Europe Needs a Good Crisis

When it comes to economies in general and financial crises in particular, it’s remarkable how little we actually understand.  While global financial actors struggle to restructure Greece’s debt and to avoid contagion throughout Europe’s periphery, we should recall the lessons of the Asian-Russian crisis 15 years ago.  As the writings of Joseph Stiglitz and Martin Wolf remind us – and those events illustrate – crises are part of an evolutionary process, and the afflicted economies often emerge with surprising vigor.

The developed world is still reeling from the global financial crisis of 2007-2009. Before the recent crisis, a sense prevailed that in the waning years of the 20th century, the global embrace of free markets and financial innovation had not only super-powered expanding prosperity, but economic stability as well. Post-financial crisis, however, there’s a widespread feeling that infatuation with free markets and financial innovation actually undermined economic stability and may have threatened prosperity, not just in the short term but in the long run.

How could such a huge shift in perceptions of economic reality take place so quickly – resulting from events over a period of only a few months, if not weeks? This shift occurred in the views of seasoned analysts, commentators and theorists of many persuasions. Are our concepts and models of economic processes still so fragile after all these years that an event of a kind that has occurred frequently throughout history (as Carmen Reinhart and Kenneth Rogoff show in their recent book, This Time Is Different) could throw them into complete disarray?

The answer to the latter question is clearly “Yes.”

And yet the last serious financial crisis occurred a scant 10 years before the 2007-2009 event, in 1997-98. It hit the emerging economies of Asia, and Russia, not the major industrial countries; its only clearly visible impact on the U.S. economy was the collapse of the large hedge fund, Long-Term Capital Management (LTCM). But that crisis set off a long-running debate on globalization. The after-effects of that crisis may have helped cause the more recent crisis, by prompting developing countries to amass enormous cushions of foreign reserves. And the concerns over the LTCM failure should have increased awareness of systemic risks posed by the complex interlocking commitments of international finance. What’s more, less than 10 years before the Asian crisis, the U.S. experienced its own crisis in the savings and loan industry, with massive government intervention and a large bailout.

We should have known about financial crises.

Globalization and financial crises

Before the global financial crisis, globalization was a hot topic. World government and corporate leaders gathered at the World Economic Forum in Davos to discuss its limitless opportunities, while protesters gathered to argue its downsides. More recently, global leaders are sounding less triumphal, especially leaders in the financial realm, because since 2007 the globalization discussion has turned to financial crises – and those leaders’ roles in them.

Globalization has been hotly debated, celebrated – and in certain circles, scorned. The globalization debate subsumed the 1997-98 financial crises that it was thought to have caused. Globalization would, some argued, open up endless opportunities, steal jobs, threaten national sovereignty, increase the pace of progress by orders of magnitude, widen the gap between rich and poor, destabilize national economies, destroy the environment – in short, turn things topsy-turvy.