Capitalism takes a left turn

Australian Prime Minister Kevin Rudd

The free market is in turmoil. Corporate giants are collapsing. And Australia's Prime Minister, Kevin Rudd, blames the global culture of greed. Is he right?

Former editor of
The Economist, Bill Emmott, looks at the quest for a cure as economic pain grips.

Put two economists in a debating room, runs an old crack, and you’ll end up with three opinions.

Right now, however, there is one thing on which virtually all economists, political commentators and other sages will agree: that thanks to the global financial and economic crisis, the balance between state intervention and free markets is swinging back towards the state.

Not just that, but an era has ended, an era in which laissez-faire ideas prevailed, an era most commentators consider to have lasted for 30 years, since the days when those dinosaurs Ronald Reagan and Margaret Thatcher roamed the earth.

But something odd then happens. If you press those making this era-closing claim to elaborate on exactly what the swing back to the state will entail, you find yourself in a largely content-free zone. National and supra-national regulation of financial services firms will have to be a lot tighter, everyone says, stating the obvious. But beyond that? There is not just a lack of consensus, but remarkably few ideas.

Perhaps it is too soon. Unemployment has been rising in most developed countries for only about six to nine months, and shows no sign of peaking. The political consequences of this crisis–social unrest, pressures on elected politicians, the jelling of opinion around new ideas–are mostly still ahead of us.

We have, of course, already seen a huge increase in government intervention, through rescue efforts for economies in general and banks in particular. But to say that this expansion of government borrowing and spending, this sudden spate of bank nationalisations and other official support efforts, marks a permanent change is like saying that because you called the fire brigade when your house was burning and accepted fire prevention tips, you now cede control of your life to the firefighters. The expansion of government borrowing will surely have consequences, but it does not necessitate or even imply a long-term, structural change.

There are, though, some possible reasons for this ideas vacuum. You find them beneath the surface of Prime Minister Kevin Rudd’s eloquent and much-discussed article in February’s issue of The Monthly. While Rudd is entirely clear as to who the villains of this crisis are–the “neoliberals”–he is surprisingly reluctant to name them, apart from Alan Greenspan.

Moreover, although the neoliberal era apparently wreaked havoc around the globe, countries other than the United States and (eventually) Australia, barely merit a mention. This reluctance and these omissions are important for they reveal a weakness in the “end of the neoliberal era” theory. The weakness is that it is rather hard to marry the theory to the facts, either about the past or about the present.

Look, for example, at my own country, Britain, which features in Rudd’s essay under the dreaded word “Thatcherism”, which he equates with neoliberalism, economic fundamentalism and the International Monetary Fund’s Washington Consensus. Social democrats, he argues, must now respond to the end of the neoliberal’s 30-year domination of economic policy by saving capitalism, focusing on social justice, and investing more in health and education.

Well, in Britain we have had a government doing exactly that ever since Tony Blair’s Labour Party won the 1997 election. Labour introduced a minimum wage, used tax credits and new job-training schemes to attack poverty, and, after 2000, ramped up spending on health and education. If that is what a paradigm shift away from neoliberalism amounts to, then Britain has already had it. Public spending as a share of gross domestic product (GDP) dropped from 45 per cent in 1980 to 35 per cent in 1989.

Now, after yo-yoing up and down during the 1990s, the figure has passed 40 per cent. Education spending as a share of GDP has taken a similar ride, and is now, at about 5.5 per cent, roughly the same as it was when Margaret Thatcher became prime minister in 1979.

We Brits would no doubt like to think we are ahead of the game. The trouble is, Tony Blair wasn’t a shifter of paradigms. He was a consolidator of the Thatcher reforms, one who left markets free to function while moving the emphasis of public policy back towards social equity and opportunity.

This was an adjustment, albeit a major one, but not a change of direction. The other trouble is that Thatcherism wasn’t, in truth, neoliberalism. Perhaps she might have liked it to be, but that wasn’t what she actually introduced–which is presumably why Blair felt happy to consolidate her reforms.

Similar stories can be found in other developed countries. Rudd claims that “the neoliberal project…followed a strategy of ‘starving the beast’, cutting taxes in order to strangle the capacity of government”.

If that is so, it wasn’t very good at it.

The OECD’s 2009 Factbook documents trends in tax revenue and social spending as a share of GDP in its 28 member countries. Tax revenue as a share of GDP has, it says, shown a “slow upward trend in almost all OECD countries during the 1990s”. Since 2001, it has stabilised. Social spending in those 28 rich, developed countries has risen as a share of GDP from about 16 per cent in 1980 to 18 per cent in 1990 and 21 per cent in 2005. Health spending, too, has risen steadily over the long term.

