A crisis and its too long overdue solution

Cette note sera publiée dans la revue scientifique russe Mir Peremen (Le Monde en Changement) à la veille du Forum Economique de Moscou qui se tiendra au début du mois de mars.

The crisis, which began in 2007 in the United States of America and spread progressively among the whole world, is not over. Of course the most urgent aspect of this crisis, the liquidity crisis, has been addressed. A general collapse of the global economy has been so far adverted and we are no more, at least for the current time, in a so tragic a situation we were in October 2008. But the main sources of economic global disorders have not been cured and are to come back, sooner or latter, and more probably than not with a vengeance.

(1) The 2007 crisis took different aspects. It began as a bank crisis, and then evolved into a liquidity crisis, and then into a debt crisis. But its sources have been the same. Actually we are confronted to two largely interconnected crises.

The first one is linked to a progressive change in the global economy with the raising power of so-called “emerging” economies. One can see this process as the end of the XIXth and XXth century anomaly. By early XVIIIth century China was actually the most important economy of the world and it will be again by 2030-2040. The crisis could be then see as the end of the European (and more precisely the Euro-Atlantic) domination, which began with the industrial revolution. One main characteristics of this process is the growing industrial power of some countries but without the accompanying monetary domination. When Great Britain was the leading world power its currency ruled supreme. When the USA was leading the world the US Dollar was the most powerful (and the most demanded) currency. However, with the current fast emergence of Asian “mammoth” countries (China, India) we are not seeing the same process as far currencies are concerned. So far the US Dollar is still largely the most important currency in the world. The Euro tried, and most probably failed to compete for global supremacy. Could a declining power still be owning the ruling currency or this unbalance is to create a major disequilibrium?

To this first dimension of the crisis we have to add another one undermining all efforts to regain global stability. Since early 1980’s a new form of capitalism developed, first in the USA and then in Europe. Its main characteristic is a high level of inequality of income coupled with the unchained development of global finance. One could check the fact and see the growing share of national income accumulated by population 1% wealthiest people1.

Figure 1

The fact that the average income is still growing in a lot of countries is not to mask this other fact: the median income is stagnating or even declining since the early 2000. This has been hidden by the huge development of lending, of course in the USA but also in Europe.

Figure 2

Figure 3

Lending, to households or to the State, has been a surrogate of a more balanced income development. But we ended up in a large and general indebtedness crisis. People are focusing on government debts and budget deficit. But the household and enterprise debt is no less spectacular. By the way public and private debts are interlinked. When the crisis began and banks were facing insolvency States had no choice but to transfer part of the “private” debt to “public” debt. This was spectacular in Spain and Ireland where the public debt was before the crisis very low and then jumped to summits. Now, this widely accumulated debt is pushing the world on to a massive deleveraging process, which would probably plunge a number of countries into recession and even depression as it already did for Greece, Portugal and Spain. But even if we could solve this problem this would still let the income distribution in most countries highly inbalanced. The combination of both crises is actually a challenge worse than in the 1930’s. It prevents a common policy addressing different problems to be found.

(2) Solutions exist, are well known, but are extremely difficult to implement. To give demand, the ultimate factor to which production is to be compared, solid ground a huge process of re-equilibrating income distribution is needed. Without such a policy, internal demand will be depressed and so will be investment. Internal savings could not be invested and will flee to other countries, where the situation will be more or less the same. Then, savings will end into highly speculative financial instruments, fuelling “bubbles” all over the world. This is why re-equilibrating income distribution is urgently needed. But if such a movement is not to begin simultaneously in different countries the risk to have some countries playing a “lone rider” policy and then to benefit massively of this re-equilibrating move is to become and overcoming obstacle. In a world where so far capitals could flow freely and largely without obstacles fiscal competition between countries is to become the rule and not the exception. States have lost a large part of their taxing power. But if every country is implementing its own deleveraging process, with its huge cost in growth and unemployment, there will be (and there is already) a strong pressure to use currency undervaluation to transfer part of even the totality of the cost on neighbour countries. This is more or less what the US government did in a recent past and what the Japanese government is currently doing. We are to note that the various “quantitative easing” implemented around the world are adding up to the process of highly speculative savings and are contributing too to fuel financial “bubbles”. So we are trapped between two evils, fiscal competition and a currency war. At this point it is to be added that global governance institutions, like the G-8 and the G-20, are important international forum but have proven to be unable to solve this situation.

(3) Such a situation implies a radical change in the philosophy behind the economic policy. The failure to set global governance institutions both legitimate and operational is just much too obvious to be ignored. There is no point to try to make working what we failed to do in the past twenty years. But to say that no global governance is possible does not imply that no coordination is possible. However to make inter-states coordination work we have to limit its scope. First of all we have to reduce the current global flow of both capitals and goods to re-focus on our own economies. This does not imply a return to autarkic practices of the past but to some principles advocated by J.M. Keynes in his famous paper about “National Self-Sufficiency”2. When reading it today we could find a lot of very useful applications.

