As the global crisis unfolds, the great gurus of
the world economy – those who have presided over its fortunes for much of the last two or three decades – have
largely ducked for cover. Some – like Alan Greenspan – have had the
courage to admit that there was a “flaw” in his thinking. Others
– like Gordon Brown – have made an apparently effortless overnight conversion to Keynesian economics after decades
of monetarist orthodoxy. A few – like Bernard Madoff – have been
unmasked as fraudulent, as well as foolishly irresponsible. But most have watched
from the sidelines, silent and confused, as the results of their handiwork have become apparent.
The immediate task and focus of governments around
the world is, of course, to put in place measures which will limit the damage, avoid a depression, and restore the world economy
to some semblance of health as soon as possible. In this endeavour, the supposed
experts of yesterday necessarily have little to say. It is, after all, their
nostrums that have driven us to this point, and the crisis has cruelly exposed the limitations of the monetary policy which
they said was all that was needed. What does liquidity matter if no one wants
to borrow and spend?
But, once the authorities have done their best,
and the course to recovery of a sort is (hopefully) set, the debate will move on. The
issue then will be not so much the steps needed for recovery as the lessons to be learned if the disaster is not to be repeated
in the future.
At that point, we can expect the champions of “free”
markets to re-enter the debate. The battle will then be on to write (or re-write)
history, and what now seems undeniable will again become hotly contested. There
will be no shortage of explanations and excuses for what has happened, ranging from the nonchalant (the crisis was a minor
blip in what has otherwise been a triumph for the “free” market) to the aggressively ideological (it was the failures
and mistake of governments that frustrated and distorted legitimate market operations).
It is vital, therefore, that – while reality
still imposes itself on perceptions – an account is drawn up of the lessons we must learn from this disastrous episode. Some of those lessons will be widely accepted, but others – even for those who
are most critical of the errors of recent times – will be more difficult to digest.
The crisis has been so damaging and so all-engulfing
that it might be argued that virtually nothing of past doctrine can survive. There
are some particular lessons, however, that absolutely demand attention. I would
select six leading contenders.
The first and most obvious is that “free” or unregulated markets are extremely dangerous mechanisms which inevitably go wrong. All markets, left unregulated, will produce extremes, and that is particularly true, as Keynes pointed
out, of financial markets, because of their inherent instability. The case for
regulation cannot be disputed, but even so, the counter-attack will certainly come.
The merits of self-regulation, the salutary effects of competition, and the advantages of a “light hand”
will again be rolled out in order to deflect any real attempt at disciplining market operators. That is when our public authorities must be strong-minded, and remind themselves that is their responsibility
to the public interest that demands effective regulation.
The second lesson is that government involvement in the management of the economy is essential. After
decades of being told that the only thing we should ask of government is that it “get off our backs”, we can now
see that it is governments - not banks or the private sector – that, as the authority of last resort, maintain the value
of the currency, guarantee appropriate levels of liquidity and credit, and make irreplaceable investments in essential infrastructure. We must not wait again until the eleventh hour before we deploy the power, responsibility
and legitimacy of government to keep the economy on the right track.
The third lesson is that fiscal policy, decided by governments, is more important and effective than monetary policy. We have again been told for decades that monetary policy is all that is necessary, and indeed all that
is effective, both in controlling inflation and in setting the real economy on a sustainable course. We now know that using monetary policy to ward off recession is no more effective than pushing on a piece
of string and that an exclusive reliance on monetary policy to restrain inflation is just another reflection of the view –
now surely discredited - that the markets always get it right.
My fourth inescapable lesson is that gross imbalances in the world economy will inevitably cause it to topple off the high wire. The growing gap between rich and poor nations is bad enough, from both an economic and moral viewpoint. But the imbalance between surplus and deficit countries is equally damaging as a strictly
economic phenomenon. The surpluses drive us toward recession because they represent
resources that are hoarded rather than spent, while those countries with deficits are likely, as Keynes pointed out, to try
to control them through deflating their economies, thereby reinforcing the deflationary bias.
To the extent that others are willing to finance the deficits (as, for example, China’s financing of the US deficit),
this simply encourages uneconomic production and an excessive reliance on credit, meaning that the world economy wobbles perilously
on an unsustainable foundation.
A related and fifth lesson is that the freedom to move capital at will around the world has exacted a heavy price.
The total removal of exchange controls meant that international investors could ignore and, if necessary, blackmail
national governments; this became a major factor in allowing market operators to escape and defy any attempt at regulatory
controls. We have to make up our minds whether we trust accountable governments,
with all their imperfections, or the unrestrained and totally irresponsible market.
Our recent experience surely makes this a no-brainer. What we now need
is a new international regime, negotiated between governments, to regulate exchange rate volatility, international lending
practices, and the obligations of international investors.
My final lesson is that bankers should not be trusted with the most important decisions in economic policy. No policy measure was more widely welcomed than the handing of monetary policy over to “independent”
central banks. We now have good reason to know that their decisions are not only
likely to be wrong, but will certainly be self-serving – no more reliable or impartial than those of casino operators
who will always set the odds in their own favour. If we are truly to grapple with the lessons set out above, we need to restore the main decisions of economic
policy, including the effective regulation of markets, to democratic control.
18 January 2009
This article was published in the online Guardian on 19 January and the New Zealand Herald
on 26 January.