The global financial crisis and Covid-19: learning the lessons

Although the policy response to the global financial crisis prevented a repeat of the great depression, it left the global economy in a fragile state.  How would it cope with the next shock that was anticipated to arise from a renewed debt crisis in emerging markets, financial difficulties in China, or tensions within the eurozone?  The unexpected external shock from the coronavirus brutally exposed the lack of resilience in the global economy a decade after the financial crisis.  The policies adopted, and approaches ignored, after 2008 continue to resonate, and the financial crisis remains central to understanding the economic shock of the pandemic and the policy response that should follow.  The policy adopted after 2008 arose from the success of fiscal conservatives in blocking the brief period of fiscal expansion which had serious economic consequences over the next decade; and the policy debates that raged then will be repeated as the world emerges from the pandemic.  Can the same mistakes be repeated and steps be taken to correct the economic weaknesses?   

The coronavirus exposed the differential impact of mortality by age, ethnicity, and deprivation that arose from growing inequality of income and wealth, the insecurities of precarious employment, and the erosion of public services.  These trends were apparent before 2008 as deindustrialisation led to a loss of relatively secure jobs for workers without formal educational qualifications, and ‘intangible’ capital benefitted workers with formal credentials.[1]  These structural changes led to discrepancies in income and wealth, and reduced resilience, which the policy response to the global financial crisis did nothing to mitigate and much to exacerbate.

This outcome was not preordained.  When the G20 met in London in 2009, Gordon Brown, the British prime minister and host, called for a fiscal response.  He was opposed by Peer Steinbrűck, the German finance minister, who criticised Brown’s ‘crass Keynesianism’ for ‘tossing around billions’ that would burden future generations.  At home, Mervyn King, the Governor of the Bank of England, exceeded his authority in rejecting a fiscal stimulus: it would increase the size of the deficit and boost consumption, so hindering the long-term need for British and American economies to save and invest, to reduce household and bank debt, and to resolve the trade deficit by shifting from domestic spending to exports. He insisted that ‘monetary policy should bear the brunt of dealing with the ups and downs of the economy’, and that was what happened.[2]

The case against fiscal stimulus and deficits was justified by Alberto Alesina who argued that reducing the deficit by an increase in high taxes would be ‘deeply recessionary’ and that taxes would continue to grow as a result of automatic, inflation-linked entitlements.  By contrast, cuts in spending would be more successful in reducing the deficit, removing uncertainty, restoring confidence, encouraging investment, and avoiding an unfair redistribution between present and future generations.  Gains from private consumption and investment could be larger than cuts in government spending and would therefore lead to higher output.[3]   Similarly, Ken Rogoff and Carmen Reinhart argued that data from 44 countries over 200 years showed that a ratio of national debt to GDP above 90 per cent reduced growth by 2 per cent.[4]  Politicians on the right, such as George Osborne, seized on the ’90 per cent rule’ to argue that an inexorable rise of debt threatened low growth and national bankruptcy.  Osborne duly embarked on a policy of austerity when he became Chancellor of the Exchequer in the British coalition government in 2010.

These economic arguments were flawed.  Alesina ignored the distributional consequences of tax increases versus spending; he overlooked the fact that current spending can leave more assets for future generations; and he neglected the harm of austerity on both young adults unable to secure work and the elderly whose mortality increased.  And was it really the case that private consumption would increase when many workers were experiencing economic hardship?  Much depended on circumstances.  A cut in public spending to balance the budget might lead to growth if debt, interest rates and taxation were all high (as they were in Italy in the 1980s and 1990s), but not necessarily in other circumstances.[5]  Oliver Blanchard and Daniel Leigh of the IMF found that a reduction in spending or tax increases of one Euro would reduce GDP by almost 2 Euro and not, as previously estimated, 0.5.[6]  Austerity and tax increases after 2010 therefore reduced GDP and drove economies into recession; unemployment rose and households had less to spend, and the short-fall was not taken up by the government.  As growth fell, so the ratio of national debt to GDP rose from what it might otherwise have been.  Fiscal expansion would have been a sensible option.

