This post appeared as an op-ed in Mint, India’s second largest business newspaper.
The financial market upheaval that started in May is a stark reminder that the conditions that produced the global financial crisis of 2007-08 have not been resolved. The sucking sound of deflation emanating from Europe and the creaking of bank balance sheets are calling into question the cheery assumption that patching up the financial system with baling wire and duct tape was a viable long-term plan.
With a large private sector debt overhang in most advanced economies, deflationary pressures are hard to forestall. It has become unacceptable politically to bail out banks, although monetary authorities such as the European Central Bank are creating SIV equivalents to do just that. Defaults look inevitable on a number of fronts, from homeowners in the US who are increasingly willing to abandon their mortgages, to the riskiness of not just Hungary, but other Eastern European borrowers as well (German investors have long expected serious trouble in Austria, whose banks were gateway lenders to Eastern Europe).
But why was the opportunity to restructure debts and revamp the financial system missed? In early 2009, the banking industry was on the ropes. Both the stock and the credit default swaps markets indicated that many of the big players were at serious risk of failure. But rather than bring vested banking interests to heel, the Obama administration and its counterparts in the UK and the European Union instead chose to reconstitute, as much as possible, the same industry whose reckless pursuit of profit had thrown the world economy off the cliff.
Why did we witness such a failure of imagination and will? Policymakers seem unable to recognize that they are in the middle of a breakdown of an economic paradigm.
In 1776, Adam Smith published The Wealth of Nations. In it, he argued that self-interested action sometimes produced, as if by “an invisible hand”, results that were beneficial to broader society. Smith also pointed out that self-interest could just as readily do harm. He fiercely criticized both how employers colluded to keep wages low, as well as the “savage injustice” that European mercantilist interests had “commit(ted) with impunity” in colonies in Asia and the Americas.
Smith’s ideas were cherry-picked and turned into a simplistic ideology that dominates university economics departments and policymaking. This theory proclaims that the “invisible hand” ensures that economic self-interest will always lead to the best outcomes imaginable. It follows that any restrictions on the profit-seeking activities of individuals and corporations are inefficient and nonsensical.
Uncritical allegiance to these precepts over the last 30 years has produced a world in which corporations, especially in finance, are far less restricted in their pursuit of profit. In my book Econned, I describe how this lawless environment allowed the financial services industry to pursue its own unenlightened self-interest. The industry has become systematically predatory. Its employees did not confine their predation to outsiders; their efforts to loot their own firms nearly destroyed the industry and the entire global economy. Similar destructive behaviour by other players, often viewed through a distorted lens that saw all unconstrained commercial behaviour as virtuous, added more fuel to the conflagration.
India, in rejecting much of this ideology, and maintaining firm control over its financial sector, escaped the worst of the crisis. But despite the abject failure of this line of thinking, its hold remains firm in the West. The parallels to the 1920s and the Great Depression are striking. The key elements of the current system then and now—lightly regulated financial firms and markets, comparatively unrestricted and destabilizing international capital flows, economic growth dependent on rising levels of consumer debt—are no longer viable. However, no one in authority seems able to see that the ancien regime is well past its sell-by date. They cling to it because the old system comported itself well for a protracted period, just as the now-repudiated crisis and deflation-generating gold standard once did. Thus, the authorities reflexively put duct tape on the machinery rather than hazard a teardown.
But is this paralysis just a failure of imagination on the part of policymakers? They are not just cognitively captured by the financial service industry’s “free markets” ideology. They are also beholden to banksters for campaign contributions and for their careers, both inside and outside Washington, DC. It is not a stretch to say that most central bankers, treasury officials, and Congressman are now sock puppets for global finanzkapital.
In the wake of the Great Depression, it took more than a decade of experimentation to construct a new architecture. Among its tenets was the recognition that successful markets depended on tough policing, and the importance of the prosperity of the middle class, which in turn meant workers should reap their fair share of productivity gains. But the amorphous and often contradictory “free markets” ideology has conditioned policymakers and the public to view unregulated commerce as virtuous, when unconstrained markets are, in fact, a brawl. In the Anglo-Saxon world where this model has been taken the furthest, we’ve seen shallow expansions, stagnant average worker wages and rising income disparity, with very big gains at the very top. That’s a particularly difficult model to dislodge. As former International Monetary Fund chief economist Simon Johnson has pointed out, reform programmes usually fail unless some members of the oligarchy break ranks. Unfortunately, it may take an unmanageable crisis to convince them.