skidelsky intro
Introduction
I. UNSETTLED ISSUES
Macroeconomics is about money and government, and their relationship. The unsettled questions in macroeconomic policy stem from disputes about the part money plays in economic life, and the part government should play. For 250 years, the dominant view of the economic profession has been that money is of no importance except when it gets ‘out of order’, and that government interference with the market usually makes things worse. ‘You can’t buck the market,’ Mrs Thatcher famously declared. A competitive market economy, it was claimed, has an automatic tendency to full employment. Disturbances to employment are the result of interference, usually by or at the behest of governments, creating or promoting monopolies, impeding price adjustments or, crucially, by ‘monkeying around’ with the money supply, thus inducing people to trade at the wrong prices. At first it was believed that control of money should be entrusted to the gold standard; when the gold standard broke down, to independent central banks. Government should be limited to ensuring the conditions required for efficient market exchange. The only task of macro policy was to control the money supply.
This view of policy was successfully challenged by the Keynesian revolution, which, starting as a new theory in the 1930s, dominated macroeconomic policy until the 1970s. The Keynesians denied that a monetary economy – one in which contracts are made in money, not goods – had any automatic tendency to full employment. This was because people could choose to hold money, rather than spend it, and the reason they might wish to do so was the omnipresence of uncertainty; as Keynes put it, the possession of money ‘lulls our disquietude’. Given the role of money as a ‘store of wealth’, the macroeconomy was inherently unstable, and was liable to settle down in a position of ‘underemployment equilibrium’. It was therefore the task of government to maintain a full employment balance between supply and demand, which included the management of money as part of the management of the economy. But it was not money that had to be kept in order; it was the market system itself. If it was left free of management and regulation, it would be socially and politically disruptive. In the Keynesian era, stretching from the end of the Second World War to the 1970s, the free world economy experienced a unique period of stability and growth.
In the 1970s, however, the Keynesian system succumbed to ‘stagflation’ – the simultaneous rise in inflation and unemployment – and the Keynesian attempt to manage the macroeconomy was abandoned. The core idea behind the new classical economic policy that succeeded it was that central banks should be mandated to control inflation, with unemployment left to settle at its ‘natural’ rate. This was taken to be a rate on which macroeconomic policy could not improve. The unemployed should get on their bikes and look for work.1
In technical terms, familiar to economists, the question about the relationship between money and government is a question about the relationship between monetary and fiscal policy. The Keynesian innovation was that the government should influence the level of total spending through fiscal policy, with monetary policy made consistent with the aims of fiscal policy. By contrast, in new classical economics, monetary policy – keeping the economy supplied with the right amount of money – is the whole of macroeconomic policy, since fiscal policy cannot influence the level of total spending, only its direction. This was the doctrine ‘in power’ in 2008.
The collapse of 2008 and its aftermath was a test of the two theories of macroeconomic policy, not under laboratory conditions but in as close to a real-life experiment as we are likely to get. According to the mainstream view of the time, the collapse should not have happened and, even if it had, recovery should have been swift. In the second, Keynesian, hypothesis, its happening was always a possibility, and recovery was never likely to be fast or full. However, the old Keynesian recipe for running economies at full employment through fiscal policy had succumbed to inflation, and has not been rehabilitated, so policy for the future remains unsettled.
The proximate cause of the collapse of 2008 was the accumulation of private debt, much of it the result of fraud on the part of the lenders and myopia on the part of the borrowers. A vast, global, inverted pyramid of bank, business and household debt was built on a narrow base of underlying assets – American real estate. When the base tottered, the pyramid fell. The failure of the sub-prime mortgage market in the United States triggered a collapse in the prices of financial assets. The fall in the net wealth of banks in 2007–8 produced a global financial crisis. This was transmitted to the real economy through a tightening of credit by the banks and a fall in demand by consumers and businesses, whose wealth and confidence had evaporated.
It all developed with astonishing speed. The bankruptcy of Lehman Brothers on 15 September 2008 precipitated a stock market collapse in October. Once banks started to fail and stock markets to fall, the ‘real’ economy started to slide too. Banks stopped lending. Creditors foreclosed on loans to debtors. Businesses laid off workers. Total spending shrank. This brought about generalized conditions of slump throughout the world by the fourth quarter of 2008. It was eerily reminiscent of what happened in the Wall Street Crash of 1929.
The worst of the storm passed after a year. Unlike in 1929, governments intervened to prevent disaster. Governments and central banks around the world vigorously pumped money into their deflating systems. But in some European countries, governments were virtually bankrupted by the excesses of their banking systems. The collapse of state revenues brought public debts to unprecedented peacetime levels, reviving the most persistent of the economic orthodoxies: that governments are the problem, not the solution. As economies stabilized, policies of austerity were adopted to put governments back into the fiscal cage from which the severity of crisis had temporarily released them. Today, monetary expansion is being eased, in recognition that it has done as much as it can, while austerity is being eased in recognition that monetary policy is not enough. The future of the fiscal–monetary mix is unsettled.
The standard account of the origins of the crisis starts with an (unexplained) shock to the financial sector, which is then transmitted to the non-financial sector through the freezing of credit. However, it is possible that the trouble was rooted in the non-financial economy. Despite the rosy retrospect of the so-called Great Moderation years of the early 2000s, the Western economies that collapsed in 2008 were not in pristine condition. Unemployment was about double what it had been in the Keynesian era. The huge accumulation of household and corporate debt – in the advanced economies, average private-sector debt as a percentage of GDP went up from 50 per cent in 1950 to 170 per cent by 2008 – was one indication that large sections of the pre-crash economy were not ‘paying their way’. This was partly a consequence of a marked growth in inequality. Real wages were stagnant or falling; investment was down from its historic levels, and with it productivity growth. The finance sector was growing faster than the economy, and financiers were getting much richer than anyone else. Signs of ‘secular stagnation’ were not hard to see, after the event. I have singled out the stagnation of real earnings as the deep cause of the crisis, the result of which was transmitted to the financial sector through the build-up of unsustainable debt. The Great Moderation is known chiefly for its low inflation and cyclical stability. It now seems more of a lull before a storm bound to break. It leaves the fate of advanced capitalist economies in limbo. At the time of writing, a resurgent financial system and a mediocre real recovery threaten a repeat crash at no distant date.
II. THE CULPRITS
‘Why did no one see it coming?’ asked Queen Elizabeth II of a group economists at the LSE in October 2008.2 This book is an attempt to answer that question and suggest how to avoid such foul-ups in the future. This will not be easy. It will not be enough to strengthen socalled financial ‘resilience’ to shocks. It is economies which need to be made resilient to shocks.
It is natural to start with the financial institutions, which egregiously over-borrowed and over-lent, and which were heavily into all kinds of fraudulent practices. Gripped by a collective hubris, the institutions were oblivious to the rocks ahead. The lure of present gains drove out the fear of future losses.
But to stop with the banks would be a mistake. The banking sector was freed up to do its best and worst by national governments and regulators, who held a benevolent view of the financial system. Finance was viewed essentially as an intermediatory, bringing together willing buyers and sellers of goods and services. In the language of the day, the financial market was an ‘efficient’ market, which needed no more regulation than any other market. The peculiar property of finance as a vent for speculation and fraud was ignored.
This benign view of finance extended to the financial innovations of the 1990s. Securitization – the process of transforming non-marketable assets into marketable ones – led to a continuous lengthening of the chain of indebtedness. This ‘financialization’ of the economy – the growing share of money being made from purely financial operations – was praised (or at least justified) as ‘making capital allocation more efficient’ and therefore maximizing growth. Business school professors set up their own hedge funds to test their theories.
