The Global Economic Crisis

and Its Impact on the Korean Society

by Professor Yang-Taek Lim

College of Economics and Finance, Hanyang University

Seoul, Korea

 

Editor's Note: This paper is divided into two segments, the first of which, presented here, offers an overview of the recent and on-going global economic situation (c. 2008-present). The second segment, which will be presented in the January-February 2012 issue of this Journal, will address specifically the current economic situation in Korea and the challenges thus presented.

 

. Introduction

 

In retrospect, the year 2009 was truly eventful. Due to the global financial/real crisis that started since the second half of 2008, most countries around the world have been suffering from economic stagnation and mass unemployment. In the political and military aspect, due to tension in the territories of Iran, North Korea, and Afghanistan, it seems as if walking through a mine field. At the same time, starvation, disease, crime, and environment destruction have been widely spread around the global village.

 

As in Emily Bronte’s Wuthering Heights (1847), it seems like storming. Human’s ‘anxiety and despair’ that Kierkegaard declared have been intensified, as well as ‘fight, conflict, and unclear instigation’ that Schopenhauer indicated. Conflict, which Thomas Hobbes called, ‘war of all against all’ is deepening.

 

What kind of shadow will the global economic crisis of the 21st century loom across the human history? Recently, as the reasons behind the collapse of financial capitalism are closely examined, ‘New Liberalism’, a belief in the market’s ‘invisible hand’ is being condemned. On the other hand, ‘Post Keynesian thought’ which advocates the restoration of the government’s ‘skillful hand’ is rising to surface.

 

South Korea’s past myth of ‘high growth’ has ended, and its competitiveness is falling deeply into the swamp of social conflict – between class, ideology, capital and labor, and region. Korea is ranked 4th (Social Conflict Index: 0.71, above the average of 0.44 among 27 OECD countries) to have severe social conflict. Especially, in fields of education, employment, medical service, and national pension, ideological conflict between the progressive and the conservative is severe. Also, voices supporting the government’s income redistribution in order to build a welfare society are high. Lee Myung-bak government is trying to cure this social conflict by ‘strengthening the moderate’ but national consensus upon what ‘moderate’ and ‘pragmatism’ are has not been clarified.

 

. Downfall of American Value

 

1. Michael Moore’s Capitalism: A Love Story

 

Michael Moore’s recent documentary ‘Capitalism: A Love Story’ starts with elderly people leaving houses in which they have lived for more than 20 years with tears in their eyes, and a notice from a bank as a consequence of using the sub prime mortgage. Moore claims that the American Capitalism has serious problems and they need to be fixed. In short, messages portrayed in the documentary are as follows:

 

Derivative products, a major factor of the financial crisis in the year of 2008, is a gamble. Major American financial firms have been making enormous profits from this “gamble”. Dignitaries of the U. S. government repealed many financial regulations so that major companies would gain more profits. What is more, when financial companies started to fall, even Alan Greenspan stepped in to stop their decline. High ranks in the Department of Treasure were dominated by the Goldman Sachs.

 

After a bail-out was rejected in the House of Representatives, the U. S. economy became a disaster. Henry Merrit Paulson Jr., the secretary of treasure, and the heads of big corporations negotiated with the Democrats, which led to enforcement of the bail-out. However, it was done in the “Don’t ask, don’t tell” way in which even the U. S. Congress did not have the slightest idea of how the astronomical amount of budget for the bail-out was used. Even what was open to public was limited because it was done in the way of a primary-stock-purchase-method. So, the government was unable to control financial companies effectively.

 

Shortly after Federal Reserve chairman Ben Shalom Bernanke carried out the bail-out, U. S. citizens witnessed the AIG bonus payments controversy and extravagant expenditures of other major banks. In contrary, American citizens were in a completely opposite situation in which they got their houses provisionally by banks and factories they had worked for stopped running. It was obvious that American citizens outraged. Just like when Hurricane Katrina hit, American citizens could not get any help from the government, whereas banks were bailed out when they “gambled” people’s money and lost it. Poor Americans desperately needed a change, as a result, Barack Obama was elected as president.

