However, the unexpected and massive loan interventions by the European Central Bank in December and February appear to have completely transformed the picture.  The new head of the ECB, Mario Draghi, invited all Eurozone banks to apply for unlimited loans at 1% interest and up to 3 years’ duration, and has thereby pumped over €1 trillion of liquidity into the banking system.  The loans under the Long-Term Refinancing Operation (LTRO) were made available to all banks operating within the Eurozone, not just those owned and headquartered in the zone, so even UK banks have been able to borrow, albeit only within their Eurozone subsidiaries.  The total amount lent was €489 billion in December, and a further €530 billion on February 29^th.

This move by the ECB took most commentators by surprise. Their attention was focused firmly on the sovereign debt problems, and when Draghi took office he made it quite clear that he was not about to take up the proposals by Keynesian critics of austerity for the ECB to directly support the sovereign debt market by large-scale bond purchases, or to consider the pooling of risk by means of exchanging national sovereign debt for ‘Eurobonds’.  Given the continuing failure of Europe’s political leaders to resolve the marathon Greek crisis and reassure the bond markets over the risk of contagion, it was politically impossible for Draghi to openly challenge the dominant views of Eurozone creditor countries, who were adamantly opposed to such a resolution.

So what is the significance of this new ECB policy?  First, the ECB has provided significant breathing space for European banks, given their need to refinance their loan books, build up their reserves and increase net lending to help the recovery.  Second, the banks have used some of their new borrowing from the ECB to buy Eurozone sovereign debt, easing the pressure on national governments. Thirdly, it has brought a political breathing space while the Eurozone’s national governments try to reach agreement on the long-term objectives of a de facto fiscal compact and a new European Stability Mechanism.

With regard to the banks themselves, in the run-up to the December loans it was increasingly clear that a major source of worry for Eurobanks was the drying-up of lending from US money-market funds – a major component in the so-called ‘shadow banking system’ in the USA.  Such lending had funded a large proportion of Eurobank purchases of US asset-backed securities during the run-up to the 2007-8 credit crunch, and many of those loans were due for repayment in 2011-12.  As the Eurozone debt crisis dragged on through 2011, the US funds cut back their exposure to both sovereign debt and European banks, reducing such lending from 30% of their assets to around 10%. But since December, they have begun once again to lend to European banks: this indicated their need to find profitable use for their mountains of cash, their increasing confidence that the US and global economies would avoid a double-dip recession, and their view that the Eurozone would at least muddle through the sovereign debt crisis. Nevertheless, this return to borrowing from US money market funds carries significant risks, in the view of Eurozone financial authorities, precisely because they don’t want the banks to rely on short-term borrowing. Instead, they hope that the general easing of what was shaping up to be a severe credit crunch will allow banks to raise much longer-term finance to enable them to meet the Basel III capital requirements and go on to finance a European recovery.

In relation to the sovereign debt crisis, while the cost of borrowing has fallen significantly, it is not clear how far this has been directly the result of the LTRO. Historians of the crisis will recall that in 2009, when the US Federal Reserve and the Bank of England embarked on their policies of quantitative easing (QE), the ECB instead, as The Economist put it, “offered unlimited loans to commercial banks for up to a year against a broad range of collateral”. The result was much the same as that of QE in the USA and UK: “Banks used much of the cash to buy government bonds, which drove down long-term interest rates”. What is more, the ECB has discreetly helped to manage the sovereign debt crisis in another fashion:  through its role as a clearing-house for the settlement of intra-Eurozone foreign trade, a system known as Target2. By December 2011, the German Bundesbank was in credit with Target2 to the tune of €495 billion, which in practice means that Germany has lent this sum to the Eurozone trade deficit countries, especially Greece, Ireland and Portugal. By giving help in this discreet way, the ECB has in effect protected Chancellor Merkel and the Bundesbank from the wrath of German public opinion.

In any case, since December 2011, Italian and Spanish banks have bought their own governments’ debt, but it is hard to separate out this factor from the generalised support that the bond markets have shown following the accession to power of first Mario Monti and his ‘government of technocrats’ in Italy, and more recently the Partido Popular under Mariano Rajoy in Spain.  Whether the bond markets will remain supportive will depend on their economic and political expectations through the rest of this year. The announcement on March 8^th that Greece’s private creditors have accepted their ‘haircut’ may turn out to be another flash in the pan, if the Greek economy continues its precipitous decline under the weight of austerity.

And this brings us to the broader question of the future of the Eurozone, and indeed the EU as a whole.  At present it looks as though the trumpeted December agreement on a fiscal compact will be ratified by those national governments that signed up to it, although the process could be delayed or even derailed, if the Irish government finds itself obliged to hold a referendum.  At the same time, businesses, households and investment institutions are sitting on huge mountains of cash, which are not going to be spent unless and until ‘confidence’ is substantially restored. Right now, while there are continuing signs of some economic recovery in North America, Europe as a whole is at best stagnating, while China and other so-called emerging economies are experiencing a slowdown.  The prospect of accelerating public spending cuts, especially across nearly all of Europe, is increasingly troubling not just Keynesian converts like Martin Wolf of the Financial Times, but also those bastions of neoliberalism, the International Monetary Fund and the Organisation for Economic Cooperation and Development.

However, we should not forget the old maxim “never waste a good crisis”.  The media debate over the Eurozone has viewed the political drama of summits and compacts very largely in terms of the issue of national sovereignty and EU governance, which has dogged the entire European ‘project’ ever since 1958.  But the underlying story which needs to be brought into the spotlight is the way this sovereign debt crisis is being used to accelerate the implementation of neoliberalism across the EU and beyond.