In this paper Keynes made a point by linking the process of income distribution to the openness of the economy. Various studies made during the last 15 years have proven that large openness increases the inequality of income distribution. The aim of the new economic policy would then be to reduce but not to suppress the level of openness in world economies. The first problem to be addressed would be capital flows, which are destabilizing economies3 without adding to their growth potential to the contrary of what is frequently believed4. We have to note that even the IMF is now acknowledging the legitimacy of capital controls5. They are to target first short-term and highly speculative flows6. Capital controls are also extremely important as they reduce to a considerable extent fiscal competition and enable then a country to implement in a safe way the rebalancing of its income distribution7.

But capital flows are not the only problem. Some restraints to the circulation of goods are also to be implemented here too in the spirit of Keynes’ “National Self-Sufficiency”. This would lead us toward a de-Globalization path, but one which is to be coordinated and managed, reducing but not suppressing interactions between economies to give national governments back the possibility to take real anti-crisis measures. The ultimate aim would then be the creation of a new international currency, not suppressing but supplementing national ones and used as the main reserve currency.

(4) The chances that such a path is to be taken are however so far very slim. The free-trade ideology, as exemplified by the WTO, is still dominating as well the so-called “mainstream” view in economics. The very fact the mainstream has been unable to see the crisis coming and has been unable to prevent it to develop has not undermined the faith political decision-makers are showing in its prescriptions. As a result the deleveraging process is to go on, with its burden of unemployment particularly in Europe, the currency war is to rage and in the end we are to face another major financial “bubble” on stock markets. We know since the last depression, the one of the 1930’s that deflation policies are doomed to fail. But still we keep trying to implement it. All these factors are to provoke huge social and political disturbances in European countries but also, through contagion and contamination, in emerging ones. Anger and despair are never good advisers.

But, the worst is still not sure. By seriously questioning current “sacred cows”, be they on finance or free trade, we could open the possibility for changes in the near future. Economic policy is to be grounded on sound economics that is realistic ones. We sacrificed too much for the sake of theoretical consistency and as a result models lost touch with reality8. It is urgent to go back to a realistic theory and to get rid of the “false science” burdening economics.


Jacques Sapir, “A crisis and its too long overdue solution”, billet publié sur le carnet Russeurope le 07/02/2013, URL: http://russeurope.hypotheses.org/827


  1. T. Piketty, Saez E. : « The evolution of top incomes : a historical and international perspectives », in American economic review, vol.96, no 2, 2006, p. 200-205. Idem, « Income inequality in the United States, 1913-1998 », in Quarterly journal of economics, vol. 118, no 1, 2003, p. 1-39.  A. B. Atkinson, T. Piketty, Saez E. : « Top incomes in the long run of history », in Journal of economic litterature, vol. 49, no 1, 2011, p. 3-71. []
  2. J.M. Keynes, “National Self-Sufficiency”, The Yale Review, vol. 22, n°4 (June 1933), p. 755-769. []
  3. G. L. Kaminsky, C. M. Reinhardt, C. A. Vegh, « When it Rains, it Pours: Procyclical Capital Flows and Macroeconomic Policies », IMF Discussion Paper , Washington (D. C.), FMI, août 2004. []
  4. D. Rodrik, “Why Did Financial Globalization Disappoint?” (with A.  Subramanian), IMF Staff Papers , Volume 56,  Number 1, March 2009, 112-138. []
  5. J. Ostry et al. , « Capital Inflows: The Role of Controls », International Monetary Fund Staff Position Note , Washington (D. C.), FMI, 2010. []
  6. J. A. Ocampo, J. G. Palma « Dealing with Volatile External Finances at Source: The Role of Preventive Capital Account Regulations » in J. E. Stiglitz, J. A. Ocampo (dir.), Capital Market Liberalization and Development , Oxford, Oxford University Press, 2007. Gallegati M., B. Greenwald, M.G. Richiardi and J.E. Stiglitz, “The Asymmetric effect of Diffusion Processes: Risk Sharing ad Contagion”, Global Economy Journal , Vol. 8, n° 3, 2008, article 2. []
  7. The point have been noted by Keynes in J. M. Keynes, « Proposals for an International Currency Union – Second draft, November 18, 1941 » in D. Moggridge (dir.), Collected Writings of John Maynard Keynes , vol. 25, London, Mac Millan, 1980, p. 42-66. []
  8. C.A.E. Goodhart, “The Continuing Muddles of Monetary Theory: A Steadfast Refusal to Face facts”, paper presented to the 12th Conference of the Research Network Macroeconomics and Macroeconomic Policy, Berlin, Germany, October 31st – November 1st , 2008. []

Jacques Sapir

Ses travaux de chercheur se sont orientés dans trois dimensions, l’étude de l’économie russe et de la transition, l’analyse des crises financières et des recherches théoriques sur les institutions économiques et les interactions entre les comportements individuels. Il a poursuivi ses recherches à partir de 2000 sur les interactions entre les régimes de change, la structuration des systèmes financiers et les instabilités macroéconomiques. Depuis 2007 il s'est impliqué dans l’analyse de la crise financière actuelle, et en particulier dans la crise de la zone Euro.

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