Sunday, December 06, 2015

My Reading List 1: The Shifts and The Shocks

I pledged to myself to read a book a week and write a short review here. The first book that I read under this pledge is Martin Wolf's 'The Shift and The Shocks : What We Have Learned - And Have Still To Learn - From The Financial Crisis'. A summary judgement, in the tradition of Amazon, is that this is a 5-star, absolutely brilliant book to read on the Financial Crisis and its causes. Martin Wolf, who I saw as an apologist of Globalisation and principally writes in the Financial Times, would not usually be an author I would start my reading pledge with, and it needed some persuasion from a friend whose I advise I value greatly and who suggested, accurately as I understand now, that if one has to read just one book about the financial crisis, this should be it.

It is, as is clear from the title, about the financial crisis that started in 2007 and shaped our lives in many ways. The boom years before 2007 is now a distant memory for many of us, and though some countries have returned to growth, its legacy still lives on in the perennial crisis of the Euro. Mr Wolf argues in the book that despite the deep crisis, the way financial sector operated has not changed much, perhaps, perversely, because the tax-payer funded rescues let them off the hook rather too easily. However, the great thing about this book is that it looks beyond the usual narrative - the misdeeds of the bankers and the mistaken assumption of the regulators - and interrogates the wider economic factors, such as the strategy of the developing countries to 'export' excess savings to advanced economies since the shocks of the 1997 Asian Financial crisis. This wider economic narrative is extremely relevant right now, as we see the warning signs in the horizon, an unsustainable property boom (when real estate prices become completely out of proportion with income) in some countries, and a real prospect of economic crisis across developing nations, yet again. Some economists are now predicting that we are just one shock away from another crisis, and if one looks around, there are plenty of candidates - Chinese stock markets, Indian Real Estate, US Current Account deficit, Greek exit from Euro, British exit from European Union, Donald Trump in the White House - that may bring it about.

The best bits of the book, in my mind, relate to European Union. The book clarified to me a lot of questions about the Greek crisis (with several moments of why-did-I-not-think-about-this-before) and the role Germany played in the crisis. There are two things in particular I should highlight. First, there is this rather naive approach that a country should manage an economy just as a household manages its finances. Originating perhaps from Margaret Thatcher, this is an underlying theme of discussions about economics, not just in the popular press, but also in the policy making circles and some parts of the academia. The discussion about the Euro in this book shows how hopelessly naive that approach is, and consequently, our idea of indisciplined Greeks causing mayhem just by themselves is rather flawed. Second, this book also makes one think about the concept of debt, particularly the underlying principle that we tend to hold dear - that all debts must be paid! While such a principle is important for functioning of a financial system (because, otherwise, there will be no credit), one must explore the concept of creditors' responsibility and look at ways how debts are dealt with in the event of a crisis. 

Jumping off towards the very end, the conclusions that Mr Wolf makes are worth taking seriously. He points out the fundamentally incomplete nature of our response to the financial crisis, and that the job remains half done. The costs of the financial crisis - more than the World Wars without a matching recovery to follow - would perhaps be compounded without a robust response, and the crisis would keep coming. Mr Wolf identified six areas of action/ attention that are worth thinking about.

First, we should be making the financial system more resilient by raising capital requirements for banks and creating more 'bail-in-able' debt. He also suggests proper funding and empowerment of regulatory bodies, giving them more teeth to deal with fraud and other criminal behaviour.

Second, we should look to de-leverage our economies. The suggested method includes the removal of tax deductibility of interests and creating incentives for equity investment, and a proper tax on land values, as most boom-bust cycles start with land and real estate.

Third, the corporate taxation and governance needs serious attention, with the aim of reducing corporate savings glut which is creating serious economic imbalances. One powerful suggestion is to remove corporate taxation altogether and treat all corporate income as a part of their shareholders' income, which will create incentives for distribution of profits. Besides, the case for attacking the bonus culture is made, as this often leads to underinvestment in capital goods and over investment in schemes such as share buyback.

Fourth, the financial contracts may change to adjust with the circumstances. One key suggestion is to create mortgage contracts where the lenders could have a share of gains if house prices rose and share the losses if it falls. 

Fifth, measures to facilitate income redistribution are urgent. Suggestions made by Thomas Piketty about Global Wealth Tax are referenced to, and even if this is ambitious, some measures to combat the rising inequality are urgent.

Sixth, measures to raise longer term economic growth, including investment in scientific research, relevant education, private sector investment, are urgent to make up for the lost growth.

In the end, I could not help but reflect how flawed the right wing orthodoxy, as demonstrated by every candidate in the Republican Presidential race, but also held with radical faith by our own Conservative front bench, is out of touch with this world. Martin Wolf is no socialist, and his clear presentation of these urgent, realistic measures would perhaps get more attention. 






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