Great Recession, The: History, Ideology, Hubris And Nemesis

History, Ideology, Hubris and Nemesis

Michael Siam-Heng Heng

• Publisher: WSPC
• Year: 2010
• ISBN:
  9789814338639
• Topic: Biological Sciences
• Subtopic: Science General
• Index: Biological Sciences

Many books on the 2008 financial crisis and the current recession focus on the financial sector. Unlike them, this book takes the real economy as the starting point and it situates the downturn within the societal context over the last several decades. Important elements of the story include global manufacturing overcapacity and declining profitability, failure of advanced industrial economies to make a quantum jump in discoveries and innovations across a broad range of technologies, ascent of neo-liberalism after the fall of the Berlin Wall, the Asian financial crisis, the Japanese “lost decade”, and the dot-com boom. This provides the backdrop of the birth of a market society, deregulation, easy credit, and financial excesses.

The financial crisis reveals much that has gone astray in the business world over the last few decades — short term thinking, manipulation of figures and image management at the cost of the basics. The financial sector has become an arena for accounting shenanigans and corporate skullduggery. It is also a symptom of deeper social and cultural change. Crisis of a very serious nature functions as a cleansing exercise. Already we have seen debates which re-examine values and ideas, state policy and business practices. If the world could rise to the challenge, history will view the crisis as a blessing in disguise and thus render it in positive terms.

Contents:

• From Berlin Wall to Wall Street
• A Tale of Two Crises
• Insights from Japan's “Lost Decade”
• Special Features of the 2008 Crisis
• Bonfire of Financial Excesses
• The Moral Economy
• A New Financial Landscape?
• Globalization and All That
• Don't Waste the Crisis

Readership: General public and finance professionals.

Chapter One

Introduction

One day of freezing cold will not produce ice one meter-thick.

— Chinese proverb

Those in key positions tend to see the world through key holes.

There is general consensus that the financial tsunami of 2008 is the worst financial crisis facing the world since the Great Depression of the 1930s. It came close to bringing down the banking system of the USA and Britain. It shook the international financial systems and subsequently pushed the world economy into a painful recession. The New York stock market plunged by 57 percent from its peak in October 2007 to its depth in March 2009. It constitutes a defining moment in the history of international financial system and economy of our life time.

Several years before the outbreak, respectable economists in the USA were warning of the danger, basing their arguments on the twin problems posed by budget deficits and trade deficits, and practices of financial excesses. Unfortunately, their warnings were ignored by the political leadership and regulatory bodies. The regulators seemed to behave like “none’s so blind as those who would not see, none’s so deaf as those who would not hear”. Surely these authorities are staffed by some of the best and brightest. What has gone amiss? Perhaps their over-optimistic assessment of the situation was shared by the broad section of society. If so, what was the intellectual climate then?

After the crisis, key words such as dysfunctional incentive schemes, deregulation, failures of rating agencies, financial excesses, greed, easy money, and financial imbalances have appeared repeatedly in reports and analyses of the current economic crisis. These have formed the main themes of policy studies and scholarly research. All these tell a good part of the story. Some offer conceptual frameworks to tell a coherent story of the collapse.¹ Others provide detailed and juicy stories, documenting the unfolding of the key episodes of the crisis.² Basically, the approaches are within the framework of monetary economics or financial economics.

This book is different. It begins with the real economy. It situates the current crisis in the societal context of the last several decades and as part of social, economic, political, cultural, and intellectual changes. Financial system is part and parcel of the economic system, and financial crisis is a manifestation of the underlying problems in the economy. The crisis blew up in the backdrop of a persistent tendency toward overcapacity in the global manufacturing sector. The advanced industrial economies could have responded to it by making a quantum jump across a broad range of technologies. Instead they resorted to financial and monetary stimulations time and again. As the fundamental problem of overcapacity was not solved, each round of stimulus provided the conditions for a bubble, leading to the formation of the super-bubble, which burst in 2008. In this sense, the current recession is at its core a very serious economic crisis.

Though it is an economic crisis, we have to go beyond an economic focus to have a well-grounded understanding of it. For example, bankers, in giving free rein to their greed, have been responsible for financial excesses and reckless speculation. But greed is part of the human condition and it can only wreak havoc under certain societal conditions. This suggests that we need to look at the deregulated financial systems inspired by free market fundamentalism. The institutional setup has provided a permissive environment for financial speculation to run wild.

Declining Vitality of Advanced Industrial Economies

Many discussions of the crisis mention American trade deficits but significantly they do not use that as a point of departure to pursue the problem further. One exception is the treatment of the subject by Robert Brenner.³ One convenient period to begin the story is the mid-1950s when Japan embarked on a state-led and export-oriented strategy to develop its economy. From mid-1950s to mid-1980s, Japan surprised the world with the most spectacular economic growth in human history. Japanese companies flooded the world market with high-quality manufactured goods. Self-confidence of the West was sapped when the German camera industry and American home appliances and machine tools industries were nearly wiped out. Until 1965 or so, these industries were thought to be without rivals.

The enormous success of the strategy was evident by the 1960s, which attracted Taiwan and South Korea to follow its footstep. Soon the two new converts were joined by other East Asian countries. The result was overcapacity in manufacturing, which led to drop in profits in advanced industrialized economies.⁴ There was a brief period from 1985 to 1995 when the US manufacturing staged a revival of profitability and export growth. Besides relying on IT innovation, this revival was based on tax breaks, wage freeze, and weak dollar (as a result of the Plaza Accord in 1985). However, the revival was too short and lacked the “critical mass” to provide the dynamism and momentum for a paradigmatic transformation of the economic landscape.

