The active state is, it seems, back. Following the outbreak of the global financial crisis of 2008, the state has made a dramatic comeback, after three decades of constant battering and vilification by the dominant neoliberal ideology. During that period, budget deficits were considered unacceptable because ‘balancing the books’ was seen as the first step in good economic policy. However, when the financial crisis broke out, Keynesian macroeconomic policy came back with a bang. Virtually all governments – that is, except for those 30 or so countries that had to cut spending because of their loan agreements with the IMF – resorted to Keynesian deficit spending to one degree or another. This was especially true of the UK, the US, and Ireland – countries particularly hard hit by the crisis due to their high dependence on finance, which started running budget deficits at levels previously unseen during peacetime.
The enormity of the 2008 crisis even made a number of governments re-calibrate their commitments to private ownership, the bedrock of neoliberal ideology. With its banking sector in a meltdown, the UK, once the pioneer of privatisation, became the pioneer in the new wave of nationalisation, when Gordon Brown decided to bail out the major banks in trouble in the autumn of 2008. In the first several months of the crisis, failing financial and industrial firms that were considered ‘too big to fail’ or ‘too interconnected to fail’ were nationalised across the world. Even in the US, long a country with an extreme aversion to state ownership, the government was compelled to take controlling stakes in GM and Chrysler, as well as a number of financial institutions.
With the failure of financial regulation being the key immediate cause of the financial crisis, the ‘light-touch’ regulation that had characterised the financial sector during the past three decades was rejected. The US took the lead in this, with the passing of the Frank-Dodd financial reform bill in July 2010, which strengthened regulations on consumer protection, derivatives, and proprietary trading by banks.
Later in 2010, the so-called Basel agreement among the world’s leading central banks on capital adequacy ratio (basically the rule on how many multiples of their capital banks can lend) was revised (Basel III) to restrict lending capacities.
Following the 2008 crisis, even the IMF has had a change of heart on controls on foreign capital flows. Its traditional opposition to capital controls had already softened a little, following the series of financial crises in the developing world in the late 1990s and the early 2000s (Thailand, Indonesia, Korea, Brazil, Russia, and Argentina are the most prominent cases). But, from 2010, acknowledging the destabilising effects of speculative capital inflows, it has come to endorse certain forms of capital controls – for example, a deposit payable on entry into a country’s capital market, which the investor does not get back if the money is taken out in, typically, less than a year.
Even industrial policy, the ultimate taboo in the books of neoliberalism, has made a partial comeback after the outbreak of the crisis. When it was revealed that much of the growth and profits in the financial sector in the past three decades had been due to de-regulation, mis-selling, and downright frauds, rather than genuine innovation, the need for a big shift away from finance was felt strongly in countries that had specialised in it, such as the UK and the US. Many argued that such large-scale change is unlikely to happen through market forces alone, so a renewed interest in industrial policy was generated.
The results of these changes have been, on the whole, positive. The financial crisis of 2008 has not – at least yet – turned into the second Great Depression only because governments maintained public spending in the face of a massive drop in tax revenue and the rise in recession-induced social welfare payments, such as unemployment benefit and income support. The injection of public money into failing private enterprises may be a sin in the neoliberal rulebook (indeed, some extreme free-marketeers have argued that these enterprises should have been allowed to fail) but, without those bail-outs, the entire financial system and a huge chunk of the industrial system would have collapsed in many countries.
Financial re-regulation has been rather slow in coming, but most of the changes that have been introduced are going to improve the behaviours of financial-market actors. The partial revival of industrial policy is yet to show the results, but that is to be expected. What is important is that it is not a taboo subject any more, even though many people still vehemently oppose it.
The comeback of the state, however, is proving to be far weaker than it appeared in the early days of the financial crisis. Indeed, in some areas it is rapidly being reversed. Worse, we are even seeing some renewed attacks on the state on new fronts.
Now that Keynes has played a useful role in saving the economy from total collapse and, more importantly, saving the bankers and other financiers from financial ruin, he is being rapidly pushed back into the netherworld. Having got what they wanted from Keynesian policy, the financial interests are now arguing that government spending has to be cut quickly and drastically in order to eliminate budget deficits and ‘put the house in order’. This is despite the fact that private sector demand has not recovered yet. And it is not just countries such as Greece, Ireland, and Spain in a sovereign debt crisis that are savagely cutting their spending. Even countries with no imminent danger of such a crisis, first the UK and now the US as well, have embarked on paths of massive cuts in government spending.
In doing so – and this is the political masterstroke – the supporters of neoliberalism have successfully smuggled in their long-standing agenda, that is the rollback of the welfare state, especially in the UK. They have successfully persuaded a large chunk of the population, if not necessarily the majority, that the deficit has been caused by a bloated welfare state, when the real cause has been the crisis, which has resulted in the collapse in tax revenue and increased government outlays in the forms of bail-outs, credit guarantees, and subsidies for the private sector. Despite all that, the welfare state is blamed and massive cuts in welfare spending are being rolled out.