In this respect, market liberalisation and deregulation may be just as important as fiscal and monetary policy.  To a considerable degree, Germany’s relative economic success since 2000 is not because of superior management, high technology and ‘patient’ bank finance, but the Hartz series of labour market reforms.  These have had two particularly important consequences: first, they led to the creation of several million mostly part-time and ‘flexible’ jobs, which has reduced the headline rate of unemployment; and second, taken together with the relentless campaign of the mainstream parties (especially the SPD) and the media, the penetration of the ideology of competitiveness into the more privileged full-time workforce.  This was reinforced in 2008-10 by government initiatives to support the adoption of shorter working hours, as an alternative to layoffs that would disperse job skills and demotivate the workforce.

The German ‘success story’ has now become the European equivalent of the Washington Consensus, through which neoliberalism was imposed across the less developed world in the 1980s and 1990s.  In the Euro-periphery, flexible labour markets, deregulation of the professions and the privatisation of the public sector have formed the core of the ‘reform’ programmes in Spain, Italy and Portugal, as well as most notoriously Greece. Ireland already had an exemplary neoliberal political economy before the crisis, although this does not appear to have spared them any of the rigours of austerity. These programmes are presented as absolutely necessary to restore national competitiveness through reducing costs of production;  it appears to have escaped most liberal commentators that if all countries pursue this strategy, they will end up on a downward spiral of reduced incomes and lower consumption, together with a system-wide redistribution of income from wages to profits.

Although having no direct role in its implementation, the ECB has nevertheless played a vital role in disseminating the ideology of market liberalisation and national competitiveness, revealed recently in Le Monde Diplomatique. Presenting itself as ‘apolitical and run by technicians’, the ECB is now busy transferring this mantra to the new governments under its de facto control in Greece and Italy.  Governments elsewhere in Europe, regardless of their supposed political colour, are using the Bank as cover for their uniform policies of austerity and liberalisation.  Furthermore, the resumption of neoliberal ‘business as usual’ has the support of the great majority of ‘mainstream’ economists, many of whom have now been ‘outed’ as the paid servants of private finance and big business.

But in addition, the ECB’s LTRO provides a loan period of three years, not the one year period offered in 2009.  Unless the Eurozone’s plans for a fiscal compact and a larger stability fund come seriously unstuck in the meantime, this has the important consequence of providing a breathing space to implement the revamped neoliberal model more fully.  Twenty years ago, the European centre-left actively pursued the alternative ‘social Europe’ model, but signally failed to convince the European public sufficiently to head off the neoliberal juggernaut.  This time round, we somehow have to do better; otherwise we face not just years of austerity, but the final dissolution of the postwar welfare state in Europe.

In developing our arguments over the coming months, we need a good understanding of the likely consequences of the budget, in the context of the ConDems’ overall fiscal strategy and the global economic outlook.

The budget

In his 2011 budget, George Osborne was clearly determined to stick with ‘Plan A’, adding little to the barrage of measures already decided in the emergency budget last summer.  We are now braced for the full impact of those measures, especially from local authority job cuts, reductions in a range of benefits, and the rise in national insurance contributions.  The Institute for Fiscal Studies has once again shown that these cuts will bear most heavily on the poor;  although the top 10% will have their incomes reduced significantly by the 50% income tax rate, for the rest of us the proportional fall in income expected over the next 5 years increases as you go down the income scale.  And to this, we have to add the hidden extra costs imposed on large numbers of households by the loss of public services such as libraries, day centre provision, rural bus services, and so on.

Osborne’s only substantial change in the budget was a reduction in corporation tax.  He claimed that this would encourage businesses to invest more and take on more workers, but as Keynes pointed out long ago, changes of this kind – a few percent off tax or a small reduction in the cost of borrowing – have no effect if business confidence is low and if households are cutting back on spending.  And as the cuts work through and spending falls, confidence is very likely to fall.

He also tried to appease the growing public discontent over the cuts with new measures helping motorists, first-time housebuyers and jobseekers.  These were fully funded by new revenues from North Sea oil, tax avoiders and the banks, so the net effect on total demand is precisely zero.  But the measures were in themselves so modest that they are unlikely to lift the encircling economic gloom.  Although he may have thought he would win public support by taking more tax from the North Sea oil producers, a penny less a litre is not going to cut much ice given that the price has risen by 20-25 pence since the election.

The second issue for this budget was whether Osborne could find some way to increase the chances of economic recovery, given Labour’s persistent accusations that he had no strategy for growth.  He knows very well that even if the coalition succeeds in its efforts to ensure that the present parliament lasts a full five years, there is little chance of re-election if the recovery is not in full swing well before that deadline.  For this reason, the main emphasis in his speech was on ‘reform’ and ‘rebalancing’.  He painted a picture of an entrepreneurial economy in which manufacturing, supported by a slimmed-down and efficient public sector, becomes the new engine of growth.  For this purpose, he  put together a menu of measures on enterprise zones, apprenticeships, technical education and tax breaks for innovation.

Such measures are all too familiar from the history of economic policy over the last half century, during which manufacturing has continually declined in terms of its relative weight in economic activity.  Is there any reason why these measures will work this time round?  Part of the problem is undoubtedly that most of the proposals will take a good while to implement, and even longer for their effects to feed through into jobs and incomes.  The creation of new enterprise zones looks helpful on the face of it, especially in those regions of the UK which will be hit hardest by the decline in public sector employment.  But the enterprise zones will have to be managed by the public sector, and the main reservoirs of expertise on regeneration, the Regional Development Agencies, are even now being dismantled and their staff dispersed.  On top of this, many experts on regional development have argued that enterprise zones merely shift jobs from one part of a depressed region to another, with little net increase in employment.  Proposals for expanding apprenticeships and technical colleges, and to extend tax reliefs for innovation and business start-ups, have likewise been a staple of many past attempts to revive British industry, but will take time to have any effect.

