Here We Go Again: The Day Neoliberalism Died

♠ Posted by Emmanuel in , at 3/27/2008 04:20:00 PM
Love 'em or hate 'em, you must acknowledge the consistently pro-market outlook of the Financial Times. Yet, here are two recent op-eds by FT stalwarts in response to Deutsche Bank CEO Josef Ackermann stating "I no longer believe in the market's self-healing power." Well, I for one never did. Both authors specifically mention the Fed bailout of Bear Stearns as a turning point. For all the disagreements I have with one Karl Polanyi--a folk hero of the anti-globalization set--I do agree with him that the self-regulating market (SRM) is a myth. Furthermore, the invisible hand trope of Adam Smith has been tortured to mean that market mechanisms have a built-in self-correcting mechanism. (As an aside, visit Gavin Kennedy's blog to disabuse yourselves of the "Chicago School" iteration of the invisible hand. Or, better yet, read his book on the topic.) Well, current events seem to question the validity of those neoliberal leanings.

Let us begin with Michael Skapinker on why the Reaganite / Thatcherite revolution may have run its course in the wake of the subprime debacle:

The US Federal Reserve is providing a $30bn safety net to engineer the fire sale of Bear Stearns to JPMorgan Chase and who knows how many more rescues there are to come? The British government has nationalised failed mortgage lender Northern Rock. This is a remarkable change after three decades in which the market appeared to be the answer to everything.

Facing defeat to Margaret Thatcher in 1979, James Callaghan, then UK Labour prime minister, observed that there were times when the tide of ideas shifted and there was nothing anyone could do about it. “I suspect there is now such a sea-change – and it is for Mrs Thatcher,” Callaghan said then. Mrs Thatcher’s victory, followed by the election of Ronald Reagan as US president a year later, set off a period of deregulation, privatisation and enterprise that greatly enriched both their countries, influenced policymakers everywhere and, thrillingly, swept away the moribund communist empire. When Reagan said “the nine most terrifying words in the English language are ‘I’m from the government and I’m here to help’,” people laughed appreciatively in many languages.

Government ownership of industry began to look as archaic as leeching and bloodletting – relics of an age when people knew no better. Private enterprise, competition, consumer choice – these were the ways to organise economies. If one company was not providing decent goods and services at competitive prices, another one would. Competing enterprises came up with better ideas. Government provision, by contrast, produced queues and shortages.

Tony Blair, former UK prime minsiter, insisted the Labour party scrap its commitment to nationalisation. Only marginal malcontents ever talked about restoring it. This is why Gordon Brown dithered before taking Northern Rock into public ownership, even though his government had guaranteed the bank’s savings accounts – and thereby the savings accounts of every British bank, because if Northern Rock could not be allowed to fail, neither could the others.

Even before the current financial crisis, there were hints that a hands-off approach by government was perhaps not the only way to organise an economy. Russia was not much of an advertisement for a state-controlled economy, but China’s government-administered capitalism appeared to be doing fine. The purchase of chunks of western companies by sovereign wealth funds was a worrying sign that governments were buying their way back into free market economies.

And now we have the great financial unravelling – with governments and central bankers playing a role for which past decades have left us unprepared. Many people remember what Callaghan said about the sea-change in ideas. Fewer remember his observation that these changes seemed to happen every 30 years or so, or that he said that 29 years ago.

So what sort of change might be we witnessing? If the Thatcher-Reagan era is at an end, what might replace it? Trawling leftwing and far-left websites is instructive, because they clearly have not got a clue either. They are not demanding the nationalisation of the banking system, perhaps because that has already happened, either explicitly or implicitly. But they do not seem to be calling for anything else…

However this ends, and however widespread the damage, most of our economies will remain in private hands. There is still no better way to apportion and price our goods and services. There will, on the other hand, be better ways to regulate and police our financial services industry. There will have to be. But the triumphalism of the past 30 years is over. The market is no longer the answer to everything. It certainly does not heal itself.

Now, let us move to the thoughts of Martin Wolf. Let it be noted that he does not take very kindly to the term "neoliberalism" in his book Why Globalization Works. Market-led globalization, arm's length transactions, neoliberalism, whatever; I think the concept is pretty much the same. Despite his reputation, though, Wolf delivers some pretty good lines as to why the SRM is a goner. Neoliberalism, we hardly knew ye:

Remember Friday March 14 2008: it was the day the dream of global free- market capitalism died. For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the US, chief protagonist of free-market capitalism, declared this era over…

The implications of this decision are evident: there will have to be far greater regulation of such institutions. The Fed has provided a valuable form of insurance to the investment banks. Indeed, that is already evident from what has happened in the stock market since the rescue: the other big investment banks have enjoyed sizeable jumps in their share prices (see chart below). This is moral hazard made visible. The Fed decided that a money market “strike” against investment banks is the equivalent of a run on deposits in a commercial bank. It concluded that it must, for this reason, open the monetary spigots in favour of such institutions. Greater regulation must be on the way.

The lobbies of Wall Street will, it is true, resist onerous regulation of capital requirements or liquidity, after this crisis is over. They may succeed. But, intellectually, their position is now untenable. Systemically important institutions must pay for any official protection they receive. Their ability to enjoy the upside on the risks they run, while shifting parts of the downside on to society at large, must be restricted. This is not just a matter of simple justice (although it is that, too). It is also a matter of efficiency. An unregulated, but subsidised, casino will not allocate resources well. Moreover, that subsidisation does not now apply only to shareholders, but to all creditors. Its effect is to make the costs of funds unreasonably cheap. These grossly misaligned incentives must be tackled…

If the US itself has passed the high water mark of financial deregulation, this will have wide global implications. Until recently, it was possible to tell the Chinese, the Indians or those who suffered significant financial crises in the past two decades that there existed a financial system both free and robust. That is the case no longer. It will be hard, indeed, to persuade such countries that the market failures revealed in the US and other high-income countries are not a dire warning. If the US, with its vast experience and resources, was unable to avoid these traps, why, they will ask, should we expect to do better?

These longer-term implications for attitudes to deregulated financial markets are far from the only reason the present turmoil is so significant. We still have to get through the immediate crisis. A collapse in financial profits (so significant in the US economy), a house-price crash and a big rise in commodity prices are a combination likely to generate a long and deep recession. To tackle this danger the Fed has already slashed short-term rates to 2.25 per cent. Meanwhile, the Fed also clearly risks a global flight from dollar- denominated liabilities and a resurgence in inflation. It is hard to see a reason for yields on long-term Treasuries being so low, other than a desire to hold the liabilities of the US Treasury, safest issuer of dollar- denominated securities.

“Some say the world will end in fire, Some say in ice.” Harvard’s Kenneth Rogoff recently quoted Robert Frost’s words in describing the dangers of financial ruin (fire) and inflation (ice) confronting us. These are perilous times. They are also historic times. The US is showing the limits of deregulation. Managing this unavoidable shift, without throwing away what has been gained in the past three decades, is a huge challenge. So is getting through the deleveraging ahead in anything like one piece. But we must start in the right place, by recognising that even the recent past is a foreign country.