Governance, Regulation & Financial Market Instability: The Implications for Policy

1. Governance, Regulation & Financial Market Instability: The Implications for Policy Sue Konzelmann & Marc Fovargue-Davies (Frank Wilkinson & Duncan Sankey) REFGOV / DEMOGOV Brussels 26-28 May 2010

2. Introduction & Overview • Galbraith’s ‘conventional wisdom’ • Shifts in policy, economic impacts & theory • ‘Galbraithian Episodes’ since 1919 • Current policy options constrained by: • Effects of globalization and progressive de-regulation • Increasing political and economic importance of the financial sector • excessive levels of debt • Conclusions and implications for policy

3. ‘Conventional Wisdom’ • ‘Conventional wisdom’ is inherently conservative and gives way not to new ideas, but to ‘the massive onslaught of circumstances with which it cannot contend.’ (Galbraith 1999: 17) • Galbraithian Episodes since 1919: • The end of World War I to the end of World War II • The end of World War II to the 1970s • The 1970s to 2007 • 2007 to the present

4. Episode 1: From ‘laissez faire’ to state stimulus in America • The ‘Roaring 20s’ – ‘an astonishing boom’ (Arndt 1944) • Rapid organizational & technical development, high levels of investment and a boom in construction and consumer spending • 1929 economic slowdown, exacerbated by stock market crash, leads to Great Depression • Roosevelt’s ‘New Deal’ intervention … although it takes World War II to bring full recovery

5. Episode 1: the British experience • The 1920’s ‘doldrums’ – the ‘years of semi-stagnation’ (Arndt, 1944; Howson 1975) • 1931: Britain is forced off the Gold Standard and interest rates are cut to reduce the 1917 War Loan • Cheap & plentiful money triggers a house building & consumer durables boom • 1937 re-armament leverages the recovery

6. Episode 2:The ‘Golden Age’ • Widespread commitment to Keynesian full-employment and the welfare state in Britain • Post-war reconstruction of Europe and Japan fuelled economic prosperity in America • Macro-economic performance characterized by full-employment, non-inflationary growth and rapidly rising living standards

7. Episode 3:The rise of Neo-liberalism • Macro-economic theory & policy postulates: • monetary causes of inflation • Efficiency & welfare benefits of free markets • Industrial organization and corporate governance theory & policy argues: • Large firms the result of – & reward for – success in competitive markets • Stock market an efficient ‘market for corporate control’ • Central bank responsible for inflation and Central government for market freedom

8. Episode 3:1970s-1980s –Neo-liberalism unleashed • The collapse of Bretton Woods and the relaxation of international money movements • Growing importance of multi-national firms and the onset of de-industrialization • Confidence in markets & ‘re-regulation’ of the real and financial sectors of the economy • Strengthening of the shareholder model • Leveraged buy-outs, foreign competition & inflation hollow out the ‘real’ economy whilst the finance sector achieves dominance

9. Episode 3: Financial Market Liberalization in London and New York • ‘May Day’ 1975 (New York) & 1986 ‘Big Bang’ (London) • Failure to revitalize the industrial base: • strengthens reliance on the financial sector • limits export and investment opportunities outside of the financial sector • provides incentives for financial ‘innovation’ involving risk and increases the national debt • Globalization & financial market ‘innovations’ have outpaced the capacity to supervise & regulate

10. Episode 3: Financial Alchemy & the American Sub-prime bubble • Presence of the pre-conditions for financial crisis • Consumer boom less comfortable for the internationalized banks in London and New York • Financial ‘innovation’ & exploitation of the American sub-prime real estate market • In liberalized global financial market, loss of confidence precipitates crisis • Financial market crisis has re-bound effects on the real economy & the recession deepens

11. Conclusions & Implications for Policy • The current debate: How to pay down the national debt by cutting government expenditure • Starving the economy of funds through policy of austerity is likely to undermine economic recovery • UK National Debt as a % of GDP since 1900 …

13. Conclusions & Implications for Policy • Reminiscences of Britain during the 1920s? • Stimulus would be better aimed at longer-term re-balancing • National debt associated with bank bailouts should stand as a levy on the banking system • Reform must be co-extensive with the market • Ironically, Britain is once again – as in 1919 – grappling with enormous government debt …