Download Feasibility and impact of a European Institute of Technology

Some reflections on the
financial and economic
crises
Luc Soete
UNU-MERIT,
University of Maastricht
The Netherlands
Maastricht University alumni meeting, Brussels 03-06-2009
Outline
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A historical day… tomorrow European elections
in the midst of the worst economic crisis since
the 2nd World War.
A unique crisis… major macro-economic
challenges. Very different scenarios of what the
crisis will bring us.
Specific focus on the impact of the financial
crisis on knowledge investments
European and global long term challenges
1. The financial crisis
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A double squeeze: a financial crisis having affected the real
economy with a mutual reinforcing double squeeze on the economy.
Practically all large international operating banks were technically
bankrupt, slow but still difficult improvement.
An economic recession which cannot be addressed using traditional
financial tools, banks no longer being in a position to carry out that
function.
Large financial banks have become “dead bodies”: black holes in
our economy, absorbing public money but no longer emitting any
economic dynamism.
As a result a declining financial sector in most (small) countries in
coming years with large public funding involvement.
McKInsey Analysis
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Systemic
failures of
credit markets
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High leverage
levels
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Globally
interconnected
High
uncertainty
Why this crisis is unique and very different
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A number of credit markets have come
to a stand still at the same time
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High leverage levels in combination with asset write
downs result in a credit contraction that slows GDP as
no cash for investments is available
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Almost all economies and markets across the globe are hit,
limiting the possibility of recovery through strong demand
or capital injection from other regions
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Two mutually reinforcing forces (the financial crisis and a
recession) are having impact on the economy which
makes potential outcomes very hard to predict and
potentially very negative
4
Mutually reinforcing effects
Banks try
to restore
solvency
Sell assets
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 Over the past 8 years, leverage has
reached unprecedented levels
to restore
capital ratio
Asset
Financial
Cheap Innovation
Price
Rise
Commercial
paper markets
collapse

Further
asset writedowns
Credit
Lowers
 US
Subprime
crisis
 Lehman Failure
asset
prices
Commercial
paper
collapses (counterparty risk)
Adverse
selection
further depresses
market
Companies who
can turn to bank
credit lines
Economic
contraction
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Economy
contracts
Banks
further
tighten lending
standards
Markets
are trying to adjust to
the changed conditions, but it is
unclear what the end-state will be
and how long it will take to get
there
Increase
in nonperforming loans
5
Source: Morgan Stanley; Federal Reserve; BEA; The Economist; McKinsey analysis
A simple way to think about policy measures in a
downturn (McKinsey Global Institute)
‘End
state’
Economic
activity
Time
1.
Limit the
slide down
2.
Accelerate
the recovery
Working through the cycle to a rate
stronger end point
• Combine short term correction with longer term
•
•
strengthening
Mix financial recovery with economic recovery
Differentiate a mix of measures for three recession
scenario’s (moderate, strong and “deep freeze”)
3.
Create stronger
end state
Example measures
Example
interventions
Protecting
business in
distress
Stimulate
demand/
economy
Strengthen/
maintain
fundamentals
“Limit the depth”
ILLUSTRATIVE
“Accelerate recovery”
“Shoot higher”
 Support
work time reduction
 Support specific companies/
sectors (e.g., construction)
 Improve bankruptcy
legislation (tax claims, ch.11)
 Creating bank rescue funds
 Create company refunding
fund
 Reduce tier-1 ratio’s in banks
 Improve
 Protect
 Create
credit guarantees
 Move forward large
investment projects
 Reduce taxes/ defer tax
payments
 Stimulate car purchases
 Stimulate
entrepreneurship
 Support adult training in
down-time
 Purposeful government
buying
 Stimulate
 Show
 Stimulate
 Focused
commitment to foreign
companies risking to move
bankruptcy
legislation (Ch.11, tax)
investment in
education
 Reduce corporate tax (to
attract and improve
business)
investments in new
technologies/Research
higher efficiency/
renewable technologies
 Purposeful government
buying
attraction of foreign
business
 Protecting investments in
R&D
Countries response so far focuses largely on short term
“Limit the depth”
 Investment
Germany
 € 62 bn
 2.6% GDP
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France
 € 26 bn
 1.4 % GDP
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UK
 € 23 bn
 1.5% GDP
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in infrastructure
 Reduce tax for low incomes
 Cuts in social security cost
 Credit guaranties for SME
 € 500 bn bank rescue fund
 € 100 bn credit fund
 Recycle premium for old cars
“Accelerate recovery”
 Recycle
 Investment
in infrastructure
 Support car industry
 Support for construction,
energy, transport sectors
 Investment in social
residences
 Faster returns of VAT
 Credit support for SME
 € 350 bn bank rescue fund
 Forward
 Reduce
 Forward
VAT 17.5 to 15%
 Delay increase in corp tax.
