OF THe gReAT ReCeSSION
1. eCONOMIC CRISeS AND POLITICAL FRAgMeNTATION
Contrary to wars against external enemies, which rally societies around a common goal, eco- nomic crises fragment them and bring about severe political instability and civil unrest.3 With
2. This chapter can also be seen, to certain extent, as an expression of a recent trend in international law aimed at a more extended dialogue with other disciplines, such as economics, political science, and international relations. See in this regard, Gregory Shaffer and Tom Ginsburg, ‘The empirical turn in international legal scholarship’ (2012) 106 American Journal of International Law 1.
3. The current Great Recession has not been the exception; the Occupy Wall Street movement in the United States and the Indignados in Spain are just two examples. As to the first, its Principles of Solidarity spell out:
On September 17, 2011, people from all across the United States of America and the world came to protest the blatant injustices of our times perpetuated by the economic and political elites. … We are the 99% and we have moved to reclaim our mortgaged future. …
<http://www.nycga.net/resources/documents/principles-of-solidarity/>.
irony, José Saramago says in the Stone Raft, a novel based on the fictional physical separation of the Iberian Peninsula from the rest of Europe:
The news that the peninsula is rushing at a speed of two kilometres per hour … was used by the Portuguese government as a pretext for resigning in view of the seriousness of the situation, the imminence of collective danger, which leads one to believe that governments are only capable and effective when there is no real need to put their ability and effectiveness to test.4
Political scientists have demonstrated that economic crises prompt enormous political frag- mentation, a reality that we have witnessed over and over again during the Great Recession in many countries particularly hit by it. Several changes in incumbent governments have taken place in the last six years in the United States, France, Italy, Greece, and Portugal, to mention some prominent examples.
Based on data from prior critical turmoil covering 70 countries and from 1981 to 2008 and on the World Bank’s Database of Political Institutions, Mian, Suffi, and Trebbi have found that government coalitions decrease and so do political majorities. On the contrary, political fragmentation increases,5 and even opposition both grows and fragments.6
These consequences weaken governments7 and make political consensus about the mea- sures required to face the given crisis much more difficult to achieve,8 both in terms of their scope and timing. These authors thus conclude:
Politics after the crisis appear substantially skewed in favor of stalemate, with systematically more polarized voters, weaker governments and more fragmented oppositions. It is essentially the worst time possible for political agreement on macroeconomic intervention, but also the time when it would be most useful. Stalemate may induce costly delay in the response to the financial crisis or even trigger further instability, such as increases in sovereign risk premia required by international investors worried about lack of sound political response, as the recent US and European cases appear to confirm.9
2. THe DIFFeReNT PHASeS IN THe UNFOLDINg OF eCONOMIC CRISeS
According to International Monetary Fund (IMF) research, financial crises undergo three stages of development: (1) containment; (2) resolution and balance; and (3) operational restructuring.10 During the containment phase, governments cope with severe liquidity stress
4. Jose Saramago, The Stone Raft (Harvest Books 1995) 184.
5. Atif R. Mian, Amir Sufi and Francesco Trebbi, ‘Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises’ (2012) NBER Working Paper No. 17831, <http://www.nber.org/papers/w17831>.
6. ibid 26.
7. ‘Greece’s coalition government hit by dissent ahead of key vote on austerity measures’ Washington Post (1 November 2012), <http://www.washingtonpost.com/business/greeces-coalition-government-hit-by-dissent- ahead-of-austerity-vote/2012/11/01/f1ced5d2-2416-11e2-92f8 7f9c4daf276a_story.html>.
8. See Mian, Sufi and Trebbi (n 5) 4.
9. ibid 27–28.