The Chancellor’s theme of ‘reform’ seems to involve cutting the cost and complexity of both taxation and regulation.  While no-one in their right mind would oppose such a worthy aim, history suggests that this will prove extremely difficult.  The complexity of public policy reflects the complexity of modern society;  the red tape that supposedly strangles local development proposals has evolved in response to the greater importance that citizens have come to place on their environment and amenities.  The furore over the proposed high-speed railway through the Tory-voting Chilterns provides a case in point.

The global context

Overall, the success of the Chancellor’s 2011 budget depends in any case on matters outside his control, matters about which he remained very largely silent.  The economic forecasts published on 23 March by the Office for Budget Responsibility reflect the widespread view that economic prospects for the UK look weaker than they did last summer: growth in 2011 is now expected to be 1.7% rather than 2.1%, while the forecast for 2012 is marginally reduced from 2.6% to 2.5%.  This revision is based largely on concerns that higher-than-expected inflation will cut into household spending, and therefore a slower growth of output.  In turn, that will also make for a worse fiscal outturn, due to lower tax revenues and higher welfare spending.

But the OBR also points to an improving outlook for the world economy as a whole in the next two years, which raises the questions of whether this optimism is justified, and whether the UK can participate fully in the global recovery.

How do our rulers currently view the world economic context?  First, the concerns widely expressed earlier in the year over tensions between the USA and China seem to have abated;  the interests of their political and business élites are too closely intertwined for either side to risk a serious rupture.  Instead, the last three months have seen three different areas of concern for global capitalism.

First and foremost, turmoil in the Middle East has had both immediate and longer-term consequences.  The loss of Libyan supplies has dramatically affected the price of oil, not so much because of the volume – Libya is a minor global exporter – but because the specific characteristics of Libyan oil and its regional delivery patterns had knock-on effects on other parts of the global oil market.  The price rise in itself, alongside continuing global increases in food prices, has increased inflationary pressures, the UK being a case in point.  This affects the short-term prospects for global economic growth, by forcing consumers to cut their expenditure on other goods and services.  Higher inflation has also encouraged the City to increase their pressure for a rise in the Bank of England’s lending rate: the government’s Keynesian critics argue that such a rise would reduce growth prospects still more.  In the longer term, for global capitalism the emergence of stable democracies may mean that at last, economic progress in the Middle East will be commensurate with their wealth of natural resources, but the picture will remain unclear for many months, if not years.

Second, the disasters in Japan have disrupted supplies in some sectors and countries, but the overall economic impact for global business is mixed.  Many economists argue that it will be positive, because reconstruction will provide business opportunities for many sectors which will stimulate their growth.  But there are concerns about the fiscal health of the Japanese state, which has one of the highest domestic debt levels in the world, and about the rising tide of criticism aimed at the Japanese political class over the way the crises have been handled.  In addition, the global consequences of the Fukushima nuclear disaster for nuclear energy policy have already been felt on the other side of the world in the state elections on 27 March in Germany: the CDU was roundly defeated in Baden-Württemburg, and the leader of the Greens is likely to become Minister-President.

Thirdly, the management of the sovereign debt of weaker Eurozone economies continue to be a source of uncertainty for global financial markets.  The fall of the Socialist government in Portugal was the direct result of the conservative opposition’s refusal to endorse a cuts programme of Osborne proportions.  The opposition instead advocate a bail-out by the EU and IMF, presumably on the grounds that Portugal’s politicians can then blame the cuts on external forces.  But no-one questions the role of bond market speculators.  They have developed the habit, ever since the first doubts surfaced about Greece’s financial health in late 2009, of picking on targets for their favourite practice of ‘short-selling’.

How does this work?  First, they place bets that the market price of a country’s bonds will fall; then they spread rumours of impending default, hopefully leading the ratings agencies to downgrade the bonds; then the price falls and they snap up the bonds on the cheap; and finally, an external intervention restores market confidence, the bond prices rise again, and they walk off with the profits.

Despite these three potential hits to global business prospects, there is little sign that bodies such as the International Monetary Fund and the Organisation for Economic Cooperation and Development are revising downwards their optimistic forecasts of global growth.  They expect the BRIC (Brazil, Russia, India and China) and other ‘emerging’ economies to continue their very rapid growth in the next 4-5 years, and the ConDems clearly hope that some of this growth will take the form of increased demand for British goods and services: hence, for example, the current high-level trade promotion trip to Mexico led by Nick Clegg.

But even if the global growth forecasts turn out to be correct, there must be concern about how UK-based businesses will fare in competing in these markets.  In 2010, the economies which import from the UK increased their total imports by 10.7%, but UK exports only grew by 5.8%, so our share of those markets declined.  Indeed, the OBR in its Economic and Fiscal Outlook says that

“relatively little of the recent strength in nominal spending has translated into domestic household wages or corporate profits. The majority of last year’s increase in spending was accounted for by higher spending on imports and higher taxes, generating income flows for overseas companies and the government rather than UK households or firms.” (p.51)

In other words, growth in exports did not feed into growth in domestic output and incomes, because of tax rises and higher imports!  Nevertheless, the OBR still forecasts that for the next three years, we will increase our share of overseas markets.  Likewise, business investment is expected to grow by an average of nearly 9% per year from 2011 to 2015, more than offsetting a steady decline in government investment.