 Allow deferred tax payment
 Exempt foreign dividends
 Forward investment in roads
 Loan guarantees for SME
 400 bln bank rescue fund
premium for old cars
investment in
education and defense
 Increased funding for energy
efficiency of houses
investment in
schools and home insulation
 Subsidy for hiring new
employees
 75.000 training places for
unemployed
 Funding jobless to set-up
business
“Shoot higher”
 Not
clear
 Increase
subsidies for energy
efficient cars
 Not
clear
Alternative crisis scenarios
Battered,
Early
Recovery
Capital
Markets
Crisis
Continued
Slowdown
but resilient
Regeneration
of
globalization
Recession 2-5 years, then
strong growth
Recession 3-4 quarters, then
strong growth
 New,
effective regulatory regime
 Recovery led by regions (eg. US,
China)
 Credit Markets recover, safe leverage
ratios, cost of capital to historic norms
 Slow recovery of global trade
 New,
Disruption
Stalled
Recession > 10 years (“Japanstyle”)
Recession 1-2 years
 Major
 Recovery
disruptions bringing about new
national regulatory policy experiments
 Credit markets rely on government
input, cost of capital and energy high
 Global trade drops, knowledge as well
highly skilled labour mobility increases
effective regulatory regime
 Recovery is broad-based
 Credit markets recover, safe leverage
ratios, cost of capital to historic norms
 Global trade recovers rapidly
is based on national markets
and national industrial policies.
 Financial and credit markets
renationalize and downsize.
 Recovery growth quickly runs into
foreign energy dependence so that
global trade recovers only slowly
Severe
Moderate
Economic Global Recession
Source: McKinsey Global Institute
Gobalization
9
Global developments
Early
Recovery
Capital
Markets
Crisis
Slow
but balanced
growth
No
 Redirection
 At
of global financial flows in
a more balanced way
 Growth in US and UK savings,
reduction in reserves in China and S-E
Asia – new role for IMF
 Stronger representation of emerging
countries in international financial
organizations
 Growing international trade conflicts
Knowledge
globalization
change
first rapid recovery
 Limits to unsustainable growth (oil
price, raw materials, agriculture
increases) expressed in re-occurrence
of crises in new areas (water, health,
environmentally induced migration, …)
 Rising inequality and exclusive growth,
resulting in unsustainable social
exclusion, increased security costs
Financial
nationalism
 Dramatic
Continued
Slowdown
slowdown in trade of goods,
 Focus on protecting national savings,
with severe structural unemployment &
going for national and international
new specialization patterns emerging
“trust” investments (local banks and
 Long disruption period with
global “community” banks)
globalization governed by green
 Regional disparities with growing labour
concerns: priority on global
migration pressures
implementation of environmental
 Financial global imbalances limit
technologies
national growth opportunities
 High skill labour mobility
Severe
Moderate
Economic Global Recession
Adapted from McKinsey Global Institute
10
2. Impact of crisis on research
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Traditionally, one would view private research investments as evolving in an anticyclical way:
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However, with respect to innovation, the cyclical view appears the most common:
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The negative impact of the recession on profitability forces firms to focus on the most
productive segments of their output: the opportuntiy costs of achieving productivity growth is
lower in recessions, providing incentives to undertake research activities in downturns
(Aghion and Saint-Paul, 1998; Canton and Uhlig 1999);
R&D-personnel will be subject to “labour hoarding”; the most qualified scientists and
engineers will be kept at the expense of lower skilled personnel.