10. Stijn Claessens and others, ‘Crisis Management and Resolution: Early Lessons from the Financial Crisis’
(2012) IMF Working Papers, 7 <http://www.imf.org/external/np/seminars/eng/2012/fincrises/pdf/ch16.pdf>.
and seek to stabilize financial liabilities. During the second phase, governments let insolvent institutions disappear and ensure the recapitalization of those that are viable; and under the third, governments restructure financial systems to ensure profitability.11
However, other scholars have gone further in their dissection of the unfolding of crises in general. Truman and Gelpern, separately, for instance, argue that economic calamities go through different phases: pre-crisis prevention or crisis denial, outbreak of the crisis, crisis containment, crisis management, and prevention of the next crisis.12
This chapter will concentrate on the following phases: crisis prevention or crisis denial, containment, crisis management, and prevention of the next crisis.
a. Crisis Prevention or Crisis Denial
“Crisis prevention” is self-explanatory. It takes place whenever a state acts just in time and with the right measures to respond to a risk of a grave and imminent economic calamity and suc- cessfully avoids it.13 “Crisis denial” may need further elaboration. It is explained by the fact that government officials may not want to jeopardize their prestige by refusing to accept an adverse reality, as in Yasukata Tsutsui’s short story, The World is Tilting.14 In it, an artificial city and island, Marine City, starts to tilt as a result of poor public planning and execution, and Miss Loyalty, a local official fearing the political backlash against her Major, decides to walk with an angle exactly the same as the tilting city to attempt to show that it is the world, not Marine City, that is leaning. Misses Loyalties abound at the time of the emergence of economic crises. In other cases, government officials are overoptimistic about the use of ordinary instruments to face early expressions of turmoil15 or regard the problems as part of the normal operation of economies.
b. Crisis Containment: “Calamity When It Comes, It Comes in a Rush”
(Philip Roth, The Plot Against America)
Crisis containment is a particular period during the unfolding of economic crises, and it takes place right after their outbreak. The purpose of government action during this phase is graphi- cally labeled by Gelpern as “to stop the bleeding.”16
11. ibid.
12. Edwin M. Truman, ‘Policy Responses to the Global Financial Crisis’ (Peterson Institute for International Economics, Remarks presented at the Ninth Annual International Seminar, on ‘Policy Challenges for the Financial Sector Emerging from the Crisis: Building a Stronger International Financial System,’ Board of Governors of the Federal Reserve System, World Bank, and International Monetary Fund, 3 June 2009),
<http://piie.com/publications/papers/paper.cfm?ResearchID=1225>); Anna Gelpern, ‘Financial crisis con- tainment’ (2009) 42 Connecticut Law Review 493, 506–13.
13. Crisis prevention is the focus of another paper by the present author entitled, ‘The Great Recession and the new frontiers of international investment law: the economics of early warning models and the international law of necessity’ (2014) 17 Journal of International Economic Law 517.
14. Yasutaka Tsutsui, Salmonella Men on Planet Porno (Vintage Contemporaries 2010).
15. Cass Sunstein highlights that people are often overoptimistic about the future, which may explain their inaction regarding important issues for them. This analysis undoubtedly also applies to politicians. Cass R. Sunstein, ‘It’s for your own good’ The New York Review of Books (2013), <http://www.nybooks.com/articles/
archives/2013/mar/07/its-your-own-good/?page=1>.
16. Gelpern (n 12) 497.
Once a crisis has erupted and is spreading, governments have to determine, first, how to face the challenge, whether on a case-by-case basis or on the basis of general solutions.