If UK exports and business investment both meet these targets, which are very ambitious by historical standards, then George Osborne’s Plan A will certainly be judged a success – in terms of conventional economic measures of performance, and ignoring the devastating effects of the cuts on households and communities.  Otherwise, he will be hard put to restore the coalition’s popularity in time for the next election.

29 March 2011

h.k.radice@leeds.ac.uk

http://www.polis.leeds.ac.uk/about/staff/radice/

First of all, we live in a world in which the financial markets pretty much dictate the government’s policies, or at least their room for manoeuvre. Osborne’s attempt to blame the fall in GDP on the bad weather seemed to cut no ice in the City.  There, the pundits and the speculators mostly concluded that the recovery had now stalled, and that the Bank of England would therefore delay the long-expected increase in its official lending rate of 0.5%.

Looking back on the growth recorded for July-September 2010, it now seems all too clear that the sudden boost to construction activity in that period owed more to a rush to complete current contracts before the spending cuts hit local authorities and government departments alike;  so the sharp fall in the last quarter was as much a case of back to normal as the result of the big freeze.

In any case, last week’s unemployment figures made grim reading, back above 2½ million, with a particularly big rise in youth unemployment -  and this well before the public sector cuts start hitting home in April.  What is more a host of recent attitude surveys, among households as well as businesses, have suggested growing pessimism about our economic prospects and therefore a reluctance to make any big spending commitments.  Add in the unexpected attack on the coalition’s lack of a growth strategy from the outgoing CBI chief Richard Lambert, and Osborne surely couldn’t maintain for much longer that shiny smile and confident air.

But although there obviously is a Plan B somewhere on his desk – to slow down the spending cuts and encourage the Bank of England to pump more cash into the banking system – the Chancellor is terrified that a change of direction would be seen by his masters (that’s the financial markets, remember, not us) as a sign of ‘weakness’.

Osborne himself has cited the International Monetary Fund’s latest update to its World Economic Outlook, issued on January 25, in support of his policies.  The IMF, he said, approved of a robust approach to restoring the public finances.  Well, yes, but only up to a point.  The IMF update didn’t actually discuss the UK as such, and they qualified their approval of spending cuts by putting them in a wider context:

“A host of measures are needed in different countries to reduce vulnerabilities and rebalance growth in order to strengthen and sustain global growth in the years to come. In the advanced economies, the most pressing needs are to alleviate financial stress in the euro area and to push forward with needed repairs and reforms of the financial system as well as with medium-term fiscal consolidation. Such growth-enhancing policies would help address persistently high unemployment, a key challenge for these economies.” (Update, p.7)

Now the Eurozone governments have, with a lot of delays and haggling, begun to sort out the debt problems afflicting their ‘periphery’ (that is, Greece, Ireland, Portugal and Spain).  They have created a Financial Stability Facility which has just successfully issued the first zone-wide Euro bond.  The Chinese government in particular is keen on this development, because they want to diversify their own bond purchases away from the USA.  But the markets, which as always in an uncertain recovery are particularly prone to rumours, fads and panics, are still worrying away at this issue.  Oddly enough this is good news for Osborne, since problems in the Eurozone make British government bonds more attractive to investors.

However, there are two other global issues which we need to keep an eye on.  The first is the one raised by the IMF, namely ‘reforms’ of the financial system.  Last week (22 January) the chair of the Independent (sic) Banking Commission, Sir John Vickers, gave a lecture on the progress that the Commission is making on this.  Given the often-stated views of the Governor of the Bank of England – and most academic commentators – it was hardly surprising that he highlighted the need to segregate the risky activities of ‘investment’ banking (issuing and trading financial assets of all kinds)  from the activities of ‘commercial’ banking (dealing with payments and routine borrowing by households and firms).

The British Bankers’ Association spokesperson, Angela Knight, immediately announced that if new regulations were brought in that were too tough on the banks, they would up sticks and relocate abroad.  Short of revolution (not a bad idea?) the way to head off this threat is to make sure that pretty much the same regulations are brought in everywhere, and especially in the USA, UK and the Eurozone.  In the more than two years since the collapse of Lehman Brothers, progress on this has been painfully slow.  In the USA, legislation was finally passed in July 2010 (the Dodd-Frank Act), but implementation is still being delayed, making because the banking lobby made sure that the proposals were incredibly cumbersome and riddled with contradictions.  In the Eurozone, progress is also slow, partly because so many banks are massive holders of those dodgy Irish, Greek, Portuguese and Spanish government debt;  so any financial squeeze on the banks threatens efforts to calm down the bond markets.

The second big issue is the tensions between China and the USA.  Basically, for years there has been a dollar merry-go-round:

• ….. the US runs a big trade deficit with China, paying for the imports in dollars;
• the Chinese government then lends the dollars back to the US – mostly through buying US government bonds;
• the US government uses this money to keep taxes low, leaving households and businesses with more money to spend;
• and they spend it on Chinese imports…..

For years, US pundits have pointed out the irony of the richest and most powerful country in the world becoming financially dependent on what remains one of the poorer countries.  But the vast majority of US citizens either don’t pay any attention to international affairs at all, or they just blithely assume that what Uncle Sam wants, he is entitled to get.

However, Chinese President Hu’s state visit to Washington last week brought the issue forcefully to a head.  Treasury Secretary Geithner yet again called for an increase in the dollar exchange rate of the renminbi, to try to correct the trade imbalance. But the global context has changed dramatically since 2007.  While the USA, as well as other major rich economies, have suffered sharp recessions and then slow jobless recoveries, China and other so-called emerging economies like India, Brazil and Russia took a smaller hit from the financial crisis, and rebounded quickly.  Even Africa has in recent years experienced much faster growth than the rich countries.

