The crisis of the economic paradigm

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It is not only the continuing global economic crisis that suggests the need for a new economic paradigm. Much was wrong with the global economic boom that preceded the crisis. Not only did the boom prove unsustainable – based as it was on speculative practices enabled and encouraged by financial deregulation – but it also drew recklessly on natural resources in a manner that has created a host of ecological and environmental problems, especially in the developing world. Furthermore, because its benefits were spread so unequally, most people in the developing world – even those in the most dynamic economic segment of Asia – did not really gain from the boom.
The financial bubble in the United States attracted savings from across the world, including from the poorest developing countries. Since 2003, there was a net transfer of financial resources from the South to the North. The governments of developing countries opened up their markets to trade and finance, gave up on monetary policy oriented to meetings the needs to of their own citizens and pursued “fiscally correct” deflationary policies that reduced public spending. So development projects remained incomplete, and citizens were deprived of the most essential socio-economic rights. Despite popular perceptions, there was no net transfer of jobs from North to South. In fact, industrial employment in the South barely increased over the past decade, even in China, the “factory of the world”. Instead, technological change in manufacturing and the new services meant that fewer workers could generate more output. Old jobs in the South were lost or became precarious, while the majority of new jobs remained insecure and low-paying, even in fast-growing China and India. The developing world’s persistent agrarian crisis hurt peasant livelihoods and generated global food problems. Widening inequality meant that the much-hyped growth in emerging markets passed most people by, as profits soared but wage shares of national income declined sharply. In most countries, real wage growth remained well below labour productivity gains in the period 1990–2006, and the wage share of national income declined in all major regions of the world during the two decades between 1985 and 2005.
Almost all developing countries have adopted an export-led growth model, which calls for containing wage costs and domestic consumption for the sake of international competitiveness and growing shares of world markets. In many developing countries, this strategy led to a peculiar combination of rising savings rates and falling investment rates. This, in turn, led to an accumulation of international reserves that were then invested in what appeared to be safe assets abroad. This is why the pre-crisis boom was globally a matter of the South subsidizing the North: through cheaper exports of goods and services, through net capital flows from developing countries to the United States in particular, and through flows of cheap labour in the form of short-term migration. The collapse of export markets brought the whole process to a sharp stop for a time, though such a strategy would have proved unsustainable beyond a point in any case, especially when a number of relatively large economies seek to use it at the same time. Indeed, not only was this strategy a recipe for widening global inequality, but it also sowed the seeds of its own destruction by generating both downward pressures on prices because of increasing competition and protectionist responses in the North.
In the pre-crisis boom, domestic demand tended to be profit-driven, based on high and growing profit shares in the economy and significant increases in the income and consumption of newly “globalized” middle classes, which led to bullish investment in certain non-tradeable sectors – e.g. financial assets and real estate – and in luxury goods and services. This enabled economies to keep growing even though agriculture was in crisis and employment did not expand enough.
The patterns of production and consumption that emerged meant that growth also involved rapacious and ultimately destructive exploitation of the environment. The costs – in terms of excessive congestion, environmental pollution and ecological degradation – are already being felt in most developing societies, not to mention the implications in terms of the forces generating climate change. The ecological constraints on such growth are already being felt, most unfairly, among those regions and people that have gained the least from the overall expansion of incomes.
It is now a cliché that every crisis is also an opportunity. Of course, as the global financial crisis continues to unfold and create downturns in real economies everywhere, it is easy to see only the downside, as jobs are lost, the value of financial savings of workers is wiped out, and material insecurity becomes widespread. But in fact this global crisis offers a greater opportunity than we have had for some time now, for the developing world’s citizens and their leaders to restructure economic relations in a more democratic and sustainable way.
There are several necessary elements of this. Globally, everyone now recognises the need to reform the international financial system, which has failed to meet two obvious requirements: preventing instability and crises, and transferring resources from richer to poorer economies. Not only have we experienced much greater volatility and propensity to financial meltdown across emerging markets and now even industrial countries, but even the periods of economic expansion have been based on the global poor subsidising the rich. Within national economies, this system has encouraged pro-cyclicality; it has rendered national financial systems opaque and impossible to regulate; it has encouraged bubbles and speculative fervour rather than real productive investment for future growth; it has allowed for the proliferation of parallel transactions through tax havens and loose domestic controls; it has reduced the crucial developmental role of directed credit. Given these problems, there is no alternative to systematic state regulation and control of finance. Since private players will inevitably attempt to circumvent regulation, the core of the financial system - banking - must be protected, and this is only possible through social ownership. Therefore, some degree of socialisation of banking (and not just socialisation of the risks inherent in finance) is also inevitable. In developing countries this is also important because it enables public control over the direction of credit, without which no country has industrialised.
