For a new Keynes

Oct 19, 2008 Features / Columnists, Ravi Dev

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As the meltdown of the financial sectors in the United States and Europe inevitably spreads horizontally outwards to every other economy of the world, we are already witnessing evidence that the effects have also spread vertically into the real economy of production of goods and the delivery of services.

Orders to factories are being cut back and even giant economies like China and India are revising their projected GDP growth figures downwards.

Even though the policy makers in the US are understandably reticent about projecting the probable depth to which the now conceded recession might sink, many commentators are concerned that the US and the rest of the world may have a downturn that rivals the great depression of the 1930’s.

During that landmark economic catastrophe, the theories of John Maynard Keynes were honed both to explain the forces behind the crisis and suggestions for returning the economies to even keel.

In his 1936 classic, “The General Theory of Employment, Interest and Money”, he proposed that self-regulating markets would not necessarily restore growth and full employment to economies that had fallen into recession.

Government intervention, he asserted, could help do the job that markets could not. This intervention would focus on fiscal fine-tuning – varying the level of government spending and taxation to cause the economy to accelerate or decelerate by a multiple of the stimulus, primarily by increasing or decreasing money in the hands of the citizenry.

While WWII actually provided the stimulus for pulling the world out of the Great Depression, the theories of Keynes underpinned both the several domestic initiatives and the 1945 Bretton Woods meeting of 40 nations that sought to stabilize the international system that had retreated into isolationism.

Unfortunately, however, the negotiations were dominated by power politics that pitted the US on one side, that was determined to secure its “rightful” place as the new dominant world power, and Britain, (led by Keynes) that fought to preserve as much as it could its former glory. The US won out and the new institutions such as the IMF and World Bank reflected its global orientation.

Thirty years later, the ideological currents shifted and the neo-classical school, which stressed the primacy of markets, started its ascendancy.

The IMF actually rejected the British attempt to attack rising unemployment at this time through the Keynesian prescription of stimulation.

Beginning as concrete policy moves by the Thatcher government in Britain (1979) then the Reaganite administration in the US, the following year, deflationary measures coupled with deregulation of the financial system and a retreat of the government from the economy became the order of the day. The economies boomed and market fundamentalism was the new mantra.

In the international arena, however, while the primacy of the market was enshrined in the Washington Consensus that guided the IMF/World Bank, the Keynesian role of the state that was enshrined in its articles was applied to the Third World states that had fallen into the debt trap, fostered by the same institutions and its developmentalism credo.

Today, the question arises as to what tools will be deployed to counter the possible world recession in the offing.

We are facing a contraction in credit facilities similar to the one in the 1930’s but we are hearing nothing from the World Bank/IMF even though they had been established to establish international financial system aimed at regulating world monetary and credit relations.

For instance, that international credits would have been accessible to countries with financial problems so that they would avoid the need for rapid and savage deflation.

This, of course is because the developed countries, especially the US, reject any oversight over its policies – economic or otherwise. They are hoping that their voluntary coordination of policy responses would resolve the crisis.

But they should learn from their experience of allowing the derivative markets to be self regulated in the US, that self interest will torpedo such initiatives.

However, their refusal to even acknowledge that their latest intervention to purchase shares in several banks and other financial institutions is a nationalization plain and simply is an indication that ideological dogma still rules the day.

This does not bode well for the deep systemic alterations that are obviously necessary to confront the crisis – especially its newer features such as what has been dubbed ‘financialization”.

Introduced by the erstwhile old Republican strategist Kevin Phillips, financialization is seen as “a process whereby financial services, broadly construed, take over the dominant economic, cultural, and political role in a national economy.”

In the US, this process occurred in the 1990’s and reached its peak between 2001 and 2007. And this is the reality of modern America and, to a lesser extent, Europe.

The massive profits and prosperity that were generated came from “money making money” and not from the real economy: profits from “derivatives”, which can be declared sometimes purely through the solving of equations with no connection to the real world, became the most esoteric but hardly the most ethereal of the new “profit”.

The individuals that benefited therefore were a tiny minority who became unbelievably wealthy while, in almost a parody of the classic Marxist critique of capitalist accumulation, the underclass were told to get its share through credit – since real wage increases had stagnated. It was inevitable that the bubble would burst at sometime, since the latter debt was unsustainable.

In his recent books, including his latest, “Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism,” Phillips, also suggests that we may be closer in other ways than mentioned above to the structural conditions underlying the depression of the 1930’s.

Just as Britain’s unique role in the world economy, with the primacy of the sterling, had been undermined by then in the rise of the US – to be confirmed at Bretton Woods, today we may be witnessing the eclipse of the US with its loss of production capabilities and the rise of new centres such as China, India and Russia – that now hold an unbelievable amount of American debt.

Are they ready to call in that debt? Will there be a new Bretton Woods? Are we going to see a new Keynes arise who may suggest a way out of the present mess?

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