Stimulus, slump, superstition and recovery: Thinking and acting beyond vulgar KeynesianismPublished Tue 23 Oct 2012
Nothing astonishes more in the present debate about recovery from the slump that followed the global financial crisis of 2007-09 than the poverty of the ideas. It is as though we were condemned to relive a yet more primitive version of the debates of the 1930s.
On one side, we hear the argument for fiscal and monetary stimulus: the more the better. The intellectual inspiration of this argument is almost exclusively vulgar Keynesianism; with each passing round in the debate, it becomes more vulgar.
The chief opposing conception is a market fundamentalism, the major premise of which is that a market economy has, despite minor variations, a single natural and necessary institutional form. One of the by-products of this market fundamentalism has been a resurgence, in response to the nostrums of the vulgar Keynesians, of the 'liquidationist' view of the 1920s and a desire to 'purge the rottenness out of the system': fiscal austerity, monetary common sense, and a return to fundamentals - that is to say, the established institutions of the market economy, with a minimum of governmental action - are supposedly all we need.
Neither approach comes close to being sufficient to respond to the depth of the economic crisis that now confronts us. In this essay, we set out the complaint against vulgar Keynesianism before discussing the left's alternative. In particular, we highlight two imperatives that the established debate about the crisis has left almost entirely untouched: the need to put finance more effectively at the service of the real economy in general, and of production and innovation in particular, as well as the need to loosen the destructive restraints that inequality imposes on growth.
The truncated debate: why stimulus fails
The left has good reason to believe that market fundamentalism is not the answer. But it also needs to wake up to the fact that its own conventional and inadequate response - vulgar Keynesianism - is equally deficient.
The truth is that, under the conditions of contemporary democracies and markets, no fiscal and monetary stimulus is ever likely to be large enough to help ensure a broad-based and vigorous recovery from a major slump. Long before it reaches the dimension needed to make a difference, the stimulus will encounter difficulties that are hard to overcome.
Whereas the ultimate effect of such actions on economic growth is both speculative and remote, the burden that they impose on governmental finance is immediate. The worsening of the fiscal position of the state may in turn arouse the spectre of a crisis of confidence in sovereign debt and in the ability of the government to repay its obligations over the long term, as indeed is the case in Europe today.
Additionally, each of the different forms of stimulus suffers from its own limitations.
The expansion of the money supply by central banks (called by a barrage of obfuscating names such as 'quantitative easing') may help to avoid serious and destructive deflation but it cannot, however, help to ensure a vigorous recovery in economies full of families and companies anxious to escape an overhang of debt.
In the case of stimulus through tax cuts, the money saved by households (and in effect spent by the government) is also likely to go disproportionately into the paying down of corporate or household debt rather than into increased consumption.
Stimulus through spending seems more promising. One route is to put money directly in the hands of those who are more likely to spend it. Another path is to undertake an ambitious programme of public works, especially works designed to enhance the transport and communications structure of the country and to promote low-carbon alternatives to present lines of production. These activities are useful, both in themselves and as responses to the slump: they can have an immediate effect on the level of economic activity. But here too the size of the stimulus will inevitably remain insufficient.
Too often on the left the errors of today are grounded in a misunderstanding of history. Contrary to common understanding, the proto-Keynsianism adopted by the United States and other major western governments during the worldwide depression of the 1930s was largely a failure. No major western economy managed to overcome the depression before the second world war, with the sole, partial exception of Germany. Roosevelt, contrary to common latter-day revisionism, had not brought the country to sustained, broad-based recovery: when he wavered and retrenched in his program of recovery through public spending, as every proponent in power of massive stimulus always has, he helped to precipitate the frightening downturn of 1937-38.
What brought the advanced economies out of the depression was the wartime mobilisation of people and resources. Between 1941 and 1945, US GDP doubled. The war economy was, in straightforward economic terms, a success.
And it was a success not simply with regard to the expansion of output. It was also a success with respect to conventional progressive redistribution through the tax system, as well as with regard to the accelerated technological and organisational innovations that are generally associated with periods of major economic growth. The central attribute of the war economy was the coexistence of a forced mobilisation of resources and a quickened pace of bold practical experimentalism in the ways of organising the effort. That - and not proto-Keynesianism - was what really worked.
When the lessons of the wartime experience are transported to the conditions of relative peace, the main lesson is that because the forced mobilisation of resources is less feasible, the other element - of institutional innovation, in the practices of production and in the forms of cooperation and coordination between public and private agents as well as among private ones - becomes all the more important.