But how, the enquirer may ask, did so many governments come to hold views which were plainly absurd in retrospect? He is led inexorably to the source of these beliefs, to the ‘intellectual climate’, the Zeitgeist, the tide of thought and feeling that liberated our financial markets from national controls. The enquirer will discover that at the heart of today’s mainstream macroeconomics is the belief that unimpeded competitive markets deliver optimal welfare, and that the financial institutions which create money, and through which money is allocated, have no independent effect on the real equilibrium of the economy, but are only acting on behalf of well-informed sovereign consumers. He will discover that the forecasting models of finance ministries and central banks lacked a financial sector. The assumption that future prices would move in line with current expectations removed any need to take precautions against financial collapse, despite a continuous history of financial manias and panics. Aiming to minimize the interference of the state, mainstream economics ignored the financial wolves on the prowl.
Surely it is here – in the world of economic ideas – that the original flaw in the regulatory design is to be found. Governments believed things about the economic system that were not true, or at least not true enough. In the name of these ideas, finance was allowed to spin out of control; and its implosion produced a world depression.
Practical people usually pooh-pooh the influence of academic scribblers. The English famously feel themselves to be healthily exempt from intellectual influences. In fact, academic thought and policy were not so closely linked in the past. But today, economic ideas penetrate much more deeply into economic policy, because economic policymaking is largely in the hands of professional economists. Most of them work not in universities, but in treasuries and central banks, in commercial banks, businesses and newspapers, in political parties and think-tanks, or as business consultants and lobbyists. The days are long past when a Governor of the Bank of England could welcome one of its first academic economists with the words: ‘you are not here to tell us what to do, but to explain to us why we have done it’.3 Now economists do tell decisionmakers what to do.
This is supposed to make policy more expert, less partisan. However, economics is by no means the scientific citadel that many of its practitioners claim it to be. It displays a silent ideological slant while sticking to the accepted canons of scientific method. Since the 1980s, the dominance of new classical theory in economics has coincided with the neo-liberal capture of politics. The connection is not fortuitous. New classical economics has provided an economic-theoretic justification for neo-liberal policies; neo-liberal ideology has shaped the way economists ‘model’ the economy. Both readily sign up to Ronald Reagan’s distillation of two centuries of conventional wisdom: ‘The government is the problem, not the solution.’4
However, to say that economics is inherently ideological is not quite to get to the root of the puzzle of what went wrong in 2008. Why this ideology and not that?
Ideology is highly influenced by the structure of power, as well as helping to bring about a structure of power favourable to it. This is the important element of truth in Marx’s claim that the dominant ideas of any epoch are those of its ruling class. The crash of 2008 revealed the power of financial interests.
A huge puzzle in the pre-crash situation is the weakness of democratic government in face of the structural power of finance. Orthodox political science tells us that in democracies accountability runs from government to the people. But one cannot get a grip on the history of the crisis without realizing that it is the financial community, far more than ‘the people’, that decides both the terms and the conditions on which government gets its money. The money–power nexus works both indirectly, through its influence on election finance and the presentations of the media, and directly through its role in financing government borrowing. What the ‘efficient allocation of capital’ means in practice is the allocation which is efficient for the financial sector. In the last twenty to thirty years, the chief economic role of Western governments has been to provide the financial system with a nice environment for it to maximize its profits. This has included being prepared to bail out banks when their excesses made them insolvent, and being prepared to cut their own spending on social welfare to retain the confidence of the bond markets. Following the crash, the financial sector has turned the brave words of politicians about the need for reform into rhetoric largely without substance.
The Marxist claim that big business controls politics rests on the twin claim that the business class is a monolith and that it is effectively unchecked by countervailing forces. In fact untrammelled business power is the exception rather than the rule. On the one side business power itself is divided, notably between exporters and importers, creditors and debtors, small and big businesses, and ‘finance’ and ‘industry’; on the other side, business power has been checked by varieties of popular power. The more equal the balance of forces, the less likely we are to get a single story about the way the economy works.
A central claim of this book is that there was a balance of power between capital and labour from the 1920s to the 1970s which enabled the emergence of a Keynesian state relatively free from the vested interests. It was in this period that the idea of the state as a benevolent guardian of the public interest gained currency. But in the last forty years the balance of power has shifted decisively from labour to capital; from the working class to the business class; and from the old business elites to new financial, partly criminal, elites. How this has come about deserves a profound study of its own, of which only hints can be given in the pages that follow. What can be claimed is that the main homage which mainstream economics pays to power is to render it invisible.
Finally, theory and policy are moulded by the conditions of the times. These produce what John Hicks called ‘concentrations of attention’,5 by which he meant the problems that economists choose to study. What causes shifts in attention? In the interwar years persistent mass unemployment was the problem; in the 1970s it was inflation. Such changes in facts disturb the kaleidoscope; they determine what the viewer sees. (For a further discussion of the relationship between ideas, power and circumstances, see the appendix to this Introduction, p. 11.)
What follows will attend primarily to macroeconomic doctrines as they developed until 2007, and the way these have been tested and found wanting by the crisis and its aftermath. The book is an essay in political economy, since it pays attention at all times to the context of the rise and fate of different economic doctrines. Knowing what economists thought in the past, and how and why they came to think as they did, is, as Hicks has pointed out, an essential part of ‘keeping watch’ on the discipline as, unlike in the natural sciences, it can record no unambiguous progress in knowledge. It is perhaps natural for me to embrace a political economy approach, since I was originally trained as a historian, and no historian can be oblivious to the historical forces that produced the stories by which economic events are understood.
III. A BRIEF SKETCH OF THE BOOK
The book is divided into four parts. The first takes the reader through the historical debates on monetary and fiscal policy before the First World War. This history is crucial to an understanding of the precrash orthodoxy. The second investigates the rise and fall of the Keynesian revolution, showing how this episode ended with the partial restoration of Victorian monetary and fiscal policy. The third part shows how this restoration was itself tested by the collapse of 2008–9 and its aftermath, reopening issues formerly considered settled. Part Four concludes with reflections on the whole and a sketch of a new macroeconomics.
Part One starts with three chapters on the history of monetary theory and policy. Chapter 1 surveys the debates on the origins of money, on the nature of money, on what determines its value, and on the consequences of disturbances to its value. Chapter 2 covers the three great nineteenth-century debates about how money might be ‘kept in order’, which, starting in the era of the gold standard, culminated in the ‘scientific’ Quantity Theory of Money at the start of the last century, the subject of Chapter 3. This chapter pinpoints the rupture in monetary theory, represented by the two versions of the Quantity Theory of Money developed by Irving Fisher and Knut Wicksell, respectively.
Chapter 4 examines the nineteenth-century theory of fiscal policy. The point of special emphasis is that fiscal rules and monetary rules were considered complementary. Their joint purpose was to prevent governments from issuing too much money. With Britain setting the pace, by 1900 all ‘civilized’ countries had linked their domestic currencies to the gold standard and their governments balanced their budgets at the lowest level of taxes and spending possible. But the theory of the ‘minimal state’ was never wholly accepted outside Britain. The idea of the state as the indispensable actor in a nation’s economic development survived in the ‘pre-scientific’ doctrine of mercantilism. Specifically, free trade, though preached by economists, was never widely accepted on the continent of Europe, or even in the United States. By the 1880s and 1890s, the doctrine of laissez-faire had started to be challenged by the rise of democracy, the depressions of the 1880s and 1890s, and the emergence of the welfare state. The appearance of the word ‘unemployment’ in the Oxford English Dictionary in 1888 marked the arrival of a ‘problem’ that would dominate economic theory and policy for the next eighty years.