Similarly, the supposed relationship between growth and national debt was bad history.  Reinhart and Rogoff lumped countries and periods together regardless of circumstances, and their ignorance of context offers a warning when attention turns to the higher levels of debt after covid-19.  The case of Britain since the eighteenth century shows that their ‘rule’ was misguided.  Peaks in debt arose from warfare in the Napoleonic and world wars, and the way that debt was subsequently reduced differed.  After 1815, the reduction of national debt from over 200 per cent of GDP to around 25 per cent by 1913 was largely the result of economic growth; by contrast, inflation had no role in reducing the real burden, for prices were no higher at the close of the period.    There was also an initial period of political unrest over the burden of the debt, for war-time income tax expired in 1816 so that the cost of debt service came from taxation of producers and workers, with a transfer to landed aristocrats and rentiers.  During the First World War, debt again rose above 200 per cent of GDP.  Now, growth was less significant for the economy experienced a decade of low growth as a result of the collapse of the global economy, adoption of high interest rates to bolster sterling in preparation for a return to the gold standard at an overvalued rate, and the emergence of competition which led to over-capacity in major industries.  ‘Financial repression’ was not an option – that is, low interest rates and diversion of savings into government funds by capital and exchange controls – for the government’s strategy was to maintain open international financial markets.  The costs of servicing the debt was high and falling prices after the post-war boom held up the ratio of national debt to GDP.  Nevertheless, the high costs of servicing the national debt was met by ensuring that the tax regime was perceived as equitable between classes and interests.  A similar level of debt after the Second World War coincided with rapid economic growth stimulated by war demand and facilitated by recovery of the global economy because of cooperative action.  The cost of debt service was reduced by low interest rates and financial repression that was now permitted by exchange and capital controls, and was paid from taxation that shifted income to poorer members of society which created greater equality of income and wealth, and increased consumption.  At the same time, inflation contributed to reducing the debt burden: about 30 per cent of the fall in the debt ratio to 2008 was a result of growth and the remainder from inflation.[7]  The political economy of debt and its relationship with growth therefore depended on circumstances – and this point needs to be recognised in dealing with the costs of covid-19 when the arguments used to justify austerity after the global financial crisis might return. 

Although a selective reading of economics provided intellectual justification for opposition to fiscal expansion, the policies were pursued for other reasons.    Mark Blyth, a leading critic of austerity, explained that the politics of debt became a morality play that ‘shifted the blame from the banks to the state.  Austerity is the penance – the virtuous pain after the immoral party – except it is not going to be a diet of pain that we shall all share.  Few of us were invited to the party but we are all being asked to pay the bill’.  The rhetoric of austerity shifted blame from the banks to a bloated and inefficient public sector and overly generous welfare.[8]    On this view, it was a cynical tactic of ‘bait and switch’.  Paul Krugman commented that the rejection of fiscal expansion was ‘the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times’.[9]    In both the great depression and global financial crisis, house prices in the United States fell by a third from peak to trough; in the former, mortgagees were assisted by the federal government and banks were regulated; in the latter, state intervention was presented as a problem rather than cure (despite a massive state bailout of bankers).[10]  The political economy of fiscal orthodoxy in Germany had a different rationale, for taxpayers would not do for southern Europe what they had done for East Germany after reunification.  Merkel was also concerned that the German – and European – population was ageing so that the crucial issue was not to boost domestic demand which would undermine competitiveness and pass the burden to future generations.   The solution was to export and accumulate a surplus.  In 2009, the Bundestag adopted a constitutional amendment to impose a rigid fiscal rule.[11]

Both Britain and the United States, which initially adopted a fiscal stimulus, now changed their approach.  At Toronto in June 2010, the G20 announced a commitment to ‘growth-friendly fiscal consolidation’ and argued that ‘failure to implement consolidation where necessary would undermine confidence and hamper growth. Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016’.[12]   The rejection of fiscal expansion had serious consequences that continue to resonate.  Merkel and Schauble adopted a rigid stance during the crisis of the eurozone: no budget deficits, no common European debt issuance and no European fiscal union.  The result was slow recovery and serious austerity in southern Europe, with a risk that when the next crisis arrived the fundamental issues of the eurozone had not been resolved.  The commitment to reducing public debt intensified the recession, whereas a fiscal stimulus would have allowed more investment in infrastructure and compensated for the reduction in consumption. 