The truncated debate: the slump and the missing structural agenda
The present debate, however, is almost entirely deficient in any view of the institutional innovations that would be required to organise socially inclusive economic growth over the long term. The dominant perspective of the debate - both from the standpoint of the proponents of stimulus and its opponents - is that the slump represents an interruption, a threat, a shadow, to be averted. Once it is averted, we can return to how things were before. However, there is a flaw in the hope of getting back to business as usual: things were not well before the crisis and the slump.
There are two fundamental issues which continue to be ignored: the far-reaching estrangement of finance from the real economy and the gross inequalities of the present organisation of market economies. Both form a large part of the causal background to the recent crisis.
Finance estranged from the real world
Under the present arrangements of all contemporary market economies, the link between the accumulated saving of society and its agenda of production is weak. To a large extent, the finance of production relies on the retained and reinvested earnings of private firms, which is to say that production finances itself. It is free to serve itself rather than production, and to design successive layers of financial engineering with an ever-more tenuous relation to any transactions in the real economy. What is more, wealth, influence and talent, debased and wasted, accrue to a form of economic activity that has lost any close and real connection to the imperatives and the opportunities of production.
A relaxation of regulatory vigilance such as occurred in the second half of the 20th century, merely magnifies these effects. Finance, relatively ineffective in helping support production, may be very effective in disrupting it, as its innovations become more and more self-referential and less and less useful to funding the production of actual goods and services. In short, finance does relatively little good to the real economy in good times and threatens to do immense harm to it in bad times.
Inequality and fake credit democracy
If the disengagement of finance from production formed part of the causal background to the crisis of 2007-09 and to its continuing aftermath, another part was the effect of inequality.
The economic growth that the advanced western economies saw in the second half of the 20th century relied heavily on the expansion of a market in mass consumption goods. Such popularisation in turn seems to depend on widespread distribution of wealth and income: either through a broadening of access to economic and educational opportunities that influences the primary distribution of income or through the redistributive effects of taxation and social spending. This is why when inequality was allowed to increase, particularly in the 1980s, western economies needed an answer: what real redistribution failed to provide, fake redistribution in the form of greater access to consumer credit helped to supply instead. Escalating household indebtedness, crucial to the continuing exuberance of the mass consumption market, and therefore to the prosperity of the firms that directly or indirectly produced mass consumption goods, was in turn made possible in part by the overvaluation of the housing stock as collateral.
Thus did a pseudo-democratisation of credit replace a real redistribution of wealth and income. A fragile credit democracy came to stand in the place of a property-owning democracy.
Inequality also matters in another deeper and less direct way that has more to do with the supply side of the economy than with its demand side, and with firms rather than with households. In all major economies in the world, the most important, wealth-creating innovations have come increasingly to be concentrated in advanced sectors of the economy and among wealthy elites. These are strongly connected to comparable productive vanguards around the world - with which they trade people, practices and ideas - but only weakly linked to other parts of their own national economies. The separation of these productive vanguards and the remainder of the economy has become the fundamental source of social inequality and exclusion. But it also means that the greatest engine for dramatic rises in productivity finds its potential diminished by the narrowness of its scope of operation and influence. This represents a formidable constraint on any attempt to make the slump give way to a new cycle of enduring and broad-based economic growth.
The left alternative
So what do these insights about the underlying causes of the crisis mean for the left's alternative? How should finance be reconnected to the real economy? How can broad-based and socially inclusive growth be achieved?
Finance: turning the bad master into a good servant
It is important to understand that finance operates in an institutional context not of its own making. This is simply a special case of a more general truth: that the market economy cannot produce its own institutional framework. The institutions of the market are not created in the market but are instead fashioned in politics as well as in thought, and embodied in law. The idea that the market in general, and the financial market in particular, generate their own institutional form becomes plausible only in the light of another idea, the practical influence of which in the affairs of modern societies can hardly be overestimated. This is the idea that a market economy has a single necessary and natural form, expressed above all in a particular system of rules and rights of contract and property.
It is an idea underlying much of the contemporary discussion of finance and of the regulation. One of its implications is that the proper task of regulation is seen as remedying particular market defects, for example of imperfect competition or asymmetrical information. But this idea disregards what may be the most important task of regulation and reform: the reshaping of the arrangements that define the market economy. The issue must always be 'which market economy do we want, and what way of solving today's problems will help us to move towards it?'
We have only to consider historical experience to appreciate how institutional innovations have succeeded in making finance more useful to production. If they have made it more useful in the past then they can do so again in the future.
The early 19th-century US, for example, witnessed a struggle over the national banks. This struggle culminated, during the presidency of Andrew Jackson (1829-37), in the disbanding of the national banks and in the subsequent development of the most decentralised system of credit that had ever existed in a major country: a network of local banks, the potential of which remains to this day. This banking network placed finance more effectively at the service of the local producer and the local consumer.