 

The Financial Crisis Inquiry Commission held a hearing on January, 13th, 2010 to establish the cause of the worst financial crisis after the Great Depression. There, Lloyd Craig Blankfein of the Goldman Sachs, James L. Dimon of J.P. Morgan Chase, John Mack of Morgan Stanley, and Brian Moynihan of BOA took the stand. Chairman Phil Angelides said furiously, “News that big financial companies have earned huge profits and bonuses while being paid trillions of dollars by the government has devastated and enraged many people struggling to make a living”. Regarding Angelides’s statement, many C.E.O.s were busy making excuses for high wages, saying “We are much grateful for support from tax payers and we deeply understand the anger that many people feel. However, we do need to pay a proper amount of wages to attract talented workers”.

 

Moore’s documentary shows that ‘social justice’ in American is brutally destroyed by the financial crisis in 2008, and the majority of Americans resign themselves to reality. Americans’ lethargy is leading the U. S. economy to deeper recession.

 

2. John Steinbeck’s The Grapes of Wrath

 

Resentment of the Americans reminds me of The Grapes of Wrath, a novel written by John Steinbeck in 1939. The Great Depression, time of which the novel takes place, was an extremely chaotic period. Social unrest reached its peak as the unemployed numbered 10 million, which was about one-third of America’s labor population, as many banks and businesses went bankrupt. In the novel appear 250 farmers who moved to California after losing their lands in Oklahoma. Their pain and anger can easily be assumed through a phrase in the novel, “hundreds of thousands of people had to starve only for one great landlord”.

 

A question I want to raise is this; how is the devastation in American today any different from the story of The Grapes of Wrath? What is the difference between farmers running away from Oklahoma to California 80 years ago and the lower classes getting kicked out of their houses today? I would rather ask this question to Americans, rather than to ask Michael Moore.

 

On the other hand, when C.E.O. of JP Morgan James L. Dimon visited Korea on May 3rd, 2011, he showed his positive perspective on the future of America, saying “The financial crisis is over”. However, even if the crisis has come to an end as Dimon said, though I believe not, social problems caused by the crisis still exist undermining our society.

 

3. Nouriel Roubini’s Crisis Economics

 

At this time, we need to pay attention to what Nouriel Roubini says in his book, Crisis Economics (2001). Roubini says that the recent financial crisis was not unexpected, rather, it was a repetition of what has happened in history. Therefore, it could possibly have been prevented.

 

C.E.O of Goldman Sachs Lloyd Craig Blankfein called the crisis “something that happens once in a hundred years” as he raised objection of the regulation of the financial system. However, it was actually something that can happen anywhere, anytime, as long as a society is run by capitalism. Although the financial crisis was natural, collapse of the bubble did not happen naturally. It was caused by deregulation, excessive financial support by the central bank, derivatives created by investment firms, and credit information companies that gave AA to bad derivatives.

 

It is normal that once a bubble is created, it eventually collapses. However, Alan Greenspan, Federal Reserve Board (Fed) Chairman at that time, did not try to solve fundamental problems of the bubble economy, which let to the 2008 financial crisis. Eventually, Lehman Brothers collapsed and Merrill Lynch was merged. Moreover, AIG, holding AAA CDO bonds worth USD5-trillion, collapsed as well. The Fed chairman Ben Shalom Bernanke carried out an aggressive financial aid and it turned out to be a success. However, Bernanke’s aid actually infringed on authority of Congress and the Executive Branch, and raised a moral question by saving all financial companies.

 

Roubini has made a statement that “capitalism without bankruptcy is like Christianity without hell”. In contrary to the previous statement, Bernanke has created “capitalism without bankruptcy”, especially a form in which “the rich never fail”. What saves the rich is the tax paid by the common people.

 

The conservative stand against welfare policy because they fear moral laxity. In other words, welfare policy does not push the poor to work hard to make money. However, what the U. S. government has done was enforcing the best “financial welfare policy’ on the rich. As a result, America’s social justice has evaporated.

 

What should the U. S. government do about the mistake -- Bernanke’s aid, to be particular -- that they have made to protect the rich? Will the anger of American citizens turn into resignation as time passes? I believe solutions to these fundamental problems to be the most important tasks that are given to the American society. This violates the founding principle of America.

 

Roubini’s solutions are as follows: regulations need to be strengthened and systematic reforms are needed for credit rating agencies to make right judgments. Roubini suggests “anti-mega bank” as a solution. Big financial companies such as Goldman Sachs and JP Morgan need to be broken down into smaller parts and specialized in various fields. It makes it possible for another part of a company to absorb and alleviate shock when one part of the company collapses.

