BY Jan Toporowski Since 2008 financial crisis is said to be everywhere, and the present crisis is definitely the worst to have hit the world since the 1930s. Politicians in crisis-hit countries like to refer to it as an ‘international crisis’, since th …

Walton Pantland

BY Jan Toporowski

Since 2008 financial crisis is said to be everywhere, and the present crisis is definitely the worst to have hit the world since the 1930s. Politicians in crisis-hit countries like to refer to it as an ‘international crisis’, since this obscures those politicians’ part in what often was a domestically-generated crisis (as in Ireland and Iceland for example). Similarly, financial crisis gives bankers a convenient excuse for their incompetence or irresponsibility, and businessmen like the crisis talk, because it makes their mundane work of making money appear more heroic than it does in more prosperous times.

What is financial crisis?


Financial crisis arises when a business, bank or financial institution, household or government cannot meet the payments on their financial obligations. In that situation, businesses, banks or financial institutions may be forced into liquidation, that is their assets sold to raise money to pay off the obligations; and households may lose their home if it is repossessed by the lender. Governments, because they are sovereign, have the unique privilege that they may simply refuse to pay their debts, i.e., default.

These days, it is not the crisis of individual businesses, banks, financial institutions or households that worries people. Much more serious is the possibility that a sufficiently large number of such individual ‘economic units’ may fail to meet their payments obligations so that the economy as a whole goes into decline. Then unemployment and poverty increase, and the remaining businesses struggle to make even minimal profits.

The possibility that a large number of individual businesses or households will fail has greatly increased since the twentieth century because of the widespread use of credit, or bank account money, in modern economy. In banking systems, credit is backed by debt. Typically, indebted households and businesses don’t have credit equal to their debt, and this is why they may get into difficulty. During the 1920s, in Europe and North America, there were huge increases in indebtedness, which turned bad after the 1929 Crash, when households and businesses lost their incomes and couldn’t repay their debts, or even pay interest on them.

Who is affected?
Debt affects different people, businesses, banks and financial institutions in different ways. If they are wealthy they will have assets (saleable property and financial wealth) that can be sold to meet debts. If this happens on a sufficiently large scale, the selling may drive asset prices down so that debts cannot be repaid. If they are not wealthy, or the wealth is insufficient, then debts have to be paid, or interest paid, out of income. When people receive income but do not spend all of it, then this becomes a drag on economic activity.

Businesses which put money into circulation by employing people or buying from other businesses, find that they do not get back as sales revenue all the money that they put into circulation in the form of costs of production. If revenue is less than costs, then a business is making a loss, and may eventually close, if it runs out of savings (or reserves) or cannot borrow to get by.

Banks and financial institutions are peculiar because they borrow and lend so much from each other, through institutions like the inter-bank market. If one bank or financial institution cannot meet payments on one day, this can quickly spread and paralyse the banking system, as happened in 2008 when Lehman Brothers failed to make payments. Such a crisis then spills over into the rest of the economy because the large corporations that use the more sophisticated financial markets, and regularly refinance their ‘positions’ (or financial obligations) through those markets, may find themselves unable to refinance or roll over short-term debt.

In this situation, large businesses will typically cut back on the investment in new production facilities. This immediately cuts the sales revenues of other businesses producing investment or construction equipment, hence employment and incomes in those other businesses. It was this kind of reduction in investment that spread the depression in the 1930s, and has done so since 2008.

The situation of governments is different. In the past, governments could borrow from what was their banker, the central bank. This is nowadays frowned upon as ‘inflationary’ and central banks in Europe, for example, are strictly forbidden to lend directly to governments. However, central banks can still lend to commercial banks money which they can lend on to governments. Such indirect lending has sustained government finances in Europe and North America since 2008.

As long as the government debt is in its domestic currency, a government can get by through raising tax revenue, or borrowing through its domestic banking system. The problems for governments arise if they borrow in foreign currency, because foreign banks may refuse to lend more; or if unrealistic ceilings on government debt or borrowing are imposed, as happens in the European Monetary Union, or the Euro-zone.

Issues for Trades Unionists
Financial crises pose particular difficulties for trades unionists. Chief among them is pay. The view that prevails among economists and politicians is that the way out of crisis is for workers to take pay cuts. This is muddled thinking promoted by very short-sighted employers. Pay cuts reduce income, and reduce the ability of workers and their families to service their debts. Pay cuts force workers to reduce their consumption and this reduces employment in consumer industries and services.

The ‘workers’ friends’ among employers will say that this will make business more competitive and there will be more employment in export business. But it is unlikely that more jobs will be created in export trades than will be lost through reduced consumption. In fact, in financial crisis, pay increases become even more essential, to create more consumption, jobs and incomes, in order to enable indebted households and firms to service their debts more easily.

A second set of issues arises out of the increased unemployment due to cuts in business investment by over-indebted firms. The only way out of this is for the government to undertake large-scale public works that can replace private investment, and even ‘force’ such investment by companies contracted to work on public projects. This was done in the United States under the New Deal and certainly helped, even if it did not altogether eliminate unemployment.

Finally, there are issues arising out of reductions in government expenditure due to fear that government debt may be getting too big. Such austerity policies are as self-defeating as pay cuts. They make the situation worse rather than better, because incomes are reduced even before the government budget can raise a surplus out of which to start repaying its debt.

However, there is no doubt that on the tax side, more imaginative policies may help to keep government debt under control. Cracking down on tax avoidance, among the wealthy and business, can raise money. So too can carefully targeted taxes on capital, or bank balance sheets. All these tax measures have the advantage that they can raise government revenue without causing reductions in spending or incomes in the economy.

*Jan Toporowski is Head of the Economics Department at the School of Oriental and African Studies, University of London. He has worked in fund management, international banking and central banking. His latest book is ‘Why the World Economy Needs a Financial Crash’ and Other Critical Essays on Finance and Financial Economics (Anthem Press 2010).


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Walton Pantland

South African trade unionist living in Glasgow. Loves whisky, wine, running and the great outdoors. Walton did an MA in Industrial Relations at Ruskin, Oxford, and is interested in how trade unions use new technology to organise.

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