A slew of flawed and incomplete ideas about the advent of a new era loses sight of the importance of the real economy - as well as overlooking the enduring stability of the global economy. Daniel Ben-Ami fillets the arguments.
There is no doubt that the financial crisis was a substantial shock to the global economy. Whether the changes are so profound that the world has entered a new era is more difficult to say.
Several prominent commentators have suggested that the changes are more than incremental. George Soros, perhaps the world’s most high-profile financier, has talked of a “new paradigm”. Mohamed El-Erian and Bill Gross of Pimco refer to the “new normal” and have talked of the emergence of “state capitalism” (for more on Pimco’s views see box, below). Anatole Kaletsky, an economics commentator for The Times (London), uses “Capitalism 4.0”. Robert Peston, the BBC’s business editor, has a book due out next year entitled: The New Capitalism: How and Why the Economic World Has Changed Forever - and How it Affects Us All (Hodder).
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But history suggests that new eras are declared too often. In an article published in 1997 entitled “Before we rush to declare a new era”, James Woudhuysen, the professor of forecasting and innovation at De Montfort University, identified several attempts at characterising new paradigms. Among the many variations on the them are the “knowledge economy” (Fritz Machlup, 1962), the “global village” (Marshall McLuhan, 1962), “post-industrial society” (Alain Touraine and Daniel Bell, 1971), the “third wave” (Alvin Toffler, 1980), the “information society” (John Naisbitt, 1982), the “age of the smart machine” (Shoshana Zuboff, 1989), the “global quantum economy” (George Gilder, 1990) and the “information revolution” (Business Week, 1994). (For more see “Blurred vision and weak sense of history” box below)
Even the terms being bandied around have appeared earlier in different incarnations. The idea of a “new economy” and “new paradigm” was often used in the late 1990s. At the time it referred to the idea that new technology, such as the internet, was leading to a surge in productivity growth and therefore supporting a stockmarket renaissance. The market crash of 2000-01 put paid to that idea.
Meanwhile, as far back as 1999 Paul Krugman, later to win a Nobel prize, had a book published entitled The Return of Depression Economics. It argued that the West was likely to follow Japan and other Asian countries in suffering a liquidity trap in which the economy suffered from a chronic lack of demand. Although he conceded the world had not entered a new Great Depression, many of the problems of the 1930s had returned.
It was later reworked and republished as The Return of Depression Economics and the Crisis of 2008.
”Even the terms being bandied around have appeared earlier - the idea of a “new economy” and “new paradigm” was often used in the late 1990s”
The idea of a “new normal” has also been used before in other contexts. For example, after the terrorist attacks of September 11, 2001 on New York’s World Trade Center it was used to refer to a new era of vulnerability. The events were often portrayed not only as terrible but as fundamentally altering the way society would work.
None of this disproves the argument that the economic crisis of 2008-09 ushered in a new era. It just signals the need for a sceptical approach to such claims. Changes that seem fundamental at the time may seem less so as they recede into the historical memory.
To assess the claims it is necessary to outline what is being argued and then set that against an assessment of real economic trends. Unfortunately there is no definitive statement of what constitutes the “new era” - different authorities sometimes identify different factors - but it is possible to generalise up to a point.
Most proponents of the new era argue that it will be a difficult time; especially for the developed economies. Kaletsky is an exception in seeing what he calls Capitalism 4.0 as largely positive. For him the economic crisis is likely to be an aberration in a generally rosy outlook. Three of the four “mega-trends” he identifies as having been key since the early 1970s are still operating: the expansion of the global economy to include the former eastern bloc, globalisation and the stabilisation of the world economy or “great moderation”. Only the financial revolution, driven by free market philosophy, will find it hard to survive (for more details see my review of his book in the August 16 issue of Fund Strategy).
In broad terms the key features of the new era are often identified as:
- Slow economic growth or even economic stagnation in the developed world. It is often assumed that the developed economies will grow significantly more slowly than they did in the run-up to 2008. High unemployment is often seen as accompanying this trend.