The policy adopted in the United States and Britain, and eventually in the European Union, had serious distributional consequences that contributed to the fragility of the economy in 2020.  Quantitative Easing was necessary to prevent the collapse of the financial system but exacerbated other problems.  It led to higher asset prices that benefitted the richest 10 per cent or so; their assets and income rose in an upward spiral and they had a lower propensity to consume.  The result was a savings glut of the rich.  In contrast, austerity – as well as economic change that led to greater precarity – meant that the lower 90 per cent of the income distribution turned to private debt and ‘dissaving’ to maintain consumption.   As their debt rose, so they had greater difficulties in maintaining their spending with the result of economic fragility – and the government did not step in with sufficient public spending to maintain consumption.[13]  In the New Deal and Second World War, taxation contributed to reduced inequality of income and wealth; after the global financial crisis, corporation taxes were reduced and disparities continued to grow with resentment and disillusion that fed into populism and economic nationalism.

The imbalance was also apparent in China whose economic development rested on unusually high savings and a low level of household consumption, as a result of low interest rates, regressive taxation, a need to supplement weak welfare provision, and gains by the party and business elite.  Before the global financial crisis, the savings fuelled domestic investment and the current account surplus, with funds flowing into the United States to fuel the subprime market.  After the crisis, China provided a massive fiscal stimulus which prevented another great depression.  ‘Keynesianism with Chinese characteristics’ involved local and regional governments embarking on ambitious schemes for investment in the infrastructure.  Domestic consumption was encouraged by subsidies to rural households to purchase large domestic appliances.  The result was the largest single stimulus to the world economy.[14]  China’s fiscal stimulus prevented the recession from being any deeper but distorted investment and created a fragile shadow banking system with a high level of non-performing loans.   Household consumption remains low, with a continued savings glut – but without profitable opportunities for investment.  The outcome could be a further round of wasteful investment based on credit with a risk of financial crisis; the export of goods with a massive external surplus that will cause tensions with the United States; or a shift of incomes to boost consumption by poorer households that will require a major change in policy.

 The other major saver was Germany, where household consumption was stagnant before the global financial crisis, the government held down its spending, and the economy produced a large external surplus.  The outcome was lending to the United States to fuel subprime mortgages and to other countries in Europe – Greece, Spain, Italy – to create unsustainable credit and consumption.  The response to the eurozone crisis did not help, for Germany did not boost its own consumption and enforced austerity on other members of the eurozone.   The foundation flow of the absence of a fiscal union alongside monetary union was not addressed.  Fiscal transfers needed to be higher in Europe because labour mobility was lower than in the United States; in fact, transfers were much lower.  In February 2020, the so-called ‘frugal four’ of Austria, Denmark, Sweden and the Netherlands aimed to limit the EU budget to 1 per cent of GDP compared with their own revenues of 48, 52, 49 and 44 per cent of GDP.  This ratio of 40 or 50 to 1 between state and federal revenues contrasted with a ratio in the United States of 1 to 2 between state/local and federal spending.  A much larger European Union budget is needed to deal with structural change, environmental sustainability, education, health care and research and development, at a time when inequalities between regions cause strain.[15]  This approach was anathema in Germany which tried to extend its own fiscal conservatism to the rest of the EU.   

When covid-19 hit, the problem of the savings glut had not been resolved: it existed before the global financial crisis, and the policy response had done nothing to resolve the problem either within individual countries or in the imbalance between global savers and debtors.   The major question is whether the crisis of covid-19 can allow an escape from the problem of the savings glut and low consumption that was not taken after the global financial crisis? 

  Despite austerity, automatic payment of welfare benefits and low growth meant that national debt rose in most OECD countries after the financial crisis.  In France, it increased from 87.8 per cent in 2011 to 98.4 per cent in 2018, in Italy from 119.7 to 134.8 in Italy, in the United Kingdom from 80.1 to 85.7, and in the United States from 99.8 to 106.9.  The exception was Germany where the level fell from 79.8 to 61.9 per cent. Debt levels were already high before covid-19 and are set to rise closer to war levels.  In April 2020, the IMF’s tentative initial estimate was that by 2021 the debt to GDP ratio would rise to 116.4 per cent in France, 150.4 per cent in Italy, 95.8 per cent in the UK, 131.9 in the US but only to 65.6 per cent in Germany. [16]   The figures are estimates whose accuracy will depend on the trajectory of the pandemic, the speed of recovery, and political choices.

