Did Globalization lead to the current Economic Crisis Essay

Did Globalization lead to the current Economic Crisis - Essay Example Although many economists were predicting the crash, their predictions did not ignite any concern until it had happened. The recession has led to many assertions and analyses on the causes and events leading up to it. There has been a reevaluation of economic and financial models to ascertain the weaknesses in the system that were over looked. Similar to the stock bubble and dollar bubble, the financial bubble burst and took the global economy with it. The events that caused this financial bubble need to be analyzed. Many experts are of the view that globalization of financial and labor markets have led to the crash, while many argue that the lack of savings and investment in the real sector caught up with the financial market. This report will analyze all these views and aims to determine the effects of globalization on macroeconomic variables. The causes of the great recession The most common perception about the recession is that the financial crisis is responsible for it. Irrespon sible banking, lack of regulation, displaced optimism and a high debt burden led to the collapse of the US financial markets resulting in ripples all over the world due to the US being the biggest economy in the world. However, these perceptions form a part of the picture but are not the underlying cause of the recession. Many economists including Alan Greenspan did not anticipate this meltdown and the fall in real estate prices was considered a minor bump in the road. Economists were focused on the integration of the financial market and the innovativeness and complexity of new financial instruments. They were excited with the increased investment and spending and the only issue of concern was the rising current account deficit. Households in the US were riding a consumption boom based entirely on credit; household spending was based entirely on credit cards. Due to the housing boom and rising asset prices, Americans felt rich, they consumed more Chinese imports and bought more hou ses on mortgage. Interest rates were low and banks had excess liquidity to lend to subprime borrowers through collateral debt obligations. For policy makers and analysts the recession was a shock; however an analysis of various factors leads to the conclusion that the recession was imminent. According to Bezemer (2009), the ignorance about the recession stems from the use of equilibrium models in macroeconomic policy making and forecasting. He advocates the use of accounting models to explain macroeconomic flows. The use of the flow of funds model, that takes into account debt, which equilibrium models ignore, is necessary to identify the effects of rising asset prices. The recession, according to him and many other experts, is the result of rising asset prices and thus greater investment in financial assets than in the real sector. The illusion of wealth that was created by the rising financial asset prices, that include real estate and insurance as well, caused the private sector to borrow more against their assets. This resulted in consumption driven by increased asset prices rather than wages and incomes. This is proven by the fact that the share of wages and salaries as a percentage of GDP dropped from 49% to 46% from the year 2001 to 2007. The resulting increase in debt and its effect was not perceived by prominent economists. The growth in debt relative to growth in GDP was unsustainable and thus resulted in the bursting of the financial bubble. According to the flow of funds view, any surplus of wealth that households own will be