This is a truly world-shaking shift.  Back in the 1970s, the newly-confident post-colonial states of the Third World proposed, in the UN and other fora, a New International Economic Order.  The idea was to place their development agenda at the heart of the international economic and financial order, using the leverage of their control over the supply of oil and other raw materials.  At first the rich states tried to ignore these demands, so when oil prices were indeed raised sharply, they were plunged into inflation and stagnation.  But from 1979, led by the UK and the USA, they took their revenge.

New economic policies of ruthless financial stringency plunged the Third World into a massive debt crisis and the ‘lost decade’ of the 1980s.  Neoliberalism was unleashed across the globe, forcing debtor states to adopt policies that favoured capital (including foreign capital) over labour and private profit over state initiatives.  And after the collapse of the Soviet bloc and the USSR in 1979-81, this leaner, meaner sort of capitalism became the universal norm.

The great irony is that the success of this strategy – from a capitalist point of view, that is – turned out to create formidable competitors.  The Chinese and other new capitalist powers are rapidly increasing their share, not only of world consumer markets, but also of available raw materials.  New Chinese, Indian and Brazilian transnationals are displacing the tired old US, Japanese and European firms.  China has in recent years outstripped the World Bank as a source of so-called ‘development aid’ to Africa (as always, the ‘aid’ comes straight back to the donor in the form of orders for their goods).

In these circumstances, the power structures of global capitalism have become more and more outdated.  The role of the dollar; the permanent seats on the UN security council; the inter-state bureaucracies in Geneva and New York;  the voting systems in the IMF; these and countless other practices are being called into question.

For the American people, it is especially hard: that famous ‘city on a hill’ is bankrupt and crumbling, unable to be a beacon for anything except xenophobia and lax gun law.  With the Tea Party Republicans on the rise, threatening everything from bombing Iran to hanging Julian Assange, there are plenty of reasons to be fearful.

Fortunately, help is at hand.  For the great irony is that America’s real rulers – the corporate rich – have invested massively in the new capitalism of the East and the South.  Knowing full well that the newly-confident ruling classes of those regions fully share their own ideology and objectives, they will ensure that the new American nationalism remains a matter of rhetoric alone.  The dollar-go-round will not be abruptly halted.

How does all this impact upon working people in Britain?  Well, it makes the outlook a bit better for exports and unemployment.  But under the government’s present policies, Mervyn King told us on 25th January what to expect: declining living standards for years to come.  As he said, such a long period of decline hasn’t been seen in Britain since the 1920s.  As he must surely know, but didn’t say, this strikes at the heart of the political love affair of the so-called middle classes with consumerism and free-market individualism, a key element in the post-1945 political settlement.

What can the left do about it?  Well, obviously fight every redundancy and every pay cut.  But also, please, this time round, recognise that workers all over the world are in exactly the same situation.  We are being urged to accept pay cuts so that we remain ‘competitive’, that is, put workers abroad out of a job instead.  And they in turn are being told just the same thing by their own rulers.  Time for an old, old slogan: workers of the world unite!

So, he announced, from now on, the Treasury’s forecasts would be rigorously vetted by an independent body, the new Office for Budget Responsibility (OBR) – and, as a result, the chancellor’s public credibility would be restored.

Trailed as an innovation on a par with Gordon Brown’s 1997 decision to set up an independent Monetary Policy Committee within the Bank of England, the OBR looked like it could be a potentially useful body.

Two months on, however, Osborne’s cunning plan seemed in tatters. First, after a Treasury leak raised serious questions about the employment forecasts presented in the coalition’s emergency budget, the OBR rushed out some fresh figures conveniently in time for Cameron to head off the critics during prime minister’s question time in the House of Commons.

Shortly after, it was announced that the OBR’s chief, former top Treasury adviser Alan Budd, was going to resign after only three months in post. It also turned out that for all its vaunted independence, the OBR had set up shop within the Treasury, a few doors down from the chancellor.

Was this another political fiasco, on top of the abrupt departure of the first coalition chief secretary David Laws? Had the unexpectedly self-confident Osborne shot himself in the foot?

Well, not really. It turned out that Budd had all along only intended to head the OBR for three months in order to get it established. As for the physical location of the OBR, one might as well argue that the chancellor’s residence at 11 Downing Street meant that the prime minister could easily keep him on a tight leash. Try telling that to Tony Blair.

However, the establishment of the OBR does raise some important issues about how economic policy is made in a capitalist democracy.

Back in 1944, the Polish socialist economist Michal Kalecki famously predicted that as public spending became more and more important, governments would be tempted to engineer a boom towards the end of their term of office in order to get re-elected. Once back in power, they would then slam on the brakes and restore the fiscal balance, only to start spending again as the next election loomed. He called this ‘the political trade cycle’.

To avoid this political manipulation, a fiscal authority completely independent of the government of the day might seem to be a good idea – but it would also make ministerial government largely pointless.

Osborne’s OBR is an attempt to shore up the chancellor’s credibility by at least ensuring that his plans are based on ‘reliable’ forecasts of where the economy is going. But reliable forecasts can’t be made in a capitalist economy.

True, they are based on statistical models of how the economy has behaved in the past. But economists have fundamental disagreements about past economic behaviour, and in any case a capitalist economy is not like a machine that functions on the basis of stable linkages between its components.

