Financial Crisis

Recession to leave permanent scars

By Chris Giles
Published: November 23 2009 19:10 | Last updated: November 23 2009 19:10
On a blustery November morning at an airfield outside London, an enormous second-hand car auction is buzzing; demand is so great
that average prices have risen 27 per cent over the past year. The turnround started in January and we havent looked back since,
says Tim Naylor of British Car Auctions.
The global recovery is now evident across the world. The risk of a double-dip recession remains. In recent weeks, though, the US,
eurozone and Japan have all reported that their economies grew again in the third quarter. Some trade-dependent economies are setting
records as they bounce back. Singapore has enjoyed the fastest rise in national income over the past six months since quarterly records
began in 1975.
But though the recovery is real, so are the scars from the global recession. Some will be permanent and many will heal only very
slowly. From global output on a persistently lower path than expected before the crisis, to severely weakened public finances, to the
evils of long-term unemployment, to rising inequality and to a permanently altered balance of global economic power, the effects of
the 2008-09 financial crisis and recession are akin to those of a war.
Carmen Reinhart of the University of Maryland, who has jointly compiled the definitive history of financial exuberance followed by
crisis with Kenneth Rogoff of Harvard University, says: More money has been lost because of the four words This time is different
than at the point of a gun.

Spanish unemployment at almost a fifth of the workforce with a budget deficit expected to reach 10 per cent of national income is just
one legacy of the culture of easy credit-fuelled growth followed by last years collapse.
In California, neighbourhoods in cities such as Palmdale and Lancaster have been left empty because of mortgage foreclosures that
have continued unabated. Unemployment across the state the most populous in the US is running at more than 12 per cent, and the
states budget is in crisis.
The economics profession, so adept at chronicling the Great Moderation of economic shocks since the mid-1980s, has been forced
to shelve this work. Delving deeper into history and scanning a wide horizon, it is producing evidence and clues about how lasting the
scars are likely to be.
The emerging consensus for the advanced world at least is that they will be deep and long-lived. In its recent World Economic
Outlook, the International Monetary Fund examined 88 banking crises between 1970 and 2002 and found, on average, that countries
do not earn back all the lost ground after the recession slips into peoples memories. In its database, it found that seven years after a
crisis, output had fallen by 10 per cent compared with the pre-crisis path. Economic growth generally returned to the pre-crisis rate,
but the loss of output seems permanent.
This average result is far from uniform, but the persistent output loss was statistically significant and, in 90 per cent of the banking
crises it studied, ranged between 7 per cent and 13 per cent. After seven years, the IMF found that three separate and equally-sized
forces tended to prevent economies rebounding to their pre-crisis trends.
First, the employment rate is persistently lower, as the pre-crisis boom sucked labour into parts of the economy such as residential
construction in the US which is no longer required in large numbers. Reallocation of labour across sectors takes time and if the
initial surge in unemployment persists, former employees lose skills, contacts and attachment to working. These losses are permanent.
Second, the capital stock takes a permanent knock as some plant and equipment is scrapped prematurely, while other companies
struggle to invest in viable projects because banks restrict credit to shore up their finances.
Third, labour and capital tend to combine to produce less than before, perhaps because innovative companies cannot raise capital or, as
the IMF says, productivity may also suffer due to less innovation, as research and development spending tends to be scaled back in
bad times.

These effects were particularly important for countries with high investment rates before the crisis.
From his joint analysis of financial crises over 800 years, Prof Rogoff told US radio: These are very traumatic events. They have
political consequences that you can see for decades. They have profound consequences on how the economy is structured. This is
going to influence a whole generation thats been through this.
The sober tone of studies of past banking crises is evident in a study published last week in the Organisation for Economic Cooperation and Developments Economic Outlook.
Although it calculates the initial effect of the crisis on potential output is only 3.5 per cent, this comes at a time when rich country
economic speed limits are still expected to slow from the 2-2 per cent a year achieved over the seven years before the crisis to
around 1 per cent in the medium-term, primarily reflecting the impact of ageing populations on potential employment growth.
Not all economists are so certain the scars are inevitable. Drawing on Rogoff and Reinharts book title This time is different, Stephen
Cecchetti, Marion Kohler and Christian Upper argue on VoxEU.org that this crisis has little in common with those studied by others.
The current crisis is less similar to all of the crises in our database than, say, the Japanese financial crisis of the 1990s is to either the
crisis experienced by Ecuador in 1998 or the one that took place in Bulgaria during the transition, they write, predicting that the
particular circumstances of this recession suggests output should reach its pre-crisis level by the second half of 2010.
That would represent a much faster recovery in advanced economies than expected. But even so, they do not think the scars will heal
quickly. Regardless of whether crisis-country output returns to its pre-crisis level slowly or quickly, it is still likely to have lasting
costs, they say.
Additional reporting by Kevin Brown in Singapore, Matthew Garrahan in Los Angeles and Victor Mallet in Madrid