Part Two traces the rise, triumph and fall of the Keynesian revolution, a period stretching from the publication of Keynes’s General Theory of Employment, Interest, and Money in 1936 to the 1970s. Chapter 5 shows how the Keynesian theory of economics and policy were a response to the Great Depression of the 1930s. It was seemingly vindicated by the achievement of full employment and stable growth in the thirty years that followed the Second World War, the subject of Chapter 6. The Keynesian regime ran into trouble in the stagflationary 1970s and was superseded by ‘monetarism’, which was in fact a reversion to pre-Keynesian orthodoxy about both money and governments. Chapter 7 ends with an account of the ‘New Consensus’ – a mixture of ‘new’ classical and ‘new’ Keynesian economics, which was in turn brought down by the collapse of 2008.
Following the theoretical twists and turns of this economic saga, no one can fail to be impressed by the persistence in economic theory of the core idea that an unimpeded market system tends to full employment equilibrium, unless obstructed by ‘spanners in the works’, generally thrown by governments. First suggested by Adam Smith’s metaphor of the ‘invisible hand’, this insight was formalized in the general equilibrium theory of Leon Walras in 1874. Much later, as late as in our own day, the microeconomics of Walras begat new classical macroeconomics. The main storyline has been heavily modified and qualified in face of disconfirming events, but has always re-emerged, in more or less unchanged form. This leads to the conclusion that there has never been a real ‘paradigm’ shift in economics comparable to those occasionally experienced in the natural sciences (by paradigm shift I mean a fundamentally different way of looking at the material being studied). The Keynesian revolution came closest to it. Mostly, it has been a story of persistence without progress. This persistence can be explained by the fact that the rise of scientific economics coincided with the rise of capitalism, and the logic of economics as we know it is not easily separable from the arguments in support of capitalism.
Part Three of the book is about theoretical and policy responses to the downturn of 2008. It relates these responses to the historical debates covered in Parts One and Two and shows how they carried the baggage of the past with them. Chapters 8 and 9 show how fiscal and monetary policy met, or failed to meet, the challenge of the downturn. The main theme is that with fiscal policy quickly disabled by ballooning government debts, the task of stabilizing economic life fell to unconventional monetary policy. Chapter 8 examines the theory and practice of ‘fiscal consolidation’: the effort by governments to liquidate deficits and reduce national debts to restore ‘confidence’. Chapter 9 surveys the rationale, and limited success, of ‘quantitative easing’, the attempt by central banks to offset the deflationary effects of fiscal consolidation by injecting large amounts of money into the financial system. My broad conclusion is that the post-crash monetary–fiscal mix was successful in preventing the collapse of 2008–9 from turning into the rout of another Great Depression, but has not succeeded in restoring durable economic prosperity. Indeed, the methods by which it rescued damaged economies from the financial excesses of the pre-crash years have set the scene for the next financial crash. Our economies are still on life-support systems, and the withdrawal of these will be exceptionally challenging.
Chapters 10, 11 and 12 look at the structural causes of financial instability. Chapter 10 analyses the macroeconomic impact of the growth of inequality of income and wealth. The focus of Chapter 11 is on financial innovation, partly in response to the explosive increase in the demand for credit. Chapter 12 examines the contribution of current account imbalances to the instability of the pre-crash economic system.
And so to the topic of the final part: what is to be done? The central question of political economy today is as it has always been: what does a government need to do to secure the relatively smooth – and socially and morally tolerable – functioning of a decentralized, money-using, largely privately owned economy?
Technical material is presented, as far as possible, in appendices to individual chapters, so as not to break up the flow of ideas.
APPENDIX I.1: IDEAS, VESTED INTERESTS AND CYCLES
Ideas versus Vested Interests
Keynes ended The General Theory of Employment, Interest, and Money with the famous words: ‘But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.’6 Anyone involved in the production of ideas has to believe this, unless they are being paid by someone to produce the ideas. In today’s world, the chief manufactory of ideas is the Academy. Pure research has long been recognized as an independent intellectual pursuit; its hallmark, disinterestedness; its purpose, the search for truth. The pecuniary interest of scholars is not directly involved in either the direction of their enquiry or its results.
At the same time, there is what Joseph Schumpeter called the ‘sociology of success’. Put crudely, why are some ideas acceptable, and others rejected or marginalized? In the natural sciences this question is relatively easy to answer: newer ideas bring us closer to reality than the older ones. For this reason, quantum physics replaced classical physics. Reality is unchanging, only the theory changes as it improves our understanding of reality. Predictive power is the ultimate test of the truth of a scientific hypothesis.
In social sciences this is much less true. The natural world does not interfere with one’s observation of it; the social world does. It is the changeability of the object being studied which demarcates social sciences from natural sciences. Social reality is constantly shifting, problems crucial at one time become irrelevant at another. As a result, propositions in social science do not satisfy the ‘universality criterion’. They are limited in time and place. As Amir Kumar Dasgupta points out, theories in economics are independent of each other, they do not supersede each other.7 Theories in the social sciences cannot be successfully confirmed or falsified, except briefly. Progress in economics consists of greater precision in stating ideas, not the greater explanatory power of the ideas themselves; and the precision may be at the expense of the explanation. In economics, much more than in physics, the research agenda and structure of power within the profession reflect the structure of power outside it. Economic research programmes have the character of ideologies. And this, of course, was precisely Marx’s contention when he wrote: ‘What else does the history of ideas prove, than that intellectual production changes in proportion as material production is changed?’8
The relationship between ideas, circumstances and power is one of the most complicated questions in social science. Ideas are not at the mercy of circumstances in any straightforward way. The disciplines which produce theories exhibit stability through time, in their concepts, techniques and language. That is why paradigm shifts are rare. It is true that disciplines turn to new topics. But there is no need to relate all new topics to changes in the world. Theorists might simply get bored with the old topics, feeling that debate about them has reached a dead end. Change of topic is also connected with generational change within a discipline.
It is nearer to our theme to say that ideas change when large facts of the world change. Dasgupta talks of ‘epochs of economic theory’. He wrote: ‘A system of economic theory evolves in response to questions that are provoked by a given set of circumstances in the economy. As circumstances change, or people’s attitude to them changes, questions are revised, and a new system springs up.’9 Dasgupta is right to distinguish between changes in circumstances and changes in people’s attitudes to these changes. A large shock can upset existing ideas, and policies based on them. But the nature of the adjustment of the ideas and policies is not determined. The Great Depression of the 1930s, coming on top of the First World War, benefitted rival claims to the liberal succession in the different forms of communism, fascism and Keynesian social democracy. The travails of the world economy since 2008 have led to outbreaks of populism of both the left and right, whose ideological and political potential is as yet undetermined.
Thus there is no direct relationship between ideas and problems. Facts can be interpreted in different ways. He who controls the interpretation controls the story. This brings us to the question of power.
Adapting Steven Lukes, one may think of ideas as a form of ‘soft power’, which structure our debates about reality.10 Alternatively, and more comprehensively, they may be seen as shaping our consciousness – the way we interpret our world.
Ideas are therefore an independent source of authority. Practical men – politicians, businessmen, civil servants – are consumers, not producers, of ideas. This gives the producers of ideas considerable latitude vis-à-vis their users. The vested interests are in no position – even were they capable of it – to dictate the precise form of the intellectual defence offered for their practices. Thus the economist’s justification of the free market is likely to be both more general and also more circumscribed than that offered by the business class. For example, economists have almost always opposed protectionism and monopoly: business has generally been in favour. Ideas are thus capable of making self-interest seem more enlightened.
