WEB DESK: There are a number of theories why global financial system went into a tail-spin following the sub-prime mortgage crisis of 2007-09 landing the world into an extended period of recession which has so far refused to die down forcing some world renowned economists to call it the Great Recession to rhyme with the Great Depression of the 1930s.
Most have blamed the recklessness in the lending policy of the big banks and financial institutions for the crisis. Some others believe the crisis happened because of reposing too much faith in the efficiency or perfection of the market. And those who look at such matters through the moral prism believe it all happened because the capitalist world had adopted the dubious motto ‘Greed is good’ as its ideological moorings.
The latest theory to come to light in this regard is called the ‘Minsky moment’. In an article in the print edition of The Economist ( July 30, 2016)-one of a series being published on subject of Financial Stability the Weekly discusses in some detail the theory of late Hyman Minsky who had passed away (1996) long before the advent of the Great Recession. In essence Minsky postulated that periods of prosperity give way to financial fragility.
“Economies dominated by hedge financing-that is, those with strong cash flows and low debt levels-are the most stable. When speculative and, especially, Ponzi financing come to the fore, financial systems are more vulnerable. If asset values start to fall, either because of monetary tightening or some external shock, the most overstretched firms will be forced to sell their positions.
This further undermines asset values, causing pain for even more firms. They could avoid this trouble by restricting themselves to hedge financing. But over time, particularly when the economy is in fine fettle, the temptation to take on debt is irresistible. When growth looks assured, why not borrow more? Banks add to the dynamic, lowering their credit standards the longer booms last. If defaults are minimal, why not lend more? Minsky’s conclusion was unsettling. Economic stability breeds instability. Periods of prosperity give way to financial fragility.
“Yet as an outsider in the sometimes cloistered world of economics, Minsky’s influence was, until recently, limited. Investors were faster than professors to latch onto his views. More than anyone else it was Paul McCulley of PIMCO, a fund-management group, who popularised his ideas.
He coined the term “Minsky moment” to describe a situation when debt levels reach breaking-point and asset prices across the board start plunging. McCulley initially used the term in explaining the Russian financial crisis of 1998. Since the global turmoil of 2008, it has become ubiquitous. For investment analysts and fund managers, a “Minsky moment” is now virtually synonymous with a financial crisis.
“Central bankers seem to agree. In a speech in 2009, before she became head of the Federal Reserve, Janet Yellen said Minsky’s work had “become required reading”. In a 2013 speech, made while he was governor of the Bank of England, Mervyn King agreed with Minsky’s view that stability in credit markets leads to exuberance and eventually to instability. Mark Carney, Lord King’s successor, has referred to Minsky moments on at least two occasions.
“Will the moment last? Minsky’s own theory suggests it will eventually peter out. Economic growth is still shaky and the scars of the global financial crisis visible. In the Minskyan trajectory, this is when firms and banks are at their most cautious, wary of repeating past mistakes and determined to fortify their balance-sheets. But in time, memories of the 2008 turmoil will dim. Firms will again race to expand, banks to fund them and regulators to loosen constraints. The warnings of Minsky will fade away. The further we move on from the last crisis, the less we want to hear from those who see another one coming.”
While the ‘Minsky moment’ reiterates the belief that global or national economies follow a pattern of ebb and flow, that is cycles of boom and bust and back to boom to await the inevitable bust, some other economists see that this cycle of boom and bust in the process continuously unleash forces that keep increasing inequality both globally and nationally.
Wealth inequality has already arrived in the rich countries. And it is becoming increasingly difficult for the not-so-rich even in rich countries to afford quality education and health cover. And in poor countries the majority has even stopped dreaming of education and health cover as the Washington Consensus imposed deregulations, supposed to achieve the so-called macroeconomic stability through free market, have made their access to these basic needs well neigh impossible.
In fact, the champions of free market themselves were forced to declare no-confidence in the free market propelled capitalism when Britain’s mortgage bank, the Northern Rock was about to keel over under pressure from the vagaries of free market. The bank was nationalised in early 2008 using tax payers’ money. Likewise in the same year the US under pressure from similar waywardness of free market was also forced to use tax payers’ money to bail out the General Motors and a number of top financial houses like Bear Stearns and AIG.