So the financial interests have got two birds with one stone by selectively using Keynes. They avoided ruin by temporarily accepting Keynes and letting the government keep the economy afloat through huge budget deficits. Then, once the worst was over, they ditched Keynes and started arguing that government deficits need to be eliminated as a matter of priority. And how is that going to be done? By cutting the welfare state, which they have always considered a drag on the economy and, more importantly, a drag on their own prosperity.
It is a similar story with nationalisation. One would assume that, having taken over failing financial and industrial firms with taxpayers’ money, the government would have the legal right and the political duty to tell them what to do so that they can better serve the interests of the electorate. That is what nationalisation should, and used to, mean.
However, the recent wave of nationalisation has not resulted in genuine public control of the nationalised firms. On the contrary, it has only served the interests of the managers of the firms. In the UK, the government, despite being the dominant shareholder, cannot – or, rather, will not – make the nationalised banks do what the electorate wants, such as top-pay restraints and increased lending to small businesses. This is not even capitalism any more. What is the point of owning a bank, when you have to negotiate hard, or (one suspects) even beg, in order to set the pay of your employees or make it lend more in the way you want?
Financial regulation is being strengthened, but the initial proposals for a complete overhaul of the system have been watered down so much that few believe that the new regulatory changes will be enough to prevent similar financial crises in the future.
Yes, capital reserve requirements for banks have been heightened through Basel III. However, the new requirements are considered by most observers to be insufficient to prevent another financial crisis. Even if Basel III were sufficient, we may well have another crisis anyway, because the requirements are supposed to be met only by 2019. Who knows what financial bubble may develop and burst before then? Indeed, some argue that the second dot.com bubble is already developing, with the boom in the social networking industry. If this were true, Basel III won’t be in place to dampen that bubble.
Very worryingly, nothing is being done about the credit-rating agencies, whose shoddy and sometimes even cynical work played a key role in the making of the crisis. It is simply amazing that most of us agree that those rating agencies are less than useless but still allow the global financial system (and government policy, which has to be partly funded by bond sales) to be run according to their judgments. And it is not as if there is nothing we can do to change the situation. We could regulate these agencies better – for example, by demanding that they do not get paid by those firms that want to have themselves or their financial products rated, so that their rating is more objective. Or we could try to create an alternative public agency (a UN agency funded by member states?) that does not charge for the service and thus can be more objective and also provide a powerful competition to the current oligopoly of three firms (Standard & Poor’s, Moody’s, Fitch). But none of these options are even being seriously discussed at the moment.
Moreover, there is no attempt to strengthen the regulation of overly complex financial derivatives, which were the key elements in the making of the crisis. The familiar refrain from the financial industry lobby is that we don’t really need such a move because market forces weed out bad products. They point out that there is very little trading now in financial products such as CDOs (collateralised debt obligations) and CDSs (credit default swaps), which played prominent roles in the 2008 crisis. People now know, they argue, that these products are too risky, so they don’t need to be told by the government what they already know.
This is a disingenuous argument. The damage done by overly-risky but unregulated products cannot be undone, so we need to regulate them in advance. The contrary argument is like saying that we don’t need the drugs approval procedure because people will stop buying bad drugs once they are known to be harmful. But of course, by the time the harmful effects are known, many people will have died or become disabled for life, which is why we demand that drugs are approved before they can be sold. So why are we not even discussing the possibility of doing something similar with financial products?
The noises made in the early days of the crisis about the elimination of, or at least severe restrictions on, tax havens have largely disappeared. However, in this age of globalised finance, if we are serious about strengthening financial regulations, tax havens have to be dealt with. Tax havens not only deprive governments of tax revenues but also make financial regulations more difficult by allowing financial institutions to operate outside the regulatory jurisdictions of other ‘normal’ countries. We can eliminate, or severely weaken, tax havens by simply declaring that all transactions with companies registered in countries/territories that do not meet the minimum regulatory standards are illegal. But nothing is done about them because many people who are rich and powerful want them to exist.
The apparent revival of industrial policy in the early days of the crisis has also turned out to be illusory. Much of the post-crisis industrial policy that has actually been implemented (rather than simply being talked about) has taken the form of ‘greening’ subsidies for the automobile industry (such as ‘cash-for-clunkers’ subsidies, to use the American expression, and subsidies for R&D in green technologies). Many of these turned out to be ploys to make the subsidies to a particular industry politically more acceptable and to avoid sanctions by the WTO (World Trade Organisation), where ‘green’ subsidies are one of the few subsidies that are explicitly allowed. In relation to other areas, little industrial policy has been implemented. Moreover, especially in countries such as the UK, even those who acknowledge the need for industrial policy are beginning to argue that the mechanisms for industrial policy have been weakened so much in the past three decades of neoliberalism that industrial policy cannot be easily implemented, even if there is a political will.