Innovation or the implementation of new ideas, wil be postponed in a recession till the boom
period (Shleiffer, 1986 and Francois and Lloyd-Ellis, 2003);
The so-called innovation acceleration hypothesis of Gerhard Mensch (1975) whereby radical
innovation would be favoured in depressions out of despair remains subject to debate (Clark,
Freeman and Soete, 1981).
Well illustrated in the case of ASML, the Dutch litographic machine maker:
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R&D intensity increased significantly over the period 2001-2003 following the dramatic
dowturn in IT sales in 2001;
innovation peaked with the introduction of a new generation of machines over the boom
period from 2005 onwards.
ASML’s R&D
ASML’s R&D budget = total revenues of one of its competitors
Second largest, non-government R&D investor in the Netherlands
500
4000
R&D investment M€
450
3500
Total sales M€
400
3000
350
2500
300
2000
250
1500
200
1000
150
500
0
0
’92
’93
’94
’95
’96
’97
Source: ASML
Slide 12 |
’98
’99
’00
’01
’02
’03
’04
’05
’06
’07
Knowledge investments not part of
recovery plans?
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As a result traditionally macro-economists will not consider supporting research,
higher education and innovation a priority in addressing the economic crisis:
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Prioirty goes to short term, demand led economic recovery plans as opposed to more long
term structural reform plans such as R&D and human caoital investment support;
Given the counter-cyclical nature of research and productivity investments, the deeper the
economic crisis, the quicker the structural transformation towards a knowledge economy.
Thanks to the economic crisis, the EU might actually come nearer to its Lisbon and
Barcelona targets in 2010!
While innovation will lag behind, there is little one can do about it... successful innovation is
ultimately crucially dependent on entrepreneurial market expectations: it is endogenous to
the business cycle.
The central assumption behind this view: firms will consider their R&D investments as
costs “of last resort”: essential long term investments for the future of the company.
However, this
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Depends on the nature of the recession
The nature of funding of research and innovation (Barlevy, 2007).
Nature of the crisis
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A rather unique crisis originating from within the financial sector and affecting the real
economy under the form of a dramatic change in “risk aversiveness”. Private financial
institutions which normally play the role of central agents in any counter-cyclical
recovery policy have become by and large “dead bodies”, in some countries even
“black holes”.
Spreading of lack of trust in future risks with private investors as a result of the huge
write-offs over the last year and growing distrust in society: a fertile ground for
growing financial nationalism;
The current dominant philosophy of “Cash is king” has a direct negative impact on
knowledge investments:
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Within stock listed companies, the CFO’s pressure to distribute as much of the limited profits
as dividends – in a recession a crucial differentiating factor signalling solvability and
managemnet reputation– is likely to prevail over long term R&D investment commitment.
Within SMEs as credit is becoming difficult to get, the focus will shift to organisational and
easy to implement process innovations reducing costs and inventories. New product
innovations and renewal investments will be postponed.
Finally high-tech starters will postpone the introduction of new product innovations. As a
result seed money providers are having difficulties in finding sufficient worthwhile investment
proposals. The venture capital market collapses.
Policy responses
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On the supply side: structural policy reforms in research:
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Broadening of existing R&D support schemes for the private sector but
also closer private-public interaction:
Need for complementary policies within broader trend of increased
(global) specialisation of private R&D within large firms with a growing
trend towards “outsourcing” in the direction of small firms.
Use opportunities for increased “outsourcing” of a number of specific
R&D-activities in the direction of public sector (universities and other
public research institutions);
New role, with partly public (local) funding support for some of the large
private R&D labs as “open” systemic innovation infrastructure;
Arguments similar to support for systemic banks but with one major
difference: not aimed at stabilisation but at enhancing growth dynamics.
