Academic journal article Business Economics

Economic and Financial Climate Change: A Business Economist's Perspective

Academic journal article Business Economics

Economic and Financial Climate Change: A Business Economist's Perspective

Article excerpt

Over the past 50 years, one of the key elements of the evolution of the world economy has been the increasing complexity of financial transactions. This complexity is manifested in financial layering and disintermediation that has increased risk in the real as well as the financial sectors. The consequences of an adverse outcome of this risk are obvious in the current economic situation. This paper analyzes the imbalances that have arisen between the real and financial sectors and the consequences of the ballooning of the financial sector without producing positive contributions to the real sector and increasing risk to both. It calls for restraint on excesses of financial innovation and risk taking that cannot be held in check by market forces alone.

Business Economics (2009) 44, 17-22.

doi: 10.1057/be.2008.7

Keywords: financial risk, imbalances, disequilibrium

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This paper is informed by over 20 years of working first in academia and later in the private sector as a business economist in the automotive and financial services industries. Those experiences, along with two years at the President's Council of Economic Advisers, have provided me with a rich and varied view of business economics and the changing business environment--both cyclical and structural. (1)

Because this is NABE's 50th anniversary year, I use the years 1958 and 2008 as the basis for contrast and discussion. There have been myriad changes to the global economic and financial environment since 1958. Without question, a key characteristic of that period is increasing complexity of financial transactions, culminating, in part, with disintermediation and the layering of financial instruments on top of each other in the late 1990s. This layering builds a pyramid, so to speak, of the financial instruments away from the underlying assets, as is seen today with mortgage-backed securities and other structured credit products. The impact of this layering--accompanied by the massive bundling and then worldwide distribution of these instruments--is unprecedented in size and scale. This paper will focus on how these financial innovations played a crucial role in contributing to a severe imbalance between the financial and nonfinancial sectors of the economy. As has been painfully and cataclysmically demonstrated in these past months, this inequality means the relationship between these two sectors changed; and, as a consequence, catastrophic imbalances resulted. I will also discuss the implications of these imbalances, how they might be resolved, and how the United States might fare in a rapidly changing world of economic growth and wealth creation in emerging markets.

1. Looking Back 50 Years

The crossroad and disequilibrium between the nonfinancial and financial sectors during 1958 to 2008 evolved in ways no one could have predicted. In 1958, the global economy was nascent but growing at a rate that was boosted by recoveries following World War II. Europe was bearing fruits from growth in manufacturing output. In fact, the 1950s were part of the European "Golden Age," aided by postwar stimulus, technological advances, and currency devaluations as part of the Bretton Woods system, that allowed export growth to accelerate. Meanwhile, the U.S. economy fell into recession in August 1957 and troughed in April 1958. This was followed by a very brief expansion that ended in April 1960. With a $2 trillion U.S. economy, the first quarter of 1958 fell at an annual rate of 10.4 percent--steep by any measure. Consumer spending fell over five percent. Fifty years ago, over 50 percent of the $7 trillion global economy was represented by U.S. and European output, as shown in Figure 1.

Figure 1. World Output Shares: 1958 and Today

1960 $ 7 Trillion

U.S.    35%
Europe  22%
Japan    9%
Row     34%

Today $ 39 Trillion

U.S.    29%
Europe  18%
Japan   13%

Source: World Bank, in constant 2000 U. … 
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