Opinion | How global financial crisis altered the course of economic thinking

After the global financial crisis of 2008, there has been a sharp increase in discussions on economics of distribution. Interestingly, most economists missed the rise in inequality and only took notice as the public started reacting. There is widespread feeling and dissent amidst the public that most of the output, whether physical goods or financial assets, has always been in the hands of the elite. These elites also have captured economic policy-making, directly or indirectly, leading to their continuous rising share in economic activity. Thus, to stay relevant, economists now need to pay equal attention to the distribution of production and ensure that the benefits are not accruing unequally.

This movement has been led by French economist Thomas Piketty who has shown how inequality has risen in most economies in the 20th century. The anger against these social inequalities was brewing for some time and reached its zenith during the 2008 crisis when it was seen that most policies were benefitting Wall Street and not Main Street.

After the crisis-laid low economic growth and employment, people were no more willing to tolerate this unjust distribution. This led to all kinds of agitations (for example, Occupy Wall Street), protests (Arab Spring) and exits (like Britain’s from the European Union).

It is also responsible for the surge in economic nationalism resulting in rise of certain politicians. The election of Donald Trump in the United States and Emmanuel Macron in France are a result of these ongoing economic changes.

Piketty’s French origins are, perhaps, one reason for his not getting similar fame as John Maynard Keynes or Milton Friedman. These thinkers came from countries which were also dominant economies in the world at their time. Keynes was from the United Kingdom, which was a top economic power as it controlled strings of several economies via its colonial status. The US had risen to the top when Friedman’s ideas came into prominence. France in the 21st century is still a major economy but hardly dominant.

There is another change in economic thinking which needs to be highlighted: the importance of finance. So far, finance was largely seen as an intermediating activity which transferred resources from surplus units to deficit units. Most thinking in finance was around efficient markets, asset pricing and recently, behavioural finance.

Very little work was done on whether, and how, financial markets can impact macroeconomic stability. One saw sharp inter-linkages in financial markets and macroeconomic developments in other crises such as those in South East Asia in 1997 and Argentina in 2001. However, these crises were seen happening in countries or regions which had poor macroeconomic stability and low institutional capability. As a result, most macroeconomic models barely had any role for the financial sector.

The 2008 crisis also forced changes in this thinking. The crisis started from insignificant sub-prime housing markets to engulfing the entire world economy. This was mainly due to the several financial inter-linkages amidst these economies which had developed as economists were busy spreading the virtues of financial globalisation before the crisis.

All these ideas have now come under serious scrutiny. As both the origins and impact of the crisis was mainly in developed economies, the older excuses, which were used for developing economies, do not apply anymore.

Moreover, financial markets were also central to rising inequality, as initially shown by researchers such as Thomas Philippon and Simon Johnson. The lack of culture in financial services has also emerged a serious concern as conveyed in speeches by central bank officials, particularly those of the New York Fed. These so-called softer aspects of finance have now become the hard issues for both economists and policymakers.

In a way, both these changes in economic thinking have led to a resurrection of old ideas by earlier generations of economists. Piketty’s book Capital in the 21^st Century is based on Karl Marx’s Das Kapital which had also talked about distribution issues. This year marks the 200th birth centenary of Marx leading to discussions about relevance and irrelevance of Marxist ideas. It is quite surreal that Marxist ideas are even being discussed in the 21st century, that too in the developed world.

In finance, Charles P Kindleberger, Hyman Minsky and several before them had warned how financial euphoria eventually led to a financial crash.

So, in that sense Skidelsky may be right that there have been no new responses during the current crisis. But the resurrection of older ideas, especially that of inequality, is quite a movement by itself.

(This is the first piece of a multi-part series on the 2008 global financial crisis. The author is faculty at Ahmedabad University. Views are personal)