Taking a view on China emerging stronger

By Peter Marsh in London

Published: November 23 2009 17:27 | Last updated: November 23 2009 17:27

Gordon Styles has strong views on who will emerge as the winners and losers in manufacturing from the global
economic crisis. The British engineer emigrated to China four years ago to set up a new company, Star Prototype, in the
southern manufacturing hub of the Pearl River delta and his bet remains on China.
Mr Styless company, employing 80 people, makes specialised parts for a mixture of Chinese and foreign businesses
and it has grown quickly, taking advantage of what he says are boom conditions in Chinese manufacturing, in spite of
the global downturn.
China is now the most powerful nation on earth, economically and politically. Its funny how the guy with cash in his
pocket becomes king during a recession, he says.
The global economic crisis has caused manufacturing output in most countries to fall a lot more than comparable declines in overall
economic output. In the US, for instance, the peak-to-trough fall in manufacturing output during the downturn has been 16.7 per cent,
compared with the fall over the period in gross domestic product of 3.8 per cent.
The falls in output in Japan, Italy and Germany have been a lot higher, at 36.9 per cent, 25.5 per cent and 24.8 per cent respectively. In
most of those places factory output has started to climb relatively fast as economies recover.
But as the recovery takes hold Chinese manufacturers may emerge as one of the biggest winners. Comparable data are not available in
China. However, evidence from company surveys in the country suggests that plant output is rising fairly strongly, after a fall of about
a year ago.
Hal Sirkin, head of the global operations practice at Chicago-based Boston Consulting Group, says he expects Chinese manufacturers
to gain strength in the coming year, as the world inches out of recession.
In an environment where so many companies will be paying attention to keeping their prices low, the advantages that the Chinese
already have [over costs] will become even greater, says Mr Sirkin.

Others counter that costs are not everything. Having a strong brand with a global reach is likely to be a help as the economy picks up.
An ability to make products in relatively narrow niches that few others can match, backed by an emphasis on innovation, will also be
important, says Hermann Simon, chairman of Simon-Kucher & Partners, a Bonn consultancy.
One example of that is Kern Microtechnic, based near Munich. Kern is a world leader in making machine tools for producing tiny
parts used in industries such as medical systems, defence, electronics and watch production.
We are being helped by our reputation for quality and the fact that there is a scarcity of companies worldwide that make the kinds of
machines that we do, says Rudolf Riedel, Kerns chief executive.
Dave Willis, chief executive of Whitford, a private company in the US that makes specialised coatings for industrial and consumer
use, says his business has continued to spend heavily on research and development, even as the recession has bitten.
One of the companys successes in the past year has been a non-stick coating for frying pans. By the end of this year, about 1.5m of
these pans will have been delivered to customers, from little more than zero 12 months ago, says Mr Willis.
Because we make so many products that sell in lots of little sub-niches, I think we will come out of the recession in better shape than
other businesses that are less specialised, Mr Willis says.

US feels pain of long-term joblessness

By Sarah OConnor in Washington
Published: November 23 2009 22:11 | Last updated: November 23 2009 22:11

The US labour market used to be whizzy. People would chop and change jobs at a furious pace, but not many stayed
out of work for long. If you wanted to see countries sagging under the weight of long-term joblessness, you had to
cross the Atlantic.
On the eve of the global downturn in 2007, 10 per cent of the US unemployed had been out of work for a year or more,
compared with 25 per cent in the UK, 40 per cent in France and 57 per cent in Germany.
Times have changed. The sheer force of the recession has driven 8.2m out of work in the US and pushed the
unemployment rate to the highest since 1983.
Long-term unemployment is already much worse than in the 1980s: in October, 5.5m almost 40 per cent of the US
jobless had been so for at least six months, the highest on record. Twenty per cent had been unemployed for a year or more,
compared with a fairly static 25 per cent in the UK.
This could have lasting reverberations both for Americas people and its economy.
Its a killer disease, says Thomas Cottle at Boston University, author of Hardest Times: The Trauma of Long-Term Unemployment.
People are going to be damaged and may not recover in their lifetime.
The longer people are jobless, the more their skills and confidence decline and the less appealing they become to employers. Theres
a lot of research showing lengthy unemployment essentially erodes the productive capacity of the economy, says Timothy Bartik, a
labour market economist at the W.E. Upjohn Institute.
The Congressional Budget Office released a report in 2007 into long-term joblessness, which was at the time something of a niche
topic.
After an unemployment spell of six months or more, peoples new jobs paid an average 20 per cent less than their previous ones, it
found. More worryingly, the CBO discovered that about one in four of the long-term unemployed dropped out of the labour force altogether.
The US is so unused to this phenomenon that unemployment insurance only lasts for 26 weeks.