- Deleveraging. The reduction of debt - deleveraging - is typically seen as an important part of the slow growth story. Companies will focus more on reducing their debt levels than reinvesting for growth. Indeed governments too will be cutting back debt rather than investing in products that could enhance growth.
An influential variation on this theme is that the rest of the developed world could be facing a Japanese style “balance sheet recession”. Perhaps the most influential exponent of this theme is Richard Koo, the chief economist at the Nomura Research Institute, who has elaborated on the theme in Balance Sheet Recession (Wiley, 2003) and The Holy Grail of Macroeconomics (Wiley, 2008). He argues that for many years Japanese companies were preoccupied with paying off their debt rather than bolstering corporate profits. As a result the economy suffers a chronic lack of demand. The only way to compensate for weak private demand is by state stimulus.
- High instability. In contrast to the period of the great moderation it is widely assumed that volatility will be higher over the coming years. This includes both financial instability - the ups and downs of the financial markets - and the economic cycle. Soros has argued that the end of American dominance, and the consequent demise of the dollar as an international reserve currency, will underpin this instability.
- Reregulation. After the financial collapse of 2008 it is argued that regulation is likely to get tighter. For example, there will be tighter curbs on bank lending.
- The end of “market fundamentalism” /free market economics/”neo-liberalism”. It is widely contended that the crisis discredited the pretensions of free market economics. The idea of financial “light touch” regulation, for example, was found to be wanting. Often free market economics is also associated with theories such as the efficient market hypothesis and rational expectations theory. But these too, so it is argued, were discredited by the emergence of giant financial bubbles and irrational herd behaviour by market players.
The future, it is suggested, needs to involve more pragmatic policy making and fewer ideologies. The influence of Margaret Thatcher and Ronald Reagan has finally waned. Some even refer to “state capitalism” to suggest the state will play a more central role in the economy.
George Soros has even pledged $50m (£32m) to sponsor an Institute for New Economic Thinking with the aim of developing an economics for a new era. Anatole Kaletsky and Joseph Stiglitz, both associated with the institute, have emphasised the importance of breaking from the fundamentalist orthodoxy by promoting fresh app-roaches to economics.
”None of this disproves the argument that the economic crisis of 2008-09 ushered in a new era – it just signals the need for a sceptical approach to such claims”
All of these factors taken together represent a plausible picture of the outlook for the global economy - otherwise they would not be proposed by economics experts. But many are wanting even at the level of description, let alone as an explanation of underlying economic trends.
Some of the points are hard to contest. There is little doubt that companies and governments will attempt to reduce their leverage. This in turn is likely to depress economic growth further than it would otherwise be.
But when it comes to looking at growth more closely the assertion that is likely to be lower than the recent past, while true, is not that revealing. It is necessary to probe deeper to ask why growth is likely to be slow. The problem is far more profound than a simple deleveraging.
There are two sets of factors that are likely to keep growth weak. First, is the powerful aversion to growth and prosperity among the elite that I discuss in Ferraris for All (Policy Press, 2010), my book defending economic progress. This outlook, which I call growth scepticism, takes the form not of an outright rejection of growth but of subjecting it to numerous caveats. It means constantly emphasising the need for caution and restraint. For example, the notion that there are cultural, moral and social limits to growth. Concepts such as corporate social responsibility and sustainability also embody the idea that growth needs to be limited.
Second, there are the more fundamental structural economic weaknesses of the West. Productive investment has been weak for many years. As a result much surplus capital has found its way into the financial markets rather than going into real capital investment. This trend is discussed further in Cowardly Capitalism (Wiley, 2001), my book on the global financial markets. (For more see box “Why is mainstream analysis so often wrong?” below)
Governments exacerbated this bloating of the financial sector by encouraging the expansion of credit as a way of muddling through economic problems. Interest rates were often kept low, state spending was maintained at a high level and rules on bank lending were relaxed. This provided an easy, although short-termist, way round economic sluggishness rather than attempting the more difficult task of encouraging economic restructuring.
This analysis suggests that the real underlying rate of growth has been lower than it seemed for many years. The headline GDP figures have flattered the western economies as credit expansion made them seem more dynamic than they really were. In effect consumption and growth in the West was being subsidised by China and other rapidly emerging Asian economies.
