The Legacy of the Crash

by Terrence Casey

  The new politics of the old politics

  The two previous major economic crises of the last 100 years – the Great Depression and the stagflation of the 1970s – represented fundamental turning points in the political development of both nations. One would have expected a seismic event on the scale of the 2008 crash to shift the political ground more than a bit. There have certainly been unique political turns, some even quite surprising. Nevertheless, based on events so far, there has not been the sort of shift in political order in either nation as experienced in the past.

  Events since 2008 have certainly been shaped by the crash. The crisis secured Barack Obama’s landslide election and created the political conditions for him to pursue an aggressive legislative agenda in the first half of his term. Despite three consecutive victories under Tony Blair, New Labour never quite lived up to people’s expectations. The lackluster leadership of Gordon Brown could not stand up to the political strains of a financial collapse that happened under his watch. Disappointment with Labour produced a sizeable swing to the Conservatives, but even David Cameron’s ‘detoxified’ Tory brand was insufficient to secure an overall majority, leading to a Coalition government. In the United States the backlash against an explosion of government spending and deficits produced the Tea Party movement, its political impact transmitted through the Republican Party, resulting in major gains in the 2010 midterm elections. The political legacy of the crash to date is, in sum, that the United States initially saw a shift to the left and support for more activist policies. However, the fruits of these efforts (the stimulus package, ‘Obamacare’) produced a conservative countermovement, returning the nation to divided government. Polls (summer 2011) indicate that American voters are not enamored with either Democrats or Republicans. With such volatile swings of the political pendulum, it is hard to predict how this will play out in the 2012 election cycle. In the UK voters rejected an ostensively left-wing government (although one which accepted the free market model), but have yet to completely embrace a more conservative regime. The Cameron government’s goal of reducing the deficit (which voters see as necessary) mainly by cutting spending (the specifics of which they often oppose) while reviving the economy (which remains sluggish) leaves them with precarious political prospects.

  Anglo-American politics have not been radically reordered in the aftermath of the crash, yet it is not accurate to suggest that politics has settled back into pre-crisis modes. Electorates are restive, volatile. In itself this is nothing new; trends toward party dealignment and electoral volatility have continued steadily since the 1960s. A new sense of angst among voters opens the possibility for deeper transformation. Some suggest that the failure to reform the political and economic system raises the specter of a turn to more extremist political forces, particularly xenophobic, isolationist, anti-statist movements – the Tea Party on steroids, as it were (Reich, 2011, pp. 79–81; Gamble, 2010, p. 13). For all of the bluster of the Tea Party, though, its main issues (opposition to higher taxes and ‘big government’) are positions comfortably nestled in the Republican camp. The movement shows every indication of following the path of past third-party movements: having its ideas and supporters absorbed into a major political party. The likely vehicles for right-wing radicalism in Britain – the United Kingdom Independence party (UKIP) or the British National Party (BNP) – remain small, marginalized movements that have made no meaningful electoral gains. And while isolationism or protectionism could manifest within the mainstream parties, there simply have not been major figures advocating such an approach to date. One cannot rule out the possibility of so radical a move to the right, but the evidence that such is occurring in Britain and America is relatively minimal.

  Some might suggest that the radical economic right dominated the previous era, so one would expect a strong counter from the left. The great unsolved mystery of post-crash politics is: Where is the left? After decades of retreat the state came roaring back to clean up the aftermath of the crash. The moment seemed ripe for a left-wing revival, and the landslide election of Obama seemed to indicate just that. Once the initial luster of the Obama administration wore off, the American public seemed to reply to his call of ‘Yes, We Can!’ with ‘Yes, But We’d Prefer You Didn’t!’ Having passed his priority health care legislation, and faced with a rising conservative tide, Obama has since retreated to the political center, trying to position himself above the partisan fray. Left-wing Democrats may be disenchanted, but they have nowhere else to go. Under Ed Miliband’s leadership the Labour Party has been able to score only a few tactical victories against the Coalition government and has edged ahead in the polls (July 2011). A strategic vision that would encourage voters to return to the fold remains elusive, however.

  After the sharp ideological conflicts of the Thatcher-Reagan years, the 1990s and 2000s were periods of relative political tranquility. First with Bill Clinton, then with Tony Blair, the major left-wing parties tied their flag to the mast of the Third Way, which accepted deregulated markets as a means of producing the prosperity needed to fund the welfare state. The ‘post-war consensus’ was effectively replaced with a ‘neoliberal consensus’. The major left-wing parties in the UK and US have yet to find their voice in the aftermath of the crisis mainly because to do so would be to repudiate their own past. Colin Hay reasonably argues that in historic terms we are still in early days; the present political conjuncture may in retrospect look more like 1974 than 1979 (Hay, 2011, p. 3). Profound political changes may yet arise which will only acquire meaning after the fact. Again, this depends on how long the recession drags on. Anglo-American politics may yet spin off in unforeseen directions.

