Put growth horse before cuts cart: The Shifts and the Shocks, by Martin Wolf

Review: a timely and serious analysis of the financial crisis with pointers about what needs to happen next

Mon, Oct 6, 2014, 19:05


Book Title:
The Shifts and the Shocks: What We’ve Learned and Have Still to Learn from the Financial Crisis


Martin Wolf

Allen Lane

Guideline Price:

At the height of the economic crisis a few years ago an economist remarked, “We will know when the crisis is over when economic crisis conferences are not booked out in advance.” Although the shock waves of the 2009-10 crisis in Ireland and the wider euro-zone crisis of 2011-12 have subsided, at least for now, it is not obvious that economics has retreated to its normal equilibrium of dry knowledge and turgid formulaic analysis.

The Shifts and the Shocks provides a timely and serious analysis of the global situation and outlines some pointers about what needs to happen next if we are not to be condemned to permanent stagnation.

Wolf, whose Financial Times column appears in The Irish Times each Wednesday, is an economist with a thorough understanding and wide peripheral vision of the world economy, something that is clear from the outset of this work. He has the honesty to acknowledge, “I did not foresee a crisis of such a magnitude in the high-income countries.”

Wolf’s starting point could be said to resemble the maxim from the road-safety ad that points out that “accidents don’t just happen: they are caused”. For him the great recession of 2008-09 was not the result of a random external shock – war, a political crisis, disruption in energy supply. Rather, it was rooted in the internal contradictions and dysfunctional institutional arrangements of global capitalism.


A lifelong believer in free markets and globalisation, Wolf is concerned that “the financially driven capitalism that emerged after the market-oriented counter-revolution has proved too much of a good thing”. Thus the genesis of the crisis was trade imbalances together with associated large-scale capital flows from the surplus-account countries to the deficit-account countries. In other words fiscal imbalances did not trigger the crisis. However, fiscal deficits did emerge as a consequence of the crisis.

Ordoliberalism, the doctrine at the heart of the euro zone, insists that the fault lies with the countries that overspent, overborrowed and declined the necessary structural reforms to regain competitiveness.

The solution, according to this mindset, is fiscal austerity in the short run (longer if necessary) combined with tight fiscal rules.

Wolf is scathing of the ineptitude of financial regulators, politicians, economists and the institutions of the European Union and its currency union. He argues, persuasively, that we came very close to a full-scale 1930s-type depression, which we may have avoided only because US policymakers in particular declined to replicate the scorched-earth strategies of their EU counterparts.

Wolf examines some options to stabilise financial markets and avoid crises in the future. His focus is on what ultimately is a simple accounting formula: deficits (the difference between spending and income) balance at the global level. Within any country, deficits in the household sector are balanced against deficits or surpluses in the corporate and government sectors. Where there is a mismatch between spending and income for the country as a whole, it is offset by a difference between goods sold and bought internationally. A deficit or surplus with regards to “the rest of the world” signals that a country is taking in more money than it sends abroad or vice versa.


One of the underlying causes of disruption in the markets is a build-up of global imbalances in trade and investment, along with domestic public and private sectors. During a recession, governments have to do a lot of heavy lifting by way of running deficits (spending more than they take in) to offset the surplus in the corporate sector (which typically slashes investment in downturns), as well as surpluses in the household sector (which typically cuts spending and investment as incomes decline and as it seeks to pay back debt).

But Wolf argues that the growth horse needs to be put before the fiscal-adjustment cart. Put simply, this means targeting growth in the first instance. (He suggests a target annual inflation rate together with a nominal GDP growth rate.) It should be possible in this way, over time, to reduce imbalances, including deficits.

The problem with “one sided” austerity is that it targets deficit reduction to the detriment of growth. It has proven self-defeating insofar as deficits remain high and the level of public debt is still rising in some euro-zone economies.

Underlying this is a lack of aggregate demand triggered by a financial crisis that in turn was triggered by poor regulation and global imbalances. A balance-sheet recession quickly turned into a banking and sovereign crisis and then became a political crisis threatening the existence of the euro and the European project itself.

If that existential crisis has abated it remains the case that the underlying causes of the crisis have not been addressed. These are embedded in the structures and internal contradictions of capitalism.

As with Thomas Piketty’s Capital in the Twenty-First Century, the least developed part of this work lies with the concluding “what is to be done” element. Wolf suggests movement towards greater “discipline over global imbalances” (such as Germany reflating to help boost periphery deficit countries) and financial controls over bank lending across borders – heresy within the euro zone but already introduced in Cyprus and necessary in the long run to save the euro.

He proposes a better targeted and more timely use of monetary and fiscal policies to boost growth, curtail casino banking and create more stability. However, this calls for international co-ordination as well as a moderation in ideologies and interests that seem well entrenched for the foreseeable future. Will it take another existential crisis to bring about what is required to save not only the euro but the EU and the world?

With a glint of hope overshadowed by threat, Wolf concludes, “We must not only learn the lessons about how the world economy went awry. We must also act upon them. If we do not, next time a big crisis arrives even our open world economy could end in the fire.”