The writer, an FT contributing editor, is chief executive of the Royal Society of Arts
After a decade of radical financial regulatory reform, designed to rid the world of institutions that were “too big to fail”, this time was meant to be different. Alas, not. Not only the big (Credit Suisse) but the medium-sized (SVB) were found to matter, the safety net was again distended, and the best-laid regulatory plans perished in their first brush with reality.
There are positives to take from the latest crisis. So far, we are suffering financial casualties rather than full-blown collapse, a credit squeeze rather than crunch. Some equity-holders (in SVB) and bondholders (in Credit Suisse) have borne the burden. Government support has been in guarantees of deposits or losses, not direct equity injections.
Yet in other respects this financial melodrama feels eerily familiar. It is a centuries-old story of policymakers talking tough then bending the knee, fearing the collateral consequences of sticking to their plans. We remain caught in a “doom loop”, with insured risk-taking begetting further risk-taking.
While this dynamic is not new, its velocity is. Recent events have seen a significant widening as well as deepening of the state safety net, casting it well beyond the financial system to households and companies.
Since the global financial crisis, the world economy has been hit by two enormous shocks, first Covid and then the cost of living. These were cushioned by monetary and fiscal measures of unprecedented scale and scope.
During Covid, quantitative easing in major central banks was expanded by over $10tn and fiscal policy by over $7tn. Direct support to households and businesses, in the US, UK and eurozone alone, amounted to around 25 per cent, 20 per cent and 12 per cent of national gross domestic product, respectively. During the cost of living crisis, support to households and companies across Europe averaged a further more than 3 per cent of national GDP. This support dwarfs the equity injections to banks in 2008/09.
Because it is difficult for households and companies to self-insure against shocks of this type, the case for social insurance is strong. I have done so repeatedly myself. Not to provide it has the potential to cause large and lasting economic and social scarring due to household unemployment and corporate insolvency.
That was the story of the 1970s and 1980s when, following large shocks, too little insurance was provided, causing long-term scarring, most clearly in high unemployment. Policy in the 21st century learnt those lessons, with responses larger and economic and social scarring lower as a result.
But all insurance carries costs by reshaping risk-taking behaviour. Whether these distortions erode the cushioning benefits is a question of degree, not principle. Even when each individual act is justifiable at the time, the cumulative consequences may nonetheless become sub-optimal. The evidence is mounting that we may be at or close to that point.
First, state-led safety nets are inherently one-sided. That inbuilt asymmetry naturally skews risks to demand and inflation to the upside. Latterly, those risks have been realised. During Covid, the world’s major economies administered the largest double-dose of fiscal and monetary medicine in human history, lighting the inflationary fire central banks are now frantically trying to extinguish.
Second, when state insurance pays out following extreme events, this ratchets up government debt. Debt-to-GDP ratios in the major economies have doubled since 2008. With debt limits at or close to being breached in many major economies, fiscal space is now constrained. This reduces room for manoeuvre in the event of future shocks and constricts public investment, damaging growth.
Third, the same safety net that prevents business gazelles and unicorns from being grounded also prevents corporate zombies from being slain. Taken too far, it crowds out creative destruction and diminishes business dynamism. There is growing evidence of a lengthening tail of stagnating firms, low rates of business entry and exit and falling market contestability.
These effects add velocity to the “doom loop”. Reversing it would require a lengthy period of macroeconomic stability, such as that experienced after the second world war and in the run-up to the global financial crisis.
In today’s world of “polycrises”, we can hope for renewed macroeconomic moderation, or a spontaneous growth spurt. But hope is not a prudent policy strategy. It is time to reconfigure our safety nets, in finance and beyond, and reinvigorate capitalism in anticipation of the next big crisis.