The Challenges Raised by the Global Financial Crisis (Collected Essays) by W B (Ben) Vosloo July 2015 Copyright © 2015 The author All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, without prior permission in writing of the author. About the Author Ben Vosloo was born in the Empangeni district, Natal, 4 November 1934. After completing his schooling in Vryheid, he went to the University of Pretoria where he majored in political science and economics taking the BA and MA degrees with distinction After serving as a teaching and research assistant, he obtained a Ph.D degree in 1965 at Cornell University, Ithaca, New York. On his return to South Africa, Dr Vosloo began his long association with the reform process in the fields of constitutional change, educational reform and economic development. He served as Professor of Political Science and Public Administration at the University of Stellenbosch for 15 years. He was inter alia member of two direction-setting Commissions: the Erika Theron Commission concerning constitutional reform and the De Lange Commission on educational reform. He published widely in academic and professional publications in the fields of management science, political science and development issues. He held offices as a founding member of a number of academic and professional associations such as the S A Political Science Association, the S A Institute for Public Administration and the S A Institute of International Affairs. During his academic career, Prof. Vosloo received several meritorious scholarships and academic awards. Ben Vosloo started his “second” career in 1981 when he was appointed as the founding Managing Director of the newly formed Small Business Development Corporation. He steered the SBDC to its successful track record and its unique position of prominence as a private sector led development institution (1981 to 1995). In recognition of his work, Dr Vosloo was made Marketing Man of the Year (1986), Man of the Year by the Institute of Management Consultants of Southern Africa (1989), given the Emeritus Citation for Business Leaders by the Argus Newspaper Group (1990) and the Personnel Man of the Year by the Institute of Personnel Managers (1990), named as one of the Business Times Top Five Businessmen (1993) and by “Beeld” as one of South Africa’s Top 21 Business Leaders in the past 21 years (1995). He acted as co-author and editor of a trend-setting publication Entrepreneurship and Economic Growth (HSRC Publishers, Pretoria 1994) and was awarded an Honorary Doctorate by the University of Pretoria in December 1995. In 1996 Ben Vosloo started his “third” career. He initially served as a business consultant on strategic policy matters and later became involved in export marketing in the USA, Canada, Europe and Asia. He obtained permanent resident status in Australia in the category “Distinguished Talents” and eventually became an Australian citizen in 2002. He is now retired and resides in North Wollongong, NSW. The Challenges Raised by the Global Financial Crisis (Collected Essays) by W B (Ben) Vosloo ------------------------------------------------------------------------------------------------------------------------ INDEX Chapter Page Preface i 1 The Causes of the 2007 Global Financial Crisis 1 2 The Impact of the Global Financial Crisis 6 3 The Damaged Economies of the Advanced Countries 22 4 Policy Options for Advanced Economies in Distress 41 5 Fixing the Flawed Financial System 54 6 The Perilous Rise of Public Debt 74 7 Unresolved Questions Relating to Deficit Budgeting 84 and Debt Levels 8 Choosing Sound Economic Growth Strategies 91 9 Essentials of Sound Growth-Enhancing Public Finances 106 10 Maintaining Public Sector Responsibility and Accountability 111 11 Major Theories on Economic Growth 120 12 The Limitations of Applied Economics 135 13 Germany’s Precarious Political-Economic Challenges 141 14 The Imperative of Budget Discipline and Monetary Restraint 149 15 Global Growth Patterns and the Risks of Contagion 160 i Preface When the financial markets of New York started to crumble in August 2007, millions of people were unaware of the impending meltdown of the world of finance. The world economy was facing its gravest threat since the Great Depression of the 1930s. By the middle of 2015, the average debt-to-GDP ratio, even in the rich countries, had risen by about 50 percent since 2007. In some cases debt levels have more than doubled. Millions of people have lost much of their savings and investments. Millions more have either lost their jobs or the prospects of finding employment. Experts were at odds trying to explain what exactly caused the crisis. Policy-makers were at a loss selecting the correct measures to deal with the consequences of the crisis. Was it caused by a generic failure of the “free market model” or a specific failure of the Anglo-American finance and banking world? Have those responsible been brought to book? If not, why not? What is the likely outcome of the heavy public debt