The Consequences of the International Crisis for European SMEs

Vulnerability and Resilience

Bruno Dallago, Chiara Guglielmetti

• Publisher: Routledge
• Year: 2012
• Print ISBN: 9781138243651
• eBook ISBN: 9781136190506
• Topic: Business
• Subtopic: Business General
• Index: Business

The book explores how, to what extent and with what consequences the international crisis of 2007-2008 and the recession which followed have affected European SMEs (small and medium enterprises) in both the well established market economies of the old member countries and in the post-transformation new member countries, and what can be done at the institutional and political level to uphold them.

Part I
The global economic crisis and its impact on SMEs

1 The U.S. financial crisis

A long day’s journey into night

Steven Rosefielde

1 Long day’s journey into night

The origins of the 2008 financial crisis can be traced to various milestones in the construction of the post-World War II American economy. During the 1950s, Keynesianism became orthodox at the same time as momentum built to rescind sundry New Deal and wartime restrictions on free enterprise, including wage-price controls, and fair trade retail pricing (Miller–Tydings Act 1937; McGuire Act 1952, both rescinded in 1975 by the Consumer Goods Price Act). Deregulation in rail, truck, and air transportation during the 1970s, ocean transport in the 1980s, natural gas and petroleum sectors 1970–2000, and telecommunications in the 1990s created opportunities for asset value speculation, soon facilitated by complementary deregulation initiatives in the financial sector. The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), and Garn–St. Germain Depository Institutions Act (1982) both increased the scope of permissible bank services, fostered mergers, facilitated collusive pricing, and relaxed accounting rules (Moody’s for example is permitted to accept fees from insurers it rates). Beginning in the early 1990s banks shifted from the direct loan business to packaging and marketing novel debt instruments like mortgage-backed securities (ultimately including subprime loans) to other financial institutions; shortly thereafter President William Jefferson Clinton approved the Gramm–Leach–Bliley Act (1999) enhancing business flexibility. The Glass– Steagall Act 1933 (Banking Act of 1933) had compartmentalized banks, prohibiting those engaged in stable businesses like mortgages and consumer loans from participating in riskier stock brokerage, insurance, commercial, and industrial activities with the intention of building a firewall against speculative contagion. The repeal of provisions banning holding companies from owning other financial companies ushered in an era of financial merger mania across old divisional lines, allowing companies like Citicorp and Travelers Group to unite.

These developments, replicated across much of the globe, were all positive from the standpoint of neoclassical microeconomic theory because they enhanced competitive efficiency, with the proviso that moral hazards and speculative abuses were optimally contained by residual regulations (“liberalization”). However, if residual “laissez-faire” (do whatever you want) regulations were inadequate, then ensuing financial crisis costs could easily outweigh deregulatory efficiency gains.

Clearly, there are legitimate grounds for conjecturing deregulatory involvement in the 2008 global financial crisis, but deregulation is not the only suspect. The financial environment also was placed in jeopardy by revisionist Keynesianism. John Maynard Keynes was an apostate monetarist who devised and spread the counter-depressionary gospel of deficit fiscal spending in his General Theory of Employment, Interest and Money (Keynes, 1936).

He contended that the Great Depression had been caused by deficient aggregate effective demand brought about by negative income effects, prolonged by a liquidity trap, and claimed that full employment could be easily restored by offsetting private hoarding (speculative idle cash balances) with government expenditure programs (deficit financed state procurements and programs). Other things equal, Keynes insisted competitive markets could and would achieve perpetual full employment, if it weren’t for income (multiplier) effects, and this destabilizing force could be overcome without inflation through countercyclical government deficit spending and countervailing surpluses. There was no place in Keynes’s universe for continuously mounting “structural deficits,” sovereign debt and/or “managed” inflation that could feed speculation and cause financial crises.