The fact that ideas are produced in non-profitmaking institutions doesn’t, though, dispose of the question of the hard power behind the soft power. Who finances the business schools that produce the MBAs of contemporary business life? Who finances the dissemination of ideas in the media and think-tanks? What are the incentives facing the producers, disseminators and popularizers of ideas even in a society in which discussion is ‘free’? In short, what is the agenda of business?
One must avoid over-simplifying. It is much harder – and I would say fruitless – to try to relate philosophical, artistic and literary productions to the structures of power. They are just as likely to be critiques of the status quo as homages to it, even though many subtle and not-so-subtle mechanisms, social and pecuniary, exist, for coopting cultural elites into the business system.11 More importantly, the cultural critique of capitalism, while persistent and often profound, has had very little influence on economics and economic policy. Nor is the state simply (or always) an agent of the bourgeoisie. Notionally, at least, it stands for the public interest. There is a bigger role for ‘public intellectuals’ in a mixed economy of public and private sectors than in one in which business calls the shots.
Assertion of the independence of ideas is a necessary modification of crude Marxism, and one which I dare say Marx himself would have accepted. Nevertheless, in the Marxist scheme, the intellectual class, like the state, attains only ‘relative autonomy’, and ideas rarely overturn the perception or promotion of self-interest, however much they may modify its expression. Practical men like nothing better than to have their prejudices dressed up in scientific language. Ultimately, the ideas in power serve the interests of the class in power; since the 1980s this has been overwhelmingly the financial class.
Cycles
Economics, taking its cue from physics, is an equilibrium system. Disturbances are said to be brief and self-correcting. But economists, as well as historians, have been fascinated by the rhythmic character of economic life, the waves of innovation and destruction, the rise and fall of systems of political economy. The most famous economic theory of cycles is the Kondratiev cycle, a long wave of forty or fifty years, which starts with a cluster of new technologies and exhausts itself when they have been used up. Schumpeter drew on this idea in his depiction of capitalism’s cycles of creation and destruction. Within the long cycles are shorter cycles of boom and bust, lasting eight to ten years. Lacking proper scientific explanation (Paul Samuelson called cycle theories ‘science fiction’), cycles have nevertheless had a great influence on macroeconomic policy. Typical macroeconomic constructions, such as the ‘cyclically adjusted budget deficit’, refer explicitly to short cycles of definite duration, which oscillate round some ‘normal’ or ‘long-run’ situation.
Historical cycles refer to disturbances of a moral/social, rather than technological, equilibrium. That is to say, they embed technological innovation within the wider frame of political and social change. Societies are said to swing like pendulums between alternating phases of vigour and decay, progress and reaction, prodigality and puritanism. Each expansive movement produces a crisis of excess that leads to a reaction. The equilibrium position is hard to achieve and is always unstable.
In his Cycles of American History (1986) Arthur Schlesinger Jr defined a political economy cycle as ‘a continuing shift in national involvement between public purpose and private interest’. The swing he identified was between ‘liberal’ (what we would call social democratic) and ‘conservative’ epochs. The idea of the ‘crisis’ is central to both. Liberal periods succumb to the corruption of power, as idealists yield to time-servers, and conservative arguments against rent-seeking win the day. But the conservative era then succumbs to a corruption of money, as financiers use the freedom of deregulation to rip off the public. A crisis of under-regulated markets presages the return to a social democratic era.
This idea fits the American historical narrative tolerably well. It also makes sense globally. The era of ‘conservative’ economics opened with the publication of Adam Smith’s Wealth of Nations in 1776. Yet despite the early intellectual ascendancy of free trade, it took a major crisis – the Irish potato famine of the early 1840s – to produce an actual shift in policy: the repeal of the Corn Laws in Britain in 1846 ushered in the free trade era.
In the 1870s, the pendulum started to swing back to what the historian A. V. Dicey called the ‘age of collectivism’. The major crisis that triggered this was the first great global depression, produced by a collapse in food prices. It was a severe enough shock to produce a major shift in political economy. This came in two waves. First, all the major countries except Britain put up tariffs to protect agricultural and industrial employment. (Britain relied on mass emigration to eliminate rural unemployment.) Second, all industrial countries except the United States started schemes of social insurance to protect their citizens against life’s hazards. The Great Depression of 1929–32 produced a second wave of collectivism, now associated with the ‘Keynesian’ use of fiscal and monetary policy to maintain full employment. Most capitalist countries nationalized key industries. Roosevelt’s New Deal in the United States regulated banking and the power utilities, and belatedly embarked on the road of social security. International capital movements were severely controlled everywhere.
This pendulum movement was not all one way, or else the West would have ended up with communism, which was the fate of large parts of the globe. Even before the crisis of collectivism in the 1970s, a swing back had started, as trade, after 1945, was progressively freed from tariffs and capital movements liberalized. The rule was free trade abroad and social democracy at home.
The Bretton Woods system, set up with Keynes’s help in 1944, was the international expression of liberal/social democratic political economy. It aimed to free foreign trade after the freeze of the 1930s, by providing an environment that reduced incentives for economic nationalism. At its heart was a system of fixed exchange rates, subject to agreed adjustment, to avoid competitive currency depreciation.
Liberalism, or social democracy, unravelled with stagflation and ungovernability in the 1970s. This broadly fits Schlesinger’s notion of the ‘corruption of power’. Keynesian/social democratic policymakers succumbed to hubris, an intellectual corruption that convinced them they possessed the knowledge and the tools to manage and control the economy and society from the top. This was the malady against which Hayek had inveighed in his classic The Road to Serfdom (1944). The attempt in the 1970s to control inflation by wage and price controls led directly to a ‘crisis of governability’, as trade unions, particularly in Britain, refused to accept them. Large state subsidies to producer groups, both public and private, fed the typical corruptions of behaviour identified by the New Right: rent-seeking, moral hazard and free-riding. Palpable evidence of government failure obliterated earlier memories of market failure. The new generation of economists abandoned Keynes and, with the help of sophisticated mathematics, reinvented the classical economics of the self-correcting market. Battered by the crises of the 1970s, governments caved in to the ‘inevitability’ of free market forces. The swing back became worldwide with the collapse of communism in 1989–90.
A conspicuous casualty of the reversal was the Bretton Woods system, which succumbed in the 1970s to the refusal of the US to curb its domestic spending. Currencies were set free to float, and controls on international capital flows were progressively lifted. This heralded a wholesale shift to globalization. Globalization was, in concept, not unattractive. The idea was that the nation state – which had been responsible for so much organized violence and wasteful spending – was on its way out, to be replaced by the global market. The promise of globalization was set out by the (highly sceptical) Canadian philosopher John Ralston Saul, in 2004:
That in the future, economics, not politics or arms, would determine the course of human events. That freed markets would quickly establish natural international balances, impervious to the old boom-and-bust cycles. That the growth in international trade, as a result of lowering barriers, would unleash an economic-social tide that would raise all ships, whether of our western poor or of the developing world in general. That prosperous markets would turn dictatorships into democracies.12
Today we are living through a crisis of conservative economics. The banking collapse of 2008 brought to a head a growing dissatisfaction with the corruption of money. Neo-conservatism had sought to justify fabulous rewards to a financial plutocracy, while median incomes stagnated or even fell. In the name of efficiency it had promoted the offshoring of millions of jobs, the undermining of national communities, and the rape of nature. Such a system needed to be fabulously successful to command allegiance. We shall see in the next few years whether the repairs made to the economic structure after the collapse have been sufficient to arrest the swing back to collectivism and nationalism that has already started.