levels, stubborn unemployment and sclerotic economic growth patterns saddled on so many countries? Is it possible to avoid these economic catastrophes by means of more regulation? Who is to regulate the regulators? Why did all the clever economists fail to see the catastrophe coming? Do they now know exactly how to avoid similar crises in the future? Are the key governmental institutions of society such as parliaments, cabinets and central banks equipped to fight the next financial crisis? What is the best way to generate economic growth? What needs to be done to stimulate business entrepreneurship and investment in order to ignite the engines of economic growth? Should growth be achieved through fiscal stimuli, structural reform, austerity measures, monetary easing or a combination of these? The essays in this collection have been written over a period stretching from the middle of 2010 to the middle of 2015. The author is a retired professor of Political Science who has developed, over many decades, a special interest in political-economic policy questions – first in relation to South Africa and since his retirement in 1998 in Australia, in relation to social democracies at large. The impetus to write about these political-economic issues stems from an abiding desire to contribute to a better understanding of the underlying policy options. It is meant to provide useful information and perspectives on important aspects of our lives at the intersection of our economic and political interests. The significance of the statistical information quoted in each essay should be interpreted within the context of the time at which it was written. Any examination of chronologically arranged economic data shows expansion and contraction of trends. Linear trends are less common, which is the main reason why uncertainty is the condition of all human life. The author wishes to thank his wife, Madalein, for taking care of the typing, collating and editing of the essays assembled in this collection. Wollongong July 2015 ii 1 1. The Causes of the 2007 Global Financial Crisis (2010) Much has been said in recent times about possible causes of the 2007 global financial crisis. Some blame it on the unbridled greed of the financing network in New York and London; others on the lax regulatory regimes in the USA and the UK. Leftist ideologues claim that the root of the problem lies in the free enterprise system associated with “Anglo-Saxon capitalism”. It is clear that glib single-cause explanations are totally inadequate. Dodgy Financial Instruments by the Shadow Banking System A major triggering role was played by the world-wide marketing of toxic securitised instruments by Wall Street investment banks. These institutions bundled sub-prime housing mortgages into a hierarchy of collateralised debt obligations (CDO’s) which they then offloaded on unsuspecting (trusting?) investors around the world. The investors at the end of the chain evidently were not able to monitor the quality of the securities because they were too far removed from the mortgage originators to be able to evaluate the quality of the underlying lending decisions. Moreover, they were snowed under interminable pages of documentation which defied proper scrutiny. The Economist ‘s “Special Report on the World Economy” dd. October 11th 2008, p.8, states “... the bright new finance is the highly leveraged, lightly regulated, market-based system of allocating capital dominated by Wall Street ... The new system evolved over the past three decades and saw explosive growth in the past few years thanks to three simultaneous but distinct developments: deregulation, technological innovation and the growing international mobility of capital.” As explained by The Economist, the hallmark of the new finance is securitisation. Banks that once made loans and held them on their books now pool and sell the repackaged assets, from mortgages to car loans. In 2001 the value of pooled securities in America overtook the value of outstanding bank loans. Thereafter the scale and complexity of this repackaging (particularly of mortgage-backed assets) hugely increased as investment banks created an alphabet soup of new debt products. They pooled asset-backed securities, divided the pools into risk tranches, added a dose of leverage, and then repeated the process several times over. Increasing computer wizardry made it possible to create a dizzying array of derivative instruments, allowing borrowers and savers to unpack and trade all manner of financial risks. The derivative markets have grown at a stunning pace. According to the Bank of International Settlements, the notional value of all outstanding global contracts at the end of 2007 reached $600 trillion, some 11 times world output. A decade earlier it had been only $75 trillion, a mere 2.5 times global GDP. In the past couple of years the fastest growing corner of these markets was credit-default swaps, which allowed people to insure against the failure of the new-fangled credit products.