Nonetheless, immediately after World War II, the U.S. government passed the Employment Act of 1946 prioritizing the attainment and maintenance of full employment (further codified and expanded in the Humphrey–Hawkins Full Employment Act, 1978). The law didn’t fix quantitative targets, but marked the Truman administration’s expansion of federal powers to include macroeconomic administration, management, and regulation, without explicit constitutional sanction, and established the Council of Economic Advisors to aid presidential policymaking, as well as the Joint Economic Committee of Congressmen and Senators to review executive policies.

These actions enabled Washington to go beyond the perimeters of Keynesian orthodoxy, whenever full employment could not be sustained with transcyclically balanced federal budgets. The exclusion remained moot throughout much of the 1950s until William Phillips discovered (Phillips, 1958), and Paul Samuelson popularized the notion that full employment could only be maintained with “excess” monetary and/or fiscal stimulation accompanied by inflationary side-effects (Phillip’s Curve). Keynes, many concluded, was almost right. Deficit spending was essential, but it also should be applied no matter how much inflation it generates to secure the higher goal of full employment. Full employment zealots insist that governments are “morally” obliged to deficit spend forever, a position still widely maintained despite Edmund Phelps’s demonstration that Phillips and Samuelson were wrong in the long run.

The orthodox Keynesian straitjacket was loosened further by Walter Heller, Chairman of President John Kennedy’s Council of Economic Advisors, 1961–1964, who introduced across-the-board tax cuts as a counter-recessionary stimulus, even though this meant creating credit not just for investment, but for consumption as well. Keynes’s employment and income multiplier theory required stimulating investment as the only legitimate method for combating deficient aggregate effective demand (Works Projects Administration 1932 (WPA) providing eight million jobs, and later investment tax credits). He argued that new investment creates new jobs, wages, and derivatively increases consumption, whereas deficit consumption spending via diminished marginal propensities to consume merely transfers purchasing power from one recipient to another, without increasing employment. Heller’s revisionism brushed Keynes’s concerns aside, making it possible for politicians to claim that any deficit spending which benefited them and their constituents would stimulate aggregate economic activity and employment, including intertemporal income transfers from one consumer’s pocket tomorrow to the next today.

This logic was extended by falsely contending that deficit spending and expansionary monetary policy accelerate long-term economic growth. Although there are no grounds for claiming that structural deficits and lax monetary policy accelerate scientific and technological progress (the ultimate source of sustainable economic growth), policymakers couldn’t resist the temptation to assert that deficit spending and inflation are indispensible for maximizing current and future prosperity. The ploy has been successful as a political tactic, making deficits and inflation seem more palatable, but also has widened the door to compounding past abuses by upping the ante whenever the economy sours. Policymakers’ reflex isn’t to retrench, but to do more of what caused problems in the first place.

Academic macroeconomists likewise succumbed to wishful thinking, brushing aside the speculative momentum embedded in post-war institutional liberalization and fiscal indiscipline. Influenced by Robert Lucas (Lucas, 2003), the conventional wisdom 2000–2008 came to hold that business cycle oscillations were primarily caused by productivity shocks that lasted until price- and wage-setters disentangled real from nominal effects. These shocks sometimes generated inflation which it was believed was best addressed with monetary policy. Accordingly, central bankers were tasked with the mission of maintaining slow and stable, Phillips Curve compatible inflation. Although central bankers were supposed to be less concerned with real economic activity, many came to believe that full employment and 2 percent inflation could be sustained indefinitely by “divine coincidence.” This miracle was said to be made all the better by the discovery that real economic performance could be regulated with a single monetary instrument, the short-term interest rate. Happily, arbitrage across time meant that central bankers could control all temporal interest rates, and arbitrage across asset classes implied that the U.S. Federal Reserve could similarly influence risk adjusted rates for diverse securities. Fiscal policy, which had ruled the roost under the influence of orthodox Keynesianism from 1950–1980 in this way was relegated to a subsidiary role aided by theorists’ beliefs in the empirical validity of Ricardian equivalence arguments, and skepticism about lags and political priorities. The financial sector likewise was given short shift, but this still left room for other kinds of non-monetary intervention. The consensus view held that automatic stabilizers like unemployment insurance should be retained to share risks; that is to assist in case there were any unpredictable shocks. Commercial bank credit similarly continued to be regulated, and federal deposit insurance preserved to deter bank runs, but otherwise finance was lightly supervised; especially “shadow banks”, hedge funds, and derivatives.

