Tuesday, October 26, 2010

The Old and New Normal

The Global Financial Crisis has ushered in huge changes in the global economy which will impact everyone from individuals to governments. The financial world will never be the same as policy makers will attempt to stem disproportionate growth. The following is an overview of the ‘Old Normal’ (the world before the Global Financial Crisis) and the projected ‘New Normal’.

The Old Normal

The Old Normal has existed since WWII and accelerated dramatically over the last 25 years. Greed was allowed to run rampant, the winner took everything and consumers looked to maximize their position.

  • Easy credit enabled spending and production above our means, the growth of money accelerates economic growth.

  • Asset (like housing) values continually inflated enabling more credit.

  • Free Trade, fueled by Comparative Advantage (a countries ability to produce a product with the highest relative efficiency given all the other products that could be produced).

  • Massive population growth fueling economic growth and rising real (read: inflation adjusted) incomes.

  • Governments got bigger as a consequence of free market activity which was becoming more deregulated (less rules).

Obviously the party was never going to last forever and, although we have had mini-recessions since (stock market crash etc), nothing has hit the global economy this hard since the Great Depression. Economists have predicted what some of the major features of the ‘New Normal’ will be…..

The New Normal

De-leveraging - Individuals, households, businesses and governments will cut their debt and save and invest more. This reduction in consumption will mean slower economic growth.

De-globalization – Countries will try and protect domestic industries by increasing tariffs, therefore eliminating cheaper imported goods. This should also breath new life into certain industries and create (some) new jobs although goods may be more expensive as local industry will not have comparative advantage. Again, economic growth is reduced as certain countries will not be able to take advantage of trade and investment opportunities.

Re-regulation – As a way to manage and reduce risks, governments will become more powerful and intrusive in business and financial markets. Financial institutions and banks will be hampered by the harsher credit conditions. Credit growth (the growth of money) is a pillar of economic growth therefore, once again, expect slow growth.

However, this New Normal is not without its issues…..

Issues with the New Normal

During the Global Financial Crisis, governments tried to stimulate the economy with “borrow and spend” fiscal packages. This debt will have to be paid back before costs set in and stall growth further. The private sector will need to produce the wealth needed to pay the governments debts. Governments could accelerate this through higher taxes but this further dampens consumption, saving and investment effectively crippling the private sector (which they desperately need).

Unemployment will also be a major factor as some industries have all but disappeared. Those affected will not be easy to re-employ and there are high costs associated in retraining and upskilling.

Other issues: Retirement, healthcare

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