POL 422
GEC
The Nature of True Capitalism
Capitalism is a free market system that:
Let’s me keep whatever I can make
Places no restrictions on how I can make money
Let’s me sell you something whether it is good for you or not
Let’s winners win and losers lose
In a system of true capitalism:
Government does not regulate economic activity: no regulations or
restrictions on making money
NO regulations for the environment or for product quality or safety
No banking regulations
No laws against making profits
If I sell you something and it hurts you or defrauds you, that is your problem
- Let the buyer beware
The government does not tax income or wealth
The government gets out of the way and let’s true individualism flower
A socialist government is one that is not capitalist
Restricts economic freedom
Regulates and taxes
Redistributes wealth
Helps losers and hurts winners
Wade, From global imbalances to global reorganizations
Different explanations for the crisis:
1. Monetary policy and regulatory mistakes
2. Global imbalances
Types of capitalism:
Liberal capitalist – state as regulator and facilitator
Governed capitalist – state sponsored structural change
Coordinated capitalist - state providing both extensive social policies to buffer
the costs of change and the framework for organised actors to coordinate their
investment decisions
1945-1980 mostly Governed and Coordinated capitalism
1980 - present is more liberal
Will the present crisis lead to another reversal?
The shift towards freer markets in 1980 occurred after a decade of economic and political disruptions. The
disruptions were nothing like as severe as in the 1930s and first half of the 1940s, of course, but they
compounded the mounting anger of big investors, corporate executives and the political right due to the
calamitous fall in the relative income of those at the top of the distribution. The top few percentiles of the US and
UK income distributions had experienced decades of compression of their share of total disposable
income. In the USA the income share of the top 1% fell from a peak of 23% in 1929 to about 8% in 1970, and
stayed at around 9–10% through the 1970s, while the middle three quintiles experienced the biggest income
growth. The hidden agenda of the Reagan/Thatcher revolution was to reverse this ‘Great Compression’ and allow
income and wealth to be restored to their rightful owners at the top—combining market liberalisation with an
array of state measures which had the effect, intended and unintended, of intensifying redistribution upwards.
In order to get income distribution back at the levels of inequality preferred by the rich,
we need to accept financial crises?
Why were US elites so willing to let US manufacturing vanish in the 1980s? Why didn’t
they fight harder to keep it?
1. Interest rates needed to be high and the dollar high (temporary).
2. Manufacturers had the option of locating in Asia and maintaining or even
increasing profits.
3. The costs of manufacturing shift could be borne by the working class.
4. Driving wages down in the US improved profitability there and undermined
the power of unions.
Explanations for the crisis:
1) Global imbalances were decisive in overexpansion of debt
The implicit or explicit implication is that global imbalances had little or nothing to do with it, as though the
existing payments imbalances would have been sustained had there been no failure of US and UK monetary
policy or financial regulation. This is a comforting belief, because it implies there is nothing wrong with the
larger system; we just have to learn not to make the same policy mistakes next time.
Rather, global imbalances have had an important causal role not at the international level, in the form of
currency recycling, but at the domestic level, in the form of credit recycling to the agents spending more than
their income, who are the other end of the external deficit.
2) Policy errors by the Fed – lower interest rates instead of raising them in 2002 and not
regulating derivatives
Predictions:
Crisis will continue and get even worse because the funds and political will for temporary
nationalization will not occur – US zombie banks will continue. German and other
European nations are even more unwilling to act to recapitalize their banks.
Risk of US soaring debt producing an even bigger debt-dollar crisis expands with
explosion of deficit.
Political backlash to rising unemployment and foreclosure crisis. Almost certainly a
right-wing backlash.
Chinese bankrolling of the US cannot be assumed. Imagine if the US were bailing out
China – political backlash in China, especially if risks increase. Chinese will extract a
pound of foreign policy flesh in return for its financial bailout of the US.
Evidence is that China is reducing its holdings of US government debt.
Will Chinese growth lead the world out of recession, thereby shifting power to China?
Another tipping point in global economy could come in early 2010.
What to do:
1) Redirect the allocation of investment resources away from “finance financing
finance” and toward the real economy and the promotion of the production of real
goods.
2) Separate saving and consumer banking from risky investment banking. A more
stringent version of the Glass–Steagall Act could be the model.