A similar myopia blinded many to the destabilizing potential of Chinese state controlled foreign trading. As post-war free trade gained momentum, liberalizers not only grew increasingly confident that competitive commerce was globally beneficial, but that trade expansion of any kind increased planetary welfare. Consequently, few were perturbed after China’s admission to the World Trade Organization (WTO) in 2001, either by the conspicuous undervaluation of the renminbi (RMB) fixed to support export-led development, or by Beijing’s ever mounting dollar reserves. It was assumed that even if China overexported (at the expense of foreign importable jobs), this would be offset by employment gains in the exportables sector as China increased its import purchases. “Overtrading” as theory teaches is suboptimal, but not seriously harmful to aggregate employment and has the compensatory virtue of expanding international commerce.

However, a fly spoiled the ointment. The Chinese (and some others like Brazil) chose to hold idle dollar reserve balances (hoard), instead of importing as much as they exported. Beijing’s dollar reserves grew from 250 billion in 2001 to 2.6 trillion in 2010. In a perfectly competitive universe this wouldn’t matter because others would borrow these unused funds, but not so in a Keynesian world where rigidities of diverse sorts transform idle cash balances into deficient aggregate effective demand, and simultaneously serve as a vehicle for financial hard asset speculation. For reasons that probably involve the Chinese Communist Party’s desire to protect privileged producers in both its domestic importables and exportables sectors (implicit, stealth “beggar-thy-neighbor” tactics), Beijing became an immense source of global real and financial sector disequilibrium, contributing both to the 2008 financial crisis and its aftermath. Chinese leaders in its state controlled foreign trade system had, and have, the power to reset the renminbi exchange rate, and increase import purchases, but they chose, and are still choosing, to do neither (Rosefielde, 2011).

The cornerstones of 2008 financial crisis in summary are as follows:

1 an evolving deregulatory consensus;

2 a mounting predilection for excess deficit spending;

3 a penchant for imposing political mandates on the private sector like sub-prime mortgage, student loan lending, and excess automobile industry health benefits which drove GM and Chrysler into bankruptcy in 2009;

4 waning concern for labor protection manifest in stagnant real wages and therefore flagging mass consumption demand (shift towards promoting the security of other social elements);

5 a proclivity to prioritize full employment over inflation;

6 the erroneous belief that structural deficits promote accelerated economic growth;

7 the notion that government insurance guarantees, off-budget unfunded obligations like social security, and mandated preferences to savings and loans banks were innocuous, despite the $160 billion savings and loans debacle of the late 1980–1990s;

8 deregulatory myopia, and activist social policy, including the encouragement of subprime loans, adjustable rate mortgages (ARM), and tolerance of finance based credit expansion which flooded the globe with credit (Mills, 2009);¹

9 lax regulation of post-Bretton Woods international capital flows (early 1970);

10 the “shareholder primacy” movement of the 1980s partnered Wall Street with CEOs to increase managers’ ability to enrich themselves at shareholder expense, widening the gap between ownership and control first brought to light by Adolf Berle and Gardner Means in 1932 (Berle and Means, 1932);

11 an indulgent attitude toward destructive financial innovation apparent in the 1987 “progr...

Table of contents

• Cover
• Halftitle
• Title
• Copyright
• Contents
• List of Figures
• List of Tables
• List of contributors
• Acknowledgments
• Introduction: The consequences of the international crisis for European SMEs
• PART I. The global economic crisis and its impact on SMEs
• PART II. SMEs’ vulnerability and resilience
• PART III. SMEs and local development
• Index