I. UNSETTLED ISSUES
Macroeconomics is about money and government, and their relationship. The unsettled questions in macroeconomic policy stem from disputes about the part money plays in economic life, and the part government should play. For 250 years, the dominant view of the economic profession has been that money is of no importance except when it gets ‘out of order’, and that government interference with the market usually makes things worse. ‘You can’t buck the market,’ Mrs Thatcher famously declared. A competitive market economy, it was claimed, has an automatic tendency to full employment. Disturbances to employment are the result of interference, usually by or at the behest of governments, creating or promoting monopolies, impeding price adjustments or, crucially, by ‘monkeying around’ with the money supply, thus inducing people to trade at the wrong prices. At first it was believed that control of money should be entrusted to the gold standard; when the gold standard broke down, to independent central banks. Government should be limited to ensuring the conditions required for efficient market exchange. The only task of macro policy was to control the money supply.
This view of policy was successfully challenged by the Keynesian revolution, which, starting as a new theory in the 1930s, dominated macroeconomic policy until the 1970s. The Keynesians denied that a monetary economy – one in which contracts are made in money, not goods – had any automatic tendency to full employment. This was because people could choose to hold money, rather than spend it, and the reason they might wish to do so was the omnipresence of uncertainty; as Keynes put it, the possession of money ‘lulls our disquietude’. Given the role of money as a ‘store of wealth’, the macroeconomy was inherently unstable, and was liable to settle down in a position of ‘underemployment equilibrium’. It was therefore the task of government to maintain a full employment balance between supply and demand, which included the management of money as part of the management of the economy. But it was not money that had to be kept in order; it was the market system itself. If it was left free of management and regulation, it would be socially and politically disruptive. In the Keynesian era, stretching from the end of the Second World War to the 1970s, the free world economy experienced a unique period of stability and growth.
In the 1970s, however, the Keynesian system succumbed to ‘stagflation’ – the simultaneous rise in inflation and unemployment – and the Keynesian attempt to manage the macroeconomy was abandoned. The core idea behind the new classical economic policy that succeeded it was that central banks should be mandated to control inflation, with unemployment left to settle at its ‘natural’ rate. This was taken to be a rate on which macroeconomic policy could not improve. The unemployed should get on their bikes and look for work.1
In technical terms, familiar to economists, the question about the relationship between money and government is a question about the relationship between monetary and fiscal policy. The Keynesian innovation was that the government should influence the level of total spending through fiscal policy, with monetary policy made consistent with the aims of fiscal policy. By contrast, in new classical economics, monetary policy – keeping the economy supplied with the right amount of money – is the whole of macroeconomic policy, since fiscal policy cannot influence the level of total spending, only its direction. This was the doctrine ‘in power’ in 2008.
The collapse of 2008 and its aftermath was a test of the two theories of macroeconomic policy, not under laboratory conditions but in as close to a real-life experiment as we are likely to get. According to the mainstream view of the time, the collapse should not have happened and, even if it had, recovery should have been swift. In the second, Keynesian, hypothesis, its happening was always a possibility, and recovery was never likely to be fast or full. However, the old Keynesian recipe for running economies at full employment through fiscal policy had succumbed to inflation, and has not been rehabilitated, so policy for the future remains unsettled.
The proximate cause of the collapse of 2008 was the accumulation of private debt, much of it the result of fraud on the part of the lenders and myopia on the part of the borrowers. A vast, global, inverted pyramid of bank, business and household debt was built on a narrow base of underlying assets – American real estate. When the base tottered, the pyramid fell. The failure of the sub-prime mortgage market in the United States triggered a collapse in the prices of financial assets. The fall in the net wealth of banks in 2007–8 produced a global financial crisis. This was transmitted to the real economy through a tightening of credit by the banks and a fall in demand by consumers and businesses, whose wealth and confidence had evaporated.
It all developed with astonishing speed. The bankruptcy of Lehman Brothers on 15 September 2008 precipitated a stock market collapse in October. Once banks started to fail and stock markets to fall, the ‘real’ economy started to slide too. Banks stopped lending. Creditors foreclosed on loans to debtors. Businesses laid off workers. Total spending shrank. This brought about generalized conditions of slump throughout the world by the fourth quarter of 2008. It was eerily reminiscent of what happened in the Wall Street Crash of 1929.
The worst of the storm passed after a year. Unlike in 1929, governments intervened to prevent disaster. Governments and central banks around the world vigorously pumped money into their deflating systems. But in some European countries, governments were virtually bankrupted by the excesses of their banking systems. The collapse of state revenues brought public debts to unprecedented peacetime levels, reviving the most persistent of the economic orthodoxies: that governments are the problem, not the solution. As economies stabilized, policies of austerity were adopted to put governments back into the fiscal cage from which the severity of crisis had temporarily released them. Today, monetary expansion is being eased, in recognition that it has done as much as it can, while austerity is being eased in recognition that monetary policy is not enough. The future of the fiscal–monetary mix is unsettled.
The standard account of the origins of the crisis starts with an (unexplained) shock to the financial sector, which is then transmitted to the non-financial sector through the freezing of credit. However, it is possible that the trouble was rooted in the non-financial economy. Despite the rosy retrospect of the so-called Great Moderation years of the early 2000s, the Western economies that collapsed in 2008 were not in pristine condition. Unemployment was about double what it had been in the Keynesian era. The huge accumulation of household and corporate debt – in the advanced economies, average private-sector debt as a percentage of GDP went up from 50 per cent in 1950 to 170 per cent by 2008 – was one indication that large sections of the pre-crash economy were not ‘paying their way’. This was partly a consequence of a marked growth in inequality. Real wages were stagnant or falling; investment was down from its historic levels, and with it productivity growth. The finance sector was growing faster than the economy, and financiers were getting much richer than anyone else. Signs of ‘secular stagnation’ were not hard to see, after the event. I have singled out the stagnation of real earnings as the deep cause of the crisis, the result of which was transmitted to the financial sector through the build-up of unsustainable debt. The Great Moderation is known chiefly for its low inflation and cyclical stability. It now seems more of a lull before a storm bound to break. It leaves the fate of advanced capitalist economies in limbo. At the time of writing, a resurgent financial system and a mediocre real recovery threaten a repeat crash at no distant date.
II. THE CULPRITS
‘Why did no one see it coming?’ asked Queen Elizabeth II of a group economists at the LSE in October 2008.2 This book is an attempt to answer that question and suggest how to avoid such foul-ups in the future. This will not be easy. It will not be enough to strengthen socalled financial ‘resilience’ to shocks. It is economies which need to be made resilient to shocks.
It is natural to start with the financial institutions, which egregiously over-borrowed and over-lent, and which were heavily into all kinds of fraudulent practices. Gripped by a collective hubris, the institutions were oblivious to the rocks ahead. The lure of present gains drove out the fear of future losses.
But to stop with the banks would be a mistake. The banking sector was freed up to do its best and worst by national governments and regulators, who held a benevolent view of the financial system. Finance was viewed essentially as an intermediatory, bringing together willing buyers and sellers of goods and services. In the language of the day, the financial market was an ‘efficient’ market, which needed no more regulation than any other market. The peculiar property of finance as a vent for speculation and fraud was ignored.
This benign view of finance extended to the financial innovations of the 1990s. Securitization – the process of transforming non-marketable assets into marketable ones – led to a continuous lengthening of the chain of indebtedness. This ‘financialization’ of the economy – the growing share of money being made from purely financial operations – was praised (or at least justified) as ‘making capital allocation more efficient’ and therefore maximizing growth. Business school professors set up their own hedge funds to test their theories.
