The repercussions of Lehman Brothers’ bankruptcy can still be felt. It has been almost seven years since the U.S. broker’s failure sparked a global financial crisis and deep recession in most developed countries. Yet the real damage is only now becoming clear.
Larry Summers says this is the era of secular stagnation, by which the Harvard economist and former U.S. Treasury Secretary means a slowdown in the GDP growth rate in much of the world. His catch-all phrase captures something real, but his focus on real policy interest rates is painfully simplistic. GDP growth is not slower because monetary policy is wrong, but because the crisis revealed, caused or amplified many economic problems.
To start, the finance trade’s reputation is severely damaged, and no monetary policy can improve it. From the 1980s to the early 2000s, politicians and economists treated the expansion of sophisticated finance as a sign of economic health. The industry is now deservedly in disgrace, but widespread mistrust means it cannot perform its valuable economic task of gathering savings, allocating investments and spreading losses.
Central banks, too, are deeply tarnished. Before the crisis, they carved out a splendid reputational niche as protectors of subdued inflation, low unemployment and steady GDP growth – a state often called the Great Moderation. That all went badly wrong. The new common belief is that the monetary authorities are lost and impotent. Such doubts discourage investments and spending.
Economists who promoted the moderation thesis are also out of favour, which might not sound like a big problem. However, some of their advice after the crisis was good. If their reputations were less damaged, they might have persuaded leaders in Europe and the United States to spend and borrow enough to restore economic momentum faster.
The injury Lehman Brothers inflicted on the financial sector has scarred the real economy too. At the government level, it amplified political authorities’ longstanding economic weaknesses. The United States and much of Europe have steadily skimped on infrastructure investments. Politicians seem too discouraged and divided to address such grave challenges as the costs of ageing populations and inadequate job creation.
The job problem is always latent in modern economies, because it is far easier to destroy than to create paid employment. The crisis turned the potential threat into enduring pain. On both sides of the Atlantic, the careers of a substantial portion of the young people entering the workforce since 2008 have been stunted. In most of Europe, unemployment rates are still painfully high. In the United States, the rate is low but in large part because so many people have unwillingly left the workforce.
Then comes the most severe damage from the crisis: to the social fabric. The unresolved financial mess made many things worse. The poor have done less well than the rich, increasing inequality. Negative housing equity and excessive debts still weigh on American families. In most European countries, welfare programmes have been cut and education and health care funding squeezed.
It may seem weird that such a small cause, the failure of one less-than-gigantic financial institution in the United States, could have such a large effect. However, a single shifting pebble can start an avalanche, and modern economies are far more complex organisms than a mountainside covered with rocks and melting snow.
Thankfully, the modern economy is often self-healing – just as communities and supply chains often are after avalanches and other natural disasters. Troubled companies are helped back to health or gradually wound down. New technologies peacefully displace old ones, with the path made safer by reasonably diligent regulators. Citizens, companies and governments can usually find enough common ground to deal with big problems, from excessive pollution to inadequate safety standards.
The 1973 oil crisis gives an encouraging example. Then, the developed world’s vulnerability to a reduction in the supply of Middle Eastern crude was laid bare. The economic pain, which included high inflation rates and two big recessions, lasted at least a decade. Subsequent increases in energy efficiency and the development of alternative sources of oil and energy protect the contemporary world from a repeat of that long struggle.
The post-2008 experience shows that the global financial system is at least as important now as Gulf oil was then. Is that dependency still toxic? There have been efforts to make finance safer and to make the world less dependent on finance. It is too early to know how well they have worked. But it is clear that economists, policymakers and financiers still have much to do, including restoring their own reputations for competence. Even if they succeed at the many needed tasks, much of the damage from the crisis cannot be undone. But the deterioration can at least be halted.