The Legacy of the Crash

by Terrence Casey

  Notes

  1. The collapse of the Russian ruble undermined Long Term Capital Management (LTCM), the financial firm headed by Nobel Prize-winning economists Myron Scholes and Robert C. Merton. Overleveraged and unable to meet margin calls, LTCM was eventually bailed out by a consortium of other financial firms under the guidance (but without direct financial involvement) of the Federal Reserve. This served to reinforce the idea that markets could correct themselves.

  2. Whether federal officials could have or should have bailed out Lehman Brothers remains a point of great controversy. In the immediate aftermath of their collapse, Paulson implied that it was a conscious choice to uphold market principles. Not so long after that, Ben Bernanke claimed that the Federal Reserve simply did not have legal authority to loan money to Lehman given their limited collateral. (The $85 billion bailout of AIG two days later was backed by its assets.) It should be noted that the thrust of informed opinion both in Washington and on Wall Street in the weeks leading up to Lehman’s bankruptcy leaned against yet another bailout.

  3. Written in haste, the original bill is only around 850 words long.

  4. Even at this point, 108 Republicans and 63 Democrats voted against the bill.

  5. Perhaps not so surprising if one assumes that Congress is effectively ‘in Wall Street’s pocket’. In a less conspiratorial vein, the uncertainty of the causes of the crash and the much more certain effects of heavy handed regulation may have blunted the drive for greater market controls.

  6. A 2010 Congressional Budget Office study suggested that unemployment was lowered from 0.7 percent to 1.8 percent as a result of Obama’s stimulus package (CBO, 2010, p. 2). Even so, whether this was sufficient return on investment is debatable.

  7. The concept implies that every dollar of government spending will increase economic output by some increment greater than one.

  8. There has also been aggressive and ongoing monetary stimulus from both the Bank of England and the Federal Reserve. See Chapter 3.

  9. While beneficial overall, the nomination of Tea Party-backed candidates hurt the Republicans in some significant Senate races, most notably in Alaska, Delaware, and Nevada. See Chapter 6.

  10. Even while converging on goals, differences remain on the means. The Conservatives have boosted taxes, notably value added tax (VAT), to try to move the budget into the black. Republicans so far (June 2011) refuse to countenance any tax hikes.

  11. The alternative vote system involves the ranking of candidates. The candidates receiving the lowest number of votes are eliminated and their second choice votes distributed to the other contenders. This process continues until someone has received 50 percent or more of the vote.

  References

  Barro, Robert J. (2009) ‘Demand Side Voodoo Economics’, The Economists’ Voice, 6(2), Article 5.

  Brooks, Arthur (2010) The Battle: How the Fight between Free Enterprise and Big Government will Shape America’s Future (New York: Basic Books).

  Cassidy, John (2009) How Markets Fail: The Logic of Economic Calamities (New York: Farrar, Straus and Giroux).

  Coates, David (2010) ‘Separating Sense from Nonsense in the US Debate on the Financial Meltdown’, Political Studies Review, 8(1), 15–26.

  Congressional Budget Office (2010) Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from April 2010 through June 2010, August (Washington, DC: CBO).

  Crouch, Colin (2009) ‘Privatized Keynesianism: An Unacknowledged Policy Regime’, British Journal of Politics and International Relations 11(3), 382–99.

  Friedman, Jeffrey (2009) ‘A Crisis of Politics, not Economics: Complexity, Ignorance, and Policy Failure’, Critical Review, 21(2–3), 127–83.

  Gallup (2011) ‘In U.S., 46% Favor, 40% Oppose Repealing Healthcare Law’, 7 January, www.gallup.com.

  Hall, Peter A., and David Soskice (eds) (2001) Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (New York: Oxford University Press).

  Jablecki, Juliusz and Mateusz Machaj (2009) ‘The Regulated Meltdown of 2008,’ Critical Review, 21(2–3), 301–28.

  James, Harold (2009) The Creation and Destruction of Value: The Globalization Cycle (Cambridge, MA: Harvard University Press).

  Lindblom Charles E. (1977) Politics and Markets: The World’s Political and Economic Systems (New York: Basic).

  Posner, Richard (2009) A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression (Cambridge, MA: Harvard University Press).

  Stiglitz, Joseph (2010) Freefall: America, Free Markets, and the Sinking of the World Economy (New York: W.W. Norton).

  Taylor, John B. (2009) Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis (Stanford, CA: Hoover Institution Press).

  Wallison, Peter J. (2009) ‘Cause and Effect: Government Policies and the Financial Crisis’, Critical Review, 21(2–3), 365–76.

  Part I

  The Causes and Consequences of the Crash

  2

  Was there Ever an Anglo-American Model of Capitalism?

  Wyn Grant

  When the Obama administration and Cameron government took office, their principal challenge was dealing with the aftermath of the global financial crisis (GFC). They had to deal with a range of potentially contradictory objectives. An overriding priority was to prevent a ‘second wave’ of the GFC which could fatally damage already weakened institutions and the whole model of Anglo-American capitalism. Quite what this model was and how it influenced decision-making after the crisis is a central theme of this chapter.

