The financial crisis which is ricocheting worldwide and causing tremendous anguish and tremors. Governments in leading industrial countries have been forced to nationalize large chunks of their banking sectors and central banks have injected heavy amounts of liquidity in money markets for the sake of avoiding a financial meltdown. Some have hastened to say that this crisis indicates that capitalism does not work; others, from the opposite side, accuse governments that, de facto, they are bringing in socialism. Both these trains of thought are wrong.
Economic freedom and entrepreneurship, which lie at the root of innovation and economic advance, rely on and feed on free markets; this is indisputable and explains why communist economies fell down, eventually. In this regard Ludwig von Mises, Friedrich von Hayek, and others were quite right. But it is misleading to argue that free markets are synonymous with non-regulated markets, with the practical extinction of public sectors and public policies. Modern economies and societies do need regulations and public policies so that public goods be in adequate supply and negative externalities be prevented or constrained; this implies the functioning of public sectors against the backdrop of a free allocation of resources (at market prices) and vibrant economic competition. That one needs to streamline public sectors and make them run efficiently so that public resources be not wasted goes without saying.
Many accept nowadays the Asian crisis was caused, primarily, by a premature opening of the capital account in the economies of that region. Similarly, the rush to privatize public utilities is not warranted. In addition, there are public utilities which should rather stay in public hands. The oversimplification of "good practices" in governance and, not least, the hypocrisy which has, in not a few instances, accompanied their propounding, by industrialized countries, around the world is more than obvious nowadays. This deep financial crisis, the failed Doha trade round (with the controversy between free and fair trade), the lack of results where-ever development policies have been simplistically encapsulated in the ideological mantra of neo-liberalism are quite telling. There is corruption, lack of clarity of property rights, waste and stealth of public resources in most poor countries, a huge misallocation of resources. But such structural weaknesses do not make up a convincing argument in favour of accepting, without qualifications, policy remedies that are too general and, sometimes, in divorce of concrete local conditions.
The financial crisis which has hit the core of the world financial industry is, arguably, a persuasive refutation of the paradigm that glorified total deregulation. The repeal of the Glass-Steagal Act in the US, in 1999, like the decision of the Securities and Exchange Commission of 2004 to exempt the brokerage operations of Wall Street investment banks from limits on the amount of debt they could take on have proved to be historical blunders. The huge bail outs underway (in the financial sectors) are going to introduce, or reinforce, elements of state capitalism in numerous industrialized countries, including the US. The impact on national budgets would by tremendous for years to come. In order to mitigate the pains and reduce dependency on external borrowings savings ratios would have to go up in all economies where bank recapitalization will be very serious. A legitimate question arises: can rich countries' societies become, almost all of a sudden, much more economizing and forward looking. This very much hinges on social cohesion (solidarity) and the capacity of politicians to lead in times of duress. If one adds here the implications of aging and strained welfare states, climate change, as well as the competitiveness challenges posed by emerging global powers, the contours of very complicated public policy agenda in the decades to come are not hard to delineate.
The effects of the current financial crisis have hit the western world at a time when tectonic shifts in the global economy had been taken place for more then a decade. The rise of China, India, Brazil, the resuscitation of a capitalist Russia (that benefits on huge natural resources) are ushering in an increasingly multi-polar world, with growing reverberations economically and geopolitically. The struggle for the control of exhaustible resources (oil and gas in particular) epitomizes this phenomenon. The financial crisis has given more salience to the inherent weaknesses of policies which are not pragmatic and which succumb to fundamentalist tenets.
The fall of communism, which was equated by some with the "End of History", has favoured immensely the advance of neo-liberal ideas. Needless to say that the overwhelming superiority of the US on all fronts (economic, military, technological), offered a sort of a sui generis Pax Americana and created prerequisites for an international regime. The latter was supposed to order the world by providing international public goods and resolving/preventing possibly major conflicts. But neo-liberalism (market fundamentalism) has revealed its serious flaws over time and is currently, willingly or not, put on the shelf for the sake of salvaging the functioning of markets economies. Because, what is happening now is not a dismissal of markets forces as an essential mechanism for resource allocation and stimulating entrepreneurship, but an invalidation of a grossly misinterpretation of what it takes for a modern economy to perform economically and socially over the long run. Fragments of state capitalism are being put in place and we will see what will remain out of them over time. Probably, substantial portions of the new state sectors in the making will get back private at one point in time. Monetary policies are geared now toward achieving financial stability and have acquired a sort of flexibility that reminds of Keynesian injunctions regarding how to avoid bad equilibria (The Great Depression was a terribly bad "equilibrium"). The very concern of governments and central banks with over-hauling radically the regulation and supervision of financial markets, so that "Minsky moments" be averted is a strong validation of Keynes' intellectual legacy and of his sense of realism in understanding the functioning of markets in general. The crux of the matter here is that the reshaped mixed economies have to function in such a way that extravagant policies be avoided for the benefit of democracy and the welfare of most citizens. Cycles cannot be eliminated, and crises will pop up again. But a financial meltdown, with its very dire effects on the real economy, can be prevented by adopting proper policies and regulations.
The EU and US will come out of this crisis with reshaped economies (with larger public sectors) and will continue to be, fundamentally, liberal democracies. But the financial crisis has already weakened them whereas the ascendancy of the new global powers is hard to stop. As argued previously the future will be driven by a competition between liberal democracy and authoritarian forms of capitalisms -the latter being represented by China and the Russian federation, principally. In liberal democracies war-type economy measures may have to be resorted from time to time; as a matter of fact, the rescue operations of banks, under way currently, are to be ranged in this sphere of policy action.
Western countries will have to come to grips with their weakened relative status in the world economy and shed much of their hubris in dealing with the rest of the world, for their own sake. This would apply to the reform of the International Financial Institutions and a new architecture for tackling global governance issues. As some say, a new Bretton Woods is needed, which I agree with.
To conclude: Keynes, not Marx, is back! We need common sense and pragmatism in economic policy-making.
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