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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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Nothing in this view implies any reason to deny or to suppress the speculative element in finance. These ideas do not contradict the conventional view that speculative financial activity can be useful in generating information and in organizing risk. It is an intrinsic feature of 31 finance to make informed bets about future states of affairs. Some of these gambles may function (as in hedging devices) to limit rather than to extend risk. Others may have no such risk-containing use without thereby ceasing to be useful and legitimate.

One of the many dimensions in which one way of organizing a market economy in legal detail may be better than another is that it encourages greater diversity and experimentation in the forms of production and exchange. That means making use, in the organization of a market economy, of the principle that market economies can take alternative legal-institutional forms.

The conventional idea of freedom to recombine factors of production within an institutional framework of production and exchange that is left unchallenged and unchanged can and should broadened into an unconventional idea of greater freedom to experiment with the institutional forms of a market economy. Among such forms are its regimes of contract and property. A national economy should not be fastened to a single version of itself. Its institutional organization should radicalize the organized anarchy that is the genius of a market economy.

One of the many terrains for such variation in the legalinstitutional regime of a market economy regards the room for speculative activity, which may properly be much greater in some economic sectors and contexts than in others. Instead of allowing only a modicum of speculation, it may be better to prohibit speculation altogether in some settings and to give it the freest rein in others. In that way, we refuse to entrench as institutional dogma what can and should be open to experiment and to collective learning.

Whether, however, society gives greater or lesser space to speculative activity, it must still shape the relation of financial speculation to the agenda of production in the real economy. In this 32 respect, neither what the government wants nor what the financiers want is decisive. The crucial point lies in the institutional arrangements that make finance, including the most speculative forms of financial activity.

either more or less useful to the expansion of output and to the enhancement of both total factor and labor productivity. The problem of speculative finance turns out to just one more field in which to confront the distinction between the hypertrophy and the deepening of finance.

Stimulus reconsidered

These ideas provide a point of departure for the design of a response to the slump that is adapted to a wide range of circumstances. Underlying the response is a conception of the path to socially inclusive economic growth -- which, together with national independence, is the most widely professed policy goal in the world today -- and of the role that public as well as private finance can play in the achievement of that objective. If the central topic of this essay is the road to recovery, its second subject is the intellectual practice that can free us from the superstitions that continue to block this road.

In the end, it is not enough to reorganize the economy; it is also necessary to reorient economics. A text like the present one can address this ulterior subject only by indirection and suggestion, but must address it nevertheless. The problem is not simply that much of the world, especially its richest part, has chosen the wrong response to the slump under the influence of powerful interests that have already profited, and stand to gain much more, from this misdirection. The problem is that policy continues bent under the yoke of illusion -- at the end of the day, illusion about the possible institutional arrangements of a market economy.

Let us begin by retaking the thread of the earlier argument about why a stimulus, deployed in the circumstances of a contemporary 33 society, is always likely to be too limited in its magnitude as well as in its instruments to achieve its proposed objectives. Under the conditions of a slump preceded by a crisis of confidence in the debt burden weighing on both households and firms (a “balance-sheet recession”), expansionary monetary policy conducted by central banks is likely to be relatively ineffective. A minimal or even negative cost of money will not, in and of itself, induce firms and households to invest or to consume if their income or profits have already collapsed and their debt exposure has come to seem dangerous or even unsustainable.

Under such conditions, fiscal policy is likely to be the sole relatively effective instrument, and indeed more fiscal policy in the form of governmental spending than fiscal policy in the form of tax reductions. The reason for this fact is simple and well established: the money saved by a lower tax obligation will tend to be used to pay debt down rather than to spend or to invest. It is the circumstance to which the policy tools of vulgar Keynesianism are most directly suited.

When, on the other hand, a dynamic of exorbitant indebtedness does not form a major part of the circumstances of the crisis and the slump, monetary stimulus, together with fiscal stimulus in the form of lower taxes rather than of higher public spending, may take the upper hand.

Whether the crisis and the slump are of the first nature or of the second, and whether therefore fiscal or monetary stimulus must perform the leading role, the same basic constraint will hold for the reasons we have examined. Under peacetime conditions, the stimulus will be too small to secure a decisive recovery. The proponents of more stimulus will protest, but to little avail, and their frustrated insistence will form a predictable part of the situation. A half-hearted stimulus, appearing (to its proponents) to be disproportionately small in relation to the severity of the slump will be the only stimulus ever to be achieved.

34 If the crisis and the slump are significant -- as they have been in many countries in the course of these recent events -- the stimulus will fail to secure a vigorous and broad-based recovery. It will fail not only because it is too small but also because it is unaccompanied by the institutional innovations that can favor socially inclusive economic growth. In both these respects, the practice of the stimulus will be unlike the experience of the war economy. That experience, we have argued, benefited from the combination of a much higher mobilization of physical, financial, and human resources with bold experimentation in the arrangements of production and exchange, coordination and competition.

None of this provides a reason to forego stimulus, designed according to the nature of the crisis and the slump. However, the stimulus should be practiced and pressed with no illusion that it is sufficient to ensure strong and inclusive recovery. Its true role, in the real conditions in which any contemporary stimulus can be wielded, is two-fold.