Sometimes, the expression of the crisis, a run for funds, does not call for solutions geared to particular cases or firms, but for the deployment of wholesale solutions, which also has the advantage of dealing with the situation on a comprehensive basis.17 However, states sometimes start with incremental measures until they have political room and legitimacy to enact those aimed at resolving the given crisis.18
In addition, the Great Recession illustrates that the choice can also depend on the amount of information that government has. For instance, according to IMF researchers, during the Great Recession, “[g] overnments faced unprecedented complexity, and were hampered by lim- ited information and limited tools to address systemic and cross-border entities.”19 This led to ad hoc measures related to AIG, Fannie Mae, and Freddie Mac in the United States and to several banks in Europe and, a couple of years later, to systemic assessments of institutions.20
A second decision that a government must make during the containment phase is whether or not to enforce normal economic regulation—financial, fiscal, or any other kind. Regulatory forbearance, as Gelpern labels it, is a common feature of economic crises. She found this situ- ation to be persistent throughout all of the recent financial crises in the United States, Latin America, and Asia.21 For instance, Gelpern mentions that a U.S. central bank official told her that enforcing U.S. laws related to capital adequacy and loan provision requirements in the current crisis “would have meant taking over the private banking system.”22 Argentina’s 2001 crisis also evidenced regulatory forbearance in the form of lack of sufficient enforcement of tax regulations. Given the extent of the crisis, the government did not aggressively collect taxes, which made it even more difficult to rein in its deficit.23
To be sure, regulatory forbearance has its contradictors, who claim that it makes regulation less credible in the future and induces risky behavior by firms and individuals who may take additional risks on the assumption that regulations prohibiting such additional risks will not be enforced in the event of a crisis.24 There are also winners and losers with regulatory forbear- ance: Those who incurred the costs of compliance during the crises are somehow penalized, while those who did not comply get the benefits of lack of compliance.25
In any case, and leaving these costs aside, the decision not to enforce economic regulations during the containment phase is certainly part of the strategy to contain the crisis. In a sense,
17. ibid 514. There are different degrees of wholesale measures. An example may well be Argentina’s decision during its 2001 crisis to serve its domestic debt over US$ 20 billion only, while refusing to serve old bondhold- ers. ibid 539.
It is also important to mention that wholesale measures adopted during the containment phase may some- times go well beyond what was required. An illustration is the IMF’s criticism of public recapitalizations, which ‘were spread too broadly, foregoing the benefits of separating viable from nonviable institutions.’
Claessens et al (n 10) 11.
18. Gelpern (n 12) 544.
19. Claessens et al (n 10) 16.
20. ibid.
21. Gelpern (n 12) 497.
22. ibid 517; Claessens et al (n 10) 11.
23. International Monetary Fund, Independent Evaluation Office, Evaluation report. The IMF and Argentina, 1991–2001 (2004) 30, <http://www.ieo-imf.org/eval/complete/eval_07292004.html>.
24. Gelpern (n 12) 517.
25. ibid.
the costs of enforcement outweigh the benefits of containing the crisis. In other words, the issue could not be seen only as a matter of fairness with those who comply but also as a topic strictly related to the containment strategy: Regulatory enforcement does not always prevent the crisis from expanding but, on the contrary, can aggravate it.
Finally, governments also determine during the containment phase the extent to which public and private actors—debtors, creditors, public entities at different levels of government, and taxpayers—will be winners and losers as a result of a crisis. Debt reduction affects credi- tors and benefits debtors, bailouts favor both and adversely affect taxpayers,26 consumers win with utility tariff freezes while utility firms lose. The same happens with governments’ recent austerity policies: There is also a choice of winners, the creditors and bondholders.27 In effect, austerity makes payment of their debt possible, at the expense of costs it imposes on workers.28
The U.S. Financial Crisis Inquiry Commission was critical of the government’s handling of the crisis in general and of the containment phase in particular. Its conclusion is telling: “We conclude that the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets.”29 According to the Commission, the Treasury, the Federal Reserve, and the Federal Reserve Bank of New York did not have a clear idea of the situation owing to absence of transparency in important markets, made mea- sures on an ad hoc basis, and lacked a general, comprehensive strategy to contain the crisis.30
c. Crisis Management/Resolution
Once crises have been contained because they have been accepted as a reality and political institutions have responded to them,31 states have usually discussed and adopted more perma- nent measures aimed at resolving grave economic difficulties. There are some distinctions to be made between containment and resolution, in general. The former addresses the present;
the latter the future.32 However, it is also possible that containment creates path dependence,33 so containment measures may be part of the resolution as well.34
In terms of decision-making in any phase of an economic crisis, it is sometimes thought or assumed that states only have to identify the right policies to address problems and that implemen- tation just follows. Alas, reality is much more complicated. As Callander says, “[p] olicymakers do not know which policies produce which outcomes.”35 Trial-and-error is the mechanism used to arrive at accurate decisions.36 In addition, authorities usually have not one but many different
26. ibid 518.