  Beyond the task of seeking to prevent a renewed crisis in the financial system, which required effective coordination between countries through arrangements such as G20, the two governments had more immediate domestic tasks to tackle. Both countries had substantial budget deficits, but taking drastic action to eliminate the structural budget deficit, largely through public expenditure cuts and the initiation of a new age of austerity, was a more central concern for the Cameron government. Because of the continuing status of the dollar as an international reserve currency, American governments can print money to help fund their deficit. This, of course, can have an inflationary effect elsewhere in the world, which is exactly the complaint of China against the United States.

  Both countries faced the dilemma of how to grow out of the recession induced by the global financial crisis. The Cameron government was criticized by the retiring head of the Confederation of British Industry (CBI), Sir Richard Lambert, for not having a coherent growth strategy to match its deficit reduction strategy. The last quarter of 2010 saw a 0.5 percent fall in gross domestic product (GDP) in the UK, although this was largely the result of exceptional winter weather. The Obama administration had been more willing to commit large sums of public money to prop up American companies in danger of failing, particularly in the motor industry. However, unemployment in the US remained at a stubbornly high level, even higher than in the UK. By the beginning of 2011, there were signs of returning consumer confidence in the US, but it remained very fragile in the UK, not least because of falls in real wages and a fear of unemployment.

  The UK also faced persistently high levels of inflation, well in excess of the Bank of England target. In part this was a consequence of the depreciation of sterling after the GFC, which did help to boost exports, but it also reflected rising world commodity prices, notably of cotton, food and oil. However, there were also domestic factors at work. It was possible that the output gap was less than had been estimated, meaning that there was less spare capacity to take up as the economy recovered. The effectiveness of the Bank of England’s Monetary Policy Committee (MPC) was called into question. The Bank had been pumping money into the economy through quantitative easing and was fearful of increasing interest rates and choking off any recovery, but it faced increasing pressure to take action to bring inflation under control. There was a concern that if consumer expectations
of higher inflation became entrenched, this would feed through to wage settlements, triggering spiraling inflation. Of course, such inflation would have the by-product of reducing the debt burden.

  Both countries therefore faced a series of difficult short-run challenges, although given the election timetable, the Obama administration had a more pressing electoral imperative to restore the economy. The Cameron government took the view that pain inflicted in the first two years of its period in office would be offset by the benefits of a recovering economy later. However, in the medium term, the Cameron government faced a likely increase in the ‘misery index’, the sum of the rate of inflation and the rate of unemployment. In the US there were prospects that the misery index would ease. Short-term pressures aside, both governments operated in economies that were characterized as ‘Anglo-American’. In what ways did this model constrain and shape their objectives and policies?

  The Anglo-American model

  Any Anglo-American model of capitalism is a construction of reality undertaken for a variety of purposes. As Andrew Gamble (2003, p. 87) reminds us, it ‘is a political space, an “imagined community”’. Opponents of what they see as an Anglo-Saxon model of capitalism may exaggerate its coherence in order to construct an account of what it is they are opposed to. The model of capitalism is nested in a wider set of relationships and narratives: ‘It is a military alliance, a model of capitalism, a form of government, a global ideology and a popular culture’ (ibid., p. 86). One form of discourse in particular has been associated with this model: ‘Globalization from its inception has been predominantly an Anglo-American discourse and an Anglo-American project’ (ibid., p. 104). One immediate reaction to the GFC was that it heralded the end of globalization, but despite a short-run fall in levels of world trade, the paradigm displayed considerable resilience.

  The essential features of the model include a primacy of the market over the state with the state performing a largely enabling role: ‘removing the barriers to free market exchange and sustaining the institutions which could define and defend individual property rights’. This role in turn gives rise to the salient characteristics of the model: ‘in particular its voluntarism and short-termism, as well as the liberal character of its welfare system and corporate governance, and the relative importance of its financial institutions, particularly its stock markets’ (ibid., p. 105).

  In any model such as that provided in the ‘varieties of capitalism’ literature a basic methodological criterion is that the within-category variation should be exceeded by the between-category variation. In Terrence Casey’s attempt to construct a comparative capitalism index, ‘the usual liberal suspects’ including Britain and the United States ‘hover in the lower left’ (Casey, 2009, p. 269). However, ‘These figures show a greater variation among Anglo-Saxon economies than their European counterparts’ (ibid., p. 270).

  One escape route is to portray the UK as a hybrid model so that ‘in much of the literature concerning international economic positioning the United Kingdom is still treated as an entity balanced somewhere between America and Europe, reflecting both political orientations but also a still recognisably European welfare system’ (Coffey and Thornley, 2009, p. 2). In the interests of parsimony, this chapter does not consider the welfare system: its focus is on the economy. In a broad strategic sense, ‘the purpose of the special relationship was to allow Britain to act as a broker between the United States and Europe’ (Gamble, 2009, p. 98). A hybrid political economy could, however, be seen as a sign of weakness rather than strength (Gamble, 2010a) in so far as it tries to bring together incompatible principles.