3) The savings and consumer organisations should do narrow, boring banking. They
should make loans mainly out of deposits, do their own due diligence, hold most of the
loans on their own books and they might, in addition, hold government bonds plus some
blue-chip stocks. They should not employ physicists or financial engineers. More of
them should be run on a ‘trust’ basis, as non-profits, perhaps as cooperatives or mutuals.
4) Investment banks—also hedge funds, trusts and the like—could innovate and speculate
within much wider regulatory limits, but should not be allowed to trade with regulated
banks. They should include both public and private banks, with the public ones having
some democratic accountability and exercising discipline over the private ones.
5) Respecialise economies
A lot of production capacity is now seen to be misaligned with demand. Developed
countries that built up large financial sectors or large construction sectors in the boom of
the 1990s and 2000s have to grow new activities; and even those that did not specialise in
this way must now respecialise in line with the coming technological revolution—the end
of the fossil fuel economy. Clearly, low-carbon technologies, public transport, life-time
education and health care are new growth areas, with lots of scope for more intensive
application of ICT technologies. The USA has to increase its domestic production
capacity in order to substitute for imports and increase exports. Economies oriented
towards export surpluses have to rely more on domestic demand, so that they can grow
without US households becoming more indebted.
This raises the question of the role of the state in accelerating movement out of declining
sectors and fostering the growth of new sectors. ‘Public planning’ and ‘industrial policy’
have become toxic phrases, but we need some of their substance (and less of ‘financial
policy’, meaning the automatic favouring of finance). This is not a matter of returning to
1970s-style controlling sectors and ‘picking winners’. It is a question of how to combine
the appropriate role of entrepreneurs in spotting economic opportunities (as they spotted
opportunities in ICTand in revitalising declining dockland areas) with a more coordinated
process of formulating agreement about directional thrust, involving representatives of
the interests whose concerns come together to constitute the ‘common good’—bringing
them together in repeated interaction to the point where they moderate sectional interest
in line with an emerging notion of the national interest.
In other words, the question is how to institute a type of capitalism with more
coordination through political mechanisms than has been normal since 1980
6) Reform to reduce global imbalances has to deal with at least two big issues: one is the
dollar as the international reserve currency, and the other is the combination of floating or
flexible exchange rates and free capital movement.
On the first, the ability of the USA to run very large current account deficits—thanks to
the dollar still accounting for two thirds of all foreign exchange reserves—has turned out
to be a calamity, and a large part of the explanation for the current financial crisis.
The post-Bretton Woods combination of flexible exchange rates and free capital
movements has failed spectacularly in keeping the world economy stable. Again and
again countries’ exchange rates have been driven in the opposite direction from that
needed to reduce global imbalances: deficit countries have often experienced real
exchange rate appreciation and surplus countries, real exchange rate depreciation or no
change
Re-legitimising capital controls today is in the broad interests of the West, as
well as developing countries, as a way to protect against the disruption of hot money
fleeing from the more unstable periphery. The next and bolder step is to establish global
arrangements to coordinate symmetrical adjustment policies for deficit and surplus
countries - a subject needing a whole new essay.
7) Reverse the growth in inequality. Inequality today is largely a result of government
policy and is NOT a result of free markets.
8) Challenge the prevailing ideas free markets always work well and better than anything
else and the most pernicious idea that what is good for financial industries is good for the
nation.
What will actually happen?
Wish lists are easy. What are the chances that powerfully entrenched interests will be
overcome, that governments will cooperate, that China will take on global
responsibilities?
Prediction one: little will change
The two big regime changes since WorldWar II were propelled not only by the
magnitude of the preceding disruption but also by the existence of enemies. The New
Deal and Bretton Woods regimes were a response to the threat posed, abroad, by Nazi
Germany and Stalin’s Russia and, at home, by trade unions and extreme political parties.
The Reagan/Thatcher transformation was helped by invoking the Soviet Union as the
external enemy and trade unions as the internal enemy. Today, no external or internal
enemy is sufficiently dangerous to forge an elite consensus for regime change. The
amount of regime change depends on a more precarious balance of forces in favour
and those opposed.
The US is exceptional among developed countries for the strength of its antiintellectualism, of which fundamentalist religion is one of the spurs. Only 26% of
Americans accept some version of the theory of evolution, 42% say that all living beings,
including humans, have existed in their present form since the beginning of time, and two
thirds want creationism to be taught in public schools with or without the theory
of evolution. These facts are fundamental for understanding American economics
and American foreign policy.
