Why the Economists Got It Wrong: The Crisis and Its Cultural Roots
82
Why the Economists Got It Wrong: The Crisis and Its Cultural Roots
82Paperback
-
PICK UP IN STORECheck Availability at Nearby Stores
Available within 2 business hours
Related collections and offers
Overview
Product Details
| ISBN-13: | 9780857289629 |
|---|---|
| Publisher: | Anthem Press |
| Publication date: | 08/01/2010 |
| Series: | Anthem Other Canon Economics |
| Pages: | 82 |
| Product dimensions: | 5.80(w) x 8.80(h) x 0.10(d) |
About the Author
Read an Excerpt
Why the Economists Got It Wrong
The Crisis and Its Cultural Roots
By Alessandro Roncaglia
Wimbledon Publishing Company
Copyright © 2010 Alessandro RoncagliaAll rights reserved.
ISBN: 978-0-85728-962-9
CHAPTER 1
Introduction
Simplistic reconstructions of the history of thought often point to two contrasting views on the relations between economy and culture. The first, attributed to Karl Marx, has it that the economic structure (or in other words, more or less, power relations in the economic field) determines the cultural superstructure, while the second, attributed to Max Weber, holds on the contrary that it is culture, inclusive of religious opinions and doctrines, which determines the economic and social set- up. As a matter of fact, neither of these two great thinkers ever dreamt of establishing univocal causal relations between economic and cultural variables; economy and culture are also to be seen as two vast and internally differentiated categories. Marx and Weber set out rather to establish the relative importance of one or the other causal relation, and did so in strong terms since each was arguing against widespread opinion to the contrary.
The complex relationship between cultural and economic elements is also to be seen at work in the development of the crisis which hit the world economy. In some instances, strong economic interests favoured one view or the other on how the economy works, as a whole or in some particular aspects. In other instances, mistaken theoretical views favoured adoption of economic policies (including a policy of non-intervention in the spontaneous evolution of the markets) which turned out to be far indeed from optimal.
In the following pages, after briefly illustrating the initial stages of the crisis (Chapters 2–4), its immediate causes and its effects, we shall consider the economic culture underlying the choices which favoured the development of conditions of financial and economic fragility (Chapters 5–9). We shall see in Chapter 5 that, despite frequent assertions to the contrary, a number of economists had foreseen the crisis in that they had drawn attention to factors of financial fragility and systemic instability. After all, this is substantially what is meant when we say that seismologists foresee earthquakes: certainly not by indicating the day and hour in which the earthquake will take place or its magnitude, but rather by indicating the areas of greatest risk, so that the authorities can set strict antiseismic building rules for them. We are thus led to look into the specific characteristics of the theoretical views underlying such analyses. In this respect, Chapter 6 will focus on the notions of risk and uncertainty; in Chapter 7, more generally, we shall compare and contrast the two main approaches to economic analysis: the neoclassical or mainstream one which dominated economic culture in the past decades, and the Keynesian (or, possibly better, classical-Keynesian) one. Subsequently, in Chapter 8 we shall briefly consider some issues in economic policy, mainly relating to the institutional set-up of the international monetary and financial system, from a classical-Keynesian viewpoint. Finally, Chapter 9 is devoted to a few remarks on the theme of the relationship between market and state, all too often conceived, especially in the United States, as an all-out opposition between a communist centralised economy and a laissez-faire rule of the market.
In depth and duration the current crisis is closer to the Great Crisis of 1929 than to the repeated, and significant, crises of the past sixty years. Even then the economic crisis developed gradually, reaching its culmination some years after the financial crisis broke out.
Opinions differ on the development of the present crisis. Some commentators display optimism talking of a V-shaped crisis – a sharp fall followed by a quick recovery – with a turning point announced for months as imminent, and now seen as passed over. However other, more pessimistic commentators depict an L-shaped crisis, with the fall followed by a rather long period of stagnation (and with a relatively modest short-run recovery attributed to a strong fiscal stimulus which cannot last long). Still other commentators warily stress the marked variability of financial and economic indicators and the differences between countries and economic areas, thus pointing to the great uncertainty in time and manner of recovery. Finally, a number of economists suggest the possibility of a W-shaped evolution, with short-run recoveries followed by new speculative bubbles and risks of public debt crises (since huge amounts of what was private debt had been transformed into public debt), in the context of a stagnating real economy and renewed perilous plunges in the financial arena. Just as in the case of interpretations of the origins of the crisis and the ensuing debate on policy choices, so these forecasts too are associated with the contending views in the economics debate.