Facing the prospect of millions of people suddenly running out of benefits, lawmakers have had to patch up the system with a series of
extensions, the latest of which was signed into law this month. In the hardest-hit states, the long-term unemployed can now claim for
as much as 99 weeks. But even then, according to the non-profit National Employment Law Project, more than 1m people may
exhaust their benefits at the turn of the year.
Lawmakers are also mulling special job-creation policies such as tax credits to persuade businesses to hire again. Professor Bartik
thinks they should consider a special programme to help groups suffering unemployment for the longest periods.
Before the recession, that group was disproportionately made up of the least educated. But the new long-term unemployed are a
more diverse bunch. A third of unemployed high-school dropouts have been out of work for six months or more, but among college
graduates the figure is 37 per cent.
At least misery now has company. More and more people are saying, I am part of a tremendous current of people being shoved down
the river here, and theyre not taking it so personally, says Prof Cottle.

German shipyards gripped by economic storm

By Robert Wright in Wismar
Published: November 23 2009 17:17 | Last updated: November 23 2009 17:17
The vast sheds of the shipyard at Wismar, in north-east Germany, are once again echoing to the sound of steel sheets being
hammered into place. The arcs of welders torches are again lighting up the halls gloom.
The yard, whose previous owner, Wadan Yards, collapsed into insolvency in June , resumed work last month on two ferries being built
for Swedens Stena Line, one of the worlds biggest ferry operators. But questions remain about how many more ships the Wismar
yard and a sister yard at Warnemnde on Germanys Baltic Sea coast will produce.
The shipyard assets have been sold to a Russian investor Vitaly Yusufov who has renamed the operation Nordic Yards. He has
promised to find more orders by the end of this year, but none has been forthcoming.

Across northern Europe since last years financial crisis, a drying-up of orders has hit shipyards cash flows and forced many into
administration or closure.
In August, Denmarks AP Mller-Maersk announced it would close its shipyard, which lost $107m in 2008, after it completed its last
orders. Germanys Hegemann Group has had to seek state support, while Kiels Lindenau shipyard went into administration in
September last year.
Such closures are happening so often that the Organisation for Economic Co-operation and Development is concerned it will hamper
the economic recovery in parts of Europe.
The question is whether the destruction of jobs and productive capacity in shipbuilding has been a result of the economic downturn or
whether the yards survival until now was a result of the boom years excesses.
Germanys regional government of Mecklenburg-Vorpommern home to both Nordic Yards and two of the Hegemann facilities has
treated the yards problems as temporary. It guaranteed extensive new borrowing by Wadan Yards in May, before it collapsed, and has
lent money to the Hegemann yards to help them recover from what it argued were problems brought on by the financial crisis. But
industry experts argue the real anomaly was that in the boom market of recent years European yards were even able to compete.
Charles Morrison, a director at London-based Braemar Shipping, says the crisis will not destroy European shipbuilding. It can still
have a role for specialised, niche ships for which large South Korean and Chinese yards seldom compete.
But he goes on: Anybody still involved in containers or bulkers, they are just going to get crushed in the stampede.
The Wismars managers argue that the yard, founded in 1946 under Soviet occupation, is now one of the worlds most modern.
Yet Thorsten Bieg, a partner at Hamburg-based Brinkmann and Partner, which has overseen the yards bankruptcy, believes it won
orders for container ships because, with Asian yards order books full, there was little effective competition.
When competition starts again, I think these German and European yards cannot win this competition, Mr Bieg says.

Recovery takes an unclear path - US consumers

By Krishna Guha in Washington
Published: November 24 2009 18:22 | Last updated: November 24 2009 18:22
The economic crisis brought jarring shifts that have moderated some of the domestic and global imbalances that many believed helped
foster the crisis in the first place.
It remains unclear, however, how far domestic adjustments in the US and elsewhere have to proceed and whether external
imbalances will be sustained at levels that do not generate risks for the global economy in the future.
A significant adjustment in US households has clearly taken place. US consumer spending turned negative for several quarters and the
stock of consumer debt has fallen by about $150bn since early last year.
The household savings rate, which averaged only 1.7 per cent of disposable income in 2007, moved higher to peak at 5.9 per cent in
May with an added boost from fiscal stimulus before easing back to 3.3 per cent in September. Yet economists are unsure how much
longer this process has to run.
The US consumer was overborrowing but one does not know exactly what that means, says Martin Bailey, a fellow at Brookings
and former senior economic adviser in the Clinton administration. There are two ways of thinking about indebtedness, and they tell
different stories.
The ratio of household debt to income which peaked at 136 per cent in the first quarter of last year has barely declined and remains
far above its historic average of about 100 per cent. This suggests US consumers have a long way to go in repairing their balance
sheets, since saving makes only a gradual dent in the stock of debt.