When the biggest financial crisis since the Great Depression hit the world economy in 2008, many people believed that it marked the end of the free-market ideology that had ruled the world in the previous three decades. After such a spectacular failure of free-market policies, it was assumed by many people, who could argue against the state taking a more active role in regulating markets? And indeed, as if to confirm this view, in the early days of the crisis, Keynesian macroeconomic policies were revived, some major failed private-sector firms were nationalised, the process of significant strengthening of financial regulation was started, and even the taboo on industrial policy was dispelled. There seemed to have been a fundamental shift in the consensus view on the role of the state.
Since then, however, things have evolved in a complicated way. Yes, the free-market ideology has taken a beating and lost its aura to a substantial degree, but a lot of what looked like fundamental shifts in our view on the role of the state have turned to be not so fundamental, while there has been quite significant retreat of the state on almost all fronts since the early days of the crisis.
As it turned out, some of the early interventionist moves were not really based on any fundamental re-thinking on the role of the state. For example, nationalisation of some major banks and industrial firms turned out to be based not on a fundamental reassessment of the roles of the private sector and the state but on the political need to save important firms. Once they were rescued, instead of working for their new masters – the government and ultimately the electorate – these companies defied even the basic rules of capitalism, such as shareholder sovereignty, in defending their narrow interests.
In certain areas, although not all, free-market ideologues have found it difficult to resist changes, but the beneficiaries of the former system have managed to minimise the changes. Financial re-regulation (or the insufficient extent of it) is the best example in this regard.
In some other areas, the interventionist moves of the early post-crisis days were cynically used by private-sector, especially financial, interests. Once they were saved by Keynesian deficit spending, they dropped their temporary endorsement of Keynesianism and started demanding cuts in government spending. Moreover, the table was even turned around and the crisis (or rather the result of it) was used as an excuse to roll back the state. The attack by the British coalition government on the welfare state is the ultimate example.
So are we back to square one? Or possibly square zero or even square minus one?
I don’t think so. However much weaker than they should have been, many measures of financial regulation introduced after the crisis will have some restraining effects on the behaviour of banks and other financial firms. The fact that industrial policy is not a taboo any more will make a difference in future debates on economic policy. But, having said that, what seemed like a major revival of the state in the early days of the crisis has largely been dissipated and in certain areas even overturned. The empire has struck back, so to speak.
But the story does not, and should not, end there, as it did not in the Star Wars trilogy. There are social unrests brewing all over the world, at intensities that have not been seen in the past three decades. These may force the politicians to change their policies or risk being ousted – sometimes through ballot boxes, but sometimes through street protests or even armed uprisings.
The uprisings in the Middle East are at the moment organised around the demand for democracy, but their people also want better economies and more jobs, which the existing neoliberal policies have failed to deliver. The new governments in the region will have to re-think their economic policies.
Following the post-crisis austerity measures, Greece, Spain, and Ireland have witnessed social unrest whose intensity would have been hard to imagine even a few years ago. It is not clear how much longer these countries can hold out with their current austerity policies in the fact of continued, or even intensified, unrest.
The recent magistrates’ protest in France shows that the conflict between the diverging visions for the future of France – the neoliberal one represented by Sarkozy and the more social-democratic one, which unfortunately is at the moment incoherent – has reached a new height. The recent declines in popularity of right-wing governments in Germany and Italy may be primarily due to corruption and personality issues, but the change of government in these countries will lead to some rejection of neoliberal policies.
In the US, the protest by public-sector unions in Wisconsin against the state’s new Tea-Party governor, who has tried to restrict union rights, has attracted a surprisingly high level of support nationwide. With the forthcoming federal government shutdown, imposed by the budget passed by the Republican-dominated Congress, the political tide may turn yet again.
Last but not least, the UK has recently seen a surprising re-birth of the student movement, around the issue of tuition fees, and the success of the UK Uncut movement, drawing the public’s attention against spending cuts and corporate tax evasion. When the spending cuts begin to bite from April, who knows what other movements are going to be successfully organised?
I don’t know – and I don’t think anyone really knows – where all these developments will lead. However, they are going to open up greater political space for a renewed debate on the role of the state. I think people who want capitalism better regulated have good intellectual cases on their side, but unless they can skillfully utilise such political space, they will fail to turn the tide and let the neoliberals get away with the most daring disappearing act in history.
Ha-Joon Chang teaches economics at the University of Cambridge. His most recent book is 23 Things They Don’t Tell You About Capitalism (Allen Lane, 2010)