Fundamentalist religion and fundamentalist capitalism are basically the same thing. A
potentially large part of the electorate believes in fundamentalism and can be persuaded
to vote one way.
Underlying the cleavage is a gut attachment on the part of many Republicans, and even
some Democrats, to tax cuts at home and preemptive wars abroad—attachments anchored
in the notion of the moral society as an aggregate of self-reliant individuals and
neighbourhoods linked by a shared commitment to ‘freedom’ and the flag . People
of this world view are viscerally opposed to the Obama stimulus package and help for the
banks.
A less familiar cleavage in US politics is between the ‘oligarchic’ and the
‘establishment’ fractions of the capitalist elite, which cross cuts the
Republican/Democrat divide. The oligarchic fraction seeks to protect a structure
favouring upwards income redistribution, in the name of ‘free markets’, and it has drawn
much of its membership from the finance sector during the past two decades.
The oligarchic faction has been dominant for the past 30 years and advocates policies of
“neo-liberalism. This means deregulation, globalization, weaken labor organization,
promote finance, accept income redistribution and more inequality, tax reductions, and
higher deficits in fiscal policy and trade.
The oligarchic faction cannot win elections without building up and allying itself to the
fundamentalist religion/fundamentalist capitalism section of the public. The oligarchic
elite accepts much of what some call “socialism” but condemns it to gain supporters in
the fundamentalist/populist voters. When actually in office, the oligarchic faction makes
small reductions in “socialism” but does not alter its basic structure.
The most successful political appeal of the oligarchs is for “unilateral nationalism” in
foreign policy. This demonstrates contempt to foreigners and foreigner ideas that appeals
to fundamentalists.
The oligarchs will call for “letting the banks fail” in order to appeal to the
fundamentalists. If they are in power during the next crisis, the oligarchs will bail out the
banks and the system – Paulson’s policies were indistinguishable from Obama’s. If they
are not in power, they will oppose the bailout in public and support it in private. The
oligarchs have “blood on their hands” for bailouts in this crisis and must convince the
fundamentalists that they really didn’t mean it.
The establishment faction allies itself to the intellectual “left” dominant in universities
and among knowledge workers. It draws on the ideas of the intellectuals for policy
guidance. The establishment faction supports mixed government and limits on capitalism
believing fundamentalist capitalism is unsustainable: produces crises that threaten the
system, increases inequality which also threatens the system, and results in gross
weakening of the nation with dependence on foreign money. Establishment faction
supports government efforts to invest in infrastructure and promote new industries.
The establishment fraction, on the other hand, sees the government’s role as being to
secure a distribution of income, wealth and opportunity that protects the overall stability
of the system; it is happy to use devices like progressive taxation and a public welfare
state to secure this objective; and in the past two decades has become critical of the
dominance of finance and the New Wall Street System.
President Obama’s recent budget, with its emphasis on investment in infrastructure,
alternative energy, education and a national health system, represents a victory—at
least at the level of discourse—for the establishment fraction. But the oligarchic
fraction, allied with a more populist elite in Congress, is focused on jump-starting
personal consumption with short-term measures, largely ignoring the dangers of even
higher debt. And it has won a victory in the Treasury’s continuing avoidance of
nationalisation of the big banks, in favour of the taxpayer bailout strategy described
earlier.
The outcome of these struggles, especially for the subsequent ability of finance to
continue to shape the US type of capitalism, is not a foregone conclusion. It is clear that
the oligarchic elite will fight tooth and claw to restore finance and the larger
neoliberal order. Having accrued such disproportionate gains under the rules of this
order it will oppose moves to strengthen the capacity of the state to discipline the
economy.
The oligarchic elite and neoliberal norms will prevail once the cognitive fog lifts—
that the normal attention cycle will operate in this case too, with a bit more regulation
added on. The dominance of the neoliberal paradigm, and its carriers in universities,
think tanks, governments and the media has been so complete for the past two decades in
the West that alternative ideas and their developers remain on the margins, far from good
currency.
The oligarchic view consists of: free market institutions, free market beliefs and
redistribution upwards. If this default position brings bad recessions and social
misery once every two or three decades for much of the world but personal fortunes
to those in the top few percentiles of the income distribution, it is a fair bargain in
the eyes of those at the top.
Prediction two: Some change
For all that, there are reasons for optimism that the liberal model of capitalism will be
significantly moderated. This crisis has—seemingly—thoroughly discredited factual
propositions about the efficiency and self-regulating tendencies of financial markets.
