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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 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 ‘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 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 Episode 1: the British experience • The 1920’s ‘doldrums’ – the ‘years of semistagnation’ (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 Episode 2: The ‘Golden Age’ • Widespread commitment to Keynesian fullemployment 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 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 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 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 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 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 … National debt as % of GDP: 1900 to 2010 250 200 150 100 50 0 00 03 06 09 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 National debt as % of GDP 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 …