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Finishing the Post-Crisis Job

LONDON – August 9, 2017, is the tenth anniversary of the decision by the French bank BNP Paribas to freeze some $2.2 billion worth of money-market funds. Those of us who were active in financial markets at the time remember that event as the beginning of the worst global financial crisis since the Great Depression.

Many economists and financial observers argue that we are still living with the consequences of that crisis, and with the forces that incited it. This is partly true. Many developed economies still have in place unconventional monetary policies such as quantitative easing, and both productivity and real (inflation-adjusted) wage growth appear to be mostly stagnant.

But it is important to put these developments in perspective. Many people, including the Queen of England in November 2008, still ask: “Why did no one see it coming?” In fact, many financial observers did warn that housing prices in the United States were rising untenably, especially given the lack of domestic personal savings among US consumers.

As Chief Economist of Goldman Sachs at the time, I had written three different papers over a number of years showing that the US current-account deficit was unsustainable. Unfortunately, these findings largely fell on deaf ears, and the firm’s foreign-exchange salespeople probably got bored passing on yet more of the same pieces to their clients.

At one point in 2007, the US current-account deficit was reported to be 6-7% of GDP (it has since been revised down to around 5% for the full year). This high figure reflected the fact that the US trade balance had been steadily deteriorating since the 1990s. In the absence of any obvious negative consequences, however, complacency had set in, and the US continued to spend more than it saved.

Meanwhile, China had spent the 1990s exporting low-value-added products to the rest of the world, not least to US consumers. In 2007, its current-account surplus was around 10% of GDP – the mirror image of the US. Whereas the latter was saving too little, China was saving too much.

For some observers, this huge international imbalance was the source of the crisis. In the years leading up to the crash, they argued that the global financial system was simply doing its job, by finding increasingly clever ways to recycle the surpluses. Of course, we now know that it performed that job rather poorly.

Much has changed in the intervening decade. In 2017, China will run a current-account surplus of 1.5-2% of GDP, and the US will most likely run a deficit of around 2% – but possibly as high as 3% – of GDP. This is a vast improvement for the world’s two largest economies.

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Still, other countries have built up ever-larger current-account imbalances over the past decade. Chief among them is Germany, whose external surplus now exceeds 8% of GDP. Germany’s current account suggests that there are deep imbalances that could lead to a new crisis if policymaking is not well coordinated. The last thing that Europe needs is another sudden reversal, as we saw at the height of the Greek debt crisis.

The United Kingdom, for its part, will have a current-account deficit above 3% of GDP this year, which is nearly three times what it was ten years ago. But that is not to say that the UK’s trade balance has significantly deteriorated. Rather, it reflects the fact that the UK is a major financial center, and that investment returns have shifted more in the UK than elsewhere.

All told, the global economy today is much healthier than it was ten years ago. Many are disappointed that real global GDP growth since the crisis has undershot performance in the previous decade. But since 2009 – the worst year of the recession – the global economy has grown at an average rate of 3.3%, just as it did in the 1980s and 1990s.

Of course, this is largely owing to China, the only BRIC country (Brazil, Russia, India, and China) that has met my growth expectations for the decade (although India is not too far behind). The size of China’s economy has more than trebled in nominal terms since 2007, with GDP rising from $3.5 trillion to around $12 trillion. As a result, the aggregate size of the BRIC economies is now around $18 trillion, which is larger than the European Union and almost as big as the US.

There will inevitably be another financial bubble, so it is worth asking where it might occur. In my view, it is unlikely to emerge directly from the banking sector, which is now heavily regulated. The bigger concern is that many leading companies across different industries have continued to focus excessively on quarterly profits, because that determines how executives are remunerated.

Policymakers should take a hard look at the role of share buybacks in this process. To her credit, in the Conservative Party’s 2017 election manifesto, British Prime Minister Theresa May announced that her government would do this. One hopes that May’s government follows through. Doing so could strike a symbolic blow against the underlying malaise of post-crisis economic life. The West needs real investments and higher productivity and wage growth – not more economically unjustifiable profits.

Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK Treasury Minister, is Honorary Professor of Economics at Manchester University and former Chairman of the British government’s Review on Antimicrobial Resistance.

By Jim O’Neill

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