As we know only too well from the credit crunch of 2007-08 and the ensuing crisis, the behaviour of financiers, businessmen and other economic actors – even politicians – is fundamentally unpredictable. Someone, therefore, has to make what amounts to a set of reasonable guesses.

The real story about the OBR concerns these guesses. Osborne’s budget projections over the period to 2014 are based on growth of 1.2 per cent this year and 2.6 to 2.8 per cent thereafter, despite falling public spending, notably a halving of investment. Yet an unprecedented private sector recovery will apparently reduce the number of unemployed people claiming benefits, from 1.6 million last year to 1.2 million. To most commentators, this is pie in the sky.

In addition, the profits of the financial sector are supposed to grow at nearly 9 per cent this year and 6 per cent a year thereafter, while house prices go up on average nearly 4 per cent per year. So forget about reining in the City and making housing more affordable: it’s back to business as usual – until the next crisis.

Hugo Radice is a political economist and visiting research fellow at the University of Leeds

So what is going on? Is this just a temporary crisis, largely restricted to the financial markets and the result of excessive risk-taking by US mortgage bankers, made worse by a minority of speculators in the mysterious world of hedge funds? Is it a broader crisis of the Anglo-Saxon neoliberal model of capitalism, leading to a return to greater state regulation and the curbing of speculative excesses? Is it an even broader crisis within global capitalism, requiring a new Bretton Woods-style conference to create a system of international economic governance that reflects the globalisation of economic life and the rise of new economic powers? Or is it a crisis of capitalism itself, an opportunity to put forward proposals that will encourage popular discussion of alternatives to the present order?

A speculative bubble?

Right up until September’s spectacular busts on Wall Street and in Washington – Lehman Brothers, AIG, Fannie Mae and Freddie Mac – the consensus among academic economists, financiers and politicians was that the credit crunch was fundamentally down to risky mortgage lending to low-income households in the USA (the ‘sub-prime’ market) combined with the practice of securitisation by mortgage lenders.

These lenders found that they could package up sub-prime loans into tradable securities, and sell them on to investors. Because these mortgages had been taken out when interest rates were very low in the early 2000s, their repayment record when sold on was very good, with the result that the credit rating agencies gave the securitised loans a risk-free AAA rating. But as interest rates climbed from 2004 onwards, and real wages stagnated or fell for many poorer households, the number of mortgage defaults steadily rose, until it became clear that many of the securities based on the mortgages were now in effect valueless. Those who had bought the mortgage-based securities from banks and building societies now refused to continue doing so, with the result that banks like Northern Rock could no longer finance their planned lending.

None of this would have led to a general credit crisis, had it not been for the growth in importance in recent years of the inter-bank loan market. Historically, banks have always relied on short-term borrowing from each other to provide money to meet immediate needs, arising, for example, because of the timing of major loans or repayments. This market has its own interest rate, the London Interbank Offered Rate (LIBOR), and much of the lending was traditionally overnight or for a few days only.

But in the summer of 2007 the problem of ‘toxic’ mortgage debt, and the pyramid of financial derivative products associated with it, suddenly made banks realise that even these short-term inter-bank loans might be at risk, if a borrowing bank actually collapsed through insolvency. This is exactly what happened with Northern Rock: it could no longer find anyone willing to lend it the money to fund the mortgages that it had issued. After that collapse, banks in general became aware that they could not trust each other to remain solvent and repay their loans. The result was a freeze on inter-bank lending, forcing banks to restrict their credit provision more generally.

Over the subsequent months, the sub-prime crisis became more widely appreciated by bankers and investors. Stock markets began to identify those banks particularly at risk, driving down their share prices and making it impossible for them to raise funds in any of the usual ways, such as share issues. Stronger banks, meanwhile, sought to strengthen their balance sheets by injections of capital from wealthy investors, especially the sovereign wealth funds set up by governments in the oil-producing countries of the Middle East and the boom countries of Asia.

For a year or so from September 2007, it seemed that the sub-prime crisis could be contained. The restoration of confidence – to be signalled by a revival of inter-bank lending and a lower LIBOR rate – was delayed by occasional bank collapses, most notably that of Bear Stearns, a second-tier New York investment bank, in April 2008. But most commentators (myself included) expected that continuing dynamic growth in China and India would allow the world economy as a whole to ‘grow out’ of the crisis, with banks making sufficient profits from that growth to be able to write off their losses from the sub-prime crisis.

The continuing price rises in oil, minerals and foodstuffs could only be because global growth was going to continue. Indeed, this justified the view of both the Treasury and the Bank of England that inflation was still a serious threat, to be contained by keeping interest rates high. The September 2008 crashes largely discredited this optimistic scenario. Now this was no longer just a sub-prime mortgage crisis: it had become a general crisis of liquidity, in which any bank or investor with cash to invest felt unable to trust any borrower. This collapse in confidence threatened the entire global financial system.

A crisis of Anglo-Saxon neoliberalism?

That global financial system has, for the past 30 years, been transformed by the rise of neoliberalism. This economic ideology has been closely associated with the accession of Margaret Thatcher in Britain in 1979, and Ronald Reagan in the US in 1980. It represents a revival of the free-market, free-trade ideology of liberalism that was eclipsed by the Great Depression of the 1930s and the rise of Keynesian policies of state economic management.

During the 1970s, the post-war boom fizzled out with the return of mass unemployment and the appearance of high levels of inflation in much of the west. Conventional Keynesian remedies seemed powerless to address the unprecedented phenomenon of ‘stagflation’, and economics was transformed by the monetarist revolution led by Milton Friedman. Friedman argued that inflation was always and necessarily due to an excessive supply of money – ‘too much money chasing too few goods’. This monetary excess was in turn said to be largely caused by excessive public spending, which had the further effect of ‘crowding out’ private investment by absorbing too big a share of available savings.