  One response to the question what variety of capitalism is British capitalism is to state that ‘the most reasonable short answer would have to be that it is a very complex one’ (Coffey and Thornley, 2009, pp. 152–3). This may be a correct assessment, but it is an inherently unsatisfactory one. Societies and economies are complex and are possibly becoming more so, but it is the task of social scientists to try and order that complexity so that we can better understand it. Such understandings will be contested and rightly so. However, we need to stand back from that complexity to see if there are patterns that we discern that can enable us to provide some coherent account of the processes at work.

  To be fair to Coffey and Thornley, following work by David Coates they argue that ‘the United Kingdom has managed to sit somewhere between America and Europe, while scoring poorly on both comparisons. The British variety of capitalism may therefore be a complex one, but it is not impressive’ (ibid., p. 153). Perhaps so, but some of the European examples are not particularly impressive in terms of rates of growth or levels of unemployment.

  The broad argument presented here is that the UK does conform to a liberal model of capitalism, not least in terms of the centrality and mode of organization of the financial services sector, but that the terrain in Britain is more contested than in the US. This is for two main reasons. First, when the British model is under pressure, as in the GFC, there is an alternative model that can be resorted to in a way that is not possible in the United States, or at least has not been possible since the days of the New Deal. This is what might be termed ‘the dirigiste temptation’. The reference to dirigisme is deliberate because it is France that is often turned to for an alternative model in such circumstances.

  Second, Britain is a member of the European Union (EU). Gamble (2003, p. 230) is unambiguous in seeing this as the direction of travel: ‘The most promising future governing strategy for Labour would be to embrace Europe both as a model for capitalism and for welfare and democracy.’ The Coalition government has placed an emphasis on a different route to either Atlanticism or one Europe, seeing emerging countries such as India with their growing middle class as an outlet for British exports and diplomatic and political assets have been deployed in that direction.

  One has to be careful about what means by Europe (or America for that matter). As subtle a writer as Gamble recognizes (ibid., p. 220) that ‘Europe and America are not monolithic, but highly complex and differentiated political spaces. There is not one Europe or one America but several, and the differences between liberal and conservative America, or between social democratic and conservative Europe are wide.’ The EU operates the highly interventionist and protectionist Common Agricultural Policy, and espouses ‘European champions’, but it also has a state aids policy which has been used to curb interventionist excesses during the global financial crisis.

  The United States is, of course, a federal state and this has permitted individual states at various times to take their own initiatives to attract foreign investment, to improve training or to promote employment, although depleted state coffers have made this more difficult in the recent past. The UK has devolved administrations and the Scottish government in particular is enlarging the political space in which it can operate and is more prone to interventionist responses. It has created agencies to stimulate innovation in the Scottish economy such as Scottish Enterprise, Scottish Development International, and the Scottish Investment Bank. The latter body has, however, been slow to start work, its budget is £150 million and it has reportedly been engaged in turf wars with Scottish Enterprise. Over time this Scottish political space is likely to become more significant, particularly if significant fiscal powers are devolved, but the analysis here focuses on the UK as a whole. That requires an historical analysis of how understandings of the government-business relationship in Britain have developed over time.

  The dirigiste temptation

  The First World War and its aftermath

  Before the First World War what was perceived as an increasing challenge to Britain’s economic hegemony drew a protectionist response. (Williams, 1896). The First World War brought a number of businessmen into government and thus gave the political class a new dimension through the formation of a network of ‘industrial politicians’ who had experience of both business and government. At the end of the war, the ‘productioneers’ mo
vement, associated with such figures as Dudley Docker, the founder of the Federation of British Industries, and Christopher Addison, the Minister for Reconstruction, sought to take British economic policy down a new path, aimed at creating a high-wage, high-output economy with a measure of government intervention and an emphasis on co-operation between employers and labor (Davenport-Hines, 1984).

  The First World War shook up traditional approaches to economic management but ‘despite the advances in industrial techniques achieved in consequence of state intervention, and a full appreciation of the competitive power of German and American enterprise, state-sponsored modernization was stillborn’. In explaining the failure of industrial reconstruction, ‘historians have traditionally cited the post-war resurgence of political and economic orthodoxy as evidence of an unshaken faith in the pre-1914 liberal order’ (Kirby and Rose, 1991, p. 21). The explanation is more complex than the resurgence of a formerly dominant discourse. Once Germany had been defeated, reconstruction as a discourse which found institutional expression in the Ministry of Reconstruction was displaced, particularly if it could be presented as an advocacy of adopting the methods of the defeated foe. Macmillan (1933) later tried to revive the discourse of reconstruction, but with no perceptible effect on the debate at the time.