Many commentators, politicians and economists now accept that rejection of fiscal expansion after 2010 resulted in weak public services and contributed to the disparities of the virus.  On the other hand are those who argue that the level of debt is unsustainable and that it will exacerbate the generational divide of the pandemic.  Why should the younger generation be left to pay for high levels of debt when their prospects are employment are reduced and growth might be suppressed?  Adam Tooze rightly thinks that the question of repayment ‘will decide the complexion of our politics, and the quality of our public infrastructure and services for years to come’  He fears that the level of covid debt can be a ‘battering ram’ for a new campaign of austerity and ‘conservative scaremongering’.[17] In April 2020, Gordon Brown reflected on his failure to sustain the case for fiscal expansion after 2008, and called for his successors to avoid making the same mistake again.[18]

                Although the generational divide is serious, the solution is not a return to austerity to reduce debt.  The real burden of debt can be reduced by moderate inflation as after 1945.  The (largely unjustified) fear of inflation led to caution in stimulating demand after the financial crisis.  Of course, rapid inflation as in Germany in the early 1920s created social dislocation and resentment as fixed incomes and savings were eroded.  Equally, the pursuit of price stability since the late 1970s benefitted creditors and increased the real burden of debt.  The solution is a careful calibration of central bank intervention to allow a modest level of inflation that can, as after 1945, gradually reduce the level of debt and stimulate consumption.

The cost of servicing the debt then needs to be held down, as it was by low interest rates and financial repression after 1945.  The policy became mor difficult with the resurgence of international capital markets and financial flows from the 1970s, but Quantitative Easing has led to a decade of low interest rates that is not likely to be reversed soon.   It is not only a policy choice by central bankers but a structural issue: the savings glut of the rich led to downward pressure on interest rates to balance the supply and demand for savings. The risk of higher rates can be reduced by extending the duration of bonds or making them perpetual.   It is therefore possible to live with the larger national debt, provided that annual deficits are reduced enough to stabilise its level – and this can be achieved by increases in taxation rather than cuts in spending.

Low interest rates and the glut of savings are not without problems, for they reflect large disparities of income and wealth that have been exacerbated by rising assets prices created by quantitative easing.  The economy was vulnerable prior to the pandemic because of high levels of household and corporate debt which led to the global financial crisis and continued afterwards. The focus on public debt distracted attention from the real problem: an increase in household debt to maintain consumption and in corporate debt to fund stock buybacks, embark on mergers and acquisitions, increase profits, and pay higher dividends.  Indebtedness rose in line with inequality.  What was needed after the global financial crisis, and could be achieved now, is a set of policies that creates greater equality to remove the savings glut of the rich, so allow consumption to rise without the need for higher levels of household debt, and removing the incentive for corporate leverage. 

This change could encourage economic growth which was the main reason for the reduction in the level of the national debt after the Napoleonic wars and a major cause after 1945.  Excessive fiscal consolidation after 2010 reduced growth and damaged productivity and made the debt burden worse.  American and European economies suffered from low growth and stagnating productivity and the policies adopted after 2008 failed to provide solutions to low growth and stagnating productivity in the United States and Europe and might have made matters worse.  The rebalancing of economies might stimulate investment and growth and remove risky reliance on corporate debt to maintain profits and household debt to maintain consumption.  Of course, redistribution and the removal of the savings glut might lead to higher interest rates and an increase the costs of servicing the national debt in the longer run, but in the short to medium term low interest rates can be locked in as the debt ratio is reduced by faster economic growth.

Faster growth will mean changing the tax regime.  In some countries, the level of taxation is low which provides more fiscal headroom to raise taxes rather than cut spending: the level of taxation as a share of GDP in France is about twice that of Ireland which therefore has more fiscal headroom.  But the issue is not only the level of state revenue, for the structure of taxation and perception of fairness are also important, as we noted at the end of the Napoleonic wars in Britain.  Tooze correctly comments that ‘who pays taxes – and who does not – remains one of the most urgent questions of the moment.  A world in which coronavirus debts are repaid by a wealth tax or a global crackdown on corporate tax havens would look very different from one in which benefits are slashed and VAT is raised.  And it is very possible that debt service will be taken out of other spending, whether that be schools, pensions or national defence’.[19]  What tax regime will permit faster growth and encourage productivity?

