Economic Policy Direction Shortcomings

The public policy edge of managing this global financial crisis has been focused on opening up the credit markets and re-establishing solvency in select financial institutions. As emergency interventions, they represent a monumental attempt to resuscitate a seriously damaged global economic system. The actual results, so far, have been only marginally convincing, if at all convincing, as to their successful outcome.

It is more than a little ironic that a primary reason this state of affairs arose is because of imprudent lending decisions. Financial institutions damaged their balance sheets, to the point of impairing their continuing business viability. Credit markets contracted and liquidity dried up. Credit is the lifeblood of our global economic system. Unfortunately, or fortunately as the case may be, prudent extensions of credit are based upon the credit worthiness of the borrower.

It should be fairly clear, by the increasing foreclosures and bankruptcies, that prospective borrowers do not, in general, represent good credit risks at the present time. It is also widely agreed that we are looking at a potentially severe and drawn out recession (depression?). We can reasonably expect that prospective borrowers will find themselves in even more distressed economic circumstances in the near future. As such, one must ask why a lending institution, after already getting its fingers burned through imprudent lending practices, would want to extend credit to prospective borrowers with deteriorating solvency prospects.

Additionally, the question should also arise as to why, a borrower already overextended, and facing a deteriorating economic picture, would wish to borrow more, other than as an act of desperation, or other irrationality. Perhaps it is a case of “if there is nothing left to lose, why not go for broke at the expense of an imprudent lender.”

It is not surprising then that despite massive capital injections, the credit markets are still sluggish. After shoring up their balance sheets, at public expense, lending institutions are possibly returning to their roots of being some of the more rational players (this is not a high bar to cross these days) in their economic and business decisions. The wiser deployment of capital would be to acquire distressed assets rather than extend credit to borrowers with poor prospects.

The dilemma facing policy-makers is still how to prevent, or at least mitigate, a global economic slowdown. What are the drivers of economic growth to be if growing debt financed consumption cannot be counted on? Several possibilities arise. As an example, China, and the Asia region, has the potential of stimulating their own internal domestic consumption. Inflation fears may have restrained efforts in this regard before. Now, however, prospects of an economic slowdown, and a more benign (at least for the time being) inflation outlook may open this up as an expeditious policy direction.

From the perspective of the West, and the United States in particular, there is a great deal that needs to be done to re-establish a strong and competitive economy. There are immense infrastructure needs and well as immense needs to fortify the intellectual capital base of the country through adequate funding of education and research. An assessment needs to occur in order to determine what the competitive and comparative advantage and long-term needs of the United States really are. This needs to be done in the context of the United States as a global citizen and its constructive relationship to other global economic players. Once this is determined focused attention and political will must be directed in this direction.