Much of the analysis of the current crisis has focused on financial institutions, regulation and monetary policy. Although these were important in shaping the crisis, they are not at its root.
The truth is that the world economy has changed in ways that are likely to lead to periodic instability. These changes have not yet been recognised and assimilated by central bankers or politicians.
The freeing of capital movements in the 1980s combined with the collapse of communism, releasing billions of new workers into the world economy, has recreated a global reserve army of labour. That in turn has contributed to a rise in the share of world GDP accounted for by profits and an accompanying decline in the share accounted for by wages. Such a development easily leads either to over-investment by businesses or a shortfall of aggregate demand. When wages lag, spending can keep up with output only by an expansion of consumer debt.
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