Miloš Pick: When Credit Crunch Becomes Capitalism Crisis

23. 12. 2008 / Miloš Pick

How the crisis has evolved

t is now quite obvious that, unlike the initial misapprehensions suggesting the turmoil was limited to mortgages in the US, what we are actually faced with is a global financial crisis typified by plummeting capital and money markets, dragging prominent banks down with them, and by the freezing of cash and confidence. The gambles taken by money market and capital market operators are not solely to blame. Their actions are a direct result of the extreme deregulation of these markets, facilitating the use of sophisticated, obscure gambling products such as multi-level derivatives (derivatives and derivatives of derivatives of securities) or entirely unregulated gambling institutions fronted in the main by hedge funds, long ago dubbed `casino capitalism' by European trade unionists.

Accordingly, governments and central banks in the US and across the world are striving to suppress the implications of the crisis not only by bailing out the leading banks that have found themselves in danger, but also – and especially – by tightening the rules of market regulation and oversight in a bid to tackle at least those direct causes.

Two different models have been put forward on how to rescue the banks. One is to buy up not only the toxic credit of vulnerable banks, but also to snap up equity stakes. Another is to steer away from shares. In the first model, the purchaser (usually the state) also acquires ownership control over what are frequently the roguish owners and managers of the failing bank. This effect of controlling the moral hazard is absent from the second model, which instead hoodwinks the public by merely limiting executive pay. The Republican hawks in the US initially stuck to their ideological guns – no nationalization – rather than accept the more effective first model proposed by the Democratic congressmen, which they swept aside. However, the global financial markets do not make calculations based on ideology and rebuffed this attempt. Let’s hope that the first model – offered by the rest of the world (starting with the EU’s main states) and only subsequently by the US rethink – wins out. These steps are accompanied by guarantees for bank deposits and by liquidity injections from central banks to thaw the frozen credit system.

Yet at the same time the real economy is also icing up. In the USA and certain other countries, notably in Europe, the economic slowdown has already sunk into the icy waters of negative growth. Is this a consequence or cause?

Here, again, ground zero was in the US. Since the latter half of the 1990s, the US external economic balance – the balance of payments current account – has consistently reported a high deficit, which this decade has climbed to a level of more than 5% of the gross domestic product. As a result, the US dollar has been in unrelenting freefall, losing a third of its value by 2007. The US has thus started to follow a course where it can compete with cheaper labour; in 2007, labour costs per unit of national economic productivity in the US were a third lower than in the EU-15, whereas until now, through its specific formulae and the Washington Consensus, the US had been forcing less developed countries to compete with cheap labour. Even so, notwithstanding all legitimate expectations, the US current account deficit has not shrunk. On one hand, this suggests that the US dollar has not yet bottomed out, and on the other it is a sign that the root causes may run deeper.

Root causes

In the US, the key long-term factor underpinning competitiveness, labour productivity, is slowing down. While, following the arrival of the knowledge economy as of the second half of the 1990s, productivity growth doubled to around two per cent per annum over a decade, in the last few years it has dwindled to approximately one per cent, i.e. reverting to the level in the 1980s, and is thus once more at its lowest ebb in almost 140 years. Further to my analyses of how well the European welfare state models perform compared to the US (Politická ekonomie 5/2006), I consider the root cause to be the USA’s delay in developing qualitative, knowledge-based productivity factors. This is borne out by the steadily contracting share of high-tech products in exports as the decade has worn on and is underscored by the World Competitiveness Yearbooks.

Although the US was the trailblazer in the development of the information and knowledge economy, its almost purely market approach based on private funding even for education and training has proved less effective than solidarity based on education funded almost exclusively from the public purse. Tuition fees act as a social screen dictating which brains get access to education. Furthermore, behind the façade of the prestigious, most elite universities, the largely marketified education has a quality that is evidently profoundly differentiated from other colleges by the market. The US is losing its qualitative competitiveness versus developed countries that have successfully adopted knowledge-based productivity factors by keeping to a road of solidarity, such as Scandinavia, and is still far from being able to offer prices that can compete with countries capitalizing on much cheaper labour, such as China.

On the other hand, the US dollar is driven by the high influx of foreign investments sucked in by the long-standing extremely low level of net domestic savings. In the post-war period, the savings rate was more than 10% of the gross domestic product; from the 1980s it gradually fell to two per cent, and as of 2005 the household saving rate has actually been negative, a development not experienced since the Great Depression of the 1930s. In my view, this is the result not only of a slowdown in the growth of real wages and the intensifying polarization of wage levels, but can also be attributed to capital savings for pensions, which squeeze out other savings, including the high level of debt (negative savings) incurred by the population in respect of mortgages and education. This is the other side of the coin when public services are marketified. Lower economic growth combined with low productivity growth was increasingly maintained by indebtedness abroad, largely in relation to developing countries, with China accounting for about half.

