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This article was originally published in the Daily Telegraph on January 10, 2010.Click here to read Mohamed El-Erian's biography. I argued almost two years ago that industrial countries could learn from the crisis management experience of emerging economies. The tenet of the argument at that time was simple: Policymakers faced what, for them, was a very unusual, and highly disruptive set of deleveraging dynamics.
Policy inaction was not an option. By necessity, the extreme situation would dislodge them from their comfort zone and force them to take extraordinarily bold and uncertain measures. The longer it took for them to adopt a proper crisis management mindset, the harder it would be to contain the damage.
As we enter this new year, industrialized countries, led by the U.K. and U.S., continue to face a number of unusual circumstances that are rapidly evolving, both in scope and content. Rather than involve unthinkables in the financial sector, as was the case in 2008"“2009, these countries today confront atypical factors that have profound economic, political and institutional dimensions. As such, even though countries are leaving the global financial crisis behind, they should again be studying the experience of emerging economies that coped with crises earlier in their histories.
Four specific issues stand out in the aftermath of the global financial crisis "“ issues that, while unusual for industrial countries, are familiar to their counterparts in emerging economies. First, post-crisis budgetary dynamics matter a great deal.
The immediate aftermath of a financial crisis can involve a period of deceptive calmness when it comes to financing the public sector. Even though balance sheets balloon as both governments and central banks go on a check-writing spree to offset private sector deleveraging, there is seemingly little market reaction. Interest rates on government debt remain well behaved, and abundant funds can be mobilized to cover the rapidly expanding public sector borrowing requirements.
This was essentially the story for 2009 for many, though not all, industrial countries (with Greece, Iceland and Ireland being the most notable exceptions). As a result, some have fallen victim to the notion that large post-crisis deficits and debt burdens can be repeatedly financed without meaningful consequences for the cost and availability of credit.
The initial calm was due to factors that erode over time. A recession-induced fall in private sector borrowing freed up resources to cover the public sector borrowing requirement. Investor risk aversion diverted funds to the perceived safety of government bonds. And rating agencies, as typically happens, lagged in adjusting their rhetoric and credit ratings to reflect the unanticipated large jumps in public sector indebtedness.
But if higher budgetary financing needs are not accompanied by credible medium-term fiscal consolidation, history suggests that the impact on financing costs can often become exponentially challenging.
The longer it takes for such commitments to materialize, the harder it becomes to arrest disruptive debt dynamics. And, once they get going, serial credit rating downgrades can aggravate already fragile financing dynamics. At that stage, playing catch-up on the fiscal adjustment front becomes even more difficult.
Second, the global financial crisis has exposed and aggravated structural problems that cannot be solved through cyclical demand management measures.
This is most pronounced in the case of the labor market, where higher government spending is not sufficient to offset widespread damage to sectors that led employment growth in the previous boom (think here of real estate, finance and construction, just to list a few). Governments must focus quickly and meaningfully on the structural dimensions of today's unemployment problem.
It's not just about the large and rapid increase in unemployment rates in several countries, including the U.K. and U.S. It is also about worrisome compositional issues. Two stand out in particular, and they speak directly to skill erosion, less flexible and less mobile workers, and lower future productivity and competitiveness.
There has been an increase in the average period of joblessness for those who are already unemployed. The longer that workers are out of a job, the more tricky their re-entry becomes.
Also, we are witnessing a dramatic rise in the level of youth joblessness. Prolonged periods of unemployment early in one's working career pose material risks to longer-term productivity, agility and prosperity.
Expansionary fiscal and monetary policies are not sufficient to address these issues in a sustainable fashion. Simply put, it is not a question of throwing more money at the problem and especially not when the fiscal dynamics are already fragile. It is about rapidly designing and implementing a more holistic approach. How governments spend money becomes the dominant issue. In the process, the approach must, at a minimum, recognize the need for labor force re-tooling and greater mobility.
This policy shift, from cyclical to structural, is not easy at the best of times. It becomes even more difficult for countries such as the U.S. that lack sufficient social safety nets and budgetary flexibility. After all, those countries' institutional contexts were based on an assumption that the economy could not experience persistently high unemployment. As such, the difficulty of responding to difficult policy challenges is compounded by the partiality of the operating framework.
Third, the emphasis on redistributing income and wealth must not crowd out the importance of creating both. Post-crisis periods, particularly in democratic societies, inevitably involve a redistribution away from segments of the population that have done relatively well to those that have suffered. This is understandable and desirable.
Yet, if handled in a piecemeal fashion, the shift can easily fall victim to politically induced excesses and result in overshoots that undermine the economy's potential for long-term growth and employment creation. And without sustainable growth, the first two challenges, which are already difficult, become even more complex.
Fourth, protectionist pressures must be countered actively and early. This is the international aspect of the previous problem.
Post-crisis countries are often inclined to fuel internal recoveries by protecting themselves from external competition. The idea is attractive because of its seeming simplicity: create jobs by taking them away from someone else "“ the concept in economics of "beggar-thy-neighbor."
Countries can produce growth and an employment burst this way, but the resulting short-term gains tend to involve significant longer-term losses that are more than offsetting. This would be especially true for the U.S. as it plays such a critical role at the core of the global economic system. It is also relevant for the U.K., whose domestic standard of living has benefited from significant inflows of capital from abroad.
These four factors speak to a more general conclusion from the experience of emerging economies: The policy mindset really, really matters.
Having navigated the worst stages of a financial crisis, it is tempting for governments to relax too early. They can easily fall victim to the belief that it is "just a matter of time" before a cyclical policy response takes hold and translates into sustainable growth that pulls the economy away from worsening debt and unemployment dynamics.
It is not that simple. Post-crisis dynamics are complex and multifaceted.
As such, they expose deeper structural problems that require hard structural policy choices and not just a cyclical response.
The recent global financial crisis is no exception. The longer it takes for industrial countries to recognize the policy implications, the greater the longer-term welfare costs of the global financial crisis. There is no time to waste in supplementing cyclical policy considerations with meaningful structural responses.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This material was reprinted with permission of Sunday Telegraph. Date of original publication January 10, 2010.
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