An advance of this kind can be achieved again, not by repeating the institutional formulas of an earlier epoch but by institutional innovations suited to the present circumstance. Options include instituting tax and regulatory changes that encourage speculative finance that has a direct relation to the enhancement of productivity and the expansion of output and, at the same time, discouraging speculative finance that does not. Such innovations would give practical content to the idea of 'financial deepening' - the intimacy of the relation between finance and the real economy - not only consumption but also and above all production and innovation. The working assumption must be that it is not enough to cut finance down to size, for example, by requiring more stringent capital leverage ratios or even by imposing absolute limits on the size of financial firms. Instead, we must democratise finance in order to make it more useful to production and innovation.
Recovery: reinventing industrial policy
A second key element of any programme for achieving broad-based and socially inclusive economic growth is the reinvention of industrial policy.
All major economies have started to move beyond the form of industrial organisation that emerged in the late 19th century and that came to prevail in the first half of the 20th: the mass production of standardised goods and services, with rigid production processes, dependence on semi-skilled or narrowly skilled labour, and stark contrasts between jobs of supervision and of execution (as well as among specialised tasks of execution), and clear-cut separations of areas of activity considered appropriate for cooperation or for competition.
All rich economies - and, indeed, emerging economies - boast advanced sectors characterised by 'vanguard productive practices'. By contrast with the industrial model, these feature relatively decentralised and flexible production of non-standardised goods and services, knowledge-intensive labour, the softening of contrasts between supervision and execution, as well as among rigid specialities at the factory or office floor, a more thoroughgoing mixture of cooperation and competition and, above all, the practice of permanent innovation.
However, even in the richest and most egalitarian contemporary societies (some of the European social democracies) such vanguard practices remain confined to relatively isolated parts of the economy, from which the majority of the workforce is excluded. The key goal of a reinvented industrial policy should be to expand the scope and reach of the vanguard sectors.
Its chief target should be the small and medium-sized businesses that in every major economy in the world represent the chief sources of jobs and output. Its method should be the expansion of access to credit, to technology, to advanced knowledge and practice, to facilities for the organisation of networks of cooperation that combine the benefits of flexibility and of scale. Its characteristic concern should be to propagate successful organisational and technological innovations wherever they may arise. Its temper should be patient and fearless experimentalism.
The power of the state can and should be used to open the economic and educational gateways of access to this productive experimentalism. To this end, we need a form of association between governments and firms that is neither the American model of arm's length regulation of business by government nor the north-east Asian model of formulation of unitary trade and industrial policy, imposed top-down by a governmental bureaucracy. We need instead a form of strategic coordination between governments and firms that is pluralistic, participatory and experimental. Its aim is to help make the conditions and instruments of advanced production available to larger parts of the economy and the society.
As with finance, here too is a huge opportunity to democratise the market economy. It is not enough to regulate the market economy or to compensate for its inequalities by means of retrospective redistribution through the familiar tools of redistributive taxation and social spending. It is necessary to change how we organise our societies and economies the better to achieve a decisive broadening of economic and educational opportunity.
Such an approach contradicts what has been the dominant model of ideological controversy over the last few centuries throughout much of the world. According to this, the central question is always 'market or government': more market and less government, or more government and less market. A thesis of our argument is this: more market and more government. Democratise the market, do not just regulate it, and use the response to the financial and economic crisis and its aftermath as an occasion to undertake this democratising work.
Conclusion: ending the poverty of ideas
In the current vacuum of ideas, the ghosts of the intellectual alternatives of nearly a hundred years ago - a shrunken Keynesianism and a fossilised market orthodoxy - have been called up, if not out of conviction then out of sheer desperation. As a backdrop, the project of the left in the US and Europe has basically been reduced to sugar-coating a reality that it despairs of reimagining or reshaping. The humanisation of the inevitable is the leitmotif of their politics.
Instead, the left must use the crisis to remake the market economy by undertaking the institutional innovations that can give more access to more markets for more people in more ways. Take the stimulus as the holding operation that is all it can be and keep your eyes focused on the prize: the growth project, designed to include and to empower as well as to enrich.
The left must insist on doing what progressives have largely failed to accomplish: to come up with a proposal that responds to the interests and aspirations of the broad (working-class) majority of the country. In so doing, such a programme would also provide a sequel to the Roosevelt's New Deal and to Europe's social-democratic settlement of the mid-20th century. Now, however, the emphasis would no longer fall narrowly on safeguards against economic insecurity or on high levels of redistributive social entitlements. It would fall on what matters most: the tools and occasions to make something of one's life, in biographical time and in history.
This piece is adapted from a longer essay, 'Stimulus, Slump, Superstition, and Recovery: Thinking and Acting Beyond Vulgar Keynsianism', 2011.