As a result the contrast between a fast-growing “old normal” and a slow-growing “new normal” is over-stated. Both before and after 2008 the developed economies were, in real terms, suffering from anaemic growth. The inflation and deflation of the financial bubble simply disguised the underlying trend.
In addition, the idea of an era of deregulation followed by one of reregulation does not even work as a description of the trends before and after 2008. There is a partial truth in the idea of deregulation in the earlier period in that, as already mentioned, lending rules and various other rules on financial activity were relaxed.
But in other respects regulation had already become more extensive and formalised. For example, before the “big bang” in the City of London in 1986 much financial regulation was informal. The City was a club with relatively few rules. Anyone who seriously transgressed the rules would be blackballed.
Over the years a much more elaborate system of statutory regulation emerged. The Financial Services Authority (FSA) had an extensive rulebook and staff to enforce its diktats. It is misleading to characterise it as minimal regulation in the way that it is often understood.
”It is necessary to probe deeper to ask why growth is likely to be slow. The problem is far more profound than a simple deleveraging”
The weakest pillar of the new paradigm argument is that idea that an era of free market economics has finally ended. Whatever some university economists would like to see, the workings of the western economies bear no relationship to the ideal of a minimal state.
Even in America, often viewed as the bastion of the free market, the state plays a huge role in economic activity. Total federal spending was already about 35% of GDP before the crisis struck. In addition, the authorities played an extensive role in both financial regulation and monetary policy. However desirable a minimal state, it is hard to believe that America really was one in the classic free market sense of the term.
Critics often confuse the reluctance of the state to intervene in some circumstances with free market economics. For instance, the slowness of the American authorities to act on the collapse of Lehman Brothers in 2008. But this is better seen as a reluctance of the authorities to take decisive action rather than a genuine ideological adherence to free market economics.
It should already be clear that the common characterisations of the features of the new paradigm are flawed. At best they only represent a partial outline of economic trends. Such accounts are insufficient to justify the claim that the world has entered a new economic era.
They also omit some of the key characteristics of the global economy. In particular they take its durability as given. Such commentators fail to see that there is a fundamental stability to the world economy despite the near collapse of the financial system in 2008. Nor should volatile asset prices be necessarily taken as a sign of economic instability.
Proponents of a new era forget that peculiar circumstances give the world economy far more durability than it would otherwise have. The rulers of the developed economies have more room to manoeuvre than they would have had in earlier times.
”The collapse of the Soviet Union and the eastern bloc more generally, consolidated the view that there is no alternative to the market”
International co-operation has remained strong thanks to the relatively muted tensions between the main world powers. Protectionism has been more-or-less kept at bay. Instead the leading economies have worked together, often through international institutions such as the G20 and the International Monetary Fund, to maintain stability. Such co-operation would be far harder to achieve during a time of intense inter-national conflict.
Opposition on the domestic front has also remained limited. Unemployment has risen sharply and real incomes have fallen in many cases yet there has been little grassroots resistance. Discussion has focused on how best to impose austerity, where to impose cuts, rather than resisting curbs on consumption.
Those who push the idea of a new era have forgotten the significance of a genuine watershed in world affairs: 1989. The collapse of the Soviet Union and the eastern bloc more generally consolidated the view that there is no alternative to the market. It no longer seemed possible to push for a qualitatively better society. A powerful mood of fatalism gripped the western world.
The world did not enter a new era in 2008. But it is possible to outline the key characteristics of the world economy over the past two decades.
It can still be characterised as what Phil Mullan, an economics writer, called a SAD economy in 2008. It is Stable, Anaemic and Durable. Growth is slow, productive investment is weak but there is little immediate chance of any existential threat to the system.
The economy is drifting along with severe bouts of financial instability but facing no fundamental challenges. Western governments face no determined international challenges or domestic opponents. However, in a strange paradox, they are themselves fearful of embracing growth or restructuring their own economies.
This stasis is unlikely to go on forever but there are no imminent signs of it being undermined. If forces eventually emerge that are powerful enough to break this equilibrium they could signal the start of a genuinely new era.
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