Will the current crisis mark the end of laissez faire capitalism in democracies.
We are all socialists now”, proclaimed Newsweek in a cover story recently. After the presentation of President Obama’s first budget to Congress, the Republicans are criticising the “Europeanisation of America”. Europeanisation is a dirty word for the American right: It signifies intrusive government and slower growth. The question is: Will the on-going crisis in the global financial markets, with the world economy teetering on the edge of recession, if not depression, mark the end of the 30-year experiment in laissez faire capitalism, in democracies? Interestingly, this time span matches almost exactly the ultra-left policies and cultural revolution in China, before it turned dramatically right: It is less than half the period socialism lasted in the Soviet Union before it imploded.
In many ways, the Obama budget makes a U-turn from the policies of the last three decades in the United States initiated by President Reagan, characterised by significant cuts in taxes for the rich — and social services for the poor; de-regulation and privatisation; the belief that “government cannot solve any problem, that it is the problem”. One of the consequences of following “reverse Robin Hood” policies was a sharp increase in income inequalities, the acceptance of the morality of the “greed is good” doctrine, of speculation as the ideal way of making money. The excesses of finance capitalism, which this market fundamentalism bred, have brought us to a situation where the actions and decisions of a few thousand (or were they just a few hundred?) traders, structurers and raters of financial instruments have brought the world to its knees.
To be sure, even under Mr Reagan and Margaret Thatcher in the UK, it was not quite laissez faire capitalism. Indeed, in a democracy it cannot be, as Ms Thatcher bemoaned. She regretted her inability to follow the Chilean model in Britain because of its “democratic institutions and the need for a high degree of consent”. And she was right: In fact, the Chicago School of laissez faire capitalism was practised in the 20th century only in Chile, Argentina, Brazil and Uruguay, under a brutal military rule. (In a way, the attempt to thrust “full convertibility on capital account” on the developing world through the Bretton Woods twins in the 1980s and 1990s, was part of the same laissez faire agenda.)
Two points are worth noting:
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To come back to Mr Obama’s budget, it proposes increased taxes for those with incomes in excess of $250,000; increased funding of education and infrastructure; gives priority to investment in the development of alternative energy sources and fuel efficiency; and, outside the budget, Mr Obama has proposed a massive programme aimed at providing healthcare to all Americans. As is to be expected, the proposals envisage a huge fiscal deficit ($1.8 trillion), comparable, in GDP terms, to that likely to be incurred by the world’s largest democracy in fiscal 2009-10. It is the re-emergence of an activist government pursuing re-distributive policies that has incurred the wrath of the Republicans. They are also criticising the “irresponsible” attitude of the administration towards the fiscal deficit: It seems that if the deficit arises from tax cuts for the rich or the war in Iraq, it is virtuous (Reagan, Bush); however, if it arises from increase in social sector outlays like education and healthcare, then it is not acceptable. The fact is that the budget is an attempt to save capitalism from its own excesses. And, post-budget, Mr Obama remains as popular as ever.
This laissez faire philosophy was also reflected in the regulatory stance of the US Federal Reserve under Mr Greenspan. The belief was that the markets produced the right outcome and are self-correcting. In his memoirs, Mr Greenspan says that “the first and most effective line of defence against fraud and insolvency is counterparties’ surveillance. For example, JP Morgan thoroughly scrutinises the balance sheet of Merrill Lynch before it lends. It does not look to the Securities and Exchange Commission to verify Merrill’s solvency.” Nouriel Roubini, lately the most quoted and credible economist to emerge — he was the first to predict the crisis, back in 2005, and was ignored by the establishment — had this to say about Mr Greenspan’s stance, “I think it led to an excessive ideological belief that there are no market failures, and no issues of distortions on incentives. Also, central banks were created to provide financial stability. Greenspan forgot this, and that was a mistake. I think there were ideological blinders, taking Ayn Rand’s view of the world to an extreme.” To quote Paul Krugman, “US bankers, empowered by a quarter-century of deregulatory zeal, led the world in finding sophisticated ways to enrich themselves by hiding risk and fooling investors.” The world economy is paying a heavy price for the regulatory failures.
Even Mr Greenspan has lately conceded that temporary nationalisation of major segments of the banking industry may well be necessary. And yet, even now the Obama administration remains coy about using the dreaded word, anxious to maintain the possibility of gains for the shareholders, even as the taxpayers’ costs keep mounting. And, this obeisance to the free market doctrine is delaying the solution to the banking crisis. They talk of supporting banks, guaranteeing assets, conducting stress tests — everything short of nationalisation. Roubini himself believes the total scale of losses could be two-third times higher than what has come out and that the solution of nationalisation may become politically acceptable in perhaps six months’ time.
Shall we say, Keynes (and Tobin) 1, Friedman (and Hayek) 0?
Coming back to the broader issue of democracy and capitalism, I am always struck by the fact that practically every fast-growing economy in Asia has been, or still is, under authoritarian regimes. From that perspective, the Indian growth story is a unique endeavour not only in Asian but world economic history. (Today’s rich democracies did not have full adult franchise when they were “developing”.) It is perhaps useful to keep this perspective in mind whenever one gets frustrated with the pace of change and reform.