But how, the enquirer may ask, did so many governments come to hold views which were plainly absurd in retrospect? He is led inexorably to the source of these beliefs, to the ‘intellectual climate’, the Zeitgeist, the tide of thought and feeling that liberated our financial markets from national controls. The enquirer will discover that at the heart of today’s mainstream macroeconomics is the belief that unimpeded competitive markets deliver optimal welfare, and that the financial institutions which create money, and through which money is allocated, have no independent effect on the real equilibrium of the economy, but are only acting on behalf of well-informed sovereign consumers. He will discover that the forecasting models of finance ministries and central banks lacked a financial sector. The assumption that future prices would move in line with current expectations removed any need to take precautions against financial collapse, despite a continuous history of financial manias and panics. Aiming to minimize the interference of the state, mainstream economics ignored the financial wolves on the prowl.
Surely it is here – in the world of economic ideas – that the original flaw in the regulatory design is to be found. Governments believed things about the economic system that were not true, or at least not true enough. In the name of these ideas, finance was allowed to spin out of control; and its implosion produced a world depression.
Practical people usually pooh-pooh the influence of academic scribblers. The English famously feel themselves to be healthily exempt from intellectual influences. In fact, academic thought and policy were not so closely linked in the past. But today, economic ideas penetrate much more deeply into economic policy, because economic policymaking is largely in the hands of professional economists. Most of them work not in universities, but in treasuries and central banks, in commercial banks, businesses and newspapers, in political parties and think-tanks, or as business consultants and lobbyists. The days are long past when a Governor of the Bank of England could welcome one of its first academic economists with the words: ‘you are not here to tell us what to do, but to explain to us why we have done it’.3 Now economists do tell decisionmakers what to do.
This is supposed to make policy more expert, less partisan. However, economics is by no means the scientific citadel that many of its practitioners claim it to be. It displays a silent ideological slant while sticking to the accepted canons of scientific method. Since the 1980s, the dominance of new classical theory in economics has coincided with the neo-liberal capture of politics. The connection is not fortuitous. New classical economics has provided an economic-theoretic justification for neo-liberal policies; neo-liberal ideology has shaped the way economists ‘model’ the economy. Both readily sign up to Ronald Reagan’s distillation of two centuries of conventional wisdom: ‘The government is the problem, not the solution.’4
However, to say that economics is inherently ideological is not quite to get to the root of the puzzle of what went wrong in 2008. Why this ideology and not that?
Ideology is highly influenced by the structure of power, as well as helping to bring about a structure of power favourable to it. This is the important element of truth in Marx’s claim that the dominant ideas of any epoch are those of its ruling class. The crash of 2008 revealed the power of financial interests.
A huge puzzle in the pre-crash situation is the weakness of democratic government in face of the structural power of finance. Orthodox political science tells us that in democracies accountability runs from government to the people. But one cannot get a grip on the history of the crisis without realizing that it is the financial community, far more than ‘the people’, that decides both the terms and the conditions on which government gets its money. The money–power nexus works both indirectly, through its influence on election finance and the presentations of the media, and directly through its role in financing government borrowing. What the ‘efficient allocation of capital’ means in practice is the allocation which is efficient for the financial sector. In the last twenty to thirty years, the chief economic role of Western governments has been to provide the financial system with a nice environment for it to maximize its profits. This has included being prepared to bail out banks when their excesses made them insolvent, and being prepared to cut their own spending on social welfare to retain the confidence of the bond markets. Following the crash, the financial sector has turned the brave words of politicians about the need for reform into rhetoric largely without substance.
The Marxist claim that big business controls politics rests on the twin claim that the business class is a monolith and that it is effectively unchecked by countervailing forces. In fact untrammelled business power is the exception rather than the rule. On the one side business power itself is divided, notably between exporters and importers, creditors and debtors, small and big businesses, and ‘finance’ and ‘industry’; on the other side, business power has been checked by varieties of popular power. The more equal the balance of forces, the less likely we are to get a single story about the way the economy works.
A central claim of this book is that there was a balance of power between capital and labour from the 1920s to the 1970s which enabled the emergence of a Keynesian state relatively free from the vested interests. It was in this period that the idea of the state as a benevolent guardian of the public interest gained currency. But in the last forty years the balance of power has shifted decisively from labour to capital; from the working class to the business class; and from the old business elites to new financial, partly criminal, elites. How this has come about deserves a profound study of its own, of which only hints can be given in the pages that follow. What can be claimed is that the main homage which mainstream economics pays to power is to render it invisible.
Finally, theory and policy are moulded by the conditions of the times. These produce what John Hicks called ‘concentrations of attention’,5 by which he meant the problems that economists choose to study. What causes shifts in attention? In the interwar years persistent mass unemployment was the problem; in the 1970s it was inflation. Such changes in facts disturb the kaleidoscope; they determine what the viewer sees. (For a further discussion of the relationship between ideas, power and circumstances, see the appendix to this Introduction, p. 11.)
What follows will attend primarily to macroeconomic doctrines as they developed until 2007, and the way these have been tested and found wanting by the crisis and its aftermath. The book is an essay in political economy, since it pays attention at all times to the context of the rise and fate of different economic doctrines. Knowing what economists thought in the past, and how and why they came to think as they did, is, as Hicks has pointed out, an essential part of ‘keeping watch’ on the discipline as, unlike in the natural sciences, it can record no unambiguous progress in knowledge. It is perhaps natural for me to embrace a political economy approach, since I was originally trained as a historian, and no historian can be oblivious to the historical forces that produced the stories by which economic events are understood.
III. A BRIEF SKETCH OF THE BOOK
The book is divided into four parts. The first takes the reader through the historical debates on monetary and fiscal policy before the First World War. This history is crucial to an understanding of the precrash orthodoxy. The second investigates the rise and fall of the Keynesian revolution, showing how this episode ended with the partial restoration of Victorian monetary and fiscal policy. The third part shows how this restoration was itself tested by the collapse of 2008–9 and its aftermath, reopening issues formerly considered settled. Part Four concludes with reflections on the whole and a sketch of a new macroeconomics.
Part One starts with three chapters on the history of monetary theory and policy. Chapter 1 surveys the debates on the origins of money, on the nature of money, on what determines its value, and on the consequences of disturbances to its value. Chapter 2 covers the three great nineteenth-century debates about how money might be ‘kept in order’, which, starting in the era of the gold standard, culminated in the ‘scientific’ Quantity Theory of Money at the start of the last century, the subject of Chapter 3. This chapter pinpoints the rupture in monetary theory, represented by the two versions of the Quantity Theory of Money developed by Irving Fisher and Knut Wicksell, respectively.
Chapter 4 examines the nineteenth-century theory of fiscal policy. The point of special emphasis is that fiscal rules and monetary rules were considered complementary. Their joint purpose was to prevent governments from issuing too much money. With Britain setting the pace, by 1900 all ‘civilized’ countries had linked their domestic currencies to the gold standard and their governments balanced their budgets at the lowest level of taxes and spending possible. But the theory of the ‘minimal state’ was never wholly accepted outside Britain. The idea of the state as the indispensable actor in a nation’s economic development survived in the ‘pre-scientific’ doctrine of mercantilism. Specifically, free trade, though preached by economists, was never widely accepted on the continent of Europe, or even in the United States. By the 1880s and 1890s, the doctrine of laissez-faire had started to be challenged by the rise of democracy, the depressions of the 1880s and 1890s, and the emergence of the welfare state. The appearance of the word ‘unemployment’ in the Oxford English Dictionary in 1888 marked the arrival of a ‘problem’ that would dominate economic theory and policy for the next eighty years.
