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«Tamara Lothian* Columbia University – Center for Law and Economic Studies Roberto Mangabeira Unger* Harvard University March 1, 2011 * © Tamara ...»

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Crisis, Slump, Superstition and Recovery

Thinking and acting beyond vulgar Keynesianism

Tamara Lothian*

Columbia University – Center for Law and Economic Studies

Roberto Mangabeira Unger*

Harvard University

March 1, 2011

* © Tamara Lothian and Roberto Mangabeira Unger 2011

CRISIS, SLUMP, SUPERSTITION, AND RECOVERY

Thinking and acting beyond vulgar Keynesianism

ABSTRACT

The intellectual and practical response to the worldwide financial and economic crisis of 2007-2009 as well as to the subsequent slump has exposed the poverty of prevailing ideas about how economies work and fail. The transformative opportunity presented by the crisis has largely been squandered; but the opportunity for insight has not. Insight today can support transformation tomorrow.

The present debate about the crisis and the subsequent slump has largely suppressed two themes of major importance. The first theme is the relation of finance to the productive agenda of society. It is not enough to regulate finance: it is necessary to reshape the institutional arrangements governing the relation of finance to the real economy so that finance becomes servant rather than master.

The second theme is the link between redistribution and recovery. A pseudo- democratization of credit has been made to do the work of the redistribution of wealth and income in laying the basis for a market in mass-consumption goods.

The most important form of redistribution is not retrospective and compensatory redistribution through tax-and-transfer; it is the reshaping of economic and educational arrangements to broaden opportunity and enhance capabilities.

Fiscal and monetary stimulus is rarely enough to redress the effects of a major economic crisis. (It was the massive mobilization and the experiments in public- private coordination of the war economy, rather than any proto-Keynesianism, that took countries out of the depression of the 1930s.) The proper role of a stimulus is to play for time by preventing the aggravation of crisis and to prefigure a program of recovery and reconstruction.

The relative success of major emerging economies in responding to the crisis and in avoiding a slump fails to provide the model of such a program. Many of the policies and arrangements pursued in these countries stabilized markets and created the conditions for continued growth. But it would be wrong to assume that economic recovery in emerging economies represents the emergence of a superior economic logic. It should be understood instead as a series of second bests. For example, the forced continuation of credit flows through governmentally 2 controlled banks and development agencies has largely reinforced preexisting inequalities rather than democratizing access to resources and capabilities.

A preliminary to a program of broad-based economic recovery is the repudiation of the regulatory dualism that has characterized the regulation of finance: the distinction between a thinly and thickly regulated sector of financial activity. In one direction such a program must seek the institutional innovations that put finance more at the service of the productive agenda of society. In another direction, it must conceive and build institutional arrangements that give practical effect to the ideal of socially inclusive economic growth. It does so by basing growth on an institutionalized broadening of economic and educational opportunity.

The vulgar Keynesianism in which many contemporary progressives have looked for orientation fails to offer a theoretical guide to such a program of recovery.

However, the fault does not lie solely in the vulgarized version of Keynes’s ideas;

it lies in those ideas themselves and indeed in the whole mainstream of economic analysis that grew out of the marginalist revolution of the late nineteenth century.

The established economics suffers from a deficit of institutional understanding and imagination. Only a broadening of institutional understanding can provide the practical and conceptual materials we need to imagine alternative futures. And although this understanding remains foreign to the main tradition of thinking about economic policy and reform, the same cannot be said of law. Law and legal thought are integral to the theoretical alternative explored in this essay, because they provide the institutional imagination with indispensable equipment.

This essay takes a first step in the effort to develop an intellectual alternative. It does so by outlining an approach to our present problems of crisis, slump, and recovery.

–  –  –

The truncated debate about the slump: why the stimulus fails Nothing astonishes more in the present debate about recovery from the slump that followed, in the richer economies, the crisis of 2007-2009 than the poverty of the ideas informing the discussion. It is as we were condemned to relive a yet more primitive version of the debates of the 1930's.

On one side, we hear the argument for fiscal and monetary stimulus: the more the better. The intellectual inspiration of this argument is almost exclusively vulgar Keynesianism; with each passing round in the debate, it becomes more vulgar.

The chief opposing conception is a market fundamentalism the major premise of which is that a market economy has, despite minor variations, a single natural and necessary institutional form. This form supports, according to the market fundamentalists, an economic logic that cannot be defied with impunity: they believe that every attempt to defy it will, sooner rather than later, prove self-defeating. One of the byproducts of this market fundamentalism has been a resurgence, in 4 response to the nostrums of the vulgar Keynesians, of the "liquidationist" view of the 1920's ("purge the rottenness out of the system"): fiscal austerity, monetary common sense, and a return to fundamentals -- that is to say, the established institutions of the market economy, with a minimum of governmental action -- is supposedly all we need.





The truth is that, under the conditions of a contemporary democracies and markets, no fiscal and monetary stimulus is ever likely to be large enough to help ensure a broad-based and vigorous recovery from a major slump. Long before it reaches the dimension needed to make a difference, the stimulus will encounter difficulties that are hard to overcome. A stimulus big enough to counteract the effects of a major slump is a gamble that will arouse opposition both because of the present interests that it threatens and because of the future evils that it risks producing.