27. Claessens et al (n 10) 10.
28. Paul Krugman, ‘How the case for austerity has crumbled’ New York Review of Book (6 June 2013) 3, <http://
www.nybooks.com/articles/archives/2013/jun/06/how-case-austerity-has-crumbled/>.
29. U.S. Financial Crisis Inquiry Commission, Conclusions (27 January 2011) xxi, <http://fcic-static.law.stan- ford.edu/cdn_media/fcic-reports/fcic_final_report_conclusions.pdf>. The full report is available at <http://
www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf>.
30. ibid.
31. Gelpern (n 12) 509.
32. ibid 506.
33. ibid 511.
34. ibid.
35. Steven Callander, ‘Searching for good policies’ (2011) 105 American Political Science Review 643, 643.
36. ibid.
policies that might, in principle, address a particular problem or situation,37 and it is not unusual to find that policy-makers arrive at policy choices that engender results that are less than ideal,38 so more trial is required for the overall situation to improve.
This situation is particularly acute during economic crises during their initial phase, in which moving far away from the status quo39 is required, since there has to be some response, which increases the uncertainty for all actors involved.
In normal times, policy changes are an alternative to an imperfect status quo. When this is the case, two decisions must be made by policy-makers: which new policy to choose and how far to go in the direction set by the new policy.40 In normal times, the magnitude of policy experimentation also depends on the level of dissatisfaction with the status quo and on the complexity of the topic to be regulated.41 The experience during the Great Recession clearly illustrates that its complexity has not prevented far-reaching policy innovation.42
It is worth mentioning that not only do crises prompt political deadlocks, as was seen above in Part A.1, but also that economists may differ regarding policy recommendations as to the type of measures or actions that must be adopted in particular during the management phase. Even if there may be a consensus regarding the suitability of those measures or actions, divergent views may exist among economists as to the depth of their implementation and their duration,43 their sequence, and timing.
This is the case, to mention a prominent example, with the significant discussion in the United States and the European Union on fiscal stimulus and austerity as two of the main recipes to cope with the current Great Recession within the crisis management/resolution phase.44 While some regard austerity as the main tool, 45 others, quoting Keynes, note that “the boom, not the slump, is
37. ibid.
38. ibid.
39. ibid 646.
40. ibid 651.
41. ibid.
42. See text accompanying (n 63) and (n 64).
43. Bech, Gambacorta and Kharroubi illustrate well this disagreement as to the current Great Recession.
Morten L. Bech, Leonardo Gambacorda and Enisse Kharroubi, ‘Monetary Policy in a Downturn: Are Financial Crises Special?’ (2012) Bank For International Settlements (BIS) Working Papers. No 388, <http://www.bis.
org/publ/work388.htm>.
44. Ben Bernanke, the U.S. Federal Reserve chairman, is among those opposing austerity in the United States. See Ben S. Bernanke, ‘The Economic Outlook’ (Testimony Before the Joint Economic Committee, U.S. Congress, Washington, D.C. 22 May 2013), <http://federalreserve.gov/newsevents/testimony/bernan- ke20130522a.htm>.
45. For instance, Buiter argues that the conditions stimulus must meet are the following: idle resources in the form of unemployment and excess capacity; there is no other way of stimulating demand through monetary policy; the fiscal expansion should not increase domestic rates; the expansionist policy should not displace pri- vate spending. On these bases, Buiter is of the view that room for fiscal stimulus did not exist at the time of his paper. Willem H. Buiter, ‘The limits to fiscal stimulus’ (2010) 26 Oxford Review of Economic Policy 48, 48. In addition, Corserri presents several reasons in support of austerity. Although he recognizes that the recipe may not be necessarily suitable for all kind of economies, but the recipe may be the appropriate one to attempt to restore confidence in the case of highly indebted countries. In effect, in that particular kind of economy, mar- kets may charge a higher risk premium if the given economy is not making efforts to achieve balance, which may surely make the fiscal position even more fragile through higher interest rates. See Giancarlo Corserri,
‘Has austerity gone too far?’ VOX (Research-based Policy Analysis and Commentary by Leading Economists, 2 April 2012), <http://www.voxeu.org/article/has-austerity-gone-too-far-new-vox-debate>. This is an endless
the time for austerity.”46 The debate is also related to the extent of the use of each formula and its timing.47 Krugman, for instance, claims that the stimulus did not last long enough for the econo- mies to recover48 and also argues that the extent of austerity has gone too far, since government spending is well below its normal trend.49
In addition, the Great Recession and its political upheavals have led to changes in the widely accepted formulas of the past, in which growth was the price to pay for austerity and fiscal balance. Today, there is no longer a one-size-fits-all formula, and case-by-case analyses are the rule. In effect, this is the approach the IMF is now taking. In the words of its First Deputy Managing Director:
We have argued for clear and specific commitments to medium-term fiscal consolidation and a case-by-case assessment of what is an appropriate pace of consolidation. But we also need to talk about how to make fiscal policy more growth-friendly, in essence about the composition of spending and revenues for any given deficit.50
Immersed as well in all these deliberations are states’ permanent choices of winners and losers and the extent of the gains or the losses in the management/resolution phase. Thus, dif- ferent stakeholders lobby for measures that will mitigate their losses or, in other words, will transfer risks to others, taxpayers included.51
As a result, some measures that may be key to resolving financial crises are not taken, due to the opposition of those interests affected by the regulation. For instance, debt forgiveness or
debate. Krugman has tirelessly objected to this kind of policy measure for both Europe and the United States.
See Paul Krugman, ‘Myths of austerity’ New York Times (1 July 2010), <http://www.nytimes.com/2010/07/02/
opinion/02krugman.html?ref=paulkrugman&_r=0>; Krugman, ‘How the case for austerity has crumbled’ (n 26).
46. John M Keynes, as quoted by Paul Krugman, ‘End this depression now’ (2012) xi (Krugman, ‘End this depression’).
47. The Great Recession has been fought with both instruments: First, fiscal stimulus and loose monetary pol- icies, and subsequently fiscal austerity. See Alex Callinicos, ‘Contradictions of austerity’ (2012) 36 Cambridge Journal of Economics 65, 66. However, there are some countries in which stimuli are being required by majori- ties, which have been able to elect new governments to pursue this policy. For instance, in Italy, an elected prime minister stated in May 2013 that ‘[s] timulus policies can no longer wait.’ ‘In Europe, widening impa- tience over austerity hits politicians hard’ Washington Post (29 April 2013), http://www.washingtonpost.com/
world/europe/in-europe-widening-doubt-over-austerity-hits-politicians-hard/2013/04/29/56d21b0a-b0c7- 11e2-9a98-4be1688d7d84_story.html, accessed 8 June 2014. In general, at the time of this writing, there is a significant debate in Europe, for instance, regarding whether growth or austerity should be the leading policy in the Union. Germany is in favor of the latter; new elected governments in France and Italy, among others, are in favor of the former. There is then a tension amicale, as the French President has put it, ‘Ne tirez pas sur Angela Merkel’ Le Monde (29 April 2013), <http://www.lemonde.fr/idees/article/2013/04/27/ne-t irez-pas-sur-angela-merkel_3167686_3232.html>.
48. Krugman, ‘How the case for austerity has crumbled’ (n 28) 1.
49. ibid. Krugman states that austerity has a strong moral appeal, as the ensuing consequence of past excesses.
However, relying on Keynes, he points out that, for Keynes, what really mattered was what to do to mitigate the recession and to achieve recovery.
50. David Lipton, ‘Bellwether Europe 2013 Speech’ (London, 25 April 2013), <http://www.imf.org/external/
np/speeches/2013/042513.htm>.
51. Let’s not forget the Carmina Burana verse of nine centuries ago: Money advises those who sit at council.
Humberto Eco, The Infinity of Lists (2009) 140.