The advanced industrial economies had shunned from the difficult strategy of investing in R&D in order to make a quantum jump across a broad range of technologies. Admittedly, there were technological breakthroughs in the case of Internet-related innovations. But these technological innovations taken together were not broad enough and they could not generate enough new high-tech manufacturing capabilities to maintain the profit levels and provide employment of the good old days. Had they done so, they could have provided the world with more sophisticated technologies while the late comers would take over their contemporary technologies. It would have benefited the world by creating a kind of win–win international division of labor through complementary specialization of production.⁵

The failure of the advanced industrial economies to do so is an inauspicious sign of their economies and societies, in the broad sense of the term. “The basic source of today’s crisis is the declining vitality of the advanced economies since 1973, and, especially, since 2000…. Most telling, the business cycle that just ended, from 2001 through 2007, was — by far — the weakest of the postwar period, and this is despite the greatest government-sponsored economic stimulus in U.S. peacetime history.”⁶ It is not that there were no warnings about the danger of hollowing out of manufacturing, but somehow they were ignored.⁷

As it happened, these countries resorted to easier ways out. First, their manufacturers chose to relocate their factories to East Asia, which welcomed them with tax holidays. Moreover, wages were held down by state powers, sometimes with naked police brutalities as in the case of South Korea. The manufacturing firms that remained behind deployed the time-honored method of squeezing the workers. From the mid-1970s, workers’ pay increase has been lagging behind the increase in productivity.⁸ In this, the business world was given a helping hand by the anti-labor policies of Prime Minister Thatcher and President Reagan. The anti-labor movement was further undergirded ideologically when the Berlin Wall collapsed in late 1989 and the subsequent ideological swing to the right.

Second, governments of the rich West maintained economic growth (and therefore capital returns) by financial and monetary expansion. For a while, traditional Keynesian measures managed to pull off the act, but over time, the approach was losing steam. To prevent the economy from sinking to a level that is politically dangerous, governments then used artificially cheap credit to boost the economy.

Third, there is a systematic move to direct resources away from the daunting project of advancing technological frontiers and building social infrastructure to the finance, insurance, and real estate (FIRE) sectors where quick money can be made. In America, the financial sector’s share of total corporate profits climbed from 10 percent in the early 1980s to an incredible 41 percent at its peak in 2007; the profits in the past decades are in the order of trillions.⁹ Its share of the stock market’s value grew from 6 percent to 23 percent. Such figures prompt even the pro-free market The Economist to comment: “It is hard to believe that financial services create enough value to command such pre-eminence in the economy. At the peak, the industry accounted for only 14% of America’s GDP and a mere 5% of private-sector jobs.”¹⁰

Financial speculation has also become part of the toolkits of industrial and commercial companies, whose senior executives are increasingly obsessed with deal-making. Their constant concern is merging and de-merging, buying and selling bits of their corporate portfolios.¹¹ The treasury department of some companies has even been actively involved in writing derivatives or in currency trading as a way to earn the extra dollar. “For a long time now a number of companies have seen their treasury areas as profit centres.”¹² There are several giant companies that disappeared from the corporate world because of this. Unless the very top of the companies are snoozing most of the time, it is hard to believe that financial transactions of such nature are conducted without their knowledge.

Along the way, the day of reckoning was postponed. It is like doing patch work to cover up cracks in the structure of a bridge that needs a major repair. While the bridge looks good after each patch work, the degeneration of the structure continues unabated. The apparent success of each patch work actually increases the cost of the major repair, until of course on one fine day the bridge simply gives way. The analogy is not to dismiss the merits of patch work. But by its very nature, patch work is a temporary measure to cope with an urgent task, to win time to do the more fundamental renovation. Every good engineer knows this point.

To Wall Street’s great delight, ingredients needed for the patch work — cheap money for the FIRE sector and fiscal deficits — are available. One source is from the foreign reserves of oil-exporting countries. Another is from Asian countries, which have built up massive foreign reserves as a defensive measure after the Asian financial crisis.

From Washington’s perspective, it is fine that Asian countries are keeping their surpluses in US dollar and therefore in the US banking system. It allows America to afford cheap credit that delivers two advantages. Cheap credit is translated into asset booms, creating enormous profits for asset owners. Businesses can use their inflated assets to borrow more money to expand or to raise more capital by selling stocks at good prices. Assets-owning households experience the “wealth effect” and they can afford a spending binge. We have thus a period of consumption-driven growth buttressed by constant supply of cheap money. “One has therefore witnessed for the last dozen years or so the extraordinary spectacle of a world economy in which the continuation of capital accumulation has come literally to depend upon historic waves of speculation, carefully nurtured and publicly rationalized by state policy makers and regulators — first in equities between 1995 and 2000, then in housing and leveraged lending between 2000 and 2007. What is good for Goldman Sachs — no longer GM — is what is good for America.”¹³ Brenner calls this “stock market Keynesianism”.

The world was given a classic example of stock market Keynesianism in the form of Japan’s response to its economic difficulties in the mid-1980s. Its results are well documented — in the form of a long recession in Japan, widely known as the “lost decade”. What the West had suffered at the hands of Japan was experienced by Japan then. By mid-1980s, South Korea, Taiwan, and other East Asian countries had become Japan’s star pupils, if not clones. And like the West, Japan failed to make breakthroughs across a range of technologies so that it could create new industries. For sure, ...