the crisis were already in place.’ It appears that a crisis that erupts seemingly out of nowhere can actually germinate and fester for decades. It is indeed noteworthy that the roots of the NAC lie in the much-noted era of the Great Moderation.

One of the culprits behind the NAC was the rapid expansion of Northern European ‘universal’ banks that grew out of ‘(r)egulatory changes in the mid-1980s’. Such changes ‘…merged commercial banking (loans to clients) with investment banking (buying and selling of assets)’. These merged entities also relied heavily on ‘internal risk models’ that were paradoxically enabled by ill-thought changes to international rules. These internal models encouraged rather risky expansions beyond national borders at the expense of prudent commercial decisions.

In the US, similar developments took place in the mid-1980s.  Regulatory changes encouraged switching of deposits and loans from ‘…sound commercial banks to more fragile investment banks that formed the core of the shadow banking system’. Further regulatory changes in 2003 and 2005 ‘helped to parasitically intertwine the…fragile US and European banking booms’.

Bayoumi goes on to highlight the collective follies – or ‘intellectual blinkers’ as he calls them – of regulators and policy-makers on both sides of the Atlantic that constrained them from identifying the dire consequences that would follow from unsustainable banking booms. These included: (a) the Basle Committee’s switch to internal risk models; (b) the undue faith of central bankers on monetary policy that led them to focus primarily on inflation rather than financial stability; (c) the belief that international spill overs were insignificant in scope and scale; (d) the inadequate mechanisms of the Eurozone to support member states when they encounter difficulties with respect to debt servicing.

What I liked most about Bayoumi’s analysis is his concern that the ‘macroeconomics profession is …slowly adapting to the lessons of the crisis’. There is still a lingering commitment in ‘standard macroeconomic models’ to the efficacy of financial markets, an enduring confidence in the ability of central bankers to cope with business cycles and the persistence of the view that international spill overs are not significant. Only time will tell whether Bayoumi’s concerns are valid.

Doing Business 2018: Modi celebrates, but what about Georgia?

The much-noted flagship publication of the World Bank Doing Business (DB) was publicly unveiled recently. This became cause for celebration for The Indian Prime Minister Narendra Modi. Why? Well, after languishing for some time, India jumped 30 places to reach a rank of 100 (the lower the rank the better in terms of the ease of doing business). It was given the accolade of the 10 ‘top improvers’ for implementing more than 50 regulatory reforms over the past year which ‘make it easier to do business’ – a distinction that India shares with Brunei Darussalam, Thailand, Malawi, Kosovo, Uzbekistan, Zambia, Nigeria, Djibouti and El Salvador. This is not exactly an inspiring list of countries. Nevertheless, the Indian Prime Minister tweeted that it was a ‘historic jump’. This is quite different from last year when the Indian government was disappointed that the World Bank did not adequately capture the reform measures that were underway. Prime Minister Modi’s ambition is to catapult India to the top 50 nations in the DB ranking scheme.

As is well known, the DB Report 2018 is the 15th in a series of annual reports that seek to measure regulations that enhance ‘business activity and those that constrain it’. The theme of this year’s report is ‘Reforming to create jobs’. Its authors claim that there is a significant association between improvements in DB rankings and growth, employment and poverty reduction. I am not going to quibble over this empirical proposition, but I do worry that the cheerleaders of good news emanating from the DB reports do not read the fine print.

As a thoughtful analyst has pointed out, one should take time to understand what exactly is being measured. He points out that ‘in India’s case, the business environment in only Delhi and Mumbai are used to compile the national ranking’. Furthermore, the emphasis is on tracking business regulations that, while welcome, are often disconnected from the daily experiences of millions of Indians.

The DB report is itself rather frank about the narrow nature of its remit. As it says, ‘the focus is deliberately narrow…’  It concedes, for example, that it does not ‘…address the extent to which inadequate roads, rail, ports, and communications may add to a firm’s costs and undermine competitiveness’.

What struck me about DB Report 2018 is the attention given to tiny Georgia which, far more than India, is a glaring example of what is revealed and what is not. Georgia is the only lower-middle income country to be part of the ‘top 20 group’ which is dominated by OECD economies. Furthermore, ‘among the top 20 economies, Georgia, with a ranking of 9, has implemented the highest number of business reforms since the launch of Doing Business in 2003’.

Does this rare distinction make Georgia the envy of the developing world? Certainly, there has been a commendable reduction in poverty. George is also classified as a ‘high human development’ country by the UNDP (with a rank of 70 out of 188 countries). It is a very attractive tourist destination. Yet, there is a lot that one should be worried about. As the Deputy Managing Director of the IMF pointed out in a recent speech, Georgia faces considerable development challenges. The country’s export base is too narrow; unemployment and underemployment remains at high levels, with a preponderance of those in long-term unemployed; almost half of the country’s labour force is employed in agriculture. If ‘reforming to create jobs’ is what Georgia has been doing since 2003, it still has a long way to go.

Perhaps, the biggest development challenge that Georgia is facing is a rapid shrinking of its population with a concomitant decline in the work-force. The last (2014) census revealed that Georgia’s population was 3.7 million whereas it was 4.3 million in 2002. Such a rapid decline in the size of the population has been driven by a variety of factors, with the most proximate ones being unattractive economic conditions, a declining birth rate and rapid emigration. If current trends persist, Georgia’s population will shrink to a little over 1 million by 2050. Georgia might be a star performer in the DB reports, but it faces a fundamental demographic challenge that it is unable to meet.

Will increasing the tax burden on the rich hurt growth? Unlikely, says the IMF

A standard refrain among those with conservative proclivities is to argue that the rich are ‘wealth and job creators’. Hence, they deserve to be treated generously, including ensuring that they are not taxed at onerous rates. Otherwise, the rich will vote with their feet and relocate to low tax environments. Protect through preferential treatment, seems to be the sentiment, the proverbial goose that lays the golden egg.

Governments across the world have been influenced by such a view. Marginal tax rates on high income groups have fallen substantially across the OECD as has corporate tax rates. During the recent UK elections, the British Labour Party proposed a 50 per cent tax rate on top income earners. Predictably, the Tory government and its enablers protested that the economy would face ruin because of a ‘tax bombshell’.

The view that the rich should be treated with care and generosity, especially through the tax system, in order to nourish their role as wealth and job creators has now been challenged by the IMF- an institution that its critics believe is a bastion of neoliberalism and fiscal conservatism. In a report that has attracted media attention, the IMF’s Fiscal Monitor (October 2017) draws on optimal tax theory to show that progressive income taxes (PIT) have a major role to play in ‘tackling inequality’ without hurting growth. A marginal tax rate on high income groups of 44 per cent would have no impact on growth while furthering the goal of redistribution. The current norm in the OECD is 35 per cent. So, the British Labour Party was not really being outlandish in what it proposed.

Of course, the IMF is a diverse institution that can speak with many voices. At the global level, though not necessarily at the country and operational level, it is making proclamations that appear to be a lot more nuanced than they have been in the past. Indeed, it even engaged in a robust critique of neoliberalism arguing that as an intellectual brand it seems to have been ‘oversold’ in some respects. The IMF’s messages on dealing with inequality through the tax system are also in line with the views of entrepreneurs and academics who seek to dismantle the myth that the rich are really job creators who deserve special dispensation from governments across the world.

Rohingya refugees – a plea to China

Adil Khan,  a Professor at the University of Queensland, and a former senior UN official, who worked in Myanmar for an extended period of time, wrote this open letter to to the President of the People’s Republic of China. Professor Khan offers a powerful indictment of China’s official position on the terrible plight of the Rohingya refugees.

Worth reading….