During the 1980s and 1990s, the new economic doctrine developed into a universal model for economic policy-makers, centred on the privatisation of the public sector, strict limits on public spending and borrowing, lower taxation and the deregulation of markets for labour, goods and credit. The model spread from its UK and US origins through its imposition first on much of the third world after the debt crisis of 1982, then on eastern Europe following the collapse of the state-socialist model in 1989, and finally on the European Union in the form of the 1992 Maastricht Treaty. By then, the model was widely known as the ‘Washington Consensus’.

The widespread triumph of neoliberalism has been resisted in many ways in academia, in parliamentary politics and on the streets. Although neoliberalism is often derided for being doctrinaire – a ‘one-size-fits-all approach’ has been a common criticism – like all really hegemonic ideologies it has been applied very flexibly in practice, with substantial variation across countries in almost every element of the model. This is due not only to more or less effective resistance by its victims, but also to objective differences in national circumstances. Such differences arise partly from to variations in the size, living standards and degree of international integration of different economies, and partly from different inherited institutions and practices – for example, in trade union organisation or patterns of business finance.

This has led many progressive academics and commentators – see, for instance, Will Hutton in his book The State We’re In (1994) – to identify an alternative ‘organised’ or ‘coordinated market’ model of advanced capitalism exemplified by Japan and Germany. Meanwhile, the travails of Africa and Latin America under the prescriptions of the Washington Consensus were contrasted with the successful east Asian ‘developmental state’ model of South Korea, Taiwan and later (for some writers) the People’s Republic of China.

Through much of September 2008, the critics of neoliberalism were encouraged by the apparent limitation of the credit crunch to the USA and UK, albeit with echoes in other countries, such as Ireland and Spain, which had experienced rapid rises in house prices and home ownership. It seemed that the solution lay in adopting the alternative non-neoliberal model, and reversing the more extreme free-market policy changes such as the radical deregulation of financial markets.

By the end of that month, though, it was clear that banks the world over had been drawn into the financial black hole of securitised sub-prime mortgages and the beguiling attractions of ‘Anglo-Saxon’ financial practices more generally. For all the apparent differences in economic institutions and policy practice, the neoliberal approach had penetrated deeply into the crucial areas of credit provision and monetary management. As a result, however larger the role of the state might appear to have been in continental Europe or east Asia, their governments were equally incapable of decisive and effective public intervention.

This should not surprise us: whatever their institutional differences, the economies of ‘non-Anglo-Saxon’ countries are still governed by the principle of production for private profit, not for social need.

A crisis of globalisation?

As the financial crisis developed, the British and US authorities were driven to more and more desperate measures. As well as the emergency rescues of particular banks, in mid-September US Treasury Secretary Paulson proposed to allocate $700 billion of public funds to restore confidence by buying up the ‘toxic debts’ seen as responsible for the freezing-up of credit markets.

Ironically, this approach had been widely used in the former Soviet-bloc countries in the 1990s as they struggled to restore capitalism. But now, far from solving the problem, this only made matters worse. If the banks’ estimates of their own balance sheets had lost all credibility, surely this was because neither they, nor ‘the markets’, had a clue as to the real extent of the losses they faced, and the ‘true value’ of the toxic debts. Clever economists proposed various forms of auction to establish a ‘fair price’, but that was no use at all if no one was buying at any price.

By the time Congress finally approved an amended package, with proposals to extend assistance to mortgage-defaulting householders as well as the banks, it was too little and too late. Stock market price falls obliged more and more banks and other financial institutions to revalue their holdings downwards, putting them in breach of one of the few remaining universal regulations – the requirement to maintain an adequate capital base to cover the possible withdrawal of deposits.

Thus the policy focus shifted towards the urgent need to recapitalise banks; and with few private investors (not even the sovereign wealth funds) willing to put up fresh capital, the only choice was for governments to do so, in exchange for substantial ownership stakes. Although Gordon Brown has been widely hailed as the architect of this new approach, it had been very successfully deployed in Sweden in 1992, and later with more limited success in Japan.

At this point, however, it quickly became clear – above all with the collapse of the bizarrely over-extended Icelandic banks – that ad hoc national intervention would simply transfer the pressure and the panic to the next country in line. Step forward, at long last, the International Monetary Fund (IMF), brainchild of the long-discredited John Maynard Keynes.

Ever since the devaluation of the dollar in 1971, and the subsequent explosive growth of global private finance, the IMF has been sidelined as far as the leading capitalist economies were concerned. Although it continued formally to coordinate balance of payments and exchange rate policies, its last significant loan to a G7 country was the British loan of 1976, long since repaid from North Sea oil revenues. Instead, the IMF’s main role – in which it was later joined by the World Bank – has been to force the neoliberal model onto indebted third world countries through its conditional lending.

At the time of writing, a rapid succession of summits is under way, necessarily involving not just the G7 but Russia and other rising economic powers. The time now appears to be ripe for a substantial and significant restructuring of global economic and monetary governance. Meanwhile, the IMF has a growing cue of countries at its door begging for bail-outs, starting with Iceland, Hungary, Ukraine and Pakistan.

The crucial point here is that all previous banking crises have been essentially national in character, even if their solution has entailed loans from international institutions and policy coordination with other governments. The present crisis is clearly a global one, in the important sense of requiring a global solution. However, to see it as a crisis of globalisation would imply, first, that the crisis was particularly the result of globalisation, and second, that it is now both necessary and possible to roll back globalisation.