The discrediting may feed into a discrediting of the associated value priorities of
acquisitive individualism, offering more scope for political parties advocating
different value priorities. The shock of the crisis emanating from the most sophisticated
financial market, the loss of US leadership, the entry of new states at the top table of
global economic governance, and the sheer difficulty of getting a strong global regulatory
framework may all encourage more effort to develop stronger national regulation and
supervision, combined with light agreement on directional principles at the global level
and denser agreement at the regional level.
International dimensions of the crisis
As for multilateral cooperation to deal with the crisis, Wade sees mostly nationalism. US
acts alone if need be; Germany won’t stimulate its own economy, preferring others do so
and maintain high German exports. The British oppose more financial regulation in order
to preserve the freedom of action of The City. The potential for default by East
Europeans on loans made by Austria, Italy and Greece threaten another cascade of losses
that Germany may have to bailout. The IMF is overwhelmed by the size of the crisis,
even with a large rise in its resources.
Conversely, the same things that make a strong global regulatory response unlikely
provide an opportunity to step back from the globalisation project aimed at creating
a whole world economy functioning like that of the USA, where nation states have no
more influence over cross-border flows and internal political economy arrangements than
US. We should give up on the attempt to frame universal operational rules, like the Basel
I and Basel II agreements on capital adequacy. We should give up on the attempt to
spread a single variety of capitalism through the WTO, the IMF and the World Bank, and
instead take the General Agreement on Tarrifs and Trade (GATT) and shallow
integration as the model.
The crisis does not signal the end of capitalism, nor will it be remotely comparable
to the Great Depression as a source of social misery. But it is generating more
pressure for intellectual, organisational and normative change than, say, the Asian
crisis of 1997–99.
The ‘establishment’ elite has come to question the proposition that financial
markets self regulate each other and even question some of the virtues of acquisitive
individualism. Establishment elites and the broad left around the world can exploit
the new ambiguity to push serious reforms through the political process.
I would argue failure to offer an alternative policy to the neo-liberal right in the
West will result in even greater dependence on the Chinese. This has two
consequences: more crises that weaken the US and that opens the intellectual door
to the Chinese and a Chinese effort to define a world order.
Stiglitz, Socialism for the Rich
Do you believe that the banking system in the US should be significantly changed?
If NO, do you accept the costs of more big financial crises? Do you believe the interests
of the banks are the same as your interests?
If YES. How will this happen without a strong government able to act against the
interests of these banks?
Why is Stiglitz critical of the Obama administration?
What is “ersatz capitalism?” Does it apply to the US?
Would a socialist nation provide direct support to the millions of families with foreclosed
homes? Has the US acted like a socialist nation in this area?
Paul Krugman’s editorial in the NYT for today:
Financial Reform Endgame
By PAUL KRUGMAN
Published: February 28, 2010
So here’s the situation. We’ve been through the second-worst financial crisis in the
history of the world, and we’ve barely begun to recover: 29 million Americans either
can’t find jobs or can’t find full-time work. Yet all momentum for serious banking reform
has been lost. The question now seems to be whether we’ll get a watered-down bill or no
bill at all. And I hate to say this, but the second option is starting to look preferable.
The problem, not too surprisingly, lies in the Senate, and mainly, though not entirely,
with Republicans. The House has already passed a fairly strong reform bill, more or less
along the lines proposed by the Obama administration, and the Senate could probably do
the same if it operated on the principle of majority rule. But it doesn’t — and when you
combine near-universal Republican opposition to serious reform with the wavering of
some Democrats, prospects look bleak.
How did we get to this point? And should reform advocates accept the compromises that
might yet produce some kind of bill?
Many opponents of the House version of banking reform present their position as one of
principle. House Republicans, offering their alternative proposal, claimed that they would
end banking excesses by introducing “market discipline” — basically, by promising not
to rescue banks in the future.
But that’s a fantasy. For one thing, governments always, when push comes to shove, end
up rescuing key financial institutions in a crisis. And more broadly, relying on the magic
of the market to keep banks safe has always been a path to disaster. Even Adam Smith
knew that: he may have been the father of free-market economics, but he argued that
bank regulation was as necessary as fire codes on urban buildings, and called for a ban on
high-risk, high-interest lending, the 18th-century version of subprime. And the lesson has
been confirmed again and again, from the Panic of 1873 to Iceland today.
