Will the financial sector meltdown in the developed economies lead to a rethink about
the path the global economy has traversed in the last few decades?
Simply put, will it curb the primacy of finance, will it rein in the penchant for financial innovation and will it lead to greater regulation? Will it lower financial leverage?
Will it lead to changing the distorted incentives that fuelled the crisis?
There’s little doubt that just as the US’ Sarbanes-Oxley Act came out of the Enron fraud, so tighter oversight of banks’ lending principles and more stringent norms for capital adequacy will emerge out of the credit crisis.
In recent months, however, a more radical critique has emerged, often from very respectable quarters. Much of it, a la George Soros, views the predominance of the financial system as the tail wagging the dog and harks back to a supposedly more rational time back in the 1950s and 1960s, when finance was the handmaiden of business rather than its master and which has often been labelled the “Golden Age of Capitalism”. Paul Volcker, ex-Federal Reserve chairman and icon among central bankers, said recently: “This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down.”
With one after another of America’s best financial institutions going belly up, the reasons for the disquiet are obvious. By one count, 112 episodes of systemic banking crises occurred in 93 countries since the late 1970s and 51 borderline crises were recorded in 46 countries.
Martin Wolf, chief economic commentator of the Financial Times, has written: “For three decades now, we have been promoting the joys of a liberalized financial system and what has it brought us? ‘One massive financial crisis after the other’ is the answer. This is not to say that liberalized finance brings no benefits. It has certainly made a substantial number of people extraordinarily rich. It may well have brought economic benefits, as well. On that, the evidence appears mixed.”
But going back to the world of the 1960s is not an option. The real is rational, which means that there are reasons why the current system is what it is. Around the 1970s, the free world was in deep crisis. Labour unions had grown too strong, the share of profits in the Western economies had gone down and the social system was being questioned by all kinds of radical movements.
The crisis, however, also spelt an opportunity for the system to reinvent itself. Within the next few years, the trade unions were crushed, industry was relocated to low-cost centres and profits as a share of national income went up substantially in the US. Consumption, especially in the US, was sustained by a sharp rise in debt. American economist Paul Sweezy pointed out long ago that stagnation and enormous financial speculation emerged as symbiotic aspects of the same deep-seated, irreversible economic impasse. He said the stagnation of the underlying economy meant that business was increasingly dependent on the growth of finance to preserve and enlarge its money capital and that the financial superstructure of the economy could not expand entirely independently of its base in the underlying productive economy. With remarkable prescience, Sweezy said the bursting of speculative bubbles would, therefore, be a recurring and growing problem.
But does the credit crisis call for a drastic change? In 1985, Sweezy, together with economist Harry Magdoff, summed it up rather succinctly. In an article called “The Financial Explosion”, they wrote, “Does the casino society, in fact, channel far too much talent and energy into financial shell games? Yes, of course. No sensible person could deny it. Does it do so at the expense of producing real goods and services? Absolutely not. There is no reason whatever to assume that if you could deflate the financial structure, the talent and energy now employed there would move into productive pursuits. They would simply become unemployed and add to the country’s already huge reservoir of idle human and material resources. Is the casino society a significant drag on economic growth? Again, absolutely not. What growth the economy has experienced in recent years, apart from that attributable to an unprecedented peacetime military build-up, has been almost entirely due to the financial explosion.”
Let’s put that in historical perspective. The Keynesian revolution of the 1930s was hailed as a solution to the contradictions engendered by the earlier era of near laissez-faire. It resulted in capital controls, a partnership between labour and capital in the West and in the welfare state. When that solution was found to be faulty, the new system, one of capital mobility, financialization and globalization, came into being. That new system, or at least a substantial part of it, is now becoming dysfunctional.
But will it lead to a call for a different system?
Perhaps we’re reading too much into the issue. Perhaps financial instability is merely the market’s way of disciplining the system. On the other hand, maybe what we’re seeing are the death throes of neo-liberalism?
Or will the current turmoil result in a change in the balance of the global economy, a shift in the centre of gravity from the West to the East?
We’ll have to wait and see.
As poet W.B. Yeats put it so aptly, “What rough beast, its hour come round at last/Slouches towards Bethlehem to be born?”
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com