Obviously, many things have changed since the period of the Great Crisis. In particular, experience has taught us something about which policies should be avoided and which adopted. Current accounts in the banks (except very large ones) are in no danger, and queues of clients wanting to withdraw their money have been avoided. Unemployment is growing, but it should be possible to keep it within socially acceptable limits (what a horrible expression!), though social tensions are likely to grow. On the other hand, the changes in the distribution of world economic power are remarkable and international political relations need to adjust to them.
Policy choices will largely determine how long the crisis will last. The monetary, financial and real policies adopted so far are of proportions never before seen in peacetime. Notwithstanding, the year 2009 closed with a negative growth record in all the developed countries, and with a sharp decline in employment. Moreover, the expansionary policies adopted with remarkable success to prevent catastrophic development of the crisis – the same policies which had frequently been criticized before the crisis as happily forgotten recipes stemming from erroneous economic theories – entail a marked increase in public debt and thus significant risks for monetary and financial stability. It is therefore hard to believe that such policies can be pursued at the present extraordinary levels for more than a couple of years. What will happen when they are abandoned?
The answer we may give largely depends on our understanding of the basic factors leading to the present crisis. According to the optimistic analysts, the crisis may be attributed to certain market excesses and policy errors, but growth may start again almost automatically with no need for big changes in the institutions or the rules of the market economy. It is our contention, however, that the fundamentalist free market attitude, by favouring the tumultuous growth of the financial sector of the economy, has a large share of responsibility in establishing conditions that were conducive to the development of the crisis. Thus, a thorough overhauling of rules and institutions will be necessary if the crisis is not to be followed by a long phase of stagnation, or recovery interrupted by new crises.
The main thesis of the present book is precisely that errors in the dominant economic culture – the so-called Washington consensus – led economic policy to dance blindly on the brink of crisis, and then plunge into it. The myth of an all-powerful invisible hand of the market, the blind faith in automatic equilibrating mechanisms, the hostility to setting rules of the game binding for all participants, the systematic under-evaluation of uncertainty are all, as we shall see, serious mistakes, favoured by their consonance with major economic and financial interests. Such mistakes had already been pointed out through heterodox theoretical approaches such as the post-Keynesian one. Open discussion of these issues is now imperative to avoid the risk of recurrence of the grim drama – not as farce, but as overwhelming tragedy.
Thanks are due to Michele Alacevich, Hossein Askari, Marcella Corsi, Carlo D'Ippoliti, Roberto Petrini, Roberto Villetti and especially Mario Tonveronachi for comments on initial drafts, and to Alberto Quadrio Curzio and Erik Reinhert for encouraging me to complete it. Thanks are also due to Graham Sells for his efforts at improving my poor English. Finally, I am in debt to Paolo Sylos Labini for the many lessons received over the years.
CHAPTER 2The Sequence of Events
Trying to set a specific date for the beginning of the crisis is a substantially useless exercise – an arbitrary choice: it all depends on what we mean by the beginning of the crisis. We may choose June 2007, when Wall Street underwent the first of a long series of falls; or 7 September 2007, when the crisis was, so to say, officially recognised by the de facto nationalisation of Fannie Mae and Freddie Mac, the two financial giants which guaranteed half of the residential mortgages in the US. Soros (2008a) begins his account with the bankruptcy of the American Home Mortgage on 6 August 2007; Morris (2008) goes back a couple of months further, pointing to the fall of two Bear Stearns' hedge funds. But as early as April 2007, the Bank of England's Financial Stability Report raised the issue of the sub-prime mortgage crisis and possible contagion effects outside the United States.
If we want to trace the origins of the financial crisis right back, though, we can go still further, to 12 November 1999, when President Clinton (not Bush, be it noted!) ratified the Gramm-Leach-Bliley Act, which drastically reduced controls and constraints on the US financial sector. These measures accelerated the abnormal and unregulated development of the financial, and in particular derivatives markets that played such a major role in the recent crisis. There was a bipartisan agreement: President Clinton, a Democrat, ratified an Act proposed among others by the Republican Senator Phil Gramm, who was the main economic adviser to the Republican candidate McCain in the 2008 presidential campaign; Gramm was also tipped as Treasury Secretary in the event of a Republican victory. As a matter of fact, the deregulation and all-out laissez-faire stage began as early as around 1980, with Reagan's presidency in the United States and Prime Minister Thatcher's in Great Britain: then the long wave of the so-called super-bubble (cf. Soros, 2008a, 2008b) of the financial sector set in, the bursting of which was primed by the house mortgage crisis.
It is in any case clearly wrong to begin with the bankruptcy of Lehman Brothers Inc. on 15 September 2008, since this should be seen rather as the moment when the crisis reached its apex. Otherwise we would lose sight of the main cause-and-effect relations underlying the explosion of the crisis.