Yet ratios of net worth which has recovered some way following the rebound in the stock
market to income tell a different story. While net worth has plummeted from about 625 per
cent of income to a little under 500 per cent, it is only modestly below the 550 per cent average
since 1993.
This suggests the US consumer may not need to make radical adjustments from here.
A recent research note from Bank of America Merrill Lynch showed that under plausible
assumptions, if US households try to cut their debts to 100 per cent of income in 10 years, the
savings rate would have to rise to 12 per cent.
But if they wanted to restore their net worth to its long-term average relative to income and
invested in assets rather than just paying down debt the savings rate would need to edge up
only to about 5 per cent.
It is quite likely that as we recover, consumption in the US will rise at a rate that is close to
growth in disposable income though not faster as in the past, says Mr Bailey.
For the time being, the decline in private sector borrowing in the US and UK (and to a lesser
extent other industrialised economies) has been partly offset by an increase in public sector
borrowing as governments have tried to maintain demand through fiscal stimulus.
But as US president Barack Obama tried to explain on his tour of Asia, the US and those nations with large budget deficits need others
to boost demand so public spending can be pared back while recovery is sustained. This is the old thorny question of global
imbalances.
Since the start of the crisis, these imbalances reflected in huge current account and trade surpluses and deficits have moderated.
The International Monetary Fund predicts the US current account deficit will halve from 5.2 per cent of GDP in 2007 to 2.6 per cent
this year, with the UK seeing a smaller decline from 2.7 per cent to 2 per cent.

The corresponding surplus in developing Asia is expected to decline from 7 per cent of GDP to 5 per cent over that period, with a
sharp but probably short-lived drop in Middle East surpluses from 18.1 per cent of GDP to 2.6 per cent.
The question is whether this moderation is cyclical or structural. It is difficult to parse, but one has the sneaking suspicion that a lot of
it is cyclical, says Ken Rogoff, a professor at Harvard and former IMF chief economist. Absent forceful policy changes, the US
current account deficit might crawl back to around 5 per cent.
Raghuram Rajan, a professor at Chicago Booth business school and former IMF chief economist, says the latest data suggests the US
current account deficit is widening again as the recovery takes hold.
Mr Rajan says surplus countries have learned the risks of being overdependent on US demand. But he adds that the adjustments
needed to produce a long-term moderation in the global imbalances involved not just politically explosive currency shifts but also
structural reforms in both surplus and deficit nations.
Some economists do not worry too much about these imbalances relative to, for example, the design of the financial system. Mr
Rogoff argues, however, that a return to large imbalances would be dangerous as capital inflows into the US and other large deficit
nations would eventually fuel another bubble. It would mean we will have another deep financial crisis in 10 to 15 years rather than
50 to 75, he says.

Fears of a generation being lost - US unemployment

By Sarah OConnor in Washington
Published: November 24 2009 17:46 | Last updated: November 24 2009 17:46
The recession dragged Kristin Davies family back together.
Even though she spent most of her last year of university job-hunting, in May the 22-year-old graduated from a liberal arts college in
the US and stepped straight into the ranks of the unemployed. She had thousands of dollars of student debt and was forced to move
back in with her parents. Soon her older brother worried he could not afford his rent also moved back to their New Jersey home.

It was claustrophobic: both of her parents lost their jobs last year. Were in such a tight space ... and theres no money
coming in, Ms Davie says.
A lot of the arguments come down to the economy, to finances, to student loans, to bills. At first its not that bad because
you have mom and dad to help you with laundry and cooking, and thats nice after four years of college. But it gets old
really quickly.
She is far from alone. The class of 2009 has spilled out of school and university into the worst recession since the Great
Depression. Unemployment among people aged 20 to 24 in the US reached 15.6 per cent last month and for 16- to 19-yearolds it hit 27.6 per cent.
Some think the trauma will change their generation. Another lost generation could be in the making, and long term for the US
economy thats terrible, says Ellen Zentner, senior US macroeconomist at the Bank of Tokyo-Mitsubishi UFJ.
It is not only a US phenomenon. David Blanchflower, a labour economist and former member of the Bank of Englands monetary
policy committee, has similar fears for his country, where the jobless rate for young people is nearly 20 per cent. Rates in some parts
of continental Europe are even worse.
If you look at the effect of youth unemployment, it scars people. A spell of unemployment when youre 20 continues to hurt you
when youre 40, he says.
Experts are particularly worried because this generation is enormous: they are the children of the baby-boomers, born between 1980
and the early 1990s. Like their parents, the so-called echo-boomers will have a disproportionate effect on the economy and society
as they move through life.
Earlier this month Peter Orszag, director of the White Houses office of management and budget, stood up in front of an auditorium of
New York University students. He did not bring a message of comfort. Research suggests that graduating during a period of high
joblessness depresses initial wages by 6 per cent for each percentage point increase in the unemployment rate, he told them, and the
effect lasts decades.