However, most economic wizards of the rich countries appear to continue to remain in a state of denial hoping against hope that capitalism as their countries have been practising since the end of the World War II and particularly since the advent of Reaganomics and Thatcherism would somehow regain its lost glory soon and that the unregulated free market mechanism would somehow become efficient enough on its own and save their economies from imminent collapse.
This is not going to happen. But a number of new ideas are being debated in the economic circles world -wide seeking an alternate model. One such idea, called the Economy of Tomorrow is said to have the potential to serve as the gateway to what is termed as the Good Society.
The central theme of this idea: Obsession with GDP growth leads to distortions and needs to be replaced with a qualitative growth paradigm. Growth is not an end in itself but a means to produce the conditions for a Good Society with full capabilities for all. It rejects the blind faith in ‘the magic of the market’.
Under this model the state would set a path towards restructuring the economy, inclusive distribution and stable investment allocation to break the vicious cycle of debt and devaluation. The choice is no longer between a ‘big’ or ‘small’ state, but how to build a ‘smart state’ capable of preventing risk, correcting distortions and giving policy guidance. Greed has been the driving force of the current economic model whereas inclusiveness would drive dynamic growth in the EoT model.
Under this EoT model all citizens must have access to education, health care, housing and transportation plus credit and must be able to start an enterprise. By providing full capabilities for all, a society unleashes the full potential of all its citizens. The provision of public goods by the state not only strengthens consumption demand, but also increases labor productivity by improving the qualification and health of the workforce. Tapping into the innovative genius, creativity, entrepreneurial energy and talent of all people unleashes the full inclusive growth potential of a society.
It seems that the idea of EoT has been inspired by what used to be called the social market economy, a form of market capitalism combined with a social policy favouring equitable social justice. The social market economy was originally promoted and implemented in West Germany by the Christian Democratic Union (CDU) under Chancellor Konrad Adenauer in 1949. Its origins can be traced to the interwar Freiburg school of economic thought propagated by the post-war economic reformer, Ludwig Erhard who later succeeded Adenauer as Chancellor.
The social market economy was designed to be a third way between laissez-faire economic liberalism and socialist economics. It refrained from attempts to plan and guide production, the workforce, or sales, but it did support planned efforts to influence the economy through the organic means of a comprehensive economic policy coupled with flexible adaptation to market studies. Effectively combining monetary, credit, trade, tax, customs, investment, and social policies, as well as other measures, this type of economic policy created an economy that served the welfare and needs of the entire population, thereby fulfilling its ultimate goal.
Some authors use the term social capitalism with roughly the same meaning as social market economy. It is also called Rhine capitalism typically when contrasting it with the Anglo-Saxon model of capitalism. Rather than see it as an antithesis, some authors describe Rhine capitalism as successful synthesis of the Anglo-American model with social democracy. The German model is also contrasted and compared with other economic models, some of which are also described as “third ways” or regional forms of capitalism including the contemporary Chinese model.
The essence of the social market economy is the view that private markets are the most effective allocation mechanism, but that output is maximized through sound state macroeconomic management of the economy. Social market economies underscore a strong social support network for the less affluent enhances capital output. By decreasing poverty and broadening prosperity to a large middle class, capital market participation is enlarged. Social market economies also promote government regulation, and even sponsorship of markets for superior economic outcomes.
Latest studies by US and European economists have shown that capitalism as is being practised currently by most of the rich countries and the not-so-rich is actually the root cause of the increasing inequality world-wide and the resulting expansion in the sea of poverty and vertical growth in small islands of excessive prosperity.
These studies also show that left to their own devices, markets are neither efficient nor stable and tend to accumulate money in the hands of the few rather than engender competition, producing slower growth and lower GDP. Indeed, inequality is said to be not an accident but rather a feature of capitalism that the experts say can be reversed only through state intervention.
Source: Business Recorder