Recent developments suggest that global political leadership has finally accepted the economic disparities that now engulf this planet. Frustrated by legislators’ inaction throughout 2013 over the rising income disparity all across the US, on January 29 President Obama finally announced his own limited initiative – an executive order to raise by 40 percent the $7.25-an-hour base wage for millions of federal workers on contract.
The same day, a UNDP report disclosed that income disparities have been escalating globally and now pose grave risks to global economic and political stability. The report said that between 1990 and 2010, income inequality rose by 11 percent in developing countries (though many recorded vigorous economic growth), and now impacts over 75 percent of their populations.
The January 27 editorial in the Washington Post highlighted another shocking example of governance of the state; it reported that in the developing economies, public justice systems are being replaced by private systems of security and dispute resolution, implications whereof are devastating for the world’s poor because they can’t move forward without basic law enforcement systems.
According to a UNESCO report, quarter of a billion children worldwide fail to learn basic reading and mathematical skills courtesy their educational systems that annually cost governments $129 billion. Inadequacy of education globally is building the worst-ever legacy of illiteracy, which isn’t a shocker for the Pakistanis who suffer from this neglect.
At the global economic forum in Davos, politicians and business magnates finally accepted these harsh realities, especially the rapidly growing rich-poor divide rooted in malgovernance in public as well as private sector, and that since 2007 the global economy is experiencing a “Great Recession”. Doesn’t that sound like the ‘Great Depression’ of the 1930s?
According to Nobel Prize-winning economist Paul Krugman, the ongoing Great Recession is the outcome of the ‘deregulation’ mantra launched in 1980 by the fiscally conservative elite in the developed world. Courtesy market deregulation and tax cuts, between 1980 and 2007, incomes of the top one percent rose by 277.5 percent, compared to just 18 percent for the bottom quintile.
Huge cuts in tax rates that progressively reduced the inflation-adjusted value of tax revenues reduced public expenditure triggering a rise in poverty, and portrayal of private sector as the best mechanism to provide essential services left the poor and the middle classes at the mercy of financial institutions for meeting even their basic necessities such as health and education.
Workers’ dependence on borrowing (due to a sustained slide in inflation-adjusted earnings) made banks the monstrosities they became. Bank owners and managers – madly in favour of ‘universal banking’ – forgot that inefficiency (and corruption) rise in direct proportion to the size of the organisation. How banks played with the lives of their customers is no more a secret.
Old habits aren’t shunned quickly. Banks still haven’t accepted the fact that banking is a social service that connects capital with people and ideas. So, a remedial trend in banking has yet to take off. According to Oliver Wyman, a financial consultancy, despite the post-2007 restructuring of banks, cost-income ratios of European and US banks remain well above 60 per cent.
Thus, despite the Great Recession, a profile change in banking won’t be wholly voluntary. It is the regulatory push for higher capital adequacy and lower asset-liability ratios that is rendering some services unprofitable and forcing their sell-off or discontinuation. In Pakistan, some banks (including foreign banks) sold their consumer loan portfolios to the country’s mega banks.
Trading in derivatives too, is shifting away from the opaque over-the-counter markets (that benefited the banks) to transparent exchanges. According to Andrew McNally, Chairman of Berenberg, UK, investment banking will again become the business of trading on behalf of “clients” rather than banks under the garb of “proprietary trading.”
At Davos, saner bankers branded as over-optimistic the claim that the Great Recession is over because much needs to be done to rectify the flaws in governance. According to these bankers, banks must now reconcile to lower but steady profitability, rather than operate as moneymaking machines that also lack transparency, as proved by events of the last decade.
Despite resistance thereto, banking will undergo a structural revamp the likes of which haven’t been seen for decades. Banks will have to focus on specialising in specific areas so that higher lending volumes lead to economies of scale to cut the cost of credit, and thus reduce the cost of doing business in a world where commodity shortfalls and price rises are inevitable.
Lower cost of doing business could allow paying workers higher wages to prop up their purchasing power. Impliedly, banks must return to the basics – act as key facilitators of economic activity, not profiteers that they became, an example thereof being the so-called ‘proprietary trading’, which is done with depositor funds, rather than “on behalf of clients”.
Overall economic uplift is not possible until all sectors are allocated a fair share in total bank credit. In Pakistan until the 1990s, a key regulatory practice (based on consultation with the Planning Commission and concerned ministries) was allocation of credit to the various sectors. This practice needs reviving to ensure that banks play a truly supportive role in overall economic growth.
For banks, profit shouldn’t be the sole consideration for lending; it should be nurturing a balanced economy wherein everyone stands to benefit. Inculcating consumerism was bad; for a better, secure, and less dependent future what needed prioritising was a culture of striving for a rational balance between consumption and saving, which wasn’t encouraged.
Banks should now be allowed to specialise in certain sectors provided they set up niche-specific research units to track risk and developments in those sectors; banks in Pakistan never did this, though they opted to go for multi-risk ‘universal’ banking. In this reckless setting, sadly, the central bank also allowed the winding up of special institutions like Development Finance Institutions.
That said, the trend for specialisation in business lines foretells a negative development – emergence of mega banks in specific areas, and banking again being dominated by few global powerhouses. The other negative side effect of banks opting not to finance high-risk businesses would be that such businesses would be forced to turn to “shadow” banks.
A shift to shadow banking is already on, and could pose a threat to the state as well as the economies wherein this distortion escalates. Resurgence of too big specialised banks and expansion of shadow banking are two real possibilities that central banks must collectively ponder on because one could lead to another spell of bailing out “too-big-to-fail” banks, and the other to the rise of mega criminal outfits.
A B Shahid, "Positive signs, are they?," Business recorder. 2014-02-04.Keywords: Economics , Economic issues , Economic policy , Economic system , Education problems , Economy-United States , Paul Krugman , President Obama