Example of dismantling of Bell Labs in the 80’s and impact on private
R&D in US of many of those underutilized R&D managers.
Long term growth opportunities
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On the demand side focus on sustainability:
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Fasten the development of various possible “lead markets” using technology
procurement following the US example with respect to DARPA, NASA, NIH, etc.;
involve the private sector more actively in technology development and
innovation in so-called societal innovation programmes (health, education,
mobility and logistics, security);
Thanks to internal EU rules, such national “innovation procurement” will not
result too easily in hidden support for the own national industry.;
Use the immediate local growth and employment opportunities associated with
the application and diffusion of green technologies to the full. E.g. “green”
construction represents a long term productive investment both for the public and
private sector, including house owners;
Focus the recognition of “grand challenges” on sustainable development. Use
this new “mission” focus so as to bring about a brake in the current lack of trust
with private investors and starters in future risk taking;
Make investments in sustainable investment shares and bonds fiscally more
attractive.
A less flat research area in Europe
after the crisis?
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Historically there have been continuous shifts in public versus private funding of research and
innovation, sometimes in favour of public funding (2nd World War and post-war period), sometimes
in favour of private funding (80s and 90s).
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EU countries with high R&D investments (Finland, Sweden, Germany) typically embrace the view
that the financial crisis offers opportunities for domestic structural reforms strengthening R&D and
innovation, including the deployment of “green” technologies and eco-innovation; countries with
low private R&D investments appear to only marginally refer to research and innovation
stimulation measures within their domestic recovery plans;
In the long term these different policy responses are likely to signal a further growing divide
between EU countries: a forced crisis knowledge specialisation
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Today given the risk aversiveness on the financial side, there is a need for stronger role of public funding;
Crucial for the effectiveness of research and innovation is not so much the funding origin but the
performance location.
technologically leading countries which have the policy room for investing more public resources in
knowledge taking a further lead
and a group of falling behind countries adjusting their specialisation towards less technologically advanced
goods and services.
The public resources for knowledge and innovation investments are up to now nowhere under
pressure (even not in Island). Most planned expansionary R&D and innovation investments
appear to be continued; the real test though will only come when countries will see their budgetary
deficits increase rapidly over 2009 and 2010.
3. Globalisation and the crisis: a
historical return to normal?
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What remains striking from ahistorical perspective is how the two largest countries in the world:
China and India, saw their share of world population and their share of world GDP more or less
continuously fall over the period 1820 till 1973. Actually, I would hypothesize that in 1973, the
imbalance between the world’s concentration of GDP and the world’s concentration of population
was the highest the industrialized world ever winessed.
This extreme geographical inequality in world GDP has formed the basis of the unilateral focus of
both social scientists and policy makers on domestic competitiveness and in particular on
technological competitiveness as the essential feature for a country’s future economic growth.
As Ulrich Beck put it: “The consequences of globalization for sociology have been spelt out most
clearly in the English-speaking countries, but above all Britain, where it has been forcefully argued
that conventional social and political science remains caught up in a national-territorial concept of
society. Critics of ‘methodological nationalism’ have attacked its explicit or implicit premise that the
national state is the ‘container’ of social processes and that the national framework is still the one
best suited to measure and analyse major social, economic and political changes. The social
sciences are thus found guilty of ‘embedded statism’ and thought is given to a reorganization of
the interdisciplinary field”.
China and India’s late
industrialisation
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However, the recent rapid industrialisation of China and India appear e.g. from the
available Cambridge world economic model simulations (Izurieta and Singh, 2008)
non-sustainable. It will ultimately lead to financial imbalances with a huge current
account deficits for the U.S. economy but also other resource constraints.
Furthermore from an environmental perspective at current levels of technology,
growth rates of 3% per annum in the advanced G7 countries and rapid sustained
growth in emerging economies are unsustainable in terms of agriculture production,
access to water and climate impact.
