Economics After the Crisis: Objectives and Means (Lionel Robbins Lectures)

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Third, I will shortly discuss the ethical problem involved in the process of financialization, namely, the fraud that was one of its dominant aspects. Fourth, I will discuss the two immediate causes of the hegemony of neoliberalism: the victory of the West over the Soviet Union in , and the fact that neoclassical macroeconomics and neoclassical financial theory became "mainstream" and provided neoliberal ideology with a "scientific" foundation.

Finally, I will ask what will follow the crisis. Despite the quick and firm response of governments worldwide to the crisis using Keynesian economics, in the rich countries, where leverage was greater, its consequences will for years be harmful, especially for the poor.

Yet I end on an optimist note: since capitalism is always changing, and progress or development is part of the capitalist dynamic, it will probably change in the right direction. Not only are investment and technical progress intrinsic to the system, but, more important, democratic politics - the use of the state as an instrument of collective action by popularly elected governments - is always checking or correcting capitalism.

In this historical process, the demands of the poor for better standards of living, for more freedom, for more equality and for more environmental protection are in constant and dialectical conflict with the interests of the establishment; this is the fundamental cause of social progress. On some occasions, as in the last thirty years, conservative politics turns reactionary and society slips back, but even in these periods some sectors progress.

The global crisis began as financial crises in rich countries usually begin, and was essentially caused by the deregulation of financial markets and the wild speculation that such deregulation made possible. Deregulation was the historical new fact that allowed the crisis. An alternative explanation of the crisis maintains that the US Federal reserve Bank's monetary policy after kept interest rates too low for too long - which would have caused the major increase in the credit supply required to produce the high leverage levels associated with the crisis.

I understand that financial stability requires limiting credit expansion while monetary policy prescribes maintaining credit expansion in recessions, but from the priority given to the latter we cannot infer that it was this credit expansion that "caused" the crisis. This is a convenient explanation for a neoclassical macroeconomist for whom only "exogenous shocks" in the case, the wrong monetary policy can cause a crisis that efficient markets would otherwise avoid. The expansionary monetary policy conducted by Alan Greenspan, the chairman of the Federal reserve, may have contributed to the crisis.

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But credit expansions are common phenomena that do not lead always to crisis, whereas a major deregulation such as the one that occurred in the s is a major historical fact explaining the crisis. The policy mistake that Alan Greenspan recognized publicly in was not related to his monetary policy but to his support for deregulation. In other words, he was recognizing the capture of the Fed and of central banks generally by a financial industry that always demanded deregulation. As Willen Buiter , p. In developing countries financial crises are usually balance-of-payment or currency crises, not banking crises.

Although the large current account deficits of the United States, coupled with high current account surpluses in fast-growing Asian countries and in commodity-exporting countries, were causes of a global financial unbalance, as they weakened the US dollar, the present crisis did not originate in this disequilibrium. The only connection between this disequilibrium and the financial crisis was that the countries that experienced current account deficits were also the countries were business enterprises and households were more indebted, and will have more difficulty in recovering, whereas the opposite is true of the surplus countries.

The higher the leverage in a country's financial and non-financial institutions and households, the more seriously this crisis will impinge on its national economy. The general financial crisis developed from the crisis of the "subprimes" or, more precisely, from the mortgages offered to subprime customers, which were subsequently bundled into complex and opaque securities whose associated risk was very difficult if not impossible for purchasers to assess.

Economics After the Crisis: Objectives and Means (Lionel Robbins Lectures)

This was an imbalance in a tiny sector that, in principle, should not cause such a major crisis, but it did so because in the preceding years the international financial system had been so closely integrated into a scheme of securitized financial operations that was essentially fragile principally because financial innovations and speculations had made the entire financial system highly risky. The key to understanding the global crisis is to situate it historically and to acknowledge that it was consequence of a major step backwards, particularly for the United States.

Following independence, capitalist development in this country was highly successful, and since the early the twentieth century it has represented a kind of standard for other countries; the French regulation school calls the period beginning at that time the "Fordist regime of accumulation". To the extent that concomitantly a professional class emerged situated between the capitalist class and the working class, that the professional executives of the great corporations gained autonomy in relation to stockholders, and that the public bureaucracy managing the state apparatus increased in size and influence, other analysts called it "organized" or "technobureaucratic capitalism".