The class of 1982 graduated in a recession and earned on average $100,000 less over the first 20 years of their careers than the class of
1986, he pointed out. Vanity Fair magazine summed up his message thus: Orszag to NYU students: basically, youre screwed.

Knocked off path

In an audio slideshow, Chris Giles explains the effect on world output and the reasons behind the change in growth
Even those who do find jobs soon may develop different attitudes towards work, spending, borrowing and home-owning. Some look
to Japan for clues, where the bursting of a property and stock bubble at the start of the 1990s flattened growth for a decade.
Annual surveys conducted by the Japan Productivity Center, a think-tank, show that young people with no memory of the boom years
turned out to be conservative participants in the labour market. In spite of modest economic growth between 2002 and 2007, by this
year 55 per cent of recruits said they would never willingly swap jobs.
Meanwhile, the popularity of stable public and quasi-public employers from utilities to the post office rose at the expense of
companies in more competitive fields such as Toyota and Sony.
Back in the US, Ms Davie has just become one of the lucky few: she started with a public relations company in New York last week.
But she has been deeply affected by what she has been through.
Even now I have a job and that weight is off my shoulders, I realise that its not going to be as easy as I thought it was, she says.
My first pay cheque I probably wont be able to enjoy because I have to divide it between all of my loans. Ill give some to my
mother and father for all the months they supported me when I was unemployed, car payments, commuting into New York; it
disappears really quickly.
Her dream has always been to move to New York with friends but Ms Davie has decided to stay at home for the foreseeable future.
Im really intent on trying to keep my job for as long as possible and save up as much money as I can.

Many economists are looking to her generation to see if a recent drop in credit and spending levels and corresponding rise in savings
will become more permanent.
How long Ms Davie and her peers stay with their parents will also have implications for the economy. The number of US households
has fallen since the downturn began as people have moved in together to save money. Economists hope that the number will
eventually rise again, helping the housing market as echo-boomers seek homes of their own.
The ageing of the echo-boomers the largest generation to reach adulthood in the nations history should reinvigorate the housing
market, Harvard University researchers wrote earlier this year. But the researchers cautioned that they started out on a lower
trajectory than the generation before them and with the tight grip on credit, even sharply lower home prices may not be enough to
help the echo-boomers match the ... home ownership rates of their predecessors by the time they reach their thirties and forties.
Tight credit may not be the only thing to put them off. Many young people have watched their parents houses plunge in value. It
definitely could have soured their view of just how good an investment a home is, Ms Zentner says.
Ms Davie hopes that the memories of this period, though painful, will stick. I hope its a long-term lesson, she says. Because it
could happen again.

Trading system battered but intact

By Alan Beattie in London
Published: November 24 2009 18:22 | Last updated: November 24 2009 18:22
Even by the standards of an extraordinary year, the collapse in global trade triggered by the financial turmoil of last autumn was
spectacular. After having survived nearly a decade of shocks beginning with September 11 and ending in a global food crisis, the
precipitate drop in commerce around the turn of 2008 was terrifying.

In two quarters, world trade volumes collapsed by about 20 per cent, wiping out three or four years of average trade
growth in half a year. Pictures of a ghost fleet of dozens of empty, idle container ships moored off Singapore came to
symbolise the slack that had suddenly appeared in the supply chains that snaked around the world.
But six months after it started, the freefall came to an equally abrupt halt. By the second half of 2009, trade had begun to
increase again. And amid a certain amount of shell shock, most trade experts and economists seem to think that the world
trade system can resurrect itself with little permanent damage.
Lasting scars on the world trading system might have arisen if, for example, geographical patterns of trade shifted
permanently, or if companies concluded that extending global supply chains was too risky. Earlier in the year there was a lot of talk
about supply chains being brought closer to home, because people realised that having to put in orders six months in advance made
them vulnerable, says Robert Joynson, who analyses global trade and shipping at Macquarie Capital in London. But that talk has
diminished, and it is not really clear that anything has happened.
Richard Baldwin, professor of international economics at the Graduate Institute in Geneva, says that most reduction in trade seems to
have been in the intensive margin where companies cut back on commerce within existing trading relationships, rather than
dropping out of routes altogether. The emerging consensus is that the trade collapse was demand-driven, and that when demand
started to recover, so did trade, Prof Baldwin says. That is not something that is likely to have a lasting effect.
As for the geographical patterns of trade, although there has been some speculation that there will be more south-south trade
between emerging market countries, the limited number of emergency restrictions on trade as a result of the crisis have largely been
imposed by developing countries on each other.
If there is any impact, it might well be to entrench multinational companies as the dominant forces in international trade. Already
around a third of global commerce is reckoned to be carried out within companies rather than between them. And since another feature
of the past year has been a rapid rise in the cost of trade credit, through which companies in effect insure their commerce with partners
in other countries, those companies big enough to have an entire global supply chain in-house are likely to gain an advantage.
For those companies, assuming demand continues to revive, normality can return without substantial lasting change.