On the contrary, what we have come to call economic globalisation – the increased dependence of all capitalist economies on international trade, investment and finance – was a consequence, not a cause, of the neoliberal revolution. And going back to a world of greater national self-sufficiency, which was advocated by Keynes in 1933 not because it was a safer system but simply to deal with the collapse of international trade and finance after the 1929 crash, would involve enormous costs of adjustment, which we would all have to bear.

A crisis of capitalism?

Are we therefore witnessing a full-blown conventional capitalist crisis – albeit the first one that is truly global in scope? Certainly periodic crises in the ‘real economy’, in which economic growth comes to a halt, profits and investment fall away and unemployment rises, have been a key element in capitalism’s perennial economic cycles, and it is normal for a credit crunch to signal the onset of such crises. The exuberance of the boom leads to overconfidence on the part of investors, and stock market speculation – using borrowed money – pushes share prices far beyond what could ‘reasonably’ be justified by future returns.

And that is just the point: given the pervasive uncertainty of capitalist markets, ‘reason’ plays second fiddle to what the great Keynesian economist Joan Robinson memorably termed ‘animal spirits’. When a credit-fuelled boom falters, panic sets in as everyone seeks the relative security of money by selling whatever financial assets they can. But these financial assets – shares, bonds, mortgages, or nowadays a vast and incomprehensible range of so-called ‘derivatives’ – all have value only as a result of entitling the holder to a share in the profits generated by productive labour in the sectors that make goods and provide non-financial services.

In the end, it is the perception that these profits will be insufficient to cover the inflated expectations of investors that drives the panic selling. It appears as though the crisis originates in the ‘financial’ economy and then spreads to the ‘real’ economy; the reality is that the two remain always intimately connected, and it is in the ‘real’ economy that the crisis has both its origins and its resolution. In a system guided by private profit rather than social need, a serious crisis is always a crisis of profitability, and profits originate in the exploitation of productive labour.

So, at long last, we have come to the ‘real world’. What has been presented to us all as a crisis of credit or of markets, unconnected to the everyday world of work, turns out to be a crisis of production. Firms respond to slowing sales growth by laying off workers and cancelling planned investments. The emphasis shifts to cutting costs and improving productivity, measures intended to raise profits for any given level of output.

Because all employers do this at the same time, there are rapid knock-on effects on retail sales, leading to further all-round declines in business orders. Today, because of much higher levels of international trade, these effects are spreading rapidly across global capitalism. The momentum of unprecedented economic growth in China and India, and the spending of the vast recent accumulations of money in oil- and minerals-producing states, can only mask the crisis for a while.

Given the dominance of consumer spending in total global demand, it is rising unemployment and increasing concerns about debt repayment that provide the focus of the next phase of the crisis. To offset falls in private consumption and investment, Keynes recommended an increase in public expenditure, to be financed by borrowing. In conditions of recession, this is by no means inflationary, as the monetarists allege. Investors of all kinds find that businesses and consumers now don’t want to borrow from them, even when interest rates start to fall: the government is no longer the ‘lender of last resort’ to the struggling banks, but the borrower of last resort for those with money to invest – they prefer to buy government bonds with at least some return, rather than leave the cash idle and earning nothing.

Furthermore, it is certainly not the case that ‘eventually taxes will have to be raised’. As and when recovery sets in, renewed economic growth generates an even faster recovery in revenues, given progressive income tax rates and stamp duty rates on house purchases, and rapid declines in spending on welfare benefits. And lastly, the claim raised by diehard monetarists, as in their letter to the Sunday Telegraph on 26 October, that governments are not competent to decide in which sectors to invest, is ridiculous: the present government proposes to bring forward infrastructural investments in transport, construction, education and training, which by definition will benefit all sectors.

Alternative solutions

It is tempting to see the crisis as an opportunity to replace capitalism with democratic socialism, and put forward the radical solutions that we would really like to see. But we need to be realistic, which means starting from the alternatives that are being put forward by the main political parties in Britain, by other governments and by international institutions.

First and foremost, despite its enthusiastic support for the delusionary ambitions of deregulated finance, New Labour led by Brown and Darling has proved to be unexpectedly decisive and flexible. The chancellor’s Mais Lecture on 29 October set out a broadly Keynesian analysis that underlies the key elements in the government’s new policy: first, abandoning the ‘golden rules’ of strict limits on public borrowing and expenditure; second, injecting new capital into the major banks in the form of temporary ownership stakes; and third, playing a major part in international efforts to coordinate the management of the crisis.

There is every opportunity for us to push for these measures to be oriented as far as possible towards the reining back of big finance and the protection of employment, production and incomes. While the models of ‘coordinated capitalism’ and the ‘developmental state’ have been seriously eroded in recent years, the state still has the capacity to override the fears and prejudices of the City and impose new institutions and policies.

Suddenly, it has become possible to put forward alternative ways of thinking. Both Keynes and Marx are back in vogue. Even if there is no ready-made model to replace neoliberalism, there is very widespread support for substantive changes in ‘the system’. Four hundred years ago, the philosopher Sir Francis Bacon got it right: ‘Money makes a good servant, but a bad master.’

Finally, where there are different options available in terms of concrete policy measures – which infrastructure projects, for example, or what areas of income support – then we need to argue for those choices that advance social justice, environmental sustainability and peace. These questions are taken up elsewhere in this issue.

Hugo Radice is a visiting research fellow at the University of Leeds, where he was the head of the Politics and International Studies school from 2004 to 2007