 

Roubini’s Crisis Economic (2011) thoroughly analyzes the 2008 financial crisis and the economy afterwards. Recently, optimistic views were raised as signs of recovery have been shown throughout the world. But, Roubini ascertains that it will not simply be an end because the certain crisis has complex causes. He adds that, rather, the recent situation in several European countries including Greece is just a start of the second global economic crisis.

 

4. Risk of Uncertainty in the Global Financial Market:

a Backward Flow of Dollars

 

What needs our attention is a fact that some ‘financial mafias’ in Korea have recently tried to promote ‘Mega bank’, which is the exactly opposite of Roubini’s ‘Anti-Mega Bank’. What is more, they even changed the present recommendation on the financial companies, which lowered shared from over 90 percent to over 50 percent, to promote the mega bank. Their intention was to establish a 505 trillion worth of financial companies that pursue ‘Economies of Scale.’

 

However, they do need to realize that they need countermeasure to growing financial risks. Otherwise, the dollar shortage in 2008 and even I.M.F can possibly happen again in the near future. Among the ‘financial mafias,’ there was even an important figure who resigned from a sense of responsibility during the money crisis in 1997.

 

Soon, the dollar in the international financial market will flow backward. After the break out of the global financial crisis in 2008, the U. S. government and the Federal Reserve lowered the interest rates to nearly zero percent and released $2.5 trillion on the market. With the interest rate dwindled to nearly zero percent, released dollars did not stay just in America, instead it rushed to an emerging market and a commodity market and created speculative enthusiasm.

 

However, on July 2011, it was decided to put an end to the release of dollars. Thus, dollars will flow from an emerging market back to America, the Fed to be specific. Although the 2008 financial crisis originated in America, shortage of dollars occurred in the international money market as dollars ebbed away from the emerging market back to America. The hedge Fund is already backing down from the emerging market and the commodity market. Price of gold, silver, and bronze, once skyrocketed, is now rapidly dropping whereas price of American government bonds, considered risk free asset, is rebounding. These are signs of another storm that is coming to the international money market.

 

It is easy for a country that has poor financial status and much short term debt to become a target of speculation (I Heard the Hedge Fund is Coming in Tomorrow, Yang-Taek Lim, Chosun Ilbo). Korea’s short term debt has been consistently decreasing from $154.5 billion; however, Korea’s current short term debt is $ 146.7 billion, which increased $11.7 billion compared to late 2010. The percentage of the short term debt out of total foreign debt has also increased from 46.3% in late 2010 to 49.1 % in March, 2011, which is an increase of 2.8% point. Korea’s short term debt has hit the highest record, even beyond the level of 2008.

 

Financially weak southern European nations, including Greece, have come very close to a national bankruptcy. Fortunately, Korea’s economy is being sustained by the currency swap agreement. With dollars depreciating, some big companies have already started speculating. Even domestic firms that are in need of won are borrowing hot dollars. In this kind of economic situation, is the ‘Mega Bank’ really needed for Korea? Mega banks, concentrating all capitals on one place, are destined to collapse with just one blow of draft.

 

5. Francis Fukuyama’s The Fall of America Inc.

 

Francis Fukuyama rose to the rank of a worldly-renowned scholar as he predicted the fall of communism in his book, The End of History and the Last Men (2006). He recently pointed out a downfall of American capitalism in his column, The Fall of America Inc. (Newsweek, August 13t, 2008). A summary of the column is as follows:

 

Ideology is one of America’s mainstays. Ever since Ronald Reagan won the presidency in the early 1980’s, the two following American ideas, i.e. Washington consensus, have dominated the world. The first idea is that low taxes, light regulations, and a small government boost the economy. Reaganism completely changed the economic paradigm that had been dominated by Keynesian for a century. Deregulation emerged as an absolute order not only in America, but also throughout the world.

 

The second is that the United States is in charge of unifying the world’s liberal democracy. Liberal democracy has always been believed to be the only way that leads to prosperity. Power of the States does not lie in its arms and capital, but in the admiration of the world which leads to Americanization. Backed by the U. S. government, international financial institutions such as IMF and WB forced developing countries to open their economy.