What matters is the intersection of events. Stock exchanges, both in the US and in Europe, fell, losing more than 50 per cent, between September 2007 and February 2009. The fall was irregular, as it always happens on such occasions, with splashes like Black Monday on 6 October 2008, followed in the same week by a similarly Black Friday. A more gradual decline followed, even with some notable upswings or, more often, periods of timid recovery up to what was taken – with greater optimism in the months of mid-2009 – as signalling a change in the trend. Under the surface, however, the difficulties and risks remained intact; stock exchange recovery was not accompanied by a clear recovery of the real economy, where the fall in employment continued.
The fall in share prices differed from one sector to another and from company to company. This was of some importance not only for stock exchange investors, but also because it determined a drastic redistribution of economic power. For instance, we may compare General Motors with Toyota within the car sector, or companies belonging to different sectors such as the financial and electricity sectors. Some countries experienced greater difficulties than others, with a different mix of financial and real crisis. Even if it is too early to identify clear and established tendencies trends, these are important factors destined to produce wide-reaching changes in the global geo-political set-up. Nevertheless, the fall was general: the overall losses of shareowners reached incredible proportions, while slow-downs in production and growing unemployment and social malaise were experienced everywhere.
In the first stages of the crisis, many attempts were made to intervene in support of share prices. To begin with came massive doses of optimism on part of the monetary authorities and political leaders, occasionally so exaggerated as to appear ridiculous and counterproductive. Actual interventions by the monetary and exchange authorities followed. The stock exchange authorities resorted to relatively modest but significant interventions on the rules of the game, such as stopping short sales (occasionally limited to some specific share or group of shares, with scant respect for the traditional declarations on the 'level playing field' principle which is an essential prerequisite for real competition). The monetary authorities, for their part, intervened with massive injections of liquidity into the economy of proportions never experienced before. In the meantime, behind the scenes, they sought to favour solutions within the private sector for the rescue of companies in serious trouble in the financial sector.
However, the interventions had only very short-run effects, or even effects that went contrary to intentions. By October 2008, the financial system was on the verge of collapse. Then, when total collapse of the world financial system seemed just around the corner, the governments and central banks of the major countries decided to intervene with the full weight of the tools at their disposal: insurance on current account deposits, very ample financing facilities for the banking sector, offers to subscribe capital in those banks which appeared to be in otherwise insurmountable trouble, active intervention to cover losses in the most difficult cases and sweeping regulatory changes. The means utilized are potentially comparable in magnitude to those thrown into the field on the occasion of the First World War; if they now appear smaller, this is only due to the fact that they are mostly contingent future expenditure, as is the case when guarantees are provided, which translate into actual outlays only if and when sizeable bankruptcies occur.
The stock exchange crash originated in the widespread opinion that a number of listed companies were in difficulty. Initially this was the case mainly of banks, insurance companies and various financial firms. Often, the difficulties perceived by public opinion were real. Besides, since the financial world feeds on confidence, pessimistic expectations rapidly and automatically became self-fulfilling, independently of whether the perceived difficulties were real. The worsening of what is called the 'economic climate' soon led to the involvement of non-financial companies in the crisis as well, giving rise to a generalized fall in the stock exchange.
Thus, what to some overoptimistic commentators appeared a limited problem – the crisis of subprime mortgages, to which we will revert shortly – very quickly spread, first from some individual financial entities to all the financial companies, then to the whole stock exchange, and then from the financial sector to the economy as a whole. The crisis spawned a long list of rescues of large financial companies and bankruptcies of minor and middle-sized ones. Occasionally, especially in the first stage of the crisis, rescue operations were launched by other private sector companies; but in any case they came about under the supervision of, or were actually originated by, the public authorities, and in particular the central banks, which often also provided costly support. However, some sensational bankruptcies were not avoided. Once 'too big to fail' resounded throughout the land, now the byword is 'too big to be rescued'.
Obviously, much depends on the economic strength of the potential rescuers. The United States, thanks to its economic standing and the role of the dollar in the international monetary system, can afford interventions which are beyond the reach of other countries, such as the rescue of Citigroup on 23 November 2008. The contrary case was shown by Iceland: when Iceland's economic policy authorities decided to rescue their main banks, it was the whole country that plunged into crisis; when, on 8 October 2008, Iceland's central bank had to abandon pegging of the krona to the euro, the Icelandic currency fell, losing more than 60 per cent in the brief span of a few hours. In subsequent months, thanks to a well organised set of active policy interventions, the situation has stabilized; however, since Iceland imports most of its consumption goods, even a relatively small devaluation, say 10 per cent, entails a loss of purchasing power for the population approaching 10 per cent.
(Continues...)
Excerpted from Why the Economists Got It Wrong by Alessandro Roncaglia. Copyright © 2010 Alessandro Roncaglia. Excerpted by permission of Wimbledon Publishing Company.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.