In the practice of monetary policy, it is easy to jump from deflation to inflation, and then to see inflation combined, as it has been in the past, with, stagnation. It is a quandary that has particular relevance to the present situation of rich economies, as they suffer the aftereffects of the crisis. The major rich economies are awash in capital that has no place, or little place, to go. The scarcity of attractive opportunities for capital has helped arouse interest in emerging markets. Nevertheless, most capital remains at home, trapped. This abundance of liquidity coexists with a determined attempt by households and firms to free themselves from the burden of debt accumulated in the years leading up to the crisis.

This effort has justified the description the slump that has followed the crisis as a “balance-sheet recession,” driven, in part, by the desire of both households and firms to reestablish a sustainable level of indebtedness.

The coexistence of abundant liquidity with daunting private 5 indebtedness is only superficially paradoxical. It is itself largely a consequence of the inequality-generating forces that helped shape the pre-crisis economy. A vast portion of profits were concentrated in financial firms in the decades preceding the crisis. At the same time, in the real economy, the most innovative, knowledge-intensive practices, the source of greatest new wealth outside high finance, remained relatively confined to advanced sectors of production. These sectors have become closely linked to similar vanguards around the world.

However, they remain weakly linked to other sectors of their own national economies. The inequalities resulting from such forces have become immense. No wonder vast stores of idle capital continue to pile up in economies populated by households and firms over their heads in debt.

In such a circumstance, the expansion of the money supply by central banks (called by a barrage of obfuscating names such as “quantitative easing”) may help avoid serious and destructive deflation without, however, ensuring a vigorous recovery. It cannot, however, help ensure a vigorous recovery in economies full of families and companies anxious to escape an overhang of debt.

Fiscal stimulus faces similar limitations and difficulties. When it takes the form of cutting taxes, the money saved by households (and in effect spent by the government) is likely to go disproportionately into the paying down of corporate or household debt rather than into increased consumption. To the extent that the beneficiaries of tax cuts are cash-rich individuals and companies, the windfall may simply stoke the already vast store of capital with nowhere to go.

Stimulus through spending seems more promising. One route is to put money directly in the hands of those who are more likely to spend it (for example, by extending and increasing unemployment benefits).

Another path is to undertake an ambitious program of public works, 6 especially works designed to enhance the transport and communications structure of the country and to promote low-carbon alternatives to present lines of production. These activities are useful, both in themselves and as responses to the slump: they can have an immediate effect on the level of economic activity.

This positive effect, however, is subject to two weighty qualifications. They are connected in a way that remains poorly understood.

The first qualification is that the value of such forms of stimulus depends on what comes next. Will the extra money spent by the jobless cause more investment and employment? Will the infra-structure projects help entice more risk-taking and innovation, creating a physical basis for the diffusion of more advanced technologies and practices throughout broader sectors of the economy? The relation of cost to return cannot be read off from the public-spending and investment initiatives taken in isolation.

It depends on the role that they may play, or fail to play, in a broader process of economic growth. The most important elements of such a process – the ones with the greatest potential to enhance productivity, on the basis of wider opportunities and stronger capabilities -- are those that include a combination of technological and organizational innovations. Increased demand, aroused through fiscal stimulus, is far from enough to ensure that such a combination will take place.

The second qualification is that whereas the ultimate effect of such actions on economic growth is both speculative and remote, the burden that they impose on governmental finance is immediate. In the presence of a process marked by the mixture of technological and organizational innovations likely to shape a new cycle of growth, the burdens may be 7 wholly justified. In their absence, however, the short-term effect on increased demand may soon wane, while the worsened fiscal position of the government inhibits it from undertaking the next round of growth and innovation-friendly measures.

The worsening of the fiscal position of the state may in turn arouse the specter of a crisis of confidence in the sovereign debt: in the ability of the government to repay its obligations over the long term. The United States will continue to be the country least vulnerable to this form of pressure so long as it detains the world’s reserve currency, and can pay all of its obligations in a currency that it is free to print as well as to count on the willingness of cash-rich countries and governments to help finance its profligacy. However, the risk of default is not the sole or normally the most significant form of declining confidence. The outward movement of capital, although less dramatic, can be nearly as decisive.

The truncated debate about the slump: why the stimuluscan never be big enough

The intrinsic limitations of fiscal and monetary stimulus as a response to economic slumps are not a reason to foreswear stimulus programs. They are a reason to regard such programs as partial and inadequate responses to severe economic downturns. Moreover taken together with a second set of considerations, they help explain why the actual implementation of these programs is almost always half-hearted and half-baked, even in the hands of progressive governments intellectually predisposed (given the dominant ideas and scarcity of ideas) to vulgar Keynesianism.

The vigorous deployment of expansionary fiscal policies puts the state in more debt and, paradoxically, makes it at once weaker and stronger: weaker because it owes more, and has, in that sense, less room for maneuver; stronger, because its influence over economic activity increases and the dependence of all economic agents on its actions and 8 inactions becomes, if not greater, at least more obvious. The willingness to risk inflation for the sake of avoiding deflation is similarly an assertion of the power of government to influence the terms of exchange in the whole economy and to devalue its obligations to its own creditors.

Fiscal and monetary stimulus taken to the hilt threatens real interests and offends influential ideas. The ideas and the interests, mixed as they always are in real history, conspire to restrain, and sometimes to reverse, the assertion of governmental power that is implicit in the deployment of stimulus policies. In their campaign, the opponents are able to exploit to their advantage the inherent weaknesses in the efficacy of fiscal and monetary stimulus.

The result is that no fiscal and monetary stimulus, conceived in response to an economic slump, will ever be likely to satisfy the proponents of these policies. Always and everywhere, they will respond with the same litany. It has been done by half, they will complain. Had it not been done and all, the downturn would have been much more severe.



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