The global financial crisis marked the end of the dominance of free-market capitalism, and even the IMF is now questioning the ideology behind it.
With money comes great influence: political, ideological, even sartorial. The doublet and hose of Henry VIII were copied from the lavish dress of rich Florentine and Venetian merchants at the height of the Renaissance; sombre suits spread throughout the world in homage to the Victorian gents who commanded the British empire, and the jeans and T-shirts of today’s teenagers were born in the United States, the 20th-century hegemon.
In their new book, The End of Influence (subtitled What Happens When Other Countries Have the Money), the economists Stephen Cohen and Brad DeLong argue that the supplanting of the US by other rising economic powers will have seismic consequences for a world that has spent the best part of the past century buying up the American dream and all its accessories – from Coca-Cola to schmaltzy Hollywood movies, hamburgers to irritating conversational tics (“like, whatever!”).
“Because America had the money – had it solidly, rightfully, self-assuredly, and durably – for about 100 years, people all over the world wanted to be like Americans: successful, modern, loose-jointed, efficient, democratic, socially mobile, leggy, clean, powerful, and, of course, rich,” they say.
Today, the US is in hock to China to the tune of $800bn (£520bn) in treasury bonds, and potentially a much larger sum in shares and other investments, after a decade-long borrowing binge by governments, families and corporations. Even before the crunch, that shift made it inevitable that the US model would lose its allure. But the crisis, which had its roots in the home of the unbridled free-market capitalism, has supercharged the transfer of power from the west to the emerging economies of China, India and Latin America.
Cohen and DeLong argue that we are about to see an end to the cultural dominance of American fashions and mores – and also a major ideological shift: what they call the collapse of “the neoliberal dream”.
The past couple of weeks alone have brought new evidence that a rethink is already under way, even in that crucible of the Washington consensus, the International Monetary Fund. A paper published on 12 February by its chief economist, Olivier Blanchard, and his colleagues acknowledges that policymakers became much too complacent during the “Great Stability” of the early 2000s, attributing years of low inflation and stable growth to their own genius, instead of a lucky conjunction of circumstances.
Blanchard et al then ask whether it wouldn’t have been better to allow inflation to rise a bit more, so central bankers would have had a bit more room to manoeuvre when everything went wrong. Perhaps, they muse, an inflation target of 4% might be better than the 2% or so that many central banks aim at.
As Blanchard told the IMF‘s house magazine: “The crisis has shown that interest rates can actually hit the zero level, and when this happens it is a severe constraint on monetary policy that ties your hands during times of trouble. As a matter of logic, higher average inflation, and thus higher average nominal interest rates before the crisis, would have given more room for monetary policy to be eased during the crisis and would have resulted in less deterioration of fiscal positions.”
He called for policymakers to look at other factors such as leverage and asset prices, as well as inflation, and to use a range of other tools, as well as interest rates, to control the economy – limiting loan-to-value ratios when a credit boom is getting out of hand, for example. It wasn’t quite as radical as Alan Greenspan’s admission after Lehman Brothers collapsed that he had discovered “a flaw” in his free-market philosophy but as Damascene conversions go, the concession that inflation might not be so bad, after all, showed how severely shaken the world’s economic policymakers have been by the credit crisis.
For decades, the IMF has promulgated a mix of anti-inflation policies, financial deregulation and free markets that became not just the accepted norm for the rich world but the recipe imposed on scores of developing countries. With this came the powerful threat, politely known as “conditionality”, that if they didn’t follow the rules, their financial lifeline – IMF funds – could be cut.
Blanchard’s paper is not official policy, just the IMF chief economist’s musings about the lessons of the crisis. But for developing countries that have endured eye-wateringly high interest rates, or pegged their currencies at artificially high levels, in the battle against the great demon of inflation, his words will have seemed like an extraordinary volte-face. Even the “Washington consensus” seems to be losing its grip.
Lord Turner, chairman of the Financial Services Authority, tore into another tenet of the “neoliberal dream” in a characteristically thoughtful speech in Mumbai last week. He had already made himself a hate figure in the City by describing as “socially useless” many of the innovations its finest minds have come up with over the past few years. This time, he turned to the international equivalent of the same argument, questioning whether the “financialisation” of the world economy has had the benefits often claimed for it.
Apart from a shrewd analysis of the causes of the crash, and its most recent predecessor, the Asian crisis of the late 1990s, Turner argues powerfully that the exponential expansion of financial activity in the run-up to the crunch had few of the benefits claimed by proponents, in terms of efficiently allocating capital around the world, or transparently revealing the “true” value of underlying assets.
“The case that short-term capital flow liberalisation is beneficial is based more on ideology and argument by axiom than on any empirical evidence.”
In 2006, he points out, the IMF was happily claiming that the now-notorious credit derivatives “enhance the transparency of the market’s collective view of credit risks”. Unfortunately, that collective view was often utterly wrong. As Turner says, in 2007, on the brink of the crisis, the credit default swap market was “revealing” that the risk of a major bank defaulting had hit its lowest ever level – a message backed up by the banks’ share prices (see graph three).
In the event, financial liberalisation led not to safer but riskier markets, a message not lost on countries such as India, where Turner was speaking. The Indians refused to swallow the neoliberal orthodoxy completely, keeping some control over the growth of credit, for example – a decision that once made Delhi look woefully backward, but has helped India avoid the worst excesses of the financial boom and bust.
After the most catastrophic crash for 80 years led to a shattering world recession, the ideology that transmitted American economic ideas across the globe has been comprehensively trashed, even in its spiritual homes of Washington and London. But the thinking about what will replace it has only just begun. China, India, Brazil and Russia have taken divergent paths to development. Cohen and DeLong suggest a growing role for governments and regulation; Turner talks about controls on capital flows, and a transaction tax to throw “sand in the wheels” of the hyperactive financial markets; the IMF muses about new macroeconomic “tools”.
But none of that amounts to a fully thought-through alternative, and that will take time. We have no more idea of what the economic orthodoxy of the next half-century will look like than of what will supplant Coke, denim or hamburgers.