Global Dimensions of the Financial Crisis

All analyses of the current crisis have been incomplete. They deal with symptoms, not causes. There has been a focus on financial sector institutions and regulation, on the operation of monetary policy and on alleged policy errors. These things were important in shaping the way that the crisis evolved but they are not at its root. The truth is that the world and its economy have changed in ways that are likely to lead to periodic instability.

The changes have not been recognised and assimilated in the practice of monetary policy or in the way that politicians regard the economy. Controls on the international movement of capital were generally lifted in the 1970s and 1980s. Together with the collapse of communism, which released millions of workers into the capitalist world economy, capital liberalisation effectively recreated a global 'reserve army of labour'. As widely noted, that development contributed to a rise in the share of profits in world GDP, and in the GDP of most individual countries, and a decline in the share of wage income. What was not widely noted is that such a development easily leads either to overinvestment by businesses or a shortfall of aggregate demand. When wages lag, consumer spending can only keep up with output through a continuing expansion of consumer debt. These tendencies are at the heart of the present crisis.