Second, the obsessively export-oriented model that has dominated developing country growth strategy for the past few decades needs to be reconsidered. This is not a just a desirable shift – it has become a necessity given the obvious fact that the US can no longer continue to be the engine of world growth through increasing import demand in the near future. This means that developing countries in general, and particularly those in developing Asia that continue to rely on the US and the EU as their primary export markets, must seek to redirect their exports to other countries and most of all to redirect their economies towards more domestic demand. This requires a shift towards wage-led and domestic demand led growth particularly in the countries with economies large enough to sustain this shift. This can happen not only through direct redistributive strategies but also through public expenditure to provide more basic goods and services.
Third, this means that fiscal policy and public expenditure must be brought back to centre stage. Clearly, fiscal stimulation is now essential in both developed and developing countries, to cope with the adverse real economy effects of the current crisis and prevent economic activity and employment from falling. Fiscal expenditure is also required to undertake and promote investment to manage the effects of climate change and promote greener technologies. And public spending is crucial to advance the development project in the South and fulfil the promise of achieving minimally acceptable standards of living for everyone in the developing world. Social policy – the public responsibility for meeting social and economic rights of citizens – is not only desirable but also contributes positively to development.
Fourth, there have to be conscious attempts to reduce economic inequalities, both between countries and within countries. We have clearly crossed the limits of what is “acceptable” inequality in most societies, and future policies will have to reverse this trend. Globally and nationally, we have to recognise the need to reduce inequalities in income and wealth, and also most significantly in the consumption of natural resources. This is even more complicated than might be imagined, because unsustainable patterns of production and consumption are now deeply entrenched in the richer countries and are aspired to in developing countries. But many millions of citizens of the developing world still have poor or inadequate access to the most basic conditions of decent life, such as minimum physical infrastructure including electricity and transport and communication links, sanitation, health, nutrition and education. Ensuring universal provision of this will inevitably require greater per capita use of natural resources and more carbon-emitting production. So both sustainability and equity require a reduction of the excessive resource use of the rich, especially in developed countries, but also among the elites in the developing world. This means that redistributive fiscal and other economic policies must be specially oriented towards reducing inequalities of resource consumption, globally and nationally. For example, within countries essential social and developmental expenditure can be financed by taxes that penalise resource-wasteful expenditure.
Fifth, then this requires new patterns of both demand and production. This is why the recent focus on developing new means of measuring genuine progress, well-being and quality of life are so important. Quantitative GDP growth targets, which still dominate the thinking of regional policy makers, are not simply distracting from these more important goals, but can even be counterproductive. For example, a chaotic, polluting and unpleasant system of privatised urban transport involving many private vehicles and over-congested roads actually generates more GDP than a safe, efficient and affordable system of public transport that reduces vehicular congestion and provides a pleasant living and working environment. So it is not enough to talk about “cleaner, greener technologies” to produce goods that are based on the old and now discredited pattern of consumption. Instead, we must think creatively about such consumption itself, and work out which goods and services are more necessary and desirable for our societies.
Sixth, this cannot be left to market forces, since the international demonstration effect and the power of advertising will continue to create undesirable wants and unsustainable consumption and production. But public intervention in the market cannot be knee-jerk responses to constantly changing short-term conditions. Instead, planning – not in the sense of the detailed planning that destroyed the reputation of command regimes, but strategic thinking about the social requirements and goals for the future – is absolutely essential. Fiscal and monetary policies, as well as other forms of intervention, will have to be used to redirect consumption and production towards these social goals, to bring about such shifts in socially created aspirations and material wants, and to reorganise economic life to be less rapacious and more sustainable.
This is particularly important for quality of life in urban areas: the high rates of urbanisation in developing countries mean that already in many populous countries more than half the population lives in urban areas. Yet, because systematic urban planning for the future to make cities pleasant or even liveable for most residents is still so rare, the tendency is to create urban monstrosities of congestion, inequality and insecurity.
Seventh, since state involvement in economic activity is now an imperative, we should be thinking of ways to make such involvement more democratic and accountable within our countries and internationally. Large amounts of public money will used for financial bailouts and to provide fiscal stimuli, and how this is done will have huge implications for distribution, access to resources and living conditions of the ordinary people whose taxes will be paying for this. So it is essential that we design the global economic architecture to function more democratically. And it is even more important that states across the world, when formulating and implementing economic policies, are more open and responsive to the needs of the majority of their citizens. 
Finally, we need an international economic framework that supports all this, which means more than just that capital flows must be controlled and regulated so that they do not destabilise any of these strategies. The global institutions that form the organising framework for international trade, investment and production decisions also need to change and become not just more democratic in structure but more genuinely democratic and people-oriented in spirit, intent and functioning. Financing for development and conservation of global resources must become the top priorities of the global economic institutions, which means in turn that they cannot continue to base their approach on a completely discredited and unbalanced economic model.
- Jayati Ghosh is Professor of Economics at Jawaharlal Nehru University, New Delhi, India, and Executive Secretary of International Development Economics Associates (
This article was first published in Spanish in edition 483 (March 2013)) of ALAI's magazine América Latina en Movimiento, titled "La crisis compleja" (the complex crisis).

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