Columns - The Sunday Times Economic Analysis

Do economists have solutions to current global crisis?

By the Economist

There are very little signs that the global economy is coming out of the recession. The only agreement is that the recovery will not be this year.

The IMF and economists in the US are cautiously optimistic that by the middle of next year there would be a recovery in US and Europe. But then they have been changing predictions and postponing the date of the recovery. It is likely that by the middle of next year the recovery would be predicted to be at the end of the year. The fact is that at the moment there is no light visible at the end of the tunnel.

There is considerable scepticism that economists know how to resolve the current economic crisis that has been described in many different ways. It is called the worst ever recession since the depression of the 1920s and the 1930s. Some have termed it a meltdown; others a recession; and still others have even used the term depression. Whatever you call it, the fact is that there are no signs of a turn around. It is openly said that it would not go away this year, but is likely to change sometime in 2010. There appears to be a postponement of the date of recovery as the measures taken have still not shown signs of being successful.Some persons in Sri Lanka are more optimistic than those in the rest of the world. But then we have always been more optimistic. Not so long ago when the crisis occurred, we were told it would not have much impact on the Sri Lankan economy. Now the effects of the global recession are a severe problem for the country. Our exports are not growing and export industries are being shut down with about 100,000 workers said to be unemployed. There is also evidence of cutbacks in salary packages to cope with the effects of the global recession. Export industries are the worst affected.

Economists hardly predicted the crisis even though there were some concerns over financial mismanagement and lack of adequate regulation of financial institutions. The naked truth is that economists, despite their predictive models, did not foresee the crisis. Once the crisis occurred they were able to adduce various causes but their solutions do not appear to resolve the problem. One of the reasons for this is that they are unable to think beyond the box. Economists are indeed myopic in vision and some suffer from even tunnel vision. They have turned to old theories to find a solution without adequate thought to the changed national and global conditions. In fact explanations from those who are not economists have been more plausible than those of reputed economists.

As one analyst has said, “What is in even shorter supply today than credit is an economic theory to explain why the current financial tsunami occurred, and what its consequences might be. Over the past 30 years, economists have devoted their intellectual energy to proving that such disasters cannot happen. The market system accurately prices all trades at each moment in time. Greed, ignorance, euphoria, panic, herd behaviour, predation, financial skulduggery and politics – the forces that drive boom-bust cycles – only exist off the balance sheet of their models.” Robert Skidelsky who made this observation is a member of the British House of Lords. More importantly he is the author of the biography, John Maynard Keynes: Economist, Philosopher, Statesman. It is in fact to Keynesian theory that economists have turned to thinking that his diagnosis of a lack of effective demand was the main cause of the problem. This is the reason why developed countries -- US, Australia and European countries have attempted to solve the problem by pump priming. This in simple words means putting more money into circulation so as to increase demand. Failing large corporations have been given massive doses of credit, pensioners in Australia given additional pension cheques and credit policy loosened in many economies.

Robert Skidelsky has argued that mainstream theory has no explanation of why things have gone so horribly wrong. He argues that to understand how markets can generate their own hurricanes they have relied on a return to John Maynard Keynes who thought that this was exactly how unregulated markets would behave. There are considerable doubts that the US Economic Recovery Plan is working. Edmund L. Andrews writing in the New York Times of July 8 has said: “With unemployment already at 9.5 percent and likely to exceed 10 percent, much higher than White House officials predicted back in February, Mr. Obama has been facing attacks that his $787 billion stimulus programme was either too timid or wrong-headed or both. Now, just five months after Congress agreed on the plan, with only a fraction of the money actually out the door, Washington is debating the need for a second round of stimulus amid economic and political crosscurrents.”

Obama’s recovery plan will not work. In fact it will lead the US into more serious difficulties. Economists know some of the causes of the recession, though not all of them. They certainly do not know the solution. It’s very much like doctors who can tell you what's wrong but can't fix you. They try several medications without success and sometimes the body heals itself, at other times their patients die. However there is no such thing as a death of an economy. The issue is one of weakening. The solution to the economic problems may require deep surgery. In the words of Thomas Friedman, the US economy requires rebooting. That would take quite some time. The United States has not woken to the fact that they are no longer competitive in the world economy; that they are consuming far more than they produce; that their styles of living are no longer sustainable. The huge holding of US Treasury bills by China, the purchases of many US businesses by Japan and the fact that the US is the largest indebted country in the world underscores this.

It would be pretentious to say that we know the solution. That will emerge in the fullness of time. Part of the explanation for the crisis is there in words of wisdom from John Maynard Keynes that explains the genesis of this crisis. "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done". Yet his answer to the Great Depression is not necessarily relevant in the current context of globalisation.
Manmohan Singh, the Indian Prime Minister, an economist of the highest calibre once said, that the developed countries created this crisis but it is poor countries that would suffer most. It is incumbent on our economists to follow policies that would harm the economy the least in this unfavourable global context. We have to recognise that we cannot escape it. What we can do is to mitigate it by prudent economic management.

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