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Production moved from family firms to large and bureaucratic business organizations, giving rise to a new professional class. This model of capitalism faced the first major challenge when the stock-market crash turned into the s Great Depression.

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Yet World War II was instrumental in overcoming the depression, while governments responded to depression with a sophisticated system of financial regulation that was crowned by the Bretton Woods agreements. Thus, in the aftermath of World War II, the United States, emerged as the great winner and the new hegemonic power in the world; more than that, despite the new challenge represented by Soviet Union, it was a kind of lighthouse illuminating the world: an example of high standards of living, technological modernity and even of democracy.

Thereafter the world experienced the "30 glorious years" or the golden age of capitalism. Whereas in the economic sphere the state intervened to induce growth, in the political sphere the liberal state changed into the social state or the welfare state as the guarantee of social rights became universal. Andrew Shonfield , p. Secondly, the growth of production over the period has been extremely rapid Thirdly, the benefits of the new prosperity were widely diffused. Yet the spread of guaranteed social rights occurred mainly in western and northern Europe, and in this region as well as in Japan growth rates picked up and per capita incomes converged to the level existing in the United States.

Thus, whereas the United States remained hegemonic politically, it was losing ground to Japan and Europe in economic terms and to Europe in social terms. In the s this whole picture changed as we saw the transition from the 30 glorious years of capitalism to financialized capitalism or finance-led capitalism - a mode of capitalism that was intrinsically unstable.

Although the reduction in the growth and profits rates that took place in the s in the United States as well as the experience of stagflation amounted to a much smaller crisis than the Great Depression or the present global financial crisis, these historical new facts were enough to cause the collapse of the Bretton Woods system and to trigger financialization and the neoliberal or neoconservative counterrevolution.

It was no coincidence that the two developed countries that in the s were showing the worst economic performance - United States and the United Kingdom - originated the new economic and political arrangement. In the United States, after the victory of Ronald reagan in the presidential election, we saw the accession to power of a political coalition of rentiers and financists sponsoring neoliberalism and practicing financialization, in place of the old professional-capitalist coalition of top business executives, the middle class and organized labor that characterized the Fordist period.

Not only neoclassical economists like Milton Friedman and Robert Lucas, but economists of the Austrian School Friedrich hayek and of Public Choice School James Buchanan gained influence, and, with the collaboration of journalists and other conservative public intellectuals, constructed the neoliberal ideology based on old laissez-faire ideas and on a mathematical economics that offered "scientific" legitimacy to the new credo.

Neoliberalism aimed also to reduce the size of the state apparatus and to deregulate all markets, principally financial markets. Some of the arguments used to justify the new approach were the need to motivate hard work and to reward "the best", the assertion of the viability of self-regulated markets and of efficient financial markets, the claim that there are only individuals, not society, the adoption of methodological individualism or of a hypothetic-deductive method in social sciences, and the denial of the conception of public interest that would make sense only if there were a society.

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With neoliberal capitalism a new regime of accumulation emerged: financialization or finance-led capitalism. The "financial capitalism" foretold by rudolf hilferding , in which banking and industrial capital would merge under the control of the former, did not materialize, but what did materialize was financial globalization - the liberalization of financial markets and a major increase in financial flows around the world - and finance-based capitalism or financialized capitalism.

Its three central characteristics are, first, a huge increase in the total value of financial assets circulating around the world as a consequence of the multiplication of financial instruments facilitated by securitization and by derivatives; second, the decoupling of the real economy and the financial economy with the wild creation of fictitious financial wealth benefiting capitalist rentiers; and, third, a major increase in the profit rate of financial institutions and principally in their capacity to pay large bonuses to financial traders for their ability to increase capitalist rents.

The adoption of complex and obscure "financial innovations" combined with an enormous increase in credit in the form of securities led to what henri Bourguinat and Eric Brys , p.

