Ramon Lopez, The Great Financial Crisis, Commodity Prices and Environmental Limits (WP 09-02, Revised May 31, 2009)
Professor Ramon Lopez of the Department of Agricultural and Resource Economics, University of Maryland, has written an interesting working paper that draws the links between changes in the global economy, commodity prices, and the current global financial crisis. It is an argument that calls into question the viability and wisdom of efforts to resume ‘business as usual’, suggests future global economic growth will be slow at best, and (implicitly) suggests that policies of large-scale public borrowing based on the assumption that future growth will help pay it off may be highly risky.
Here’s my take on the argument:
Despite vast increases in the consumption of commodities & natural resources, commodity prices have only recently begun to show a significant long-term upward trend. Previously, the ‘global south’ had been able to provide commodities cheaply for the ‘global north’. But the inclusion of the two most populous nations of the world (China and India) in sustained economic growth has begun show us the physical limits of the earth’s resources, and put strong pressure on commodity prices. So the era of cheap commodities seems to be over, and with inelastic supply, commodities now present a permanent serious inflationary risk (because, all other things being equal, the price of goods with inelastic supply rises rapidly with increases in demand).
At the same time, within the rich ‘global north’ there has been a massive concentration of wealth, and a matching relative decline in the position of the middle classes and poor. Given this relative decline, and the crucial economic role of the middle classes as consumers, the only way to sustain growth in capitalist economies has been to allow and foster a massive expansion of middle-class debt. We are probably all now familiar with the tale of how consumers were reassured in taking on this debt by the rapid rise of housing prices (the housing bubble) which appeared to be increasing household wealth, even though real income was stagnant or declining.
But with the growth of China and India, this exposed rich capitalist economies to an irresolvable contradiction: growth required lax-monetary policy (to facilitate expansion of debt-based consumption) but global growth was threatening enormous commodity-price inflation, which suggested tight monetary policy. And when finally the central bankers did start to tighten monetary policy in response to commodity inflation pressures, the housing bubble popped, and the financial crisis and global recession ensued.
While commodity prices have dropped sharply due to the global recession, given that we are now facing real physical resource constraints (and increasing socio-political constraints in the ‘global south’) they will rise again once growth resumes, and in future commodity prices will continue to be a brake on global economic growth (see also here).
This suggest policies to resume ‘business’ as usual through reflation will sputter out in the face of inflation pressures, and further, that governments ought to be very cautious about undertaking public borrowing where the fiscal viablity of that borrowing depends on assumptions of a return to previous paths of sustained economic growth.
This is disturbing, even if we asses it only as a matter of economic and fiscal policy (and ignore such weighty concerns as global warming, biodiversity collapse, and poverty reduction etc).
I would draw further conclusions from the argument:
1. We urgently need policies to substantially reduce consumption of commodities and natural resources, particularly in the world’s rich nations;
2. We urgently need to address the concentration of wealth and ‘race to the bottom’ fiscal policies that facilitate it. We need a more equitable income distribution, globally and within rich nations, and we need a willingness to raise and pay the taxes necessary for sustainable government finances;
3. We need to address the dysfunctional role of consumer, student, and housing debt in rich world economies: namely, consumer credit needs to be more difficult to get, financial literacy improved, and advertising of credit deals curtailed; tertiary education needs to be affordable but diverse and have non-price rationing systems; strong social housing policies need to be put in place, and housing should not have tax advantages relative to other forms of investment.
I doubt that ‘Go green for fiscal prudence!’ would be a winning slogan, but there you have it 🙂