Taxpayers face a generation of pain - Fiscal consolidation

By Chris Giles, Economics Editor
Published: November 25 2009 19:46 | Last updated: November 25 2009 19:46
Fiscal stimulus was the economic tool, so long disparaged by the policymaking community, that came into its own during the
economic crisis, playing its part alongside monetary easing and bank bail-outs in warding off a depression.
But the result of fiscal stimulus in almost every Group of 20 economy has been the rise of deficits to levels never seen in peacetime,
debt so high there is not the ammunition to fight another economic war and a bill to clean up the mess that will be felt by taxpayers for
a generation to come.
The latest estimates from the International Monetary Fund show that advanced countries deficits averaged 1.9 per cent of national
income before the financial crisis started in 2007. This year they are expected to hit 9.7 per cent, followed by 8.7 per cent in 2010.
Public sector gross debt is expected to explode from an average across advanced economies of 78 per cent of national income in 2007
to 118 per cent in 2014.
Emerging economies with their faster economic growth and greater constraints on borrowing expect much lower build-up of debt.
The greatest effect on deficits and debt has come not from discretionary stimulus measures but lost tax revenues and increases in
public expenditure as unemployment has risen.
The problem for advanced economies is that plans for a great fiscal consolidation are needed at the same time as they are expected to
cope with the retirement of the postwar baby boomer generation.
Few are under any illusion that this will be a difficult task. Jrgen Elmeskov, acting chief economist of the Organisation for Economic
Co-operation and Development, argues that stopping the rot is clearly necessary and will call for fiscal consolidation that is
substantial in most cases and drastic in some.

Dominique Strauss-Kahn, managing director of the International Monetary Fund, said this week that fiscal consolidation should be the
top priority for the medium term in advanced economies once recovery was firmly established, because the threats are greater, the
politics are more complicated and the machinery of adjustment is more unwieldy.
The IMF chief was speaking in London, which was apt as the UK has potentially one of the most difficult feats of fiscal consolidation
to perform. Its tax revenues were heavily dependent on financial sector profits; public spending had been set to rise rapidly until 2011;
and the country has very strong automatic stabilisers and an extensive means-tested system of state support, which automatically kicks
in as people become unemployed.
The UKs budget deficit is projected to rise from 2.6 per cent of national income in 2007 to 13.2 per cent in 2010, according to the
IMF. Gross debt is forecast to more than double from an internationally low 44 per cent of national income to 98 per cent in 2014.
The UK has records on government borrowing and debt stretching back to 1691. The expected 50 percentage point rise in the debt-tonational-income ratio is similar in proportion to that experienced during the many wars Britain fought in the 18th century and is the
biggest peacetime explosion of government liabilities.
In cash terms, the government expects to borrow more in 2009 and 2010 than the entire borrowing of centuries of British governments
between 1692 and 1997.
The pressure mounted this week when Mervyn King, the Bank of England governor, reiterated his view that official plans to reduce
the deficit by half over the next four years were insufficient and not credible.
Instead, he called for something where a really significant reduction in deficits to eliminate a large part of the structural deficit should
take place over the lifetime of a parliament.
Plans for deficit reduction are central to the domestic political debate, but neither main UK party has come close to providing a
detailed programme for public expenditure curbs of the scale needed to cut the deficit and control debt.
The scale of the cuts is, however, already clear. Under the governments existing Budget, it is planning to halve the annual level of
capital expenditure between 2009-10 and 2013-14. Road, hospital and school building will bear the brunt. Day-to-day expenditure will
also be hit hard.

Over the three years from April 2011 government departments will face cuts of 1.9 per cent a year in real terms, compared with the
annual rises of more than 4 per cent they were used to in the previous decade.
This would be the tightest squeeze in spending on public services since the UK was negotiating its spending plans with the IMF in
the late 1970s, says Robert Chote, director of the independent Institute for Fiscal Studies.
The main difference between the parties is that Labour believes that doing too much deficit reduction too soon might threaten the
anaemic recovery, while the Conservatives claim that doing too little might lead to higher borrowing costs.
But the big issue confronting Britain and governments in all advanced economies is that the current level of public borrowing is too
high but few know when to start consolidation, or how fast it should be.
Whatever happens, people in Britain will have to get used to paying much more for their public services and receiving much less.

Bankers contemplate life under state rule

By Patrick Jenkins, Francesco Guerrera and Delphine Strauss
Published: November 25 2009 19:55 | Last updated: November 25 2009 19:55
The auction signs that pepper villas on the Bosphorus and family holiday homes across Turkey are an enduring testimony to the
countrys devastating banking sector collapse eight years ago.
A microcosm of the financial crisis that has swept the world over the past two years, Turkeys banking failures and the subsequent
government bail-outs and retribution have shown the way for a regime of intervention, which, though punitive, has been effective in
reining in risk.
Turkish bankers are now personally liable for losses, in the event that the state Savings and Deposits Insurance Fund has to bail out a
bank a big deterrent to risk-takers that has insulated the countrys financial industry from the ravages of the global crisis this time
around.

