What is really going on? — Real-World Economics Review Blog

by Yanis Varoufakis

. . . what is really going on? My answer: A half-century long power play, led by corporations, Wall Street, governments and central banks, has gone badly wrong. As a result, the West’s authorities now face an impossible choice: Push conglomerates and even states into cascading bankruptcies, or allow inflation to go unchecked. […]

What is really going on? — Real-World Economics Review Blog

Ha-Joon Chang on the nature of economics

Professor Ha-Joon Chang of SOAS, formerly of Cambridge University, is always good value if one favours a critical, open-minded, heterodox and lively approach to economics, or political economy, the term which he favours.

In this short introductory lecture, Chang discusses how to define economics, and briefly explores and compares three schools of economic thought which have been used to justify free markets in today’s economies: the neoclassical, classical and Austrian.

He is critical of the modern approach which defines economics by its methodology and its supposed ability to explain ‘everything’, rather than it being defined by its subject matter, as the study of the economy itself. He notes that the modern approach failed to predict or satisfactorily explain the greatest economic crisis since the Great Depression and was rather complacent in its belief that economic management would prevent such crises from occurring once and for all.

He also favours a pluralist approach to economic theory, using the example of Singapore to argue that no single theory can account for its economic success and distinctive economic structure.

Considering the work of a maverick economist: introduction to a new series

I recently happened upon the work of economist Andrew Smithers, whose books and articles portray an unconventional and original thinker, and one who is unafraid to challenge the conventional wisdom in economic theory and policymaking. He could be classed as heterodox, while not falling easily into any particular political or ideological category. He studied at Cambridge in the 1950s, and was taught by, among others, the distinguished post-Keynesian Nicholas Kaldor, as well as Brian Reddaway. While he is now retired he continues to contribute to economic debate, via the Institute for New Economic Thinking, the Financial Times and elsewhere.

He has many years experience in international investment and has written extensively on financial economics, bringing together the spheres of finance and the real economy. His latest book is The Economics of the Stock Market, which is on my current reading list. However, I decided to start with his 2013 work The Road to Recovery, written in the wake of sluggish global growth following the financial crisis, followed by Productivity and the Bonus Culture, published in 2019, which tackles more comprehensively phenomena described in the earlier book.

The global economy has more recently been hit by shocks arising from a pandemic and war, but one of Smithers’ main contributions to economic debate is his argument that poor growth in output and productivity in the US and UK is largely down to the ‘bonus culture’ that has arisen in recent decades.

On liberalisation, ‘free’ markets and state intervention

Here is another helpful quote from the conclusion of the book Banking Systems in the Crisis – The faces of liberal capitalism, which emphasises the contentious nature of ‘free’ markets, liberalisation and the role of state intervention. Since markets are ‘political and social constructs’ and can lead to concentrations of power which undermine their effective functioning in the economy and society, they require intervention by the state. In the crisis of 2008, many governments intervened heavily to prevent financial and economic collapse. Although leaving the resolution of the crisis to the ‘market’ might have worked eventually, the political and social consequences, on top of the economic fallout, would surely have been severe.

“Economic liberalisation is not a precisely defined process – even by its main advocates. It is typically identified as involving de-regulation with an emphasis on ‘free’ markets, but even these identifiers are misleading. The process of de-regulation is perhaps more appropriately described as one of re-regulation since it is usually not so much about the removal of regulation as it is a re-orientation of the ‘rules of the game’ (which is likely to privilege certain groups over others), despite the freeness implied in the process. This is turn creates the second incongruity; the use of the terms ‘free’ and ‘competitive’ – often interchangeably – to describe liberal markets. However, as we have already seen, markets are not, in fact, the force of nature that many liberal apologists claim them to be. They are political and social constructs; and the ability to effectively compete in markets is likely to depend upon the state ensuring that they perform as intended. Truly competitive markets require intervention – by law and the state – to ensure a level playing field that allows market actors to compete on meaningful criteria. This gives rise to the question of how, to what extent and when the state should intervene – not whether the state should intervene at all. Moreover, since markets are vulnerable to domination by particular interest groups as their economic power increases, they can never really be ‘free’ in the sense that economic liberals theorise them to be.

…[T]he re-regulation of markets in general – and financial markets in particular – during the decades preceding the 2008 financial crisis, increasingly privileged the interests of private financial elites (albeit to varying degrees in different countries). However, their rescue, through internationally coordinated government intervention, effectively socialised costs (whilst the benefits remain private). This was hardly in the spirit of liberal values, where the freedom of markets from government intervention should have demanded the refusal of state intervention during the 2008 financial crisis. Whilst it is very likely that markets with this sort of freedom would have proven to be self-regulating after a fashion, the adjustments would in fact have been unsustainably brutal and almost certainly unacceptable, politically and socially.”

Konzelmann, Suzanne J. and Marc Fovargue-Davies (2013), ‘Conclusion’ in Suzanne J. Konzelmann and Marc Fovargue-Davies (eds), Banking Systems in the Crisis, Routledge, p.269-70.

Too much finance – misallocation, corruption and ideology

“[T]he financial sector has become much more profitable than the non-financial sector, which has not always been the case. This has enabled it to offer salaries and bonuses that are much higher than those offered by other sectors, attracting the brightest people, regardless of the subjects they studied in universities. Unfortunately, this leads to a misallocation of talents, as people who would be a lot more productive in other professions – engineering, chemistry and what not – are busy trading derivatives or building mathematical models for their pricing. It also means that a lot of higher-educational spending has been wasted, as many people are not using the skills they were originally trained for.

The disproportionate amount of wealth concentrated in the financial sector also enables it to most effectively lobby against regulations, even when they are socially beneficial. The growing two-way flow of staff between the financial industry and the regulatory agencies means that lobbying is often not even necessary. A lot of regulators, who are former employees of the financial sector, are instinctively sympathetic to the industry that they are trying to regulate – this is known as the problem of the ‘revolving door’.