 

Signs that the mentioned ‘first idea’ that Fukuyama suggested and Reaganism and drifting have already shown twice in the last decade. The first sign was the financial crisis in Asia that lasted from 1997 to 1998. Asian countries such as Thailand and Korea have liberalized their market since the early 1990’s under pressure from America. The second signal was America’s accumulated budget and trade deficit. Since 1997, many countries including China have started to buy U. S. dollars as a measure to protect their economies from the global financial crisis by depreciating their own currency. Thanks to appreciating of dollars, America was able to cut taxes on local citizens and boost domestic demand. They were also able to pay off massive cost of two wars and carry out deficit financing. Accumulated deficit in trade eventually reached a point where it could not possibly be maintained, making a loss of 700 billion dollars.

 

Although when exactly the Washington consensus will fall cannot be easily assumed, it is undeniable that the influence America has on the world economy is getting weaker and weaker. However, in contradiction what Fukuyama has said, I believe America will never fall. Although ascendancy of America in the world economy is rapidly weakening, I strongly believe that America still has capacity of self-adjustment. Their capacity to self-adjust will recover only when Americans accept a new economic thought, neo-pragmatism for example, instead of new liberalism. In other words, the age of America will arrive again only when neo-pragmatism realizes social justice, and sense of solidarity among Americans strengthens.

 

The essences of America’s founding principle are freedom, equality, and Puritanism. They are specified in the Declaration of Independence. The First chapter is a preface that briefly explains inevitability of independence which came from natural rights and national self-determination The second chapter states the founding principle of America as philosophical background of the Declaration of Independence in the following:

 

“We strongly believe that the followings are self-evident truths: All men are created equal and they have certain rights and among these are life, liberty and the pursuit of happiness. For these rights, men created a government and power of the states comes from people’s agreement. Also, people have the right to punish any government that ignores the purpose for its establishment and institute a government for their own sake” (The rest omitted).

 

The mentioned quotation asserts people’s right to resist, which justifies turnover of an unjust government for its establishment is legitimized by people’s agreement. The factors that led the U. S. economy to recession are as follows: a rise in prices of raw materials such as farm produce and oil weakened real purchasing power of Americans, and car production was hindered by the earthquake in Japan, which resulted in interruption to supply parts to America. Also, government demand weakened due to worsening budget deficit and implementation of austerity measures. These all led to a downward movement in various economic indicators of the U. S. economy, which made outlook on world’s economy uncertain. It seems certain that the U. S. is losing the initiative in the global economy.

 

In particular, the current economic crisis in America can be considered a result of a potential conflict concerning the upcoming presidential election. President Obama and leaders of the Republicans are in sharp disagreement over raising the limit of government debt. Obama is saying yes, and the Republicans are saying no. With a political calculation that defeat on this debate will also result in a defeat in the next election, each side refuses to back down on this matter.

 

The Obama administration claims to support progressive liberalism. However, it seems uncertain which side the Americans would pick between the progressive and the conservative. President Obama made public the administration’s plan to reconsider regulation in his column on the Wall Street Journal on January 18th, 2011. This change in a policy line may have come from a strong need of firms’ cooperation, which is essential to bring recovery to economy and win the next election. The Obama administration needs to cooperate with companies to push 9% unemployment down, promote investment, and increase exports. That would be the way to enhance relations with companies, which have become uneasy due financial reform and medical insurance reform.

 

6. Arrival of the Age of Asia

 

Jeffrey Sacks of Columbia University said, “By 2050, the center of the global economy will be Asia as China’s economy outdoes that of America. The U.S hegemony will eventually come to an end”. He added at some point in the 21st century, America will lose its power and Asia will come to the fore as a new dominating force”. Nouriel Roubini, a professor at New York University, has also predicted the advent of the Asian hegemony in the global economy.

In addition, Sakakibara Aiske of Waseda University said, “Asia’s outstanding application technology will become an engine of the global economy,” and Andy Xie, economic analyst in China, stated “4-5 Asian cities are competing to become a new center of the world economy as the initiative that New York held is going over to Asia after the global financial crisis”.

 

As the mentioned scholars have predicted, Asia is indeed emerging as a new center of the global economy. As the new rich class in Asia is emerging as a new consumption group after the financial crisis in 2008, the Asian market is currently regarded as the blue ocean of the global economy. Founded on low-wages, Asian firms used to function as a cheap manufacturing base for western firms. However, they are now leading global businesses taking advantage of a large-scale market. Korean companies are rapidly taking over the Asian market with their mainstays such as cars and electronic applications.

