And if debtors recognise that risks in contracts will not be enforced, they will no longer have incentives to price risk and exercise discipline themselves. So it has been for well over a century. There are many examples of time-inconsistencies in the private debt contracts issued by banks. Uncalled capital and reserve liability were banks’ loss-absorbing contract of choice in the late 19th and early 20th centuries. They ultimately proved ineffective and were abolished. Why? Because managers feared that invoking these instruments, at precisely the time they were most needed, might make a bad situation worse. This is time-inconsistency writ large. BIS central bankers’ speeches  7  A century on, hybrid bank debt instruments fell into the same trap. They gave bank management the option to rollover debt automatically in the event of stress. In principle, this option had insurance value in a situation of liquidity stress. In practice, facing the liquidity crunch of 2008, banks failed to exercise this option at just the point it was most valuable. Why? Because they too feared scaring creditors and making a bad liquidity situation worse. Hybrid debt, too, was time-inconsistent. Time-inconsistencies in public policies regarding bank debt have been every bit as acute. Both liquidity and deposit insurance have a long and revealing history. Liquidity insurance by the central bank was firmly established in the UK by the end of the 19th century and spread to all major central banks during the course of the 20th century.
As an illustration, emerging market economies have accounted for 70 percent of global output growth since the crisis—double their share from two decades ago.3 This growth has provided much-needed support to world economic activity, as advanced economies have recovered slowly from the crisis. Rising economic integration is also very evident when we examine the trade relationship between India and the United States. Bilateral trade flows have risen tenfold, from $ billion in 1995 to almost $ billion in 2015. In particular, half of U.S. imports of computer services are now sourced from India. In 2015, the stock of bilateral foreign direct investment in both countries was $ billion, up from $ billion in 2002.4 The potential for further increases has been reinforced by the liberalization measures India announced last year to encourage greater foreign direct investment. Benefits of Open Trade Increased trade, through its longer-term impact on productivity, has been a key contributor to global growth and prosperity since the Second World War. Openness to trade brings many benefits to the supply side of the economy. These include: larger markets, greater specialization opportunities, and the increased ability to exploit economies of scale and scope; faster transmission of technology and innovation; and greater competitive pressure on domestic firms to increase their productivity. Collectively, these forces lead to a more efficient allocation of a country’s scarce resources— one that is more closely aligned to its international comparative advantage.