If these assumptions hold true, the opposite sequence of the cause and effect behind the development of the crisis emerges. Since the start of the decade, the US has dampened the ramifications of these braking tendencies by pursuing the macroeconomic expansive policy of a ‘twin deficit’ – a current account deficit and a public budget deficit corresponding to more than 4% of GDP. This tension in the real economy gradually spilled over into friction on the financial markets, where it triggered the gambles discussed above. Therefore, the financial crisis did not just emerge on the back of the financial sector’s greed alone; internally, the avenue to financial turmoil was opened by extreme deregulation, whereas externally the tension in the real economy put pressure on the exploitation of the softened regulation.


The switch by the world's largest economy to a path of price-based competition shifted the ramifications of the USA’s weaker competitiveness on to the rest of the world and slowed its growth primarily in areas where this could not be prevented.

In particular, the European Union is intensifying the pressure it is under by following a passive exchange-rate policy and restrictive budgetary policy based on the Maastricht rules. To stop the indebtedness of public budgets from growing, these rules not only set limits for debt levels, but also duplicitly keep watch over any changes by limiting the deficits of public budgets, which has restrictive implications for domestic demand. This pressure on public budgets is amplified by pressure to cut taxes. All this has contributed to a situation where, this decade, productivity growth in the euro area has lagged behind that in the US and the EU-15. These consequences have been manifested in the individual EU countries unevenly, mainly depending on whether they themselves have adopted knowledge-based productivity factors. Scandinavia, primarily on account of its high taxes, enabling it to engage in high levels of public spending in science and education while maintaining a ‘twin surplus’ of public budgets and the current account, has so far warded off pressure slowing down the growth of its productivity and economy better than the EU-15. In the largest EU Member States, developments have progressed in the opposite direction.

Four main consequences can be expected in the immediate future. First, the pricking of the qualitative bubble due to the delayed adoption of knowledge-based productivity and competitiveness factors in the US, in the EU and in the Czech Republic also requires the fundamental reform of the education system, but this reform must be the complete opposite of that sought by neoliberal doctrines. This reform cannot be implemented quickly; it is a long-term task. However, even in the short term steps should not be taken that would barricade the path to the long-term solution, in particular reduced expenditure on science and education. Secondly, providing a reliable estimate of when the current slump in the real economy will bottom out is currently impossible; all we know is that it is set to continue for some while. Thirdly, if the US dollar’s demotion from its position as the world’s reserve currency, caused by its steady depreciation, is fitful rather than smooth, even more serious global turbulence could lie ahead. Fourthly, the formation of the multi-polar world, not controlled by a single superpower, is accelerating; the US is now losing its primacy not just in terms of quantity, but also quality.

Even in the Czech Republic, we cannot expect to avoid the indirect ramifications of these braking trends, not only from the perspective of the slowdown of the real economy in the US and, in particular, in the EU, but also in terms of the fact that if the financial crisis around us is not managed by means of rescuing the key banks, our own banks could be at risk despite their relatively consolidated position. However, at the same time direct influences are also emerging, primarily as a result of the passiveness of our dependent exchange-rate policy, even though our currency remains autonomous, due to the anachronic application of a restrictive budgetary policy that goes beyond the framework of the Maastricht criteria, including tax cuts. We are starting to see credit freezing up. These risks are intensified by the current Czech government’s passive approach to the EU’s rescue efforts and to domestic measures.

Immediate point of departure

The G8 group of countries, expanded to embrace the emerging superpowers, should evidently coordinate the necessary intensification of global financial market regulation. The International Monetary Fund should provide financial assistance to rescue countries at risk without imposing the condition that its neoliberal principles have to be applied.

Besides the rescue measures adopted so far on the financial markets, the EU, the ECB, governments and central banks of the Member States should progress to an active pro-growth, or at least ‘anti-depression’ budgetary, monetary, and hence exchange-rate policy. The promises to the automotive industry indicate that microeconomic interventions will not be avoided either.

The Czech government, too, at least in this grave situation, needs to abandon its increasingly dangerous childish efforts to provoke Europe and should not only back the rescue measures, but also contribute its own initiatives. In particular, it should drop its malignant policy of tax cuts, which deprived us of much needed tax revenues in the region of a hundred billion crowns in 2007 compared to 2004. Nor can we continue to keep ahead of the criteria of the restrictive Maastricht budgetary policy (of deficits below 3 % of GDP), which the EU is actually relaxing. We could also proceed more independently in our exchange-rate policy while we still have an autonomous currency. We should focus exports more on those markets which are less exposed. Further, the continuation of efforts to restrict investment incentives instead of diverting them to the development of more sophisticated products and services is hardly a down-to-earth policy. And if the EU is injecting two billion euros (almost 50 billion crowns) into rescuing the banks, in warranted cases we will not avoid at least reasonably modest state aid for certain significant enterprises which can prove that their vulnerability is not of their own making.

