A world in turmoil

By Shabiya Ali Ahlam
Being given the post of Minister of Finance at a young age is certainly a career milestone one can be excited about, but given that responsibility when the world economy is crumbling is more than challenging.
Former Finance Minister and Secretary of State for Finance of Netherlands Jan Kees de Jager was one of the many politicians who took up the key role in keeping the country moving forward at the time when the world was in turmoil.
Sharing his experience and predicting growth trends of the future, Jager at the sixth Eminent Speaker Series facilitated by the Ministry of Finance, delivered his address on the topic ‘A World in Turmoil: From Subprime Crisis and Sovereign Debt Crisis to a New World Order Driven by Global Trends That are Propelled by Technology, Civil Empowerment and Demographic Shift’, where he recalled what the global economy went through in the recent decades, and ways nations can be cautious from being hit by similar shocks that may be in store in the coming years.
The large unbalance in global economy
Having taken up office when the world was in a phase of large unbalance, Jager noted it was one that economists and policy makers strangely missed to notice.
While the unbalance started in the United States (US) and the Europe Union (EU), economic history states that in 120 years almost all financial crises originate in residential mortgages.
Pointing out that although people tend to blame corporations alone for mistakes in the economy, most of the problems of the big bubbles were originated in residential mortgages in the US and EU.
The reasons being before the crumble residents of those countries were not only able to easily obtain mortgage facilities, but could get then many times by presenting false income statements. These the banks readily took up, securitised it and presented to the rating agencies a diverse portfolio for which they were given high rating.
The continuity of the process eventually led to the collapse of then stable institutions such as Lehman Brothers which filed for Chapter 11 bankruptcy protection on 15 September 2008. The filing remains the largest bankruptcy filing in US history, with Lehman holding over $ 600 billion in assets.

The fall of Lehman Brothers
In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman’s loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgage tranches when securitising the underlying mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear. In any event, huge losses accrued in lower-rated mortgage-backed securities throughout 2008. In the second fiscal quarter, Lehman reported losses of $ 2.8 billion and decided to raise $ 6 billion in additional capital. In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten. In August 2008, Lehman reported that it intended to release 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.

On 13 September 2008 the president of the Federal Reserve Bank of New York called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets and on 14 September 2008 The New York Times reported that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed. It emerged subsequently that a deal had been vetoed by the Bank of England and the UK’s Financial Services Authority.
Leaders of major Wall Street banks continued to meet late that day to prevent the bank’s rapid failure. Bank of America’s rumoured involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman’s sale.
The series of events around the bankruptcy of Lehman Brothers and the collapse itself sent shockwaves that were least expected, to the world. According to Jager, the fall of this particular institution was observed to be one of the greatest that resulted in troubles for other banks.

Shift in world economy
The collapse of the banks also took place at the time when the world economy was in a very important transition, where it was shifting from a decade of high economic growth to a recession and then depression. At that time the leaders of the world, the G20 expressed the need to come on to one platform to discuss ways on tackling the current crisis and preventing it from taking place in the near future.
Jager pointed out this particular scenario took place at the time when the Netherlands was a part of the G20 and when he was in his first year serving as the Minister of Finance.

Looking at meetings of similar nature of the G20 that place in the past, specifically in 1992, that was the start of the European debt crisis, according to Jager since the member countries entered into the single currency agreement.
“Although it is a good move and the decision was made at that time to ensure the region continues to prosper, it is easier said than done. It is difficult to manage the single currency since all countries have to align their money and budget policies. Failing to do so will result in the EU to collapse and that is precisely what happened,” noted Jager.
Despite the region having entered into a single currency agreement, the policies, economic reforms and budget were out of place, he added.
The EU crash
The result of the financial crisis, bank crisis, and the sovereign debt crisis resulted in the crash of the EU. The first was in 2009 where there was a contraction of 4% of the economy. While economic crisis are usually temporary, the major issue in what took place in 2009 was that it went deeper than expected and was followed by a second crisis, resulting in a low initial growth path.
Economic literature has suggested that such crisis takes place only every 70 or 80 years. About 30 years ago Asia also experienced a shift in its economy, but such situations are rare, said Jager.
Elaborating on the reasons of the EU crash he said the issue is that with the single currency is the currency cannot be devaluated to become more competitive. The devaluation is usually the path taken for this regard. A country will have to do it by economic reforms alone.

In addition to the single currency, the EU was faced with the issue of not being able to make use of the market based system such as what the US has in place where corporation can go to the markets for capital, along with the option of going through the equity market or bond market.
In Europe, corporations are dependent on banks for financing, and after the crisis the banks were unable to finance the way they did before. Having acknowledged the seriousness of the issue the region is now looking out for alternatives.
“The issuing of loans completely fell apart and you see a little revival in equity market but not enough to compensate the falls in the banks. If you need economic growth after the crisis, you need banks to finance that growth and in Europe this is a problem,” observed Jager.
It is to come of this situation that the EU has expressed an interest in establishing a new banking union. It has proposed to have a single complete system of banks in the Eurozone that has a single supervisory mechanism.
However, the notion has yet to reach its full cycle as it is not developing in the pace it is supposed to, but getting the initiative off the ground will result in the region having ‘solid’ banks, according to the ex Finance Minister.