A redistributive strategy to remove the savings glut of the rich and transfer consumption to the rest of society will require a major shift to a more progressive pattern of taxation and spending in the United States on the lines of the New Deal; and a return in Britain to something more like the pre-Thatcher period.  In China, it will require greater benefits for migrants from the country to the town, improved welfare benefits and workers’ rights, and a shift in taxes to the rich.  Abolishing tax deductibility of corporate debt could discourage a reliance on financial leverage.  Action could be taken against multinational corporations who erode the fiscal base by shifting their profits to low tax regimes – and taxes could be introduced on the rent-seeking behaviour of digital and tech companies. A wealth tax could capture the gains of rising assets from Quantitative Easing and break the upward spiral of inequality.  ‘Green’ taxes on carbon and congestion would ensure that growth did not come at the expense of the planet.  The revenue from higher or restructured taxes could then be spent in ways that encourage an economic transformation by giving incentives to green technology, better education and training, and improved physical and social infrastructure to regenerate declining industrial areas.  The failure to tackle these issues after 2008 contributed to the economic fragility and populism that hindered the response to the pandemic.

None of these changes will be easy, but they are not impossible.  The Chinese Communist party’s main aim is to maintain social order and power, so a shift in its policy is not implausible – and the outcome n the United States might change with the demands of younger members of the Democratic party.   There are also signs of change in the European Union away from the refusal of Germany to transfer resources or to stimulate domestic consumption that limited the response to the crisis of the eurozone.  Concern about the bond purchasing programme of the European Central Bank was raised in the German constitutional court and passed to the European Court of Justice which supposed the policy.  The issue was returned to the German constitutional court which decided in May 2020 to reject the ECJ’s judgement – a potentially devasting blow to the ECB’s response to the pandemic that caused outrage in Spain and Italy.   The decision was economically perverse but the court’s defence was that it interpreted the law which democratically elected politicians should change.  There are indeed signs that the German finance ministry is shifting its position, starting even before the pandemic.  The new finance minister, Olaf Scholz, appointed a chief economist – Jakob von Weizsacker – who had proposed in 2011 that debt up to 60 per cent of GDP should be pooled among participating countries, with additional debt remaining a national responsibility.  Covid-19 pushed Scholz to accept the need for fiscal stimulus and a eurozone package which he claimed, with considerable exaggeration, was Europe’s ‘Hamiltonian moment’.  In 1790, Hamilton mutualised existing debt which Scholz’s proposal does not.  It does allow joint issuance of debt, but as an emergency measure, and there is no sign that the EU will have major tax-raising powers or a single finance minister.  The ‘frugal four’ remain doubtful – and the electoral risks in Germany are high.  The proposal might succeed only because it is not a ‘Hamiltonian moment’.  At least it is symbolic, as the German deputy finance minister put it, as ‘a significant signal to Europe that we’re serious about the idea of solidarity’.[20]

Solidarity is needed not only in Europe, for even before the covid-19 crisis there were warning signs of a crisis of debt in emerging and developing economies, with some countries close to default and unable to borrow more on international markets.  In 2020, the World Bank worried about ‘a global wave’ of private and public debt in developing and emerging markets that was fuelled by the savings glut: the level of debt was higher than in previous waves of indebtedness over the previous 50 years, each of which led to a crisis.[21]  The problem if not only the scale of debt but a shift in its character.   In the 1980s and 1990s, creditors were banks and governments; now more debt is owned by bond funds who are reluctant to reschedule and more inclined to hold out.  Members of the ‘Paris club’ of official creditors can negotiate a deal with debtor governments – but the largest official creditor – China – is not a member and is suspected of using loans to further its strategic aims. The emerging market debt was an issue before covid-19 and is much more serious and the prospects of international institutions reaching agreement to prevent another devastating debt crisis and wave of default are slight given American hostility to multilateral institutions.[22]  