I suspect that even Republicans, in their hearts, understand the need for real reform. But
their strategy of opposing anything the Obama administration proposes, coupled with the
lure of financial-industry dollars — back in December top Republican leaders huddled
with bank lobbyists to coordinate their campaigns against reform — has trumped all other
considerations.
That said, some Republicans might, just possibly, be persuaded to sign on to a muchweakened version of reform — in particular, one that eliminates a key plank of the
Obama administration’s proposals, the creation of a strong, independent agency
protecting consumers. Should Democrats accept such a watered-down reform?
I say no.
There are times when even a highly imperfect reform is much better than nothing; this is
very much the case for health care. But financial reform is different. An imperfect health
care bill can be revised in the light of experience, and if Democrats pass the current plan
there will be steady pressure to make it better. A weak financial reform, by contrast,
wouldn’t be tested until the next big crisis. All it would do is create a false sense of
security and a fig leaf for politicians opposed to any serious action — then fail in the
clinch.
Better, then, to take a stand, and put the enemies of reform on the spot. And by all means
let’s highlight the dispute over a proposed Consumer Financial Protection Agency.
There’s no question that consumers need much better protection. The late Edward
Gramlich — a Federal Reserve official who tried in vain to get Alan Greenspan to act
against predatory lending — summarized the case perfectly back in 2007: “Why are the
most risky loan products sold to the least sophisticated borrowers? The question answers
itself — the least sophisticated borrowers are probably duped into taking these products.”
Is it important that this protection be provided by an independent agency? It must be, or
lobbyists wouldn’t be campaigning so hard to prevent that agency’s creation.
And it’s not hard to see why. Some have argued that the job of protecting consumers can
and should be done either by the Fed or — as in one compromise that at this point seems
unlikely — by a unit within the Treasury Department. But remember, not that long ago
Mr. Greenspan was Fed chairman and John Snow was Treasury secretary. Case closed.
The only way consumers will be protected under future antiregulation administrations —
and believe me, given the power of the financial lobby, there will be such administrations
— is if there’s an agency whose whole reason for being is to police bank abuses.
In summary, then, it’s time to draw a line in the sand. No reform, coupled with a
campaign to name and shame the people responsible, is better than a cosmetic reform that
just covers up failure to act.
Attached at the Wallet
the financial relationship
between China and the U.S. is beginning to look like an unhealthy
co-dependency. China holds so much of its foreign reserves in
dollar-based assets that it is now vulnerable to shifts in the U.S.
economy. And the U.S. has allowed China to purchase so much of its
debt that it is now beholden to Chinese interests.
Some in the U.S. worry that China's massive dollar holdings could spell trouble for the
U.S. economy if China ever decided to divest. "It's a weakness from the U.S. point of
view," says Wharton finance professor Franklin Allen. "We are the vulnerable ones,
because if [China] pulled out, there could be a run on the dollar, which would be very bad
for the U.S."
Such economic calamity is precisely the reason why China won't sell off its U.S. debt,
others argue. China is dependent on the U.S. to buy its goods, and has no interest in
seeing the American economy or the dollar collapse. Besides, if China sells off a chunk
of its U.S. Treasury bonds, the value of the rest of its dollar-backed holdings would also
fall. "If they begin to unload their holdings of U.S. Treasuries or even slow down the
purchase [of them], it's going to have a huge impact on the dollar, and that's going to
have a huge impact on the U.S., and they don't want to do that," says Todd Lee, greater
China chief economist at research firm IHS Global Insight. "The U.S. is, after all, the
most important export market for them."
But a lot of China-watchers assert that China purchases U.S. Treasuries as a way of
manipulating its currency. "The way the Chinese manage the value of the yuan is through
buying and selling dollars," says Wharton professor of business and public policy
Howard Pack. "They have been intentionally incurring these export surpluses, so they
have too much foreign currency. When they buy U.S. Treasuries, it keeps the value of the
yuan low relative to the dollar. That enables Chinese exporters to sell at relatively low
prices to the U.S."
What really worries the Chinese, says Allen, is that "we're going to borrow so much that
we're going to have really high inflation. I don't think they're worried that we'll actually
default." But if the U.S. borrows so much that the value of the dollar begins to fall, then it
will be as if China "gave us $2 trillion and we give them back, effectively, $1 trillion."