Budgetary rules
Sharing how it is done in the Netherlands, Jager shared the budget framework is based on macroeconomic forecast that is made by an independent agency which it does at regular intervals. And the Ministry of Finance has to make new estimates for the budget based on those that has been put forward by the independent agencies.
Pointing out the cornerstones of the budgetary rules, he noted revenue and expenditure are treated as separate. “Keeping revenue and expenditure separate is one that protects the Finance Minister and the Ministry. This is also important since ministers cannot raise income by increasing taxation to have the allowance of having high expenditure.”

The next corner stone he said is having in place an expenditure ceiling which under no circumstances can a ministry cross this level. While it is encouraged to spend less, in the Netherlands it is fixed for a period of five years. Only if a government falls and a new one comes in can it be changed. Even if the economy is performing better than expected, the ceiling cannot be crossed, and the ministry should look at rearranging the budget. “This will increase the responsibility of all individual ministers, since this ceiling is divided per ministry. So every ministry has its own expenditure ceiling that simply cannot be crossed,” he emphasised.

Five future global trends Looking back at the changes the world has gone through, it has certainly gone through many waves such as the first industrial revolution, rise of the petrochemical industry and aviation. However, much has progressed since and today the world is at a digital age. Predicting the five global trends for the next fifteen years, former Finance Minister and Secretary of State for Finance of Netherlands Jan Kees de Jager shared during his address at the Eminent Speaker series as to how these will help in the development of any nation. Digital revolution The first he said is the digital revolution where in it are a number of sub trends. Speaking on the internet trends pointed out going forward by 2020 there will be about 50 billion devices connected to the internet. Which means by that time every person will have 6.5 devices connected to the internet. Another sub trend is the mobile phones. Smart phones and tablets make up to more than 50% of internet traffic. It is the first year ever that mobile devices have created more internet traffic than PCs and laptop combined. He stressed the smart devices are very important and software industries will play a key role in the next few years. Jager noted ecommerce is also very importing especially in fast economies but soon other developing and emerging economies will follow. In most of the fast economies ecommerce industries have already taken 80% of the transaction. In the West businesses such as travel agencies are highly concentrated on the internet, and more and more activities are processed exclusively on the internet. “If you put all data every produced by man kind in the past thousands of years, only 90% of that was produced in the last two years. There is an enormous explosion. Data and business intelligence is becoming more and more apparent and emerging as the most important industry in the world,” he stressed. Data Analyst, a profession that was identified as plain few years ago will be considered the next big thing. “I am certain Sri Lanka will do a very good job in retaining its knowledge and its people skills for this purpose. From big data you have to intelligently extract and make meaningful information. If you are able to do that you are the winner of the future,” expressed Jager. Demographic changes An important trend that nations have to focus on, the world is currently witnessing urbanisation. According to the international definition of urbanisation, which is the process by which large numbers of people become permanently concentrated in relatively small areas, forming cities, Netherlands is the highest urbanised population in the world with 82% of its population being in cities. Urbanisation doesn’t happen in many regions but it is happening in Asia and Africa and somewhat in America, he pointed out. Then there is the ageing issue. This is sometimes looked at by the western economies as a western problem. While this is not true, China is ageing and will soon have a problem if they do not change their policy, noted Jager. One of the biggest changes is the rise of the middle class. Calling it a beautiful trend he said the middle class is increasing very fast and it is growing faster in Asia than anywhere else. In USA it is not growing at all but in China and India it is growing rapidly. In 2000 China had no middle class, but it is predicted that in a few decades they will have about 50% of the world’s population in the middle class. “The growth of middle class in absolute terms in 2012 there will be 5 billion middle class and that is good as it is an economic growth driver for the future stability of the country. It is important for Asia, Sri Lanka included, and the nations need to make use of this. Clean tech The third most important trend is the emphasis on clean technology. While currently only 2% of the world economy uses clean tech, it is imperative to increase it further to ensure the limited natural resources are protected and utilised efficiently, causing minimal or no harm to the environment. Clean technology has emerged as an umbrella term encompassing the investment asset class, technology, and business sectors which include clean energy, environmental, and sustainable or green, products and services. Clean technologies are known to improve the lives of people in both developing and developed countries, and therefore investments can render a nation competitive, offering added value to its citizens. Shift of world powers With the world heading towards a shift in world powers, Jager expressed confidence in the world witnessing a significant change in the future. “This is because when you redraw the map on the basis of economic growth achieved by individual countries, the result will be an enormous change. China, India and Indonesia will become very apparent. Also some African countries as for the first time are experiencing an increase in power. This will continue,” he said. New financial order The last future global trend is the emerging of new financial order. In this one that orders banks to have Basel III framework, a much stricter framework than what was in the past. “Also we are seeing new technology coming in and it is the best to use the same in the future since there will be a much better understanding of companies than the bank does.” The card issuing companies are also noted to be coming up and they are putting pressure on finance companies and banks. Banks in the advanced economies will be under big stress due to such developments he said. Highlighting on an emerging soft trend in taxation, he said there is a shift from direct to indirect tax. Some governments are trying to prevent the shift but it is something that has to be dealt with.