 

South Asia, called “the Far East” in the late 19th century because of its location, has become “a global factory” that produces 20 percent of the world’s GDP. Trade structure in three major Asian countries, South Korea, China, and Japan, has turned from vertical specialization to horizontal specialization and there is a fierce competition both within and out of the area.

 

Considering this trend, President Obama declared a new foreign policy regarding East Asia in Tokyo, Japan, on November 14th, 2009. He announced that the administration would focus not only on their traditional allies such as Japan and Korea, but also on China, which have emerged as growing powers. Not only that, he said the U. S. would also put importance on rising nations such as Indonesia and Malaysia. He also promised to show more interest in international organizations such as APEC and ASEAN.

 

On October, 15th, 2009, Prime Minister Hatoyama offered cooperation to establishment of East Asian community (EAC) at a speech he gave after participating in APEC. With lack of political leadership and aftereffects of the recent Tsunami, it seems that Japan’s “lost two decades” will last longer.

 

Korea, praised as a country that overcame the global economic crisis in the shortest period of time in the world, is now facing a sharp rise in prices in Korean Won, and interest rate, which is expected to lead to a fall in economic growth, stock prices, and real income. According to the IMF, Korea’s government debt is 447 trillion won, and rate of the government debt compared to GDP is 44.9 percent. Even Spain, coming nearly to state bankruptcy, has 46.1% government debt and Ireland has 46 percent.

 

Chinese president Hu Jintao said at the 2009 APEC that China would cooperate with the international community to overcome the recent crisis and pursue peace and co-prosperity. He also said at a 2011 New Year’s Address, “The world is now facing a cataclysm and prodigious development”. This statement may have expressed his dream of opening “Pax China,” an age in which China surpasses American and leads the world.

 

In fact, G2, the United States and China, came into the spotlight after the breakout of the recent crisis. Even in the 1980’s, when China started to open doors, Chinese diplomacy had to be passive. The keynote for diplomacy that Deng Xiaoping founded was “building up strength in secrecy”. It meant unnecessary troubles for upcoming 100 years. In 1997, former Chinese president Jiang Zemin announced to have a responsibility of a power house. It was taking one step further from the Deng Xiaoping’s previous basis. Now with Hu Jintao in power, the basis for Chinese diplomacy has changed to “strong pressure on the opponent”.

 

After the 2008 financial crisis, there is a buzz word going around in China: In 1979, only capitalism could save China. In 2009, only China can save capitalism. To elaborate, the revolution in China 30 years ago was backed by western capitalism, but the situation has changed completely and the world economy is now making ends meet with the aid of China. China is now able to say ‘no’ to economic standards of the west. However, China is also tightening its belt in fear of inflation, which is weakening domestic demand. The Chinese government is currently trying to change its growth engine from exportation and investment to consumption. This success of this plan depends on whether domestic demand can sufficiently reinforce weakening exportation.

 

With enormous debts to deal with, both Europe and America are incapable of resolving the serial national bankruptcies that are occurring in the world. International assistance of G7 and G20 is not working as well. Emerging nations such as China, Brazil, and India are considered inadequate to lead the world economy. In this situation, the world economy is again falling into the second global crisis.

 

. Controversy and Critics on the Global Financial Crisis

 

1. Conflict between Friedman and Tobin

 

As new liberalism and market economy system were found to be the causes of stagflation of the 2008 global economic crisis, New Keynesian, which pursues big government, is rising.

Milton Friedman’s economic theory became a basis of Reaganomics, which supported small government, deregulation, and tax cuts. Since then, Reaganomics has been a foundation for the U. S. economy. When the financial crisis broke out in 2009, Milton Friedman was severally criticized for having caused the crisis.

 

Meanwhile, Noble Prize winner James Tobin was a godfather of New Keynesian economics, which emphasized the importance of government intervention on the market. His idea emerged as a new direction for the Obama administration after the 2008 economic crisis. Known for his Optimal Portfolio Theory, which states “don’t put all your eggs in one basket”, Tobin emphasized the necessity of dispersion of financial risk and efficient allocation of resources and urged the government to intervene in the market.

