V K Sharma: Unearned and unshared prosperity are unsustainable
Keynote address by Mr V K Sharma, Executive Director of the Reserve Bank of India, at the
International Leadership Symposium on "Rethinking capitalism and globalization", organized
by the World Forum for Ethics in Business in partnership with the World Bank Institute at the
European Parliament, Brussels, Belgium, 30 November 2012.
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The views expressed are those of the author and not of the Reserve Bank of India.
1. As is invariably the case with any major crisis, the ongoing global financial and
economic crisis, including lately, of course, the eurozone crisis, have unleashed a passionate
debate over the design of a new architecture of finance, capitalism and globalization.
However, the trouble has been not so much with the inter-temporally evolved architecture of
finance, capitalism and globalization as really with how it was actually worked in practice.
The apocalyptic denouement, almost bordering on a veritable global financial and economic
nuclear winter, happened not because the existing systems and best practices failed but
because those responsible for implementing, and enforcing, them failed them! After all, of all
risks to regulators and regulatees alike, human resources risk is by far the most serious as it
is the source of all risks as confirmed by the ongoing financial and economic cataclysm.
Effective and credible systems are not about right architecture but about right people for right
people can make a wrong architecture work while wrong people can't make even a right
architecture work! This "right people-wrong people" trade-off is substantively, and effectively,
about "ethics-expediency" trade-off, with the overwhelming anecdotal evidence of
"expediency" prevailing over "ethics"! The crux of the matter is what we need is not more, or
less, regulation, but good regulation, and governance. This has been the undoing of
regulators/supervisors and financial firms/banks alike. But unfortunately broad-spectrum and
generic failure of an inertial regulatory and supervisory system worldwide, especially in the
West, precipitated the unprecedented global financial crisis and the resulting great recession.
This regulatory and supervisory inertia and imperviousness to the early warning signals of
unprecedented underpricing of risk, which were galore, and aplenty, pre-crisis, is graphically
epitomized by the most no-holds-barred acknowledgement of this - though it came much
later only recently - was when Donald Kohn, former Vice Chairman of the US Federal
Reserve apologized by saying, "The cops were not on the beat, resulting in the worst
economic recession and loss of millions of jobs"! At the end of the day, the problem is not not
knowing the problem, but knowing it and dithering, agonizing over choices, temporizing,
procrastinating and doing nothing credible, timely, tangible and decisive about it. In other
words, in my considered opinion, we don't really have to rethink capitalism and globalisation,
for paraphrasing John Ruskin, what finally matters is not knowing what must be done but
actually doing what must be done and doing it when it must be done!!
2. The cataclysmic financial crisis has thrown into sharp relief, as never before, the
critical and important role of "asset price" inflation/asset bubbles also, as opposed to that of
shop floor/products/services inflation alone, as a key variable, in monetary policy response.
For what happened was unprecedented in that with monetary policy focused only on
traditional CPI, interest rates were kept low in spite of exploding prices of assets like real
estate/property, credit assets, equity and commodities. And this was all made possible
because of the huge pre-crisis current account surpluses in China and other Emerging
Market Economies (EMEs), and huge private capital inflows into EMEs in excess of their
current account deficits, getting recycled back as official capital flows into government bonds
of reserve currency countries, especially the USA, resulting in compression of long term
yields which, in turn, translated into lower long term interest rates even for the riskier asset
classes mentioned above. This chasing of yield, due to global savings glut, in turn, led to a
veritable credit bubble, characterized by unprecedented underpricing of risk as reflected in
the all-time-low risk premia with junk bonds spreads becoming indistinguishable from
investment grade debt! Such a low interest rate environment coupled with luxuriant supply of
liquidity, created enabling environment for excessive leverage and risk taking. This financial
syndrome was a classical case of "too much" and "too little" - too much liquidity, too much
leverage, too much complex financial engineering, too little return for risk, too little
understanding of risks". This syndrome of too much of arcane rocket science and financial
alchemy in the financial sector, almost entirely for its own sake to almost complete exclusion
of the needs of the real sector, created a massive "financial sector - real sector imbalance"
which, being, intrinsically unsustainable, culminated eventually into the now-all-too-familiar
apocalyptic denouement.
