Although Sweden is a small country, its experiences managing its financial crisis of the early 1990s may provide valuable lessons for others.
The Swedish crisis began in 1991 with the first major insolvency in the financial market. A number of damaging developments followed:
Most of the banking system fell into deep crisis. One bank went into liquidation, while the rest of the system required extensive governmental emergency aid.
Property values fell by approximately 35 percent over four years. Equities fell by 55 percent over a three-year period.
Despite the central bank’s 500 percent interest rate, it was impossible to defend the Swedish krona, which was pegged to the euro’s forerunner, the European Currency Unit or Ecu. The krona depreciated by around 25 percent in the autumn of 1992, a year after the crisis began.
The crisis triggered a sharp economic downturn. GDP fell by 7 percent over three years, and unemployment rose by 7 percent over five years.
During a three-year period, government debt increased by about 50 percent, with the public deficit reaching 12 percent of GDP. Falling GDP led to declining tax revenues, while rising unemployment led to an automatic increase in public expenditure.
Although the crisis that began in the US in 2007 has since spread worldwide, the outlook for the US economy is clearly crucial to eventual global recovery. If we assume that the US is experiencing a typical financial crisis, GDP will fall this year as well. Unemployment can be expected to peak at around 12 percent, and gross public debt will have increased by 50 percent, which corresponds to around 90 percent of GDP.
If the US follows the Swedish pattern, the worst of the financial sector’s problems are now in the past. However, in terms of fiscal problems and real economic decline, the US would still have most of the crisis ahead of it.
In Sweden, the decline in GDP lasted for three years, and the economy was then lifted by a dramatic increase in exports, owing to the sharp depreciation of the krona, with annual industrial output rising by around 10 percent on average over two years.
The US is not likely to repeat this experience. Financial crises and currency crises are often linked, but we have not seen this in the US. Instead, paradoxically, the dollar has at least until recently been bolstered somewhat by the crisis. Although the US is the epicenter of the crisis, its government debt instruments continue to be regarded as the safest investments in the world.
Will America’s widening fiscal deficit alter this perception? One can imagine two scenarios for the dollar over the next five years. In the first, the dollar retains its position or perhaps even rises slightly. In the second, the decline in the US economy and growing fiscal problems lead to a sharp fall in the dollar. Some estimates show that it would take a 40 percent depreciation of the dollar to bring US foreign payments into balance.
Neither scenario is good for Europe — or for the rest of the world. In recent decades, the fast-growing Asian economies, as well as EU economies such as Germany and the Nordic countries, have made export-led growth their primary economic strategy. As a result, growth in those countries is dependent on US demand, and their industrial sectors have become too large to be compatible with long-term balance.
So both these scenarios seem to preclude export-led growth as a successful strategy. In any case, rich European countries will suffer a permanent structural decline in manufacturing: Much of the decline that we now see in European manufacturing is not the result of temporary economic movements but is part of a long-term adjustment of the industrial sector’s size.
Although the bigger EU countries have embarked on a policy to protect their industries as long as the crisis continues, they will doubtless be unsuccessful, because no country can ultimately halt structural adjustment by offering subsidies. Moreover, protectionist measures will increase fiscal problems and this will ultimately deepen the international downturn and delay recovery.
But it is too easy to say what should not be done. In the absence of any “miracle” cure, the medium-term aim should be to renew and strengthen the framework for international economic and trade cooperation. A significant cause of the current crisis was the imbalances in international trade and capital flows that built up over many years, without anybody taking responsibility for the consequences.
Remedial action in Europe should include completing the internal market. Only when Europe has a dynamic internal market can balanced European growth occur. Achieving that goal is more important than ever, because it will be some time before the US can re-assume the role of locomotive for the world economy.
Urban Backstrom is director general of the Confederation of Swedish Enterprise and a former state secretary in the Ministry of Finance who was charged with managing the 1991 to 1993 Swedish banking crisis.
Copyright: Project Syndicate
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