At the same time, fast economic growth in India and China appears a social necessity
because of the need to shift hundred of millions of people from farms to industry. In
the Indian case there is an additional compulsion of providing jobs for a labour force
which is growing at 2% per annum.
The advent of the ICT revolution in the 90’s has radically challenged the nationalterritorial bias in research and policy making. The cluster of ICT represents from a
global perspective a historically unique process of technological, organisational and
above all social transformation in terms of speed and world-wide impact. A level
playing field in aspirations: in consumption, income and quality of life.
G-5 share of population and GDP
Percentage share of world population
Year
1820
1870
1913
1950
1973
2001
2006
China
36.6
28.1
24.4
21.7
22.5
20.7
20.2
India
19.9
17.0
14.2
14.8
14.8
16.5
16.9
Brazil
0.4
0.8
1.3
2.1
2.6
2.9
2.9
South Africa
0.1
0.2
0.3
0.5
0.6
0.7
0.7
Mexico
0.6
0.7
0.8
1.1
1.5
1.7
1.7
Total
57.6
46.8
41.0
40.2
42.0
42.5
42.3
Brazil
0.4
0.6
0.7
1.7
2.5
2.7
2.4
South Africa
0.1
0.2
0.4
0.6
0.6
0.5
0.5
Mexico
0.7
0.6
0.9
1.3
1.7
1.9
1.8
Total
50.1
30.6
18.3
12.3
12.5
22.8
27.4
Percentage share of world income
Year
1820
1870
1913
1950
1973
2001
2006
China
32.9
17.1
8.8
4.5
4.6
12.3
16.8
India
16.0
12.1
7.5
4.2
3.1
5.4
6.1
Source: Deepak Nayyar (2008) based on data from Maddison (2003); Maddison(forthcoming)
The 21st Century and some EU
international implications
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The advent of the ICT revolution in the 80’s and 90’s has radically challenged the
national-territorial bias in research and policy making. The cluster of ICT represents
from a global perspective a historically unique process of technological,
organisational and above all social transformation in terms of speed and world-wide
impact.
In a certain way this means that compared to GDP as in the past, population is likely
to become the indicator of future market opportunities.
For countries like the EU ones, it means that their future global role will decline, first
because decline of share in world population, given the demographic structure of EU
population with the ageing of the baby boomers, and second because likely relative
lower labour based GDP growth compared to emerging economies.
Migration and/or enlargement should from this perspective be seen as an important
future additional growth factor for the EU.
As Gijs Beets illustrated of the 15 most populated countries in 2025 (countries with
more than 100 million), not a single one will be a European country. In short, the EU
is primarily composed of small countries, and thus also small markets. Only if the EU27 would act as a singly country, as in the case of WTO, will the EU still play an
important international role.
The global knowledge challenge
Conclusions
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Crisis is unlikely to disappear with partial recovery of stock markets, interaction between real and
financial sector works both ways. Negative influence today and probably in the coming year from
the real economy to the financial sector.
Limited public sector room for further interventions… It will be essential for the Ministries of
Finance to get the surplus value on their financial participations. Danger of being governed by
strict but overly negative accounting rules.
Long term challenges to European knowledge investment. E.g. the European Barcelona 3%
R&D/GDP target arose from concerns that Europe’s industrial R&D appeared to lag too far behind
that of the other technologically leading countries such as the US and Japan. The assumption was
that more R&D carried out in Europe would be a crucial factor behind Europe’s attempt at
becoming the most competitive region in the world. It was always obvious that R&D as an
investment cost target is somewhat of an odd policy target. More important is the question what
the results are…
iT is time to think of a new Lund green R&D investment/GDP target whereby the focus would not
just be on research but also include knowledge diffusion and application. This new Lund target
would ultimately also have to focus on implementation outside of Europe. European
competitiveness will ultimately be most dramatically strengthened if doing so directly contributes
to the global grand challenges.
As European citizens we are ultimately dependent on the speed of (green) knowledge diffusion in
both our countries as well as those in the rest of the world.