3. Significantly, the above pre-2007 story of massive and unprecedented current
account imbalances was almost replicated in the current on-going eurozone crisis with large
and persistent current account imbalances between the core, proxied by Germany, and the
Netherlands, and the crisis-hit periphery, with the surpluses of the core being almost mirror
image of the current account deficits of the periphery. Indeed, it is noteworthy that current
account surpluses of the core increased dramatically after the launch of the single currency
because of significant depreciation of the real exchange rate in the core and appreciation of
the real exchange rate in the periphery. Such large, and persistent, current account
imbalances between the core and the periphery would not have been possible but for the
explicit moral hazard of fixed and stable exchange rates created by the single currency
because the respective national currencies of the periphery would have depreciated in real
terms resulting in timely automatic rebalancing of the current account imbalances!
Incidentally, but significantly, these current account imbalances between the "core" and the
"periphery" are, to an extent, the result of post-1999 fiscal convergence to fiscal divergence
story in the eurozone for, unless, net private savings offset it, fiscal deficit typically tends to
spill over into current account deficit and, therefore, post-euro launch, there ought to have
been a credible, effective and functioning institutional enforcement mechanism to ensure
ongoing compliance on Maastricht fiscal parameters. Of course, this post-1999 fiscal
convergence to fiscal divergence story in the "periphery" would not have mattered if, like in
the case of Japan, net private savings more than offset the comparable net public dissaving
(fiscal deficit) of -9.5%! So the way out of the current crisis is unwinding these imbalances
through higher productivity and competitiveness in the periphery relative to the core. This is
exactly what happened post-crisis in the case of unwinding of the imbalances between
China, on the one hand, and the United States, on the other, with the United States current
account deficit halving from almost 6% in 2007 to 3% currently and that of China's current
account surplus shrinking steeply from 10% in 2007 to 2.6% currently! Thus, in the
framework of "unearned - unshared prosperity", it was the case of "unearned" prosperity for
the "deficit" periphery and "unshared" prosperity for the "surplus" core! But as in the case of
China and the United States, there is some good news that real wages in Germany have
gone up by 3% and those in Greece have gone down by 7%. Going forward, this then holds
the promise of unwinding such imbalances by export of goods and services from the
"periphery" and import of goods and services by the "core".
4. As I said, these large and persistent current account imbalances represented
"unearned" prosperity for deficit reserve currency countries and "unshared" prosperity for
surplus countries. Such a global economic order was inherently unsustainable, and unstable,
from the word go. But the greatest good, and the highest virtue, as it were, of sustainable
globalization is that, it does not permit, except in the very short term, "unearned" and
"unshared" prosperity but delivers "sustainable prosperity" only if they are "earned" and
"shared" prosperity! And mind you, "unearned" and "unshared" prosperity are no
socialistic/egalitarian platitudinal rhetoric but pretty compelling real-politik and geo-economic
imperatives given the current irreversibly globalised and, increasingly integrated, and
interdependent, world. Sustainable globalization is about macroeconomic equilibrium,
balance and harmony. In fact, the whole thing can be likened to cosmic
balance/equilibrium/harmony where stars, suns, planets, all orbit within the inviolable
discipline of their elliptical orbits which do not permit deviant behavior beyond the shortest
and the longest distance from suns and stars of orbiting planets! Any deviant
behavior/conduct, inconsistent with the cosmic harmonious balance and equilibrium, will
invite, and inflict, extremely retributive backlash; the more severe and prolonged the
disequilibrium and imbalance, the more wrenching and excruciating will be the resulting pain
as is currently being experienced, especially in the euro zone, where, it is no brainer to see
that, in the event of the break-up of the euro, it is the surplus/creditor "core" that has far more
to lose than the deficit/debtor "periphery"! For if the surplus/creditor "core" exit the euro, value
of what is left of the euro will be worth much less in terms of national currencies of the exiting
surplus/creditor countries. On the other hand, if the deficit/debtor "periphery" exit, they will
simply default on their euro-denominated debt owed to the surplus/creditor "core" because of
the collapse of their national currencies against the euro! In other words, in sustainable
globalization, there can be both winners, and losers, only in the short term, for such is the
nature of sustainable globalization that, in the long term, there can only be all winners and no
losers! To conclude, therefore, if we earn and share, we prosper together, and if we don't, we
perish together!!