Looking beyond the crisis: An appeal for economic cooperation

As Europe continues to battle with the impact of the global financial crisis, policy makers are hard-pressed to respond in a way that will put the economy on a more secure footing in the future. The POLHIA research project is supporting this effort with in-depth analysis of the financial crisis and concrete recommendations for European policy makers. While parts of the research are quite technical, the project has succeeded in producing a series of documents that are accessible to the non-specialist and provide fascinating insights into the roots of the crisis. Moreover, the researchers have proposed a series of policy measures which they feel could be instrumental in preventing a similar crisis in the long run.

In addition to arguing for an overhaul of the way forecasting methodologies are applied (particularly with respect to monetary policy), the researchers offer a three-pronged policy prescription to avoid future macroeconomic problems:

  • Support for a more robust social protection system in the developing world.
  • An end to ‘destructive’ social and fiscal competition among countries (both within Europe and on a global scale).
  • More mutually beneficial cooperation among countries.

These recommendations - together with a thought-provoking analysis of what caused the crisis - are found in a policy brief entitled ‘The Structural Roots of the Crisis and the Way Out: Mitigating Inequality and Rethinking Global Governance’1. As the title suggests, the crisis is described as having a structural root - and that root is income inequality.

Looking back over the decades leading up to the crisis, the researchers identified a potential reduction of demand for goods and services, which they say was caused by a massive structural change in income and wealth distribution. Jean-Paul Fitoussi, the POLHIA team member who authored this part of the study, notes that during the past 30 years the median wage in most advanced countries has stagnated or declined. Inequalities have surged in favour of high incomes, he observes, resulting in weak global demand.

According to the researchers, the global strain was exacerbated by the way Asian countries reacted to the Far East crisis of 1997. To guard against macroeconomic instability, they ran systematic current account surpluses, thereby pressing down global demand even further. To keep up demand, the United States and other countries responded by pursuing expansionary monetary policies, with US consumers and the government running up massive debts.

As Fitoussi explains it, “once the bubble exploded, the financial crisis unfolded and eventually spilled over to the real economy, bringing about a devastating recession.” The research suggests that the consequences could be exceptionally damaging in the areas of employment and poverty.

Looking at the situation in Europe, the POLHIA consortium points out that the institutional architecture in Europe has produced a vacuum of sovereignty that prevents it from exercising governance when a crisis occurs. There is a dissociation between power and legitimacy at the EU level, the researchers argue, describing this as ‘the European contradiction’. They say there is no federal policy in Europe to sustain internal demand, with the result being that growth can only be export led.

In order to address the structural root of the crisis, POLHIA appeals for a global policy response that it characterises as ‘protection without protectionism’. This would involve, first of all, helping the developing world to set up a ‘decent’ social protection system. Second, the researchers urge countries (particularly in Europe) to abandon destructive social and fiscal competition. Attempting to attract business by decreasing taxes and social regulation is deeply counterproductive, they argue, noting that it leads to further inequalities.

Finally, the consortium calls on policy makers to stop trying to boost exports by lowering wages and labour costs. European citizens are among the primary victims of this system, the research suggests, noting that there has been a progressive dismantling of collective protections.

 

1 See: http://www6.unicatt.it/dotnetnuke/polhia/Publications/PolicyBriefs.aspx

POLHIA - Monetary, fiscal and structural policies with heterogeneous agents (duration: 1/11/2008 – 31/10/2011). FP7 Socio-economic Sciences and Humanities, Activity 1 – “Growth, employment and competitiveness in a knowledge society”, Research area 1.3 “Strengthening policy coherence and coordination in Europe”. Collaborative project (small and medium scale focused research project).

See: http://www.polhia.eu

Contact: Domenico Delli Gatti, domenico.delligatti@unicatt.it