Why are we in a recession? The Financial Crisis is the Symptom not the Disease! October 2009 G lobal izat ion has brou ght a shar p increase in the develope d wo rld’ s labor supply . Labor in developing countries – countries with vast pools of underemployed people – can now more easily augment labor in the developed world, without having to relocate, in ways not thought possible only a few decades ago. We argue that this large increase in the developed wo rld’s effecti ve labor supply, triggered by geo-political events and technological innovations, is the major underlying cause of the globa l macro econo mic imbala nces that led to the grea t reces sion. The inabilit y of existing institutions in the US and the rest of the world to cope with this shock set the stage for the great reces sion: The inab ilit y of emerg ing economie s to abso rb savin gs throu gh domes tic investme nt and consumption due to inadequate national financial markets and difficulties in enforcing financial contracts; the currency controls motivated by immediate national objectives; and the inability of the US economy to adjust to the perverse incentives caused by huge money inflows leading to a brea kdow n of checks and balance s at variou s financ ial institu tions. The financia l crisis in the US was but the firs t acute sympto m that had to be tre ated. A sus tainable rec overy wil l onl y occu r when the natural flow of capital from developed to developing nations is restored. 1
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