More problematically, the revolving door has also encouraged an insidious form of corruption. Regulators may bend the rules – sometimes to the breaking point – to help their potential future employers. Some top regulators are even cleverer. When they leave their jobs, they don’t bother to look for a new one. They just set up their own private equity funds or hedge funds, into which the beneficiaries of their past rule-bending will deposit money, even though the former regulators may have little experience in managing an investment fund.

Even more difficult to deal with is the dominance of pro-finance ideology, which results from the sector being so powerful and rewarding to people who work in – or for – it. It is not simply because of the sector’s lobbying power that most politicians and regulators have been reluctant to radically reform the financial regulatory system after the 2008 crisis, despite the incompetence, recklessness and cynicism in the industry which it has revealed. It is also because of their ideological conviction that maximum freedom for the financial industry is in the national interest.”

Ha-Joon Chang (2014), Economics: The User’s Guide, Penguin Books, p.306-7.

Inequality, global imbalances and crisis

Tracing a connection between rising inequality and the Great Recession of 2008 is appealing to leftist economists. It suggests that what they see as two of the potential downsides of capitalism and in particular the neoliberal economic order can perhaps be mitigated via appropriate policies. Thus, a more egalitarian capitalism can become less prone to crisis or recession.

Of course, what is appealing as social and economic outcomes is not a good enough reason to investigate linkages between them, though I suspect that I am far from the only one who is drawn to particular ideas as a matter of bias.

Perhaps there is nothing wrong with that as a starting point, followed by economic analysis of the chosen object of study.

An article in the latest issue of the heterodox Cambridge Journal of Economics explores the potential linkages between the distribution of income and current account imbalances in a simplified model of the global economy consisting of the US, Germany and China, prior to the 2008 recession.

These three countries had the largest current account imbalances in absolute terms in the run-up to the recession. The US ran a deficit, and Germany and China were running surpluses. Since these imbalances have been pinpointed by some economists as a cause of the recession itself, analysing them is important.

Heterodox critiques of quantitative easing

Following last week’s quote from Michael Hudson on quantitative easing (QE), here are some other insightful perspectives which for me offer explanatory power, given the course of economic and financial events over the decade since the crisis began.

The aim of QE is to reduce long-term interest rates, boost private sector lending, and raise asset prices to generate a positive wealth effect on private spending. Altogether, these are meant to raise private sector consumption and investment, and thus economic growth.

Richard Koo, economist at Nomura and originator of the theory of balance sheet recessions, has outlined the potential problem of the ‘QE Trap’ (2015). While QE might have the effect of mitigating such a recession, once the recovery is underway, its withdrawal could lead to slower growth than otherwise. In other words, over the longer term, its overall effect might be negligible or even negative:

Michael Hudson on Quantitative Easing

Plenty of economists, investors and others have been wondering what will happen to financial markets and the real economy as monetary stimulus in the form of Quantitative Easing is wound down by central banks from the US to the Eurozone in the face of stronger growth.

I will be writing more about it next week, considering the perspectives of critic Richard Koo among others, but here is Michael Hudson from, as ever, his iconoclastic and insightful ‘dictionary’ J is for Junk Economics (p.189-91):

The Global Minotaur and beyond

Yanis Varoufakis is a self-styled ‘erratic Marxist’ and a former finance minister of Greece under the Syriza-led government. He penned his illuminating book The Global Minotaur (TGM) some years ago, in the aftermath of the evolving Global Financial Crisis.

He has become a prolific writer for the intelligent layman, and his website is well worth a look, particularly for those interested in progressive reform in the European Union and the Eurozone.

TGM is Varoufakis’ thesis on the roots of the crisis, which according to him lie back in the 1940s, towards the end of World War II. At that time, the US had emerged as the global capitalist hegemon, economically, politically and militarily.

The 1944 Bretton Woods Conference in New Hampshire was attended by such figures as the economist John Maynard Keynes, who led the British delegation, and Harry Dexter White, his US counterpart. The aim was to construct a post-war global economic and financial order which would avoid another Great Depression, as had occurred in the 1930s, and the achievement of peace and prosperity via international cooperation.

Yanis Varoufakis on the paradox of success

“Self-restraint, as the philosophers know, is a rare and bewildering virtue. It is also a virtue that tends to come unstuck the more powerful we become. In this it resembles the relationship between trust and success: the stronger the bonds of trust between us, the greater our collective and individual success. But success breeds greed, and greed is a solvent of trust. Similarly with self-restraint: having it can help one succeed. But then success poses a threat to one’s self-restraint.”

Yanis Varoufakis (2015), The Global Minotaur – America, Europe and the Future of the Global Economy (p.249)

This thought-provoking quote is taken from the postscript of Varoufakis‘s enlightening book on the roots and evolution of the Global Financial Crisis, originally published in 2011.

The author describes how post-war US hegemony produced a ‘Global Plan’ which helped to underpin a successful capitalism for twenty years; its ‘finest hour’, according to Varoufakis, and what has often been called the Golden Age. This gave way to his ‘Global Minotaur’ in the 1970s, which ultimately led us to the crisis of 2008 and its collapse.

The key that links these systemic ideas, and the possibility of a successful global capitalist future is what he calls the ‘global surplus recycling mechanism’ (GSRM). The evolution of the GSRM is the unifying theme which unites the book, which I will discuss in a future post.

Some of The Global Minotaur‘s ideas overlap with those of Michael Pettis, particularly in the latter’s book The Great Rebalancing. In fact the two are largely complementary, as Pettis describes the domestic policies in countries such as China and Germany, which helped to create the financial imbalances that caused the crisis.