 

2. A debate between Ferguson and Krugman

 

There’s still an on-going controversy on whether the recent crisis was market failure or government failure. A good example of the controversy is the argument between Niall Ferguson and Paul Krugman on the recent economic situation in the U. S. Their dispute traces back to the “bond controversy” in April, 2009. I would like to sum their argument up as follows: according to Ferguson, twin deficits in the U. S. are extremely severe. Investment in health care and education facilities, which are the two major policies of the Obama administration, do not produce results in short time. Especially health care will result in enormous government deficits, leading to fear of purchasing bonds.

 

Therefore, monetary policy and expansionism will only result in inflation by raising interest rates and lowering the dollar value.

 

However, Krugman refutes Ferguson’s opinion, saying “It is extreme pessimism”. The recent economic crisis is similar to the Great Depression. The only difference is the financial sector, in which derivatives are not regulated by the government. What is important in this kind of economic structure is the 10 percent unemployment. This unemployment rate will eventually trigger deflation, therefore, expansionist policies are needed. What is more, even if the government increases expenditure, interest rates will not rise because the U. S. economy is in the liquidity trap.

 

With respect to Krugman’s view, Ferguson fights back saying, “Only the situation in the U. S. is similar to that of the Great Depression. In other countries, a bubble in asset prices is being created”. He says expanding policy cannot solve the unemployment problem, therefore, the U. S. government’s priority is solving structural problems, not carrying out expansionist policies. The Obama administration is simply printing dollars, and without resolving the organizational contradiction, which will only bring in another bubbles and business fluctuations.  Niall Ferguson puts more stress on the financial market than the physical market, as seen in his book Ascent of Money. Considering only the money market, dollars will overflow if the U. S. government engages in radical expanding policies. This will eventually lower the dollar value.

 

As previously mentioned, Ferguson picks inflation in the financial sector and a fall in dollar value as America’s facing subjects whereas Krugman picks mass unemployment in the real sector and deflation. Furthermore, Ferguson suggests solving the structural problem and Krugman suggests carrying out expansion as a solution to this problem.

We need to be aware of the fact that the problems that each believed were the cause of the recent crisis do exist in reality. At the same time, both inflation and deflation are not working properly. That is, both the real and financial sectors are becoming immobilized. The financial market has recovered almost to the state before the recent crisis, however, the real sector still shows high rate of unemployment.

 

At this point, I want to raise this question. Why is there no inflation in the U. S. even with the Obama administration carrying out expanding policies? Also, why is there no deflation in the U. S. as well when mass unemployment is prevalent?

 

The answer to the Ferguson’s paradox is that as the dollars that were released by the U. S. government were leaked into foreign markets, the pressure for inflation in America naturally decreased. With an economic structure specialized in banking business, money flows back to foreign countries and the effect of stimulus on the economy is lost as America imports the majority of commodities from China.

 

We need to take a closer look at the correspondence strategies that foreign countries took towards the U. S.’s expansionism. Exchange rate defense of foreign countries is hindering recovery of the U. S. economy. In times of recession, prices and supply usually fall in the physical market. However, foreign companies are not affected by the price fall in the American market as effect of the price fall is cancelled out by depreciated currency of exporting countries. Exporters even lower domestic prices more to increase foreign demand and exports. Therefore, what central banks in Asian countries, currently holding the largest foreign exchange reserves, want is stability in the US economy, not profits produced by the US government bonds. This is because Asian countries are able to continue their economic growth with depreciation of exchange rates and stability of the U. S. economy. Asian countries are even producing potential profits of appreciation by which American banking businesses make money.

 

However, in times of the global repression, exchange rate defense of one country can provoke other countries and possibly led to co-destruction. Return of the U. S. protectionism needs to be prevented as well. If America returns to protectionism, it would be unavoidable for other countries to raise tariffs as well. The world will eventually face co-destruction because of nations that pass their own economic burden on each other. In this aspect, the Obama administration has made a right choice to invest in education rather than to return to protectionism.