Part Two traces the rise, triumph and fall of the Keynesian revolution, a period stretching from the publication of Keynes’s General Theory of Employment, Interest, and Money in 1936 to the 1970s. Chapter 5 shows how the Keynesian theory of economics and policy were a response to the Great Depression of the 1930s. It was seemingly vindicated by the achievement of full employment and stable growth in the thirty years that followed the Second World War, the subject of Chapter 6. The Keynesian regime ran into trouble in the stagflationary 1970s and was superseded by ‘monetarism’, which was in fact a reversion to pre-Keynesian orthodoxy about both money and governments. Chapter 7 ends with an account of the ‘New Consensus’ – a mixture of ‘new’ classical and ‘new’ Keynesian economics, which was in turn brought down by the collapse of 2008.
Following the theoretical twists and turns of this economic saga, no one can fail to be impressed by the persistence in economic theory of the core idea that an unimpeded market system tends to full employment equilibrium, unless obstructed by ‘spanners in the works’, generally thrown by governments. First suggested by Adam Smith’s metaphor of the ‘invisible hand’, this insight was formalized in the general equilibrium theory of Leon Walras in 1874. Much later, as late as in our own day, the microeconomics of Walras begat new classical macroeconomics. The main storyline has been heavily modified and qualified in face of disconfirming events, but has always re-emerged, in more or less unchanged form. This leads to the conclusion that there has never been a real ‘paradigm’ shift in economics comparable to those occasionally experienced in the natural sciences (by paradigm shift I mean a fundamentally different way of looking at the material being studied). The Keynesian revolution came closest to it. Mostly, it has been a story of persistence without progress. This persistence can be explained by the fact that the rise of scientific economics coincided with the rise of capitalism, and the logic of economics as we know it is not easily separable from the arguments in support of capitalism.
Part Three of the book is about theoretical and policy responses to the downturn of 2008. It relates these responses to the historical debates covered in Parts One and Two and shows how they carried the baggage of the past with them. Chapters 8 and 9 show how fiscal and monetary policy met, or failed to meet, the challenge of the downturn. The main theme is that with fiscal policy quickly disabled by ballooning government debts, the task of stabilizing economic life fell to unconventional monetary policy. Chapter 8 examines the theory and practice of ‘fiscal consolidation’: the effort by governments to liquidate deficits and reduce national debts to restore ‘confidence’. Chapter 9 surveys the rationale, and limited success, of ‘quantitative easing’, the attempt by central banks to offset the deflationary effects of fiscal consolidation by injecting large amounts of money into the financial system. My broad conclusion is that the post-crash monetary–fiscal mix was successful in preventing the collapse of 2008–9 from turning into the rout of another Great Depression, but has not succeeded in restoring durable economic prosperity. Indeed, the methods by which it rescued damaged economies from the financial excesses of the pre-crash years have set the scene for the next financial crash. Our economies are still on life-support systems, and the withdrawal of these will be exceptionally challenging.
Chapters 10, 11 and 12 look at the structural causes of financial instability. Chapter 10 analyses the macroeconomic impact of the growth of inequality of income and wealth. The focus of Chapter 11 is on financial innovation, partly in response to the explosive increase in the demand for credit. Chapter 12 examines the contribution of current account imbalances to the instability of the pre-crash economic system.
And so to the topic of the final part: what is to be done? The central question of political economy today is as it has always been: what does a government need to do to secure the relatively smooth – and socially and morally tolerable – functioning of a decentralized, money-using, largely privately owned economy?
Technical material is presented, as far as possible, in appendices to individual chapters, so as not to break up the flow of ideas.
APPENDIX I.1: IDEAS, VESTED INTERESTS AND CYCLES
Ideas versus Vested Interests
Keynes ended The General Theory of Employment, Interest, and Money with the famous words: ‘But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.’6 Anyone involved in the production of ideas has to believe this, unless they are being paid by someone to produce the ideas. In today’s world, the chief manufactory of ideas is the Academy. Pure research has long been recognized as an independent intellectual pursuit; its hallmark, disinterestedness; its purpose, the search for truth. The pecuniary interest of scholars is not directly involved in either the direction of their enquiry or its results.
At the same time, there is what Joseph Schumpeter called the ‘sociology of success’. Put crudely, why are some ideas acceptable, and others rejected or marginalized? In the natural sciences this question is relatively easy to answer: newer ideas bring us closer to reality than the older ones. For this reason, quantum physics replaced classical physics. Reality is unchanging, only the theory changes as it improves our understanding of reality. Predictive power is the ultimate test of the truth of a scientific hypothesis.
In social sciences this is much less true. The natural world does not interfere with one’s observation of it; the social world does. It is the changeability of the object being studied which demarcates social sciences from natural sciences. Social reality is constantly shifting, problems crucial at one time become irrelevant at another. As a result, propositions in social science do not satisfy the ‘universality criterion’. They are limited in time and place. As Amir Kumar Dasgupta points out, theories in economics are independent of each other, they do not supersede each other.7 Theories in the social sciences cannot be successfully confirmed or falsified, except briefly. Progress in economics consists of greater precision in stating ideas, not the greater explanatory power of the ideas themselves; and the precision may be at the expense of the explanation. In economics, much more than in physics, the research agenda and structure of power within the profession reflect the structure of power outside it. Economic research programmes have the character of ideologies. And this, of course, was precisely Marx’s contention when he wrote: ‘What else does the history of ideas prove, than that intellectual production changes in proportion as material production is changed?’8
The relationship between ideas, circumstances and power is one of the most complicated questions in social science. Ideas are not at the mercy of circumstances in any straightforward way. The disciplines which produce theories exhibit stability through time, in their concepts, techniques and language. That is why paradigm shifts are rare. It is true that disciplines turn to new topics. But there is no need to relate all new topics to changes in the world. Theorists might simply get bored with the old topics, feeling that debate about them has reached a dead end. Change of topic is also connected with generational change within a discipline.
It is nearer to our theme to say that ideas change when large facts of the world change. Dasgupta talks of ‘epochs of economic theory’. He wrote: ‘A system of economic theory evolves in response to questions that are provoked by a given set of circumstances in the economy. As circumstances change, or people’s attitude to them changes, questions are revised, and a new system springs up.’9 Dasgupta is right to distinguish between changes in circumstances and changes in people’s attitudes to these changes. A large shock can upset existing ideas, and policies based on them. But the nature of the adjustment of the ideas and policies is not determined. The Great Depression of the 1930s, coming on top of the First World War, benefitted rival claims to the liberal succession in the different forms of communism, fascism and Keynesian social democracy. The travails of the world economy since 2008 have led to outbreaks of populism of both the left and right, whose ideological and political potential is as yet undetermined.
Thus there is no direct relationship between ideas and problems. Facts can be interpreted in different ways. He who controls the interpretation controls the story. This brings us to the question of power.
Adapting Steven Lukes, one may think of ideas as a form of ‘soft power’, which structure our debates about reality.10 Alternatively, and more comprehensively, they may be seen as shaping our consciousness – the way we interpret our world.
Ideas are therefore an independent source of authority. Practical men – politicians, businessmen, civil servants – are consumers, not producers, of ideas. This gives the producers of ideas considerable latitude vis-à-vis their users. The vested interests are in no position – even were they capable of it – to dictate the precise form of the intellectual defence offered for their practices. Thus the economist’s justification of the free market is likely to be both more general and also more circumscribed than that offered by the business class. For example, economists have almost always opposed protectionism and monopoly: business has generally been in favour. Ideas are thus capable of making self-interest seem more enlightened.