The continued implications of policies adopted after the global financial crisis mean that it has not receded into history.  Rather, the policies left economies in a fragile position.  In Europe and the United States, weak growth and productivity was combined with a savings glut for the rich and debt-funded consumption for the rest, and with an obsession with austerity and the public debt rather than the inequalities that fuelled private indebtedness.  The crisis of the eurozone and the need for fiscal transfers was not resolved; and both China and Germany continued to build up savings and surpluses. The need after covid-19 is to adopt policies that were rejected after 2008 in order to provide a better foundation for high and sustainable growth in a green economy where GDP is not at the expense of climate change, and with the benefits more widely distributed.

[1] Jonathan Haskel and Sian Westlake, Capitalism Without Capital: The Rise of the Intangible Economy Princeton and Oxford, 2018; Jim Tomlinson, ‘De-industrialization Not Decline: a New Meta-narrative for Post-war British History’, Twentieth Century British History 27 (2017), 76-99

[2] George Parker and Bertrand Benoit, ‘’Berlin Hits Out at “Crass” UK Strategy’, Financial Times,10 Dec 2008  Adam Tooze, Crashed: How a Decade of Financial Crises Changed the World London, 2018, 272-3

[3] Alberto Alesina, Carlo Favero and Francesco Giavazzi, Austerity: When it Works and When It Doesn’t Princeton and Oxford, 2019

[4] Carmen Reinhart and Kenneth Rogoff, ‘Growth in a Time of Debt’, NBER Working Paper 15639, Jan 2010

[5] Barry Eichengreen, Hall of Mirrors: The Great Depression, the Great Recession, and the Uses – and Misuses – of History New York, 2015, 10.

[6] Oliver Blanchard and Daniel Leigh, ‘Growth Forecasts and Fiscal Multipliers’, NBER Working Paper 18779, Feb. 2013

[7] Nicholas Crafts, ‘Reducing High Public Debt Ratios: Lessons from UK Experience’, Fiscal Studies 37 (2016), 201-223; Duncan Needham, ‘Covid-19 and the UK National Debt in Historical Context’, at

[8] Mark Blyth, Austerity: The History of a Dangerous Idea New York, 5, 7, 13-16.

[9] Paul Krugman, ‘The Third Depression’, New York Times 28 June 2010

[10] Eichengreen, Hall of Mirrors, 250-2

[11] Tooze, Crashed, 96-7, 286-9

[12] Martin Wolf, The Shifts and the Shocks: What We’ve Learned – and Have Still to Learn – from the Financial Crisis, London, 2014, 257

[13] Atif Mian, Ludwig Traub and Amir Sufi, ‘The Savings Glut of the Rich and the Rise in Household Debt’, NBER Working Paper 26941, April 2020

[14] Tooze, Crashed, 243-54

[15] Jeffrey Sachs, ‘The World Needs a Prosperous and Properly Funded Europe’, Financial Times, 19 Feb 2020

[16] IMF Fiscal Monitor, April 2020, table A7 at

[17] Adam Tooze, ‘Should We Be Scared of the Coronavirus Debt Mountain?’, Guardian 27 April 2020

[18] Guardian 16 April 2020

[19] Tooze, ‘Should We Be Scared?’

[20] Guy Chazan, ‘The Minds Behind Germany’s Shifting Fiscal Stance’, Financial Times 9 June 2020; Ben Hall, Sam Fleming and Guy Chazan, ‘Is the Franco-German Plan Europe’s “Hamiltonian” Moment?’, Financial Times, 21 May 2020

[21] M Ayhan Rose, Peter Nagle, Franziska Ohnsorge and Naotaka Sugawara, Global Waves of Debt: Causes and Consequences Washington DC: World Bank, 2020

[22] Colby Smith and Robin Wigglesworth, ‘Why the coming emerging markets debt crisis will be messy’, FT 12 May 2020; Patrick Bolton, Lee Buchheit, Pierre-Olivier Gourinchas, Mitu Gulati, Chang-Tai Hsieh, Ugo Panizza and Beatrice Weder di Mauro, ‘How to Prevent a Sovereign Debt Disaster: A Relief Plan for Emerging Markets’,  at