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Avoiding another Lehman

The collapse of Lehman Brothers in 2008 and the global financial crisis that followed are seen as the cause of the subsequent economic downturn. From this assumption it is easy to conclude that greedy bankers and lax financial regulation were to blame.

One reason this view seems plausible is that the economic downturn did indeed come after the financial crisis. If one event follows another, it is easy to assume that the first event must be the cause of the second.

But this is a common logical fallacy. There is even a Latin name for it: post hoc, ergo propter hoc. This translates as ‘after this, therefore because of this’.

This error is compounded because mainstream analysts tend to make the mistake of understanding the global financial crisis and its aftermath in cyclical terms. They assume that the financial turmoil caused the subsequent recession. From this perspective, the world economy has recently recovered, albeit slowly, from the preceding cyclical downturn.

However, if the world is viewed from a longer-term perspective a different picture emerges. Economic growth in the developed world has been on a downward trend since the 1970s. What is commonly viewed as strong growth today would have been seen as pitiful not long ago.

This weakening growth dynamic is also apparent in the figures for productivity and business investment: key determinants of economic health. Both have trended downwards for a long time. If it were not for China’s spectacular rise, acting as a counter-tendency, the West’s rut would be even deeper.

“Although such measures postpone an economic reckoning they only make problems worse in the long term”

Rather than try to tackle these productive weaknesses, the West’s leaders have instead opted to pump liquidity into the system. They have kept public spending high and interest rates low in a bid to offset sluggish economic activity. The past decade or so of quantitative easing (QE) is only the latest and most grotesque example of this trend.

Although such measures postpone an economic reckoning, they only make problems worse in the long term. For one thing, they create the conditions for further financial crises. The continuing saga of QE could well mean that the next substantial crisis will dwarf the last one. 

The alternative is for the authorities to support a concerted programme of economic revitalisation. This means allowing weaker ‘zombie companies’ to go bust rather than maintaining them on life support with cheap credit. It also means supporting the development of new technologies and new sectors. It should involve the creation of the new, as well as destruction of the old.

Postponing the difficult decisions involved in tackling the economy’s productive weaknesses will only make matters worse.

Daniel Ben-Ami, Deputy Editor
daniel.ben-ami@ipe.com

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