“There have been many explanations of the 2008 crash – no two are the same. We were at the precipice of a total economic collapse – and are still experiencing the aftermath.”
Ian Goldin of the Oxford Martin School at Oxford University was addressing STIAS fellows on his perceptions of the 2008 financial crisis and the changing world in the decade since then.
“In September 2008 the world financial system narrowly averted melt-down. It was the most serious crisis in the global economy since the oil shocks of the 1970s and brought profound changes in politics, economics, power relations and social attitudes,” said Goldin. “A decade on, five lasting legacies of the crisis are apparent. First, the crisis has led to a period of austerity and sharp increases in inequality. Second, it has led to a collapse of trust in authority and experts. Third, it has been associated with significant power shifts nationally and globally. Fourth it has led to only a modest rethinking of economic theory and policies. Fifth, it has led to a regulatory reaction that has exacerbated the prospects of another crisis.”
“Businesses went bankrupt. Pensions were affected. Millions were out of work.”
The immediate impacts included a dramatic reduction in growth rates of advanced economies especially. “We have not yet recovered,” said Goldin. “This is permanently lower in some countries.”
“Government expenditure on health and social welfare was reduced and inequality increased,” he added. “Although the biggest impact was on poor people who are less able to cope with risk, for the first time in a long time the middle classes were adversely affected.”
Emperor had no clothes
But it was the changes in power relations and attitudes that probably have had the greatest long-term impact.
“There has been a sharp reduction in trust – in authorities, experts and institutions,” explained Goldin. “This is a significant long-term impact. Finance is a sophisticated expert system attracting the best students and paying the highest salaries. The sector wields immense power. Everyone believed the system knew what it was doing. So, why did this sophisticated system fail? And why were they unable to do anything about it?”
Goldin believes this break in trust led to power, attitude and behaviour shifts. “Politicians were seen to be asleep at the wheel,” he said “Traditional authorities were disempowered leading, in some cases, to a rise in extremism.”
“We would not have had Brexit or Trump if not for the crisis,” he added.
Previous economic power houses slipped in global economic rankings and the shifting power balance exacerbated the identity crisis in politics in Europe and the USA. Anti-globalisation and protectionism rose in some of these advanced economies. Market growth, and therefore power, shifted to the emerging markets with growth driven by China at four to five times the rate of the advanced economies.
“We no longer live in a world where when the US gets a cold we all get a fever,” he said.
“But,” Goldin warned. “The tragedy of this crisis is that there is huge complacency and lessons have not been learnt.”
“The immediate reaction was to tighten regulatory controls but this is backward looking and inadequate,” he continued. “The regulatory actions have focused on the wrong things and created an environment that makes the next crisis more likely.”
“The focus has been on reducing risk which means low return and less money available. Pension funds have also been heavily regulated which reduces their returns. Interest rates are down so people don’t have an incentive to save. This traps economies in a low growth cycle.”
“The reaction has not focused on the systemic risk. There has been a failure to deal with the underlying causes,” he said.
Goldin believes that the biggest issue was “the total intellectual failure of the economics profession. Economics is a social science that wants to be a science. It reduces the world to equations and assumes that human behaviour is rational.”
He believes the profession requires a more integrated, multidisciplinary approach.
“Economists are caught in a silo,” he said. “There has been a failure in interdisciplinary thinking. There is a need to include other dimensions of individual and systemic behaviour.”
“During the so-called ‘credit bubble’ that preceded the crisis, people were behaving rationally – if there is cheap money available why not take it – it was the system that was irrational. But it was difficult for economists to believe that people were so naïve.”
“Lots of people saw the crisis coming just not those in the predictive agencies.”
“Learning from other disciplines is vital. This is beginning to percolate into the field,” he added.
“Quantitative economics and the basic economic toolkit can give us huge insights but most economists look too much at the numbers and intuition and judgement are thrown out the window,” he continued. “There is a need to embrace a diversity of ideas and perspectives, and there is a growing body of new people, institutions and ideas.”
He also pointed out that part of the problem is economic illiteracy “people can’t engage because they don’t have the vocabulary”.
Integrate and co-ordinate
He also warned of the dangers of isolationism and protectionism.
“You can’t manage globalisation by withdrawing, he said. “There is no wall high enough to protect you.”
“Globalisation is the source of rapid progress,” he said, “but some people get left behind. Governments need to be more active in education and in the regulatory systems to make sure that people renew their skills and don’t get left behind.”
He added that one of the achievements of globalisation has been the massive reduction in people living in poverty. In the 1980s an estimated 1.2 billion lived in extreme poverty now it’s an estimated 800 million. “The challenge is within countries where there is an increase in relative, and also sometimes absolute, inequality.”
“Inequality sometimes matters and sometimes doesn’t – in the US exacerbating inequality probably led to the Trump government.”
“It’s essential to get people to the right place with the right skills. Otherwise we create greater inequality and potentially greater extremism.”
“Globalisation leads to higher risk and therefore needs more sophisticated management. Any integrated system is subject to more shocks – like pandemics, cyber-attacks and terrorism. Globalisation means there is more choice but decisions affect more people therefore more co-ordination and regulation is required. The system must be designed to give more people more freedom but restrictions are needed for stability.”
He also warned of the impact of accelerated technological change and the resulting loss of jobs to machine intelligence over the next 20 years.
“The pace of reskilling has to dramatically increase,” he said.
“The financial crisis showed us the problem of a silo in an integrated system,” he continued. “We need to be forward looking. We can’t predict where the next crisis will come from but it will be different.”
“I believe we require more co-ordination to stop future crises – more co-ordinated mechanisms to manage the system.”
Michelle Galloway: Part-time media officer at STIAS
Photograph: Christoff Pauw