Its first role is to prevent the aggravation of the crisis or of the subsequent slump. In so doing, it gives time to develop the intellectual content and the political basis for a program of broad-based and inclusive growth.

Its second role is to serve, so far as feasible, as the first step of such a program, a down payment on its intentions. With ingenuity and luck, the stimulus can be so designed that it incorporates, in fragmentary and anticipatory form, some elements of the inclusive growth project while helping to create more favorable conditions for the adoption of other elements.

The crucial attribute that would enable a short-term program of 35 recovery to perform this role is some limited combination of the two elements of the war economy: heightened demand for consumption and investment goods and a series of institutional innovations suggesting the proposed direction for advance. Consider each of these concerns in turn.

Both monetary and fiscal stimulus may strengthen demand for consumption and investment goods. However, expansionary monetary policy does so only indirectly. It can create a circumstance in which households and firms are not discouraged from going further into debt in the pursuit of entrepreneurial or consumption opportunities. In circumstances in which the household and the firm already find themselves bent under the yoke of debt, and the anticipation of a benign economic future has already dissipated, such encouragement is likely to prove insufficient. That is precisely the circumstance of a balance-sheet recession.

And what if the cost of borrowing money is made negative? The government may in effect pay firms and households to borrow by any number of devices. They may still prefer to use the money simply to pay down their debts rather than to extend them. Or the central bank (were it free from the worship of sound money) might simply opt to debase the currency by any number of other devices, thus redistributing wealth from creditors to debtors. It would do so under cover of the bias of the law, which refuses to recognize in this redistribution through the debasement of the currency a taking of property, requiring compensation.

The redistributive effect may weaken the unwillingness to risk and to invest only at the cost of a planned inflation, with all the sequel of social consequences and political reactions that such an event has regularly produced. The remedy may be universally regarded as worse than the evil that it is designed to correct.

36 Even if monetary policy could be effective in the circumstance of a slump subsequent to a debt overhang, it cannot, by its very nature, serve as the means with which to prefigure a project of inclusive growth.

Monetary stimulus may perform the first role of the stimulus -- to avoid the worsening of the crisis or of its aftereffects and to buy time. It may do so either because the economic downturn is not contaminated by excess debt or because, even if it is, cheap money may help. It is, however, incapable of performing the second role of a stimulus: to foreshadow a different economic future.

For that role, only fiscal stimulus suffices. In fact, only one species of fiscal stimulus can do the job: the species that involves public spending as opposed to tax abatement. For the diminishment of taxation is likely to suffer, in the performance of the foreshadowing role, limitations similar to those faced by monetary policy. At least it will suffer such limitations unless the grant of the tax favors is subject to the requirement that tax-payers use the money foregone by the government to invest in certain ways and to specific ends. The imposition of such requirements, however, turns the tax favors into the equivalent of a public-spending program.

A fiscal stimulus, understood in this restricted sense, should emphasize each of the components of the growth strategy we later outline. Its chief concern should not be further to divert public resources to failing big financial organizations or inefficient mass-production industries. It should prefer those uses of governmental resources that strengthen the supply as well as the demand side of the economy. It should also give priority to the commitment of public resources that combines such two-sided stimulus with an opening to the institutional innovations useful to broad-based and inclusive economic growth. In this way, the stimulus mimics features of the war economy.

Imagine three large directions for such a project. We later discuss 37 each of them in greater detail.

One direction has to do with the tightening of the link between saving and production: the diminishment of the extent to which the production system is required to finance itself, as it does in all contemporary market economies, while much of the productive potential of saving gets squandered in a financial casino. That implies investing in the organizations that most directly connect saving to productive investment: the country’s network of local banks. It also suggests use of independent public entities -- administered independently and professionally and subject to the discipline of market competition -- to imitate the work of private capital.

A second direction is that of the enhancement, through governmental action and investment, of the productive apparatus of the country. The most important addressee of such action is the multitude of small and medium-size businesses responsible for generating the vast majority of jobs and of output in every contemporary economy. The most promising method is the propagation of successful local practice and the opening of access to credit, technology, knowledge and knowledge-based capabilities. The favorable institutional setting is one that organizes a form of coordination between government and firms that is decentralized, pluralistic, participatory, and experimental.

The radicalization of the experimental impulse so important to innovation and thus to growth ought to count for more than any dogmatic preference for a particular sector of the economy. To this principle, however, there are two important exceptions.

The first exception is the most traditional object of any program of public expenditure: public works undertaken to improve the physical infrastructure of productive activity. Here the reason for the exception is the contribution of such investment to the feasibility and productivity of 38 first-order productive activity.

The second exception is public investment, or public incentives to private investment, in the technologies, products, and services of a lowcarbon economy. The ground of this exception is the need to prepare a growth strategy that is not self-defeating.

The third direction of priority public investment, in a fiscal stimulus foreshadowing another future, is the development of human capabilities through the generalization of a form of education that marshals information selectively as a tool for strengthening our powers of analysis, prefers cooperation to the combination of individualism and authoritarianism in learning, and approaches every subject dialectically through contrasting points of view. Generic and flexible conceptual and practical capabilities, rather than task-specific skills, and freedom from the mental constraints of the immediate circumstance are its overriding concerns.

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