Policy Study


This year the G’s are meeting at a critical moment in history, at least economic and social history. They will confront the gravest economic and social crisis in almost 80 years. To paraphrase Keynes, the destiny of the world is in the hands of the members of the G’s.

They could act in such a way that would allow us to get out of this situation, creating a future where growth is more sustainable, friendlier to the environment, and where its fruits would be distributed in a more equitable way, both within and among countries. Otherwise, they will bear an enormous responsibility before history, that of not having done the duty which has been delegated to them by their people, despite having been in exceptional circumstances that gave them much more room for manoeuvre than they would have had in ‘normal’ times.

That is why a group of ‘experts’, with no commitments other that of being citizens of the world, decided to meet to reflect on what could be done, hoping that from their reflection some useful recommendations to the powerful of this world would emerge. This group, which christened itself the Shadow GN, has been constituted under the leadership of Joseph Stiglitz and Jean-Paul Fitoussi, thanks to a partnership between Luiss and IPD.

The group has met twice, once in New York at Columbia University on 4-5 February 2009 and once in Rome on 6-7 May 2009.


The crisis that began in 2007 in a small segment of the US credit market (subprime mortgages) is today a global recession. The crisis has four distinguishing features. The first is that it is truly global in nature, as it started right at the centre of the system. The second is that, more than was the case with past crises, the present one is dominated by a widespread sense of unfairness. The third peculiarity is that its roots lie as much in structural causes as in the loose regulatory framework of the financial sector. The fourth is that it is ‘doctrine made’. The belief in the self-regulating properties of markets led to deregulation and a widespread mistrust of government intervention.

The financial crisis, triggered by a modest number of defaults on subprime mortgages, has evolved into a systemic crisis because of the chain of financial innovations prompted by lax monetary policy and loose regulatory framework, which multiplied the effects of the initial shock. Contagion to the real economy mainly happens through tightening credit constraints for households and firms. In an attempt to recover more reasonable ratios, banks either hoard liquidity or lend at high rates. On the other hand, firms tend to use their own cash flow to restore more prudential ratios of debt to capital, thus postponing investment. Households suffer from a negative wealth effect. The result is a generalized decrease of aggregate demand that has led the majority of economists to forecast a recession well into the year 2010, with exceptionally strong effects on unemployment and poverty all over the world. It now appears likely that the ILO’s ‘worst-case’ scenario of unemployment increasing by 50 million worldwide in 2009 will turn out to be over-optimistic. Over 200 million workers could be pushed into extreme poverty, mostly in developing and emerging countries where there are no social safety nets, meaning that the number of working poor – earning below 2 USD per day for each family member – may rise to 1.4 billion. 60 per cent of the world’s poor are women.

The crisis has structural roots. The aggregate demand deficiency preceded the financial crisis and was due to structural changes in income distribution. Since 1980, in most advanced countries the median wage has stagnated and inequalities have surged in favour of high incomes. This is part of a broader process which has also affected several parts of the developing world. This trend has many causes, including asymmetric globalization (with greater liberalization of capital than of labour markets), deficiencies in corporate governance and a breakdown of the egalitarian social conventions that had emerged after WWII. As the propensity to consume out of low incomes is generally larger, this long-term trend in income redistribution by itself would have had the macroeconomic effect of depressing aggregate demand.
In the US the compression of low incomes was compensated by the reduction of household savings and by mounting indebtedness that allowed spending patterns to be kept virtually unchanged. At the same time, the limited safety nets forced the government to pursue active macroeconomic policies to fight unemployment, increasing government debt as well. Thus, growth was maintained at the price of increasing public and private indebtedness.

Most European countries tread a different path. The redistribution to higher incomes resulted in an increase in national savings and depressed growth. In the past fifteen years the institutional setting, notably the deficit constraints embedded in the Maastricht criteria and in the Stability and Growth Pact, resulted in low reactivity of fiscal policies and restrictive monetary policy. Together with a financial sector less prone to innovation, this limited consumer borrowing. The shift in distribution resulted in soft growth.

These two paths were mutually reinforcing because the savings from the EU zone contributed to the financing of US borrowing, along with surpluses of other regions which for different reasons – essentially to insure themselves against macroeconomic instability caused by Balance of Payments crises and the subsequent loss of sovereignty due to the intervention of IFIs – also experienced high savings rates (notably East Asia and Middle Eastern oil producing countries). Thus, the combination of structural disequilibria that goes by the name of global imbalances resulted in a fragile equilibrium that temporarily solved the aggregate demand problem on a global scale at the expense of future growth. An important component of this fragile equilibrium was lax monetary policy. In effect without a continuously expansionary monetary policy aggregate demand deficiency would have affected economic activity. In a way monetary policy was endogenous to the structural disequilibrium in income distribution.

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