Anomalies in the International Economy (I)

There are certain situations in the global economy that contradict university textbook principles. For instance, strong economies are borrowing massive amounts of capital, thus accumulating large external debts. Instead of moving from abundant economies to less affluent ones, capital flows in just the opposite direction. The U.S. is a notorious case from this viewpoint. It is not difficult to understand why emerging economies accumulate foreign exchange reserves as a buffer against adverse shocks. However, the situation is curious as it is also an expression of excessive expenditure in advanced economies, some of which are overburdened from an economic and military point of view.

Another “anomaly” is the level of net public debt, which is estimated to have reached 70-80 percent of the GDP (from under 50 percent in 2007) in the developed world; this level is considerably higher than the one in many emerging economies. Some might say that this is not surprising, given that financial markets are different in their tolerance of state indebtedness. On the other hand, the current crisis has greatly increased public debt in the industrialized Western world, which has, in its turn, highlighted the threat of sovereign bankruptcy. Sovereign failures traditionally occur in the underdeveloped world and emerging economies.

We are currently witnessing a radical change, which will influence economic developments and interest levels on international credit markets, because financing needs are growing. We should, at this point, make a distinction between bonds that are predominantly bought by residents of a state and major acquisitions made by non-residents; the exposure to foreign nations is what makes countries more vulnerable to the instability of financial markets (e.g. Japan has a very large public debt of over 200 percent of its GDP, but the debt is predominantly held by locals; Spain’s debt is approximately 50 percent of the GDP, but a large part of this debt is held by non-residents).

The impact of the crisis on financial systems is food for thought. Systems that are less connected to others, less integrated in the external environment from a financial point of view, have been less affected. Among emerging economies, China and India are notable examples because of their pragmatic policies. A lesson we have to learn from this crisis is the danger of premature financial liberalization, which occurred in countries that joined the EU (and were forced to open their capital account). The extraordinary tension within the Monetary Union shows that we are dealing with a deep financial integration crisis in this area, while institutions and economic policies remain inadequate.

This is why the EU is seeking an economic governance reform that is not limited to controlling tax deficits. The financial crisis is also a crisis in globalization, which has shown its side effects in the absence of mechanisms and instruments for global governance. What the G20 will manage to achieve in this sense and how the reform of the international architecture (of what is left of the Bretton Woods system) will take place, are questions that remain to be answered.

As regards the crisis of financial intermediation in advanced economies, we can notice phenomena that are typical of the underdeveloped world: rent-seeking, interest groups taking control of public policies, entities grossly abusing their dominant positions on the market, etc.

To be continued …