  International transformations

  Most of this volume examines the crash in terms of domestic politics. It would be remiss, however, to not briefly discuss the international repercussions. Part of the underlying conditions – the deep systemic causes – for the crisis were the imbalances accumulating in the global economy in the years prior, with some countries (especially the US and UK) running huge current account deficits matched by the growing surpluses of others, both advanced (such as Germany and Japan) and developing economies (especially China, but also India, Brazil, and so on), as well as oil-producing states. What was missing was a means of recycling these surpluses without destabilizing the financial system (Gamble, 2009a, p. 119); China’s ‘savings glut’ begat America’s ‘credit boom’.13 The trillions of dollars flooding into US markets kept interest rates low. Increased demand for assets from international purchasers also produced a proliferation of supply; that is, the US financial sector produced more exotic assets to sell, which proved to be more toxic in the long run (Cabalerro and Krishnamurthy, 2009). The assumption was that the innovation, efficiency, and flexibility of financial markets would be able to absorb these huge cashflows without engendering systemic dangers. That, of course, proved a false hope. ‘In effect, the global imbalances posed stress tests for weaknesses in the United States, British, and other advanced-country financial and political systems – tests those countries did not pass’ (Obstfeld and Rogoff, 2009, p. 4).

  International imbalances have been underemphasized in many explanations of the crash (including in this volume) because they did not develop as pessimists predicted, with a disorderly unwinding of international accounts: transnational credit drying up, the dollar depreciating rapidly, rising inflation, and a sharp increase in interest rates – a classic balance of payments crisis (Blanchard and Milesi-Ferretti, p. 12). Moreover, the crash harmed the surplus states as well, as export markets dried up with the onset of recession. Still, global imbalances helped to create the conditions in which a crisis could develop. Some natural adjustment has occurred since as decreased US consumer spending served to halve the current account deficit from its nadir in 2006. Even though the financial contagion spread from the US, enormous amounts of capital continue to be funneled back into the US through Treasury bond purchases. Both the then prime minister, Gordon Brown,
and President Obama pushed for coordinated stimulus through the G20 and were met with resistance from others, especially Germany’s Angela Merkel.14 The selection of Christine Lagarde to replace the disgraced Dominique Strauss-Kahn as head of the IMF does not indicate an institution ready to reconstitute its organization or mission to deal with a changed global environment. In short, the international conditions that inflated the bubble have not abated, attempts to coordinate orderly readjustment through the G20 have come to naught, and the basic architecture of the Bretton Woods institutions remains unaltered.

  All of this raises a bigger question: Does the global financial crisis represent the end – or perhaps the beginning of the end – of western (and specifically American) global economic and political dominance? Scholars of international politics have long recognized that the late twentieth century saw a shift in power toward East Asia. If the past century was the ‘American century’, this ‘rise of the rest’ may harken a ‘post-American world’ (Zakaria, 2009). The United States entered the twenty-first century as a ‘unipolar’ power, but failed to maintain that status, responding to 9/11 with two wars that, on best outcome, will fall uncomfortably between victory and defeat, and a financial crisis that brought the economy to its knees. The facts remain that the US economy is four times as large as Japan or China, the dollar is the preferred medium of international exchange and investment, and America remains a technological leader. That being said, ‘If the Iraq War and George W. Bush’s foreign policy had the effect of delegitimizing America’s military-political power in the eyes of the world, the financial crisis has had the effect of delegitimizing America’s economic power’ (Zakaria, 2009, p. xxi).

  Power shifts are to be expected in global politics. Economic power shifted decisively and irretrievably from Britain to the United States after the First World War. Then again, the reality and practice of this did not manifest with policy-makers until after the Second World War. US foreign and economic policy in the 1920s and 1930s was narrowly focused, driven by nationalistic concerns, unwilling to make serious sacrifices for the collective good. The consequences were devastating. China today is in a somewhat analogous position. They have not yet supplanted the United States and their ‘inevitable’ rise to dominance suffers from a hint of hyperbole.15 For all of the dynamism of the Chinese economy, it has its own political and economic problems. Rapid development engenders myriad social and environmental disruptions. Corruption is a persistent problem in a Chinese Communist Party whose legitimacy is based on continuous rapid growth. The manufacturing base has yet to fully scale the technological ladder, developing as an assembly platform for products designed elsewhere more than a true creator of products. And despite its spectacular growth, China remains a poor country. Even with that, its power and influence will