So where is the triumph of neoliberalism? Why wasn’t the beast starved? The answer is that although vocal neoliberals did, of course, exist in many countries, few governments actually followed their advice. The trend that Margaret Thatcher chiefly began was privatization, not ultra-laissez faire. But when you think back to what her British government owned in 1979–interests in steel, coal, cars, oil, commercial aviation, aero engines and many more–it no longer looks so revolutionary. In addition, she weakened trade union rights. Yet every employer knows that employees’ rights have meanwhile been strengthened in many ways. Rare is the sound of anyone lobbying for stronger labour laws.

In assessing this “30-year domination”, one needs to bear in mind the starting point as well as to recognise how few real neoliberals there have been. The period up to the end of the 1970s was not “Keynesian” as Rudd describes it, at least not in any sense that John Maynard Keynes would have recognised. He did not recommend state ownership of industry, or strong trade union protections, or state protection of cartels in many sectors, or government determination of prices and incomes in many parts of our economies.

The swing away from the state and towards markets was a repudiation of those powers, essentially powers of central planning, not of Keynesianism. The high inflation of the 1970s and ’80s did discredit high levels of public borrowing, which were seen as contributors to inflationary pressures. But Keynes would have agreed with that too. His fiscal formula was a cure for deflation, not for inflation.

Ronald Reagan continued the policy of deregulation of many goods and services markets that had been started by his predecessor, Jimmy Carter, and that policy was echoed around the world.

By reducing internal barriers to commerce (in industries such as aviation, telecommunications and many more), countries thereby also reduced external barriers to trade in goods and services. Other forms of business regulation meanwhile became tighter, including anti-trust enforcement, health and safety rules, and environmental protection laws. Such a shift towards open markets became popularly known as globalisation–a trend that Rudd says he wants to retain.

This wasn’t, it is true, all that happened, especially in the United States. George W. Bush did cut taxes for the rich–although he didn’t, in fact, reduce government spending overall, and tax revenue slipped only from 29.9 per cent of GDP to 28.3 per cent. Admittedly, defence and homeland security accounted for much of his spending. But spending on education, health and overseas aid also increased during his two terms.

Given this “30-year domination” by the neoliberals, was his predecessor, Bill Clinton, also in their grip? Hardly. His aide, James Carville, famously said he would like to be reincarnated as the bond market, for that is where the power lay, but that was because bond investors feared inflation, and blamed big budget deficits for causing it. Nor was Bush’s father, George H. W. a neoliberal, despite saying, “Read my lips, no new taxes”. He broke that promise, however, and lost to Clinton partly in consequence.

Where does that leave us? It leaves us with no era to end, and just one really clear change, the obvious one stated at the outset: tighter regulation of financial services firms. That is where, as Rudd argues, Greenspan was culpable for believing that financial firms would avoid excessive risk in their own interest. Larry Summers, now back in the White House as chief economic adviser, took a similar view in the late 1990s when he was Clinton’s treasury secretary. They were naïve. But so, too, were the finance-ministry bureaucrats in Japan in the 1980s when they turned a blind eye to an asset-price boom that turned spectacularly to bust. And no one has ever accused Japan of being a hotbed of laissez faire or neoliberalism.

The big problem in finance was a complete lack of transparency about the risks being taken in derivatives issuance and trading, because it mostly happened off the banks’ balance sheets and outside regulated exchanges. This allowed financial innovation to run amok during a period of (for other reasons entirely) ultra-cheap and abundant credit, in ways and to degrees that even the innovators could not track. They did not understand the risks they were taking because they, like the regulators, did not know what was going on.

So, plainly, this is going to change. There will be strict rules about disclosure, and probably also tougher (and hence more costly) capital requirements and, in some countries, new restrictions on how much leverage some types of financial firms are allowed.

That will be quite a change if you are a banker. But it is no more of a game-change than was the tightening up of bank regulation and supervision brought in by most East Asian countries following that region’s financial crisis in 1997-98 (which was, by the way, one of the key recommendations of the IMF’s Washington Consensus).

There is another area of possible change in some countries. This is a rebalancing of taxes and some public spending back towards redistribution of income and outcomes. You can already see that in Barack Obama’s ambitious budget proposal. Yet even his proposed tax changes would only return to the US the sort of tax structure it had under Bill Clinton in the 1990s. His proposal would greatly extend public spending on health care, but that would merely bring the US more into line with Western Europe and Canada. It does no more than repeat Tony Blair’s post-1997 policies.

Inequality has certainly grown as a political grievance. This means that as governments need to raise tax revenue to try to repair the public finances, many of them will feel they can and should squeeze the rich more than the poor, as Obama wishes to do. Note, however, the point that the effort to repair public finances will force governments to raise taxes, or cut spending, or some combination of the two. In that environment, it is going to be hard for a brave new world of state activism to take hold.

It could, it is true, occur through further regulation rather than taxes and spending. That is indeed a likely form as and when governments get serious about tackling climate change, though taxes will also play a part. But elsewhere? Any ideas anyone?

Bill Emmott is a former editor of The Economist and author of Rivals: How the Power Struggle between China, India and Japan will Shape our Next Decade.