There was a joke at first that now bankers wouldnt be able to get married, says the chief executive of one local institution.
As the likes of Goldman Sachs rack up record profits and plan record bonuses memories of a year ago, when even Goldman and
JPMorgan were temporarily forced to take government bail-out money, are faint.
But the question confronting the worlds bankers now is how long they, like their Turkish counterparts, will be forced to live under the
thumb of an emboldened state.
The financial crisis has changed the banking sector on two broad fronts.
First, through bail-outs, many of which are still in place, governments have been left owning all, or part, of leading banks.
Second, the worlds regulators are in the throes of imposing far stricter requirements on banks capital levels and remuneration policies
in an effort to limit the risk they pose in future. With so many banks still reliant on state support some see the power they hold as a
once-in-a-lifetime opportunity to change the world.
The paradigm between banks and governments will change going forward, says Gordon Nixon, chief executive of Royal Bank of
Canada. Hopefully it wont rotate to a level where you end up with pressure on financial institutions to do things that are uneconomic
or bad credit decisions.
Experts agree that plans by the Basel committee on banking supervision to boost required capital buffers will be a key reform. But
already the more enthusiastic, knee-jerk response to the crisis has been to impose restrictions on banker remuneration.
The real impetus for change was the Group of 20 meeting in September, at which global leaders decided that about 40-60 per cent of
bankers bonuses should in future be deferred for three years.
The US has been among the most enthusiastic in reining in pay at its bailed-out financial groups Citigroup, AIG, Bank of America
Merrill Lynch.

The moves by Kenneth Feinberg, the government pay tsar, to dramatically reduce executive pay at AIG, for example, prompted
Robert Benmosche, chief executive, to threaten to quit only three months into the job, claiming he would be unable to recruit and
retain key employees.
The other campaign of governments around the world has been to ease recessionary pressures by urging banks, particularly ones in
which they have stakes, to step up lending to businesses, with governments even giving specific targets for additional lending.
Bankers seem resigned that a new environment embracing not only restrictions on pay, and tougher regulatory capital regimes, but
also sustained pressure to lend is here to say.
The politicisation of banking is not going to go away very quickly, says Peter Sands, chief executive of Standard Chartered. I think
the question of when will it get back to how it was is the wrong way to frame the problem. It wont get back to where it was. I think
weve had a step change.

Free-market ideals survive the crunch - Deregulation

By Alan Beattie in London and Geoff Dyer in Beijing
Published: November 26 2009 17:57 | Last updated: November 26 2009 17:57
The global crisis prompted more than the loss of a string of financial institutions. It also inflicted collateral damage to the economic
ideology that had sustained the rich world, or at least the US that of finance capitalism.
For much of the 20 years since the end of the cold war, the US with sporadic support from industrialised countries, such as the UK,
and institutions, including the International Monetary Fund had propagated the gospel of economic liberalisation and financial
deregulation. Having evoked scepticism among its audience, particularly after episodes such as the 1997-8 Asian crisis, the global
financial crunch might have been expected to bury that message for good.
But reactions have been measured among the so-called Bric (Brazil, Russia, India and China) countries and other key emerging
markets.

Few are hurtling headlong into more financial deregulation as one Chinese official says: We used to see the US as our teacher but
now we realise that our teacher keeps making mistakes and weve decided to quit the class. Yet the dominant reaction appears to be a
pause to consider rather than an immediate clampdown. And paradoxically, the fact that restrictions have protected the financial
sectors from the worst of the downturn seems to have kept the prospect of more liberalisation on the table.
John Cooke, chairman of the liberalisation committee at industry group International Financial Services London, says: The likes of
China and India have made statements congratulating themselves for escaping the worst of the crisis by keeping their financial sectors
relatively closed. But while they have drawn strength from that position, they have not, on the whole, put up new barriers.
China has spent the past year quietly pushing through financial reforms that are building the foundations for a more active domestic
capital market. We have actually seen more in the way of financial reform since the collapse of Lehman Brothers than we have in the
preceding three years, says Arthur Kroeber, managing director of the Dragonomics consultancy in Beijing.
China has engineered a major expansion in its domestic bond market and launched a stock market in Shenzhen for small companies. It
has also taken steps to encourage greater international use of the renminbi, allowing selected companies to use the currency to settle
trade transactions and issuing the first renminbi government bond.
If anything, the crisis has enhanced the credibility of many of those who had pushed for a gradual opening of the system, including
Zhou Xiaochuan, governor of the Peoples Bank of China, and Liu Mingkang, head of the Chinese banking regulator. Both have seen
their reputation enhanced by the way the economy survived the crisis. By publicly suggesting that the US dollar should eventually be
replaced as the global reserve currency, Mr Zhou also has won some nationalist credentials.
In India, which has strict controls on how foreign banks and investors operate in the country and imposes limits on domestic
businesses borrowing abroad, the crisis generated suspicion of reform, and the opposition Bharatiya Janata party attacked deregulation
as irresponsible.
But with the liberalising instincts of Manmohan Singh, prime minister, to the fore, the government is gently pushing forward with
some reforms, including reducing government stakes in banks and raising the limit for foreign investment in insurers.
Montek Singh Ahluwalia, deputy chairman of Indias Planning Commission and a close economic adviser to Mr Singh, said that with
India needing to attract foreign capital to fund investment and growth, it would be a great mistake to stop financial sector reforms.