The fact that ideas are produced in non-profitmaking institutions doesn’t, though, dispose of the question of the hard power behind the soft power. Who finances the business schools that produce the MBAs of contemporary business life? Who finances the dissemination of ideas in the media and think-tanks? What are the incentives facing the producers, disseminators and popularizers of ideas even in a society in which discussion is ‘free’? In short, what is the agenda of business?
One must avoid over-simplifying. It is much harder – and I would say fruitless – to try to relate philosophical, artistic and literary productions to the structures of power. They are just as likely to be critiques of the status quo as homages to it, even though many subtle and not-so-subtle mechanisms, social and pecuniary, exist, for coopting cultural elites into the business system.11 More importantly, the cultural critique of capitalism, while persistent and often profound, has had very little influence on economics and economic policy. Nor is the state simply (or always) an agent of the bourgeoisie. Notionally, at least, it stands for the public interest. There is a bigger role for ‘public intellectuals’ in a mixed economy of public and private sectors than in one in which business calls the shots.
Assertion of the independence of ideas is a necessary modification of crude Marxism, and one which I dare say Marx himself would have accepted. Nevertheless, in the Marxist scheme, the intellectual class, like the state, attains only ‘relative autonomy’, and ideas rarely overturn the perception or promotion of self-interest, however much they may modify its expression. Practical men like nothing better than to have their prejudices dressed up in scientific language. Ultimately, the ideas in power serve the interests of the class in power; since the 1980s this has been overwhelmingly the financial class.
Cycles
Economics, taking its cue from physics, is an equilibrium system. Disturbances are said to be brief and self-correcting. But economists, as well as historians, have been fascinated by the rhythmic character of economic life, the waves of innovation and destruction, the rise and fall of systems of political economy. The most famous economic theory of cycles is the Kondratiev cycle, a long wave of forty or fifty years, which starts with a cluster of new technologies and exhausts itself when they have been used up. Schumpeter drew on this idea in his depiction of capitalism’s cycles of creation and destruction. Within the long cycles are shorter cycles of boom and bust, lasting eight to ten years. Lacking proper scientific explanation (Paul Samuelson called cycle theories ‘science fiction’), cycles have nevertheless had a great influence on macroeconomic policy. Typical macroeconomic constructions, such as the ‘cyclically adjusted budget deficit’, refer explicitly to short cycles of definite duration, which oscillate round some ‘normal’ or ‘long-run’ situation.
Historical cycles refer to disturbances of a moral/social, rather than technological, equilibrium. That is to say, they embed technological innovation within the wider frame of political and social change. Societies are said to swing like pendulums between alternating phases of vigour and decay, progress and reaction, prodigality and puritanism. Each expansive movement produces a crisis of excess that leads to a reaction. The equilibrium position is hard to achieve and is always unstable.
In his Cycles of American History (1986) Arthur Schlesinger Jr defined a political economy cycle as ‘a continuing shift in national involvement between public purpose and private interest’. The swing he identified was between ‘liberal’ (what we would call social democratic) and ‘conservative’ epochs. The idea of the ‘crisis’ is central to both. Liberal periods succumb to the corruption of power, as idealists yield to time-servers, and conservative arguments against rent-seeking win the day. But the conservative era then succumbs to a corruption of money, as financiers use the freedom of deregulation to rip off the public. A crisis of under-regulated markets presages the return to a social democratic era.
This idea fits the American historical narrative tolerably well. It also makes sense globally. The era of ‘conservative’ economics opened with the publication of Adam Smith’s Wealth of Nations in 1776. Yet despite the early intellectual ascendancy of free trade, it took a major crisis – the Irish potato famine of the early 1840s – to produce an actual shift in policy: the repeal of the Corn Laws in Britain in 1846 ushered in the free trade era.
In the 1870s, the pendulum started to swing back to what the historian A. V. Dicey called the ‘age of collectivism’. The major crisis that triggered this was the first great global depression, produced by a collapse in food prices. It was a severe enough shock to produce a major shift in political economy. This came in two waves. First, all the major countries except Britain put up tariffs to protect agricultural and industrial employment. (Britain relied on mass emigration to eliminate rural unemployment.) Second, all industrial countries except the United States started schemes of social insurance to protect their citizens against life’s hazards. The Great Depression of 1929–32 produced a second wave of collectivism, now associated with the ‘Keynesian’ use of fiscal and monetary policy to maintain full employment. Most capitalist countries nationalized key industries. Roosevelt’s New Deal in the United States regulated banking and the power utilities, and belatedly embarked on the road of social security. International capital movements were severely controlled everywhere.
This pendulum movement was not all one way, or else the West would have ended up with communism, which was the fate of large parts of the globe. Even before the crisis of collectivism in the 1970s, a swing back had started, as trade, after 1945, was progressively freed from tariffs and capital movements liberalized. The rule was free trade abroad and social democracy at home.
The Bretton Woods system, set up with Keynes’s help in 1944, was the international expression of liberal/social democratic political economy. It aimed to free foreign trade after the freeze of the 1930s, by providing an environment that reduced incentives for economic nationalism. At its heart was a system of fixed exchange rates, subject to agreed adjustment, to avoid competitive currency depreciation.
Liberalism, or social democracy, unravelled with stagflation and ungovernability in the 1970s. This broadly fits Schlesinger’s notion of the ‘corruption of power’. Keynesian/social democratic policymakers succumbed to hubris, an intellectual corruption that convinced them they possessed the knowledge and the tools to manage and control the economy and society from the top. This was the malady against which Hayek had inveighed in his classic The Road to Serfdom (1944). The attempt in the 1970s to control inflation by wage and price controls led directly to a ‘crisis of governability’, as trade unions, particularly in Britain, refused to accept them. Large state subsidies to producer groups, both public and private, fed the typical corruptions of behaviour identified by the New Right: rent-seeking, moral hazard and free-riding. Palpable evidence of government failure obliterated earlier memories of market failure. The new generation of economists abandoned Keynes and, with the help of sophisticated mathematics, reinvented the classical economics of the self-correcting market. Battered by the crises of the 1970s, governments caved in to the ‘inevitability’ of free market forces. The swing back became worldwide with the collapse of communism in 1989–90.
A conspicuous casualty of the reversal was the Bretton Woods system, which succumbed in the 1970s to the refusal of the US to curb its domestic spending. Currencies were set free to float, and controls on international capital flows were progressively lifted. This heralded a wholesale shift to globalization. Globalization was, in concept, not unattractive. The idea was that the nation state – which had been responsible for so much organized violence and wasteful spending – was on its way out, to be replaced by the global market. The promise of globalization was set out by the (highly sceptical) Canadian philosopher John Ralston Saul, in 2004:
That in the future, economics, not politics or arms, would determine the course of human events. That freed markets would quickly establish natural international balances, impervious to the old boom-and-bust cycles. That the growth in international trade, as a result of lowering barriers, would unleash an economic-social tide that would raise all ships, whether of our western poor or of the developing world in general. That prosperous markets would turn dictatorships into democracies.12
Today we are living through a crisis of conservative economics. The banking collapse of 2008 brought to a head a growing dissatisfaction with the corruption of money. Neo-conservatism had sought to justify fabulous rewards to a financial plutocracy, while median incomes stagnated or even fell. In the name of efficiency it had promoted the offshoring of millions of jobs, the undermining of national communities, and the rape of nature. Such a system needed to be fabulously successful to command allegiance. We shall see in the next few years whether the repairs made to the economic structure after the collapse have been sufficient to arrest the swing back to collectivism and nationalism that has already started.
Comments
Post a Comment