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Hugo Radice: History lessons from the man who saved capitalism
As the weeks pass, what began as a crisis in the US sub-prime mortgage market has been revealed as a wider global credit crisis, one that increasingly threatens economic growth and employment as well as the stability of banking systems across many countries.
Setting aside the more apocalyptic forecasts of massive economic and social collapse, many sober commentators are now seeing this as a crisis of the free market type of capitalism that has come to predominate around the world in the last three decades.
This scenario has clear echoes of the crisis that brought the last era of free markets to a close – the Great Depression of the 1930s.
Economists, politicians and even bankers have therefore turned to their history books and rediscovered the extraordinary man who more than any other helped to save both capitalism and democracy – the British economist John Maynard Keynes.
However, as with all such influential historical figures, there are many interpretations of what Keynes wrote and achieved. This is not least because the supposedly Keynesian economic policies practised after the Second World War were eventually held responsible when the post-war boom ignominiously ended in high inflation and the return of mass unemployment in the 1970s. Then, too, the policymakers turned to the history books, and revived under the banner of monetarism the free-market creed that Keynes had challenged.
After a brief truce in which both opposition parties endorsed the decisive measures taken by Prime Minister Gordon Brown and Chancellor Alistair Darling to avoid a total collapse of our banking system, we are quickly returning to adversarial politics.
The Chancellor's Mais Lecture on October 29 explicitly signalled a return to Keynesianism, and his arguments echoed a famous dictum of Keynes himself: "When the facts change, I change my mind. What do you do?"
Shadow Chancellor George Osborne denounced the Government's change of mind, in his speech at the London School of Economics a few days later, as "a return to spend, spend, spend", arguing that the solution was to be found in less rather than more government spending – in short, a continuation of the monetarist doctrines adopted by the Thatcher administrations from 1979.
He has been strongly supported by a group of leading monetarist economists in a recent letter to a national newspaper. Across the Atlantic, the closing days of the Presidential campaign were marked by very similar arguments, pitting Keynesian Democrats against monetarist Republicans.
In principle, monetarists are firm believers in free markets. If prices
are freely set by the interaction of supply and demand, the most efficient producers will supply the goods and services that consumers most want to buy, there will normally be full employment of resources, and the financial markets will fund those investments that yield the highest return.
The Government's role should be restricted to the provision of collective goods like defence, basic education and public health, and the legal system, to be funded by minimal levels of taxation. Of course, there will be economic cycles, but free markets ensure that the economy is flexible enough to restore full employment quickly.
Keynes argued that such a system was prone to breakdown because so many economic decisions depended upon expectations about the future.
An economic downturn could be magnified by a collapse in confidence, with investors in particular holding back because of the fear that they would lose their money; the more developed the credit system, the more volatile investment behaviour became.
In a recession, in particular, confidence could be so low that even large reductions in interest rates might not allay the fears of investors. At that point, the Government had to step in, borrowing money and spending it to kick-start an economic recovery.
Today, both the Government and its monetarist critics are agreed on the need for lower interest rates, and the Bank of England has at last acted decisively on that front with yesterday's 1.5 per cent cut. This is very welcome but there still remain some important areas of disagreement
First, the critics argue that increased government borrowing will have to be repaid eventually by the taxpayer.
But a recovery will automatically generate more tax revenues from increased income and expenditure, even without any increase in tax rates.
As incomes recover, savings will also grow faster, and this will fund a recovery in private spending without requiring the immediate repayment of government debt.
Indeed, history tells us that there is no necessary fixed limit to sustainable government borrowing – and that the current levels of UK public borrowing and total public debt are still very low compared with other leading economies and the post-1945 historical record. On this, the Chancellor is right.
Second, the banking fraternity sees the Government's offer of funding through the issue of preference shares as a poisoned chalice, threatening "political" interference in what should be purely commercial decisions.
They are resisting pressure to pass on lower interest rates to their borrowers and to rein back their spending on bonuses. This is truly the arrogance of power: it is precisely their untrammelled "commercial decisions" that created the present mess – and destroyed their own shareholders' wealth on a massive scale.
Unfortunately, there are signs that the Government is losing its resolve on this issue, perhaps because of its own culpability. On this point, it is Vince Cable of the Liberal Democrats who has got it right.
Third, the Prime Minister's repeated call for banks to maintain the 2007 level of lending is absurd. Not only was that level unsustainable, as the Bank of England has clearly demonstrated, but, also, while the recession deepens, neither businesses nor consumers will want to borrow more. This point seems to have escaped all three political parties.
Finally, despite the recognition that the credit crisis and the recession are now global in scope, Mr Brown continues to maintain that Britain is somehow better equipped than other economies to ride out the storm.
This is no time for such playground rivalries, which simply undercut his own otherwise admirable attempts to bring about global co-operation in seeking solutions.
Hugo Radice is an economist based in North Yorkshire.
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Saturday 26 May 2012
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