Opinion Sajjid Z Chinoy writes: 15 years after 2008, developed countries still making mistakes

What’s less appreciated is how the policy response to the crisis accentuated these cleavages. After the initial response, fiscal policy tightened dramatically, and injudiciously across the West.

“Structural” fiscal deficits in advanced economies tightened a whopping five to 10 percentage points of GDP from peak to trough between 2007 and 2017, as per the IMF. Some of this was ideological (remember “the sequestration fights” in the US) and some of this was complex and inflexible European fiscal rules that unduly emphasised austerity. Worried about public debt, fiscal policy was fighting the last war, even as the hysteresis from the GFC crisis was getting deeper and broader.

Given this fiscal tightening, it was unsurprising that advanced economies limped back from the crisis. By 2018, as Martin Wolf points out, the GDP gap from the pre-GFC trend was 13 per cent in France, 17 per cent in the US and 22 per cent in the UK. These staggering shortfalls cannot be attributed to more slow-moving forces like demography. Fiscal policy had clearly amplified any secular stagnation.

But the excessively tight fiscal policy was only half the problem. It induced excessively loose monetary policy that was struggling to combat post-crisis economic malaise. Central bank balance sheets exploded, forward guidance promised “low forever” and monetary policy soon became the only game in town.

The too-tight-fiscal, too-loose-monetary over the last decade was exactly the wrong policy prescription for advanced economies and the world for several reasons. First, monetary and fiscal policy, working at cross purposes nullified each other and labour markets in advanced economies were too slow to recover.

Second, excessive monetary easing distorted and inflated asset prices that accentuated inequality, kept zombie firms alive preventing the necessary creative destruction and induced a substitution away from labour towards cheap capital, accentuating the employment malaise.

Third, quantitative easing became the cure for every ailment, obviating the need for more fundamental reform in advanced economies: Re-tooling and re-skilling workers confronting the China shock, building infrastructure and cutting regulation, building deeper and smarter safety nets to compensate those who had been displaced from globalisation.

Fourth, all this sowed the seeds for deglobalisation. Frustrated by the economic malaise and deepening inequality, politicians in advanced economies did the easy thing — assign blame outside. It was the decade of Brexit and the US-China trade war.

By 2018, there was a belated recognition that fiscal policy had scored a self-goal. Then the pendulum swung too far in the other direction. Inflation and interest rates in some quarters were presumed to permanently remain low. The implication: “R” (borrowing costs) would always stay below “g” (nominal growth), and public debt could easily be sustained in advanced economies.

Armed with the comfort, scarred by the experience of 2008, and confronted with the unquantifiable uncertainty of the pandemic, it was now the turn of fiscal policy to go all in once the pandemic struck. The right response should have been large, but temporary and state-contingent fiscal support. Instead, structural fiscal deficits surged in advanced economies. Fiscal transfers kept private sector demand strong, and in the wake of myriad supply shocks, contributed to the highest inflation in five decades. Fiscal policy had gone from being countercyclical to counterproductive. Meanwhile, monetary policy which was initially fighting the last war, is now scrambling to catch up.

But these policy missteps pale in comparison with the more profound choices currently being exercised. Rising geo-political uncertainty is inevitably inducing multinationals to de-risk their supply chains. What’s more worrying is pre-Covid deglobalisation tendencies by governments have only gotten stronger, with muscular industrial policy in the West (Inflation Reduction Act, Chips Act) aimed, in part, at re-shoring production and boosting domestic blue-collar job creation. The ostensible justification is resilience and “national security.” But national security is often the first refuge of the protectionists. History is replete with examples of how this is a very slippery slope. Incentives are only likely to deepen and broaden. Today it’s semi-conductors and electric vehicles. Tomorrow it could easily be pharmaceuticals and agriculture.

Furthermore, once a few large economies go down the road, the “demonstration effect” is potent. Unsurprisingly, South Korea, Japan, Taiwan and Europe have all responded with their own version of subsidies and, in this environment, emerging markets will unfortunately become more emboldened to be protectionist. We seem to be on the cusp of a “beggar-thy-neighbour” industrial policy race to the bottom.

The risks of this approach are well understood. First, when the state starts picking winners and losers, allocative efficiency inevitably suffers, hurting medium-term productivity, competitiveness and growth.

Second, muscular industrial policy that succeeds in re-shoring and friendshoring (where economic considerations are undermined) will result in economic balkanisation and risks undoing the gains of the last 30 years. Globalisation induced an outward shift in the global supply curve, boosted global growth, helped low-income countries catch up, structurally reduced inflation, and pulled millions out of poverty. De-globalisation risks undoing all those gains. We are on the cusp of the “Great Unravelling”.

The problem was never about globalisation, per se. It was about how its gains were shared, and the failure of domestic policy to correct the skew. Today, the bigger threat is rapid advances in technology and AI. The “China shock” hollowed out blue-collar jobs in the West. Will the ChatGPT shock hollow out white-collar jobs everywhere? Every industrial revolution has increased the share of capital vis-à-vis labour. The current technological revolution threatens the same.

What we need, therefore, is an intelligent and coordinated global response to these challenges. What we need is to educate, train and skill workforces so that they can complement technology, not be substituted by it. What we need are institutions that will enable creative destruction in response to the breathtaking pace of technological change. What we need are intelligent and robust safety nets to protect those left behind. What we need is a tax system that can finance all of this. What we don’t need is counter-productive protectionism.

Next year is the 80th anniversary of the Bretton Woods Conference that created a new global architecture to protect against beggar-thy-neighbour currency devaluations. Eighty years later, we need another meeting of the minds. This time to protect against beggar-thy-neighbour industrial policy and protect hard-earned globalisation gains from unravelling. Eighty years later, the context may be different. But the imperative is every bit as urgent.

The writer is Chief India Economist at J.P. Morgan. Views are personal