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| Thomas L Palley |
Broadly speaking, there exist
three different perspectives on the crisis. Perspective 1 is the hard-core
neoliberal position, which can be labelled the “government failure
hypothesis”. In the U.S. it is identified with the Republican Party and the
Chicago school of economics.
Perspective 2 is the soft-core
neoliberal position, which can be labelled the “market failure hypothesis”.
It is identified with the Obama administration, half of the Democratic Party,
and the MIT economics departments. In Europe it is identified with Third Way
politics. Perspective 3 is the progressive position which can be labelled the “destruction
of shared prosperity hypothesis”. It is identified with the other half of the
Democratic Party and the labour movement, but it has no standing within major
economics departments owing to their suppression of alternatives to orthodox
theory.
The government failure argument
states that the crisis is rooted in the U.S. housing bubble and bust which was
due to failure of monetary policy and government intervention in the housing
market. With regard to monetary policy, the Federal Reserve pushed interest
rates too low for too long in the prior recession. With regard to the housing
market, government intervention drove up house prices by encouraging
home-ownership beyond people’s means. The hard-core perspective therefore
characterises the crisis as essentially a U.S. phenomenon.
The soft-core neoliberal market
failure argument states that the crisis is due to inadequate financial
regulation. First, regulators allowed excessive risk-taking by banks. Second,
regulators allowed perverse incentive pay structures within banks that
encouraged management to engage in “loan pushing” rather than “good lending.”
Third, regulators pushed both deregulation and self-regulation too far.
Together, these failures contributed to financial misallocation, including
misallocation of foreign saving provided through the trade deficit. The
soft-core perspective is therefore more global but it views the crisis as
essentially a financial phenomenon.
The progressive “destruction of
shared prosperity” argument states that the crisis is rooted in the neoliberal
economic paradigm that has guided economic policy for the past thirty years.
Though the U.S. is the epicentre of the crisis, all countries are implicated as
they all adopted the paradigm. That paradigm infected finance via inadequate
regulation and via faulty incentive pay arrangements, but financial market
regulatory failure was just one element.
The neoliberal economic paradigm
was adopted in the late 1970s and early 1980s. For the period 1945 - 1975 the
U.S. economy was characterised by a “virtuous circle” Keynesian model built on
full employment and wage growth tied to productivity growth. Productivity
growth drove wage growth, which in turn fuelled demand growth and created full
employment. That provided an incentive for investment, which drove further
productivity growth and supported higher wages. This model held in the U.S.
and, subject to local modifications, it also held throughout the global economy
- in Western Europe, Canada, Japan, Mexico, Brazil and Argentina.
After 1980 the virtuous circle
Keynesian model was replaced by a neoliberal growth model that severed the link
between wages and productivity growth and created a new economic dynamic.
Before 1980, wages were the engine of U.S. demand growth. After 1980, debt and
asset price inflation became the engine.
The new model was rooted in
neoliberal economics and can be described as a neoliberal policy box that
fences workers in and pressures them from all sides. Corporate globalisation
put workers in international competition via global production networks
supported by free trade agreements and capital mobility. The “small” government
agenda attacked the legitimacy of government and pushed for deregulation
regardless of dangers. The labour market flexibility agenda attacked unions and
labour market support structures such as the minimum wage, unemployment
benefits, and employment protections. Finally, the abandonment of full
employment created employment insecurity and weakened worker bargaining power.
This model was implemented on a
global basis, in both North and South, which multiplied its impact. That
explains the significance of the Washington Consensus which was enforced in
Latin America, Africa and former communist countries by the International
Monetary Fund and World Bank by making financial assistance conditional on
adopting neoliberal policies.
The new model created a growing “demand
gap” by gradually undermining the income and demand generation process. The
role of finance was to fill that gap. Within the U.S., deregulation, financial
innovation, and speculation enabled finance to fill the demand gap by lending
to consumers and spurring asset price inflation. U.S. consumers in turn filled
the global demand gap.
These three different
perspectives make clear what is at stake as each recommends its own different
policy response. For hard-core neoliberal government failure proponents the
recommended policy response is to double-down on neoliberal policies by further
deregulating financial and labour markets; deepening central bank independence
and the commitment to low inflation; and further limiting government via fiscal
austerity.
For soft-core neoliberal market
failure proponents the recommended policy response is to tighten financial
regulation but continue with all other aspects of the existing neoliberal
policy paradigm. That means continued support for corporate globalisation,
so-called labour market flexibility, low inflation targeting, and fiscal
austerity.
For proponents of the destruction
of shared prosperity hypothesis the policy response is fundamentally different.
The challenge is to overthrow the neoliberal paradigm and replace it with a
“structural Keynesian” paradigm that re-packs the policy box and restores the
link between wage and productivity growth. The goal is to take workers out of
the box and put corporations and financial markets in so that they are made to serve
the broader public interest. That requires replacing corporate globalisation
with managed globalisation; restoring commitment to full employment; replacing
the neoliberal anti-government agenda with a social democratic government
agenda; and replacing the neoliberal labour market flexibility with a
solidarity-based labour market agenda.
Managed globalisation means a
world with labour standards, coordinated exchange rates, and managed capital
flows. A social democratic agenda means government ensuring adequate provision
of social safety nets, fundamental needs such as healthcare and education, and
secure retirement incomes. A solidarity-based labour market means balanced
bargaining power between workers and corporations which involves union
representation, adequate minimum wages and unemployment insurance, and
appropriate employee rights and protections. Lastly, since the neoliberal model
was adopted globally, there is a need to recalibrate the global economy. This
is where the issue of “global rebalancing” enters and emerging market economies
need to shift away from export-led growth strategies to domestic demand-led
strategies.
The critical insight is that each
perspective carries its own policy prescriptions. Consequently, the explanation
which prevails will strongly impact the course of economic policy. That places
economics at the centre of the political struggle as it influences which
explanation prevails.
As of now, the economics
profession is split between the hard-core and soft-core neoliberal positions.
However, that can change under the pressure of an ugly reality that produces
mass political demand for change. The Great Depression of the 1930s forced
economics to change and provided an opening for Keynesian economics. The Great
Recession and the prospect of stagnation may also force economics to change.
The only certainty is change will
be politically contested as powerful elites and orthodox economists have an
interest in preserving the dominance of the existing paradigm by ensuring that
their explanation of the Great Recession prevails. That makes it essential for
unions to engage with the theoretical debate regarding the causes of the crisis
and how economies work. Their political muscle is needed and the outcome of
that debate is critical to their own existence and success.
Dr. Thomas Palley is Senior
Economic Adviser to the AFL-CIO and an Associate of the Economic Growth Program
of the New America Foundation in Washington. D.C. His most recent book (on
which this column is based) is From Financial Crisis to Stagnation: The
Destruction of Shared Prosperity and the Role of Economics which was published
by Cambridge University Press in February 2012. His numerous op-eds are posted
on his website.
Please note: A 20% discount
on the book is available at:
[Select country location (top
right hand corner) & enter code "palley2012" at checkout].
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