Such packaging, combined with classical speculation, led the price of financial assets to increase, artificially bolstering financial wealth or fictitious capital, which increased at a much higher rate than production or real wealth. In this speculative process, banks played an active role, because, as Robert Guttmann , p. Given the competition represented by institutional investors whose share of total credit did not stop growing, commercial banks decided to participate in the process and to use the shadow bank system that was being developed to "cleanse" their balance sheets of the risks involved in new contracts: they did so by transferring to financial investors the risky financial innovations, the securitizations, the credit default swaps, and the special investment vehicles Macedo Cintra and Farhi, , p.

The incredible rapidity that characterized the calculation and the transactions of these complex contracts being traded worldwide was naturally made possible only by the information technology revolution supported by powerful computers and smart software. In other words, financialization was powered by technological progress. Adam Smith's major contribution of economics was in distinguishing real wealth, based on production, from fictitious wealth.

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Marx, in Volume III of Capital , emphasized this distinction with his concept of "fictitious capital", which broadly corresponds to what I call the creation of fictitious wealth and associate with financialization: the artificial increase in the price of assets as a consequence of the increase in leverage. Marx referred to the increase in credit that, even in his time, made capital seem to duplicate or even triplicate. It was instrumental not only in guaranteeing the speed of financial transactions but also in allowing complicated risk calculations that, although they proved unable to avoid the intrinsic uncertainty involved in future events, gave players the sensation or the illusion that their operations were prudent, almost risk-free.

This change in the size and in the mode of operation of the financial system was closely related to the decline in the participation of commercial banks in financial operations and the reduction of their profit rates Kregel, The commercial banks' financial and profit equilibrium was classically based on their ability to receive non-interest short-term deposits. Yet, after World War II, average interest rates started to increase in the United States as a consequence of the decision of the Federal reserve to be more directly involved into monetary policy in order to keep inflation under control.

The fact that the ability of monetary policy either to keep inflation under control or to stimulate the economy is limited did not stop the economic authorities giving it high priority Aglietta and rigot As this happened, the days of the traditional practice of non-interest deposits, which was central to banks' profitability and stability, were numbered, at the same time as the increase in over-the-counter financial operations reduced the share of the banks in total financing.

Commercial banks' share of the total assets held by all financial institutions fell from around 50 percent in the s to less than 30 percent in the s. On the other hand, competition among commercial banks continued to intensify. The banks' response to these new challenges was to find other sources of gain, like services and risky treasury operations.

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Now, instead of lending non-interest deposits, they invested some of the interest-paying deposits that they were constrained to remunerate either in speculative and risky treasury operations or in the issue of still more risky financial innovations that replaced classical bank loans. This process took time, but in the late s financial innovations - particularly derivatives and securitization - had became commercial banks' compensation for their loss of a large part of the financial business to financial investors operating in the over-the-counter market. Yet from this moment banks were engaged in a classical trade-off: more profit at the expense of higher risk.

Not distinguishing uncertainty , which is not calculable, from risk , which is, banks, embracing the assumptions of neoclassical or efficient markets finance with mathematical algorithms, believed that they were able to calculate risk with a "high probability of being right".

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In doing so they ignored Keynes's concept of uncertainty and his consequent critique of the precise calculation of future probabilities. Behavioral economists have definitively demonstrated with laboratory tests that economic agents fail to act rationally, as neoclassical economists suppose they do, but financial bubbles and crises are not just the outcome of this irrationality or of Keynes's "animal spirits", as George Akerlof and Robert Shiller suggest.

It is a basic fact that economic agents act in an economic and financial environment characterized by uncertainty - a phenomenon that is not only a consequence of irrational behavior, or of the lack the necessary information about the future that would allow them to act rationally, as conventional economics teaches and financial agents choose to believe; it is also a consequence of the impossibility of predicting the future.

While commercial banks were just trying awkwardly to protect their falling share of the market, the other financial institutions as well as the financial departments of business firms and individual investors were on the offensive. Whereas commercial banks and to a lesser extent investment banks were supposed to be capitalized - and so, especially the former, were typical capitalist firms - financial investors could be financed by rentiers and "invest" the corresponding money, that is, finance businesses and households liberated of capital requirements.