 

I want to remind the fact that Smoot-Hawley Tariff Act of the U. S. cause the Great Depression. To elaborate, in 1930, Congress concluded that foreigners were the cause for the recession. Thus, Congress enacted the Smoot-Hawley Tariff Act, the purpose of which was to block imports by raising tariff rates up to 60 percent. At that time, more than a thousand economists petitioned the government for abolition of this bill and 36 nations appealed to Congress to turn the bill over. However, their efforts did not work out. Consequently, allied nations in Europe retaliated against the U. S. by turning to protectionism, and cargo docks became barricades of protectionism. 60 nations followed this action, making the world fall into poverty as two-thirds of the world trade collapsed. As a result, the recession in 1930 turned into the Great Depression.

 

3. Stiglitz’s Prescription: Increase Government Regulations

 

In his book Freefall: America, Free Markets, and the Sinking of the World Economy, Joseph Stiglitz says “With the coming of the recent economic crisis, the U. S. supremacy has ended. The controversy on market fundamentalism has ended as well. The recent crisis has revealed a fundamental defect of capitalism”. He criticizes blind faith in capitalism and corruption of Wall Street as the cause of the crisis and calls for fundamental solutions. This means the recent crisis will not be solved simply by resolving a few problems and changing few policies.

 

What Joseph Stiglitz suggests as a solution to the crisis is reinforcement of regulations. He has persistently been claiming, “Costs that are caused by the government regulation are less than costs incurred due to deregulation”. Thus, he criticized the Obama’s administration for not addressing thoughtless deregulation, which was the cause of the crisis. He also insisted on reinforcement of government regulation as well as an increase of government spending.

 

As seen previously, Stiglitz is a thorough Keynesian. He supports Keynesian economics by saying, “The world will fall into deeper recession if it does not go back to the very basic of Keynesian economics”. For example, he praised China for carrying out the world’s biggest stimulus to recover from the recent crisis and pointed out the U. S. and Europe for not pushing through stimulus big enough to offset shock from the crisis.

 

He also worries more about problems incurred in the financial market due to inflation and government debt than he does inflation and government debt themselves, as these problems are slowing down economic growth, increasing unemployment and reducing income. He also warned of retrenchment in Europe, saying ‘will only lead many nations to a double-dip.’

 

Stiglitz says what is really important is for what purpose the government spends money, not whether the government has debts. In that, capital should be used to establish new banks and invest in fields that can be growth engines for the future, not to bail out insolvent banks.

 

Another renowned Keynesian Paul Krugman has also made the following statements in this latest book, The Return of Depression Economics: emphasizing technological innovation and encouragement of productivity. Recent economic theory is well aware of importance of supply, but ignores the aspect of demand; as a result, a gap between supply and demand has created today’s crisis. He even urges a return to Keynesian economics. However, he points out that the economics does not reflect reality, with central banks in major countries already enforcing monetary policies concerning demand.

 

Based on new liberalism, hedge fund magnate George Soros claimed that the financial market can fix problems on its own with the help of the ‘invisible hands’ in his book, The New Paradigm for Financial Markets. However, Stiglitz raised objection to this statement, saying “The reason why the invisible hands are invisible is because they do not exist”.

 

Soros insists on responding and adjusting to the financial market rather than predicting it because it -- as he puts it -- is like a living thing that moves and evolves. But, he also says the government cannot be free from a responsibility of stabilizing domestic and international economy because the market is incapable of correcting its own mistakes. He advises the government to build reliance of properly restricted markets as well as prevent the free-market economy from self-destruction.

 

He also argues that the 2008 crisis was caused by internal problems of the economic system, not by exogenous shock. The 2008 crisis has shown how the power of an unrestricted market brought capitalism to the edge of disaster, and the global financial system has heightened risk rather than spreading it.

 

Meanwhile, Australian prime minister Kevin Rudd suggested the following three steps to save modern capitalism through his column The Global Economic Crisis and the Government’s Responsibilities (Joong-Ang Ilbo, March 2nd, 2009).

 

First step is to establish proper regulation for the market and utilize the government to boost domestic and global demand. The government should bail out the private financial system which is on verge of destruction, come up with an effective economic stimulus, and establish domestic and international regulation systems.

 

Second, each nation has to come up with a financial remedy to prevent capital from flowing into areas with the least regulations. Strict standards for discharge of financial institutions are also required. In addition, incentives should be given to responsible firms.

 

Last, protectionism must be firmly excluded because it is an extremely dangerous policy that can lead to economic recession.

 

Editor’s Note: The conclusion of this paper will be presented in the upcoming January-February issue of this Journal.

 

 

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