In fact, managing flows of capital is providing emerging market policymakers their most immediate test in what to regulate and what
to leave alone. With a flood of money into higher-yielding assets and commodity currencies in particular, many countries in Asia and
Latin America are having to cope with an influx of cash, which is pushing their currencies up against the dollar.
Brazil raised some eyebrows by imposing a tax on capital inflows to prevent destabilising speculation, prompting debate about other
countries following suit. But economists say it will take more evidence to justify a wholesale recourse to capital controls across the
emerging market world.
Gerard Lyons, chief economist at Standard Chartered, says: If Brazil shows it is possible to stop the inflow of short-term capital
without affecting the international view of your country, it might be a template.
More generally, he says, the crisis has reinforced a philosophy of eclectic pragmatism rather than provoking a wholesale retreat into
government intervention. The real message ... from both the Asian crisis and the past two years is that countries will deregulate at a
speed overwhelmingly determined by domestic economic conditions.

Bankers contemplate life under state rule

By Patrick Jenkins, Francesco Guerrera and Delphine Strauss
Published: November 25 2009 19:55 | Last updated: November 25 2009 19:55
The auction signs that pepper villas on the Bosphorus and family holiday homes across Turkey are an enduring testimony to the
countrys devastating banking sector collapse eight years ago.
A microcosm of the financial crisis that has swept the world over the past two years, Turkeys banking failures and the subsequent
government bail-outs and retribution have shown the way for a regime of intervention, which, though punitive, has been effective in
reining in risk.

Turkish bankers are now personally liable for losses, in the event that the state Savings and Deposits Insurance Fund has to bail out a
bank a big deterrent to risk-takers that has insulated the countrys financial industry from the ravages of the global crisis this time
around.
There was a joke at first that now bankers wouldnt be able to get married, says the chief executive of one local institution.
As the likes of Goldman Sachs rack up record profits and plan record bonuses memories of a year ago, when even Goldman and
JPMorgan were temporarily forced to take government bail-out money, are faint.
But the question confronting the worlds bankers now is how long they, like their Turkish counterparts, will be forced to live under the
thumb of an emboldened state.
The financial crisis has changed the banking sector on two broad fronts.
First, through bail-outs, many of which are still in place, governments have been left owning all, or part, of leading banks.
Second, the worlds regulators are in the throes of imposing far stricter requirements on banks capital levels and remuneration policies
in an effort to limit the risk they pose in future. With so many banks still reliant on state support some see the power they hold as a
once-in-a-lifetime opportunity to change the world.
The paradigm between banks and governments will change going forward, says Gordon Nixon, chief executive of Royal Bank of
Canada. Hopefully it wont rotate to a level where you end up with pressure on financial institutions to do things that are uneconomic
or bad credit decisions.
Experts agree that plans by the Basel committee on banking supervision to boost required capital buffers will be a key reform. But
already the more enthusiastic, knee-jerk response to the crisis has been to impose restrictions on banker remuneration.
The real impetus for change was the Group of 20 meeting in September, at which global leaders decided that about 40-60 per cent of
bankers bonuses should in future be deferred for three years.

The US has been among the most enthusiastic in reining in pay at its bailed-out financial groups Citigroup, AIG, Bank of America
Merrill Lynch.
The moves by Kenneth Feinberg, the government pay tsar, to dramatically reduce executive pay at AIG, for example, prompted
Robert Benmosche, chief executive, to threaten to quit only three months into the job, claiming he would be unable to recruit and
retain key employees.
The other campaign of governments around the world has been to ease recessionary pressures by urging banks, particularly ones in
which they have stakes, to step up lending to businesses, with governments even giving specific targets for additional lending.
Bankers seem resigned that a new environment embracing not only restrictions on pay, and tougher regulatory capital regimes, but
also sustained pressure to lend is here to say.
The politicisation of banking is not going to go away very quickly, says Peter Sands, chief executive of Standard Chartered. I think
the question of when will it get back to how it was is the wrong way to frame the problem. It wont get back to where it was. I think
weve had a step change.
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