Attempt at an overview

On a higher plane of abstraction, let us attempt a more general overview.

After a century of monopolistic capitalism, it is established that monopolized markets are not competitive; here, the invisible hand of the market is unable play its stimulating, optimizing role and the visible hand of state regulation must step in. In my opinion, experience suggests that, unlike the indirect regulatory effect of government macroeconomic and interventional macroeconomic policy, in this neuralgic case it requires a greater degree of regulation – state ownership control.

I believe that the current financial crisis has brutally shown that the banks and the money market, the heart and lifeblood of the economy, are even more vulnerable and, likewise, require the very highest level of regulation, which had to be created quite literally overnight. Therefore, I do not regard it as simply a temporary emergency improvisation, but as a permanent component of the new economic structure.

Since the early 1990s, capital and activists in the field, notably neoliberal theoreticians and politicians, have tried to prune down the European welfare state by marketifying, charging and privatizing public services. Thus far, this struggle has taken place in the form of theoretical and political sparring, in which the welfare state and its advocates have been retreating. People have glossed over the fact that the largely market-based health system in the US is twice as expensive as the predominantly solidarity-based European system. Even in the 1990s, people chose not to listen to the International Labour Organization’s warnings that, with private capital pension funds, no one could forecast, let alone guarantee, the real purchasing power of a pension forty years in advance. Only now have they received a shocking, highly expensive lesson. An even worse awakening awaits when they find out about the gap that can be created by market-based education; this is stealthy, which makes it all the worse. Here the challenge is not ‘just’ the social consequences, but literally survival in global competition. The question is when and how current protective measures will cover this step.

On an even higher plane of abstraction, let us attempt an even more general overview. Over several weeks of crisis, the greatest changes since the neoliberal wave of the 1990s have started emerging. We are witnessing the collapse of much more than the financial markets, and subsequently, the foundering of the run-in to a welfare state. Neoliberal ‘pure’, unregulated capitalism has crumpled. Defeat has been inflicted not by leftwing opponents in the political struggle, but by a market pampered by neoliberals that has gone wild. With a little poetic licence, something in the vein of World War Three is under way, but in a form completely different from how it had been imagined by those who try to switch development away from the economic competition they are losing to a cold or even hot war. It is a ‘war’ waged on an economic ‘battlefield’, and it is still a “Blitzkrieg”.

Perhaps the nucleus of an anti-crisis coalition is forming that reaches beyond the borders of superpowers and political movements. This currently seems most likely on the basis of the G8 expanded to incorporate newly emerging superpowers. A coalition that will be driven from short-term measures to other steps against contemporary capitalism, as we hear even from the lips of President Sarkozy, where just a few weeks ago we would not have thought of looking. Are these merely words to placate the panic-stricken public?

Or are the proposals for a new structure of global economic architecture, starting with a new Bretton Woods system, serious? In my view, this would mean reconstructing the International Monetary Fund as a multi-polar entity and perhaps creating a UN Economic Security Council on a similar basis. This basis would appear to be more effective for the coordination of exchange rates too – in accordance with UNIDO suggestions – instead of the current policy where they are left to the whims of the markets, disrupted by the decline of the largest economic superpower. To start along a new road towards the liberalization of international trade and ensure it is balanced, instead of pressure on the predominantly unilateral, premature liberalization of weaker countries, culminating in their discrimination and thus weakening their protection through a policy of extremely cheap labour. Can we – even without Roosevelt – strike a modern global New Deal in a multi-polar world?

Whereas since the 1960s, pseudo-socialist systems of a ‘pure’ state, based on the nearly exclusive role of the state without (or almost without) market forces, have failed, today, as in the crisis of the 1930s, we are seeing the collapse of capitalism, based on the nearly exclusive role of the market without (or almost without) the regulatory role of the state. Will we avoid the two extremes – will the invisible hand of the market finally shake the visible regulatory hand of the state, apparent primarily in the creation of rules for fair market procedures, in macroeconomic and microeconomic intervention policy, in the co-existence of various forms of capital ownership, in a predominantly solidarity-based form of public services, starting with education, health and pension insurance, and in the social redistribution of income to an extent that will tackle the poverty trap and yet not weaken – but reinforce – the performance stimulus?

Will the need to resolve the catastrophe prevail over power-hungry and group interests? How long will it take for passions to subside? Or will battles be fought on this between Wall Street (capital, invoked by Bush) and Main Street (the people on the street, backed by Obama)?

Czech version published in the electronic journal Britské listy, 25 November 2008

Miloš Pick: Od krize hypoték ke krizi kapitalismu - zápasy mezi Wall Streetem a Main Streetem ZDE


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