Bailing Out Economies

The volatility of modern globalisation has been a cause of growing anxiety among wage earners the world over. The days of life- time employment are mostly over, contracts are growing ever shorter, and the number of ‘temp’ staff is seemingly on the rise. Since capital is increasingly mobile, investment is always moving to countries where absolute returns are higher, regardless of the consequences for immobile workers. One pronounced impact of globalisation in the 1970s was the massive redistribution of factory locations. Millions of US blue collar jobs have disappeared as factories have been moved to lower wage China and Southeast Asia.

The relocation fattened the corporate bottom line as western-designed, low-priced made-in-China goods have invaded shopping malls. Low prices at Wal-Mart and Tesco helped middle-class wage earners to cope with their declining real income, but the uncertainty about the future continue to haunt workers. The anxiety is even more acute in the US where, unlike in Europe, retrenchment often entails the loss of healthcare or a drop in living standards as the next job might pay less. Economists argued that this ‘creative destruction’ was an inevitable part of economic growth and innovation, which would in the end create new jobs and benefit the society as a whole.

But as reforming China and India and other developing countries joining the globalised world have brought in hundreds of millions of new workers, many western economists, who championed globalisation, are no longer so sure of themselves. They fear that the industrial prowess of the emerging economies poses a serious challenge to the prosperity and welfare of working class and even white collar workers in the West. The backlash, in turn, threatens the hallowed principle of free trade. A serious debate is underway in the European Union and the US on how to help workers who fall victim to creative destruction. Should governments come to the aid of companies who are unable to cope with global competition or collapse because of mismanagement and misfortune? The answer on that score used to be clear: bailouts create moral hazard, economists warned, and only encourage reckless behaviour.

During the 1997 Asian financial crisis, companies were allowed to go under in application of this principle, in the process throwing tens of millions of people out of jobs and toppling governments. The US treasury secretary, and the IMF, sternly lectured Asia about crony capitalism and exhorted them to build transparent models of good governance in their economies.

That was then. Since then, the Enron, Tyco, Global Crossing and Worldcom scandals have shown corruption and greed are not uniquely Asian attributes, nor is the lack of transparency and good governance. Barely a year after the Asian crisis, the US government bailed out Long-Term Capital Management, claiming that its collapse would have sent shockwaves through a world already reeling. After the bull run of the past decade, exceptions seems to have become the rule. “Wall Street got drunk,” said president George Bush, and the resultant subprime mortgage crisis now threatens three million American home owners with foreclosure, and devastate banks and investment companies. But before drawing up regulations to prevent such catastrophes in future, the US government has to get into full rescue mode. And this time, the object of the bailout is the health of the American as well as the world economy.

The fallout of the subprime crisis has now engulfed the giant government-sponsored mortgage lenders Fannie Mae and Freddie Mac, which together own or guarantee $6 trillion, representing roughly half of US home mortgages. The failure of these institutions would not only have devastating consequences for the US economy — leading to the collapse of many other banks and businesses and leaving millions out of work — but seriously affect foreign investors who have sunk some $1.5 trillion in these institutions. The failure of these icons could trigger a flight from dollar-denominated investment with incalculable consequences for the US economy.

When one out of 10 American mortgages is guaranteed by foreign investors, enabling Americans to keep their homes is as much a concern in Washington as it is in Bejing or Tokyo. Not surprisingly, there is no more talk of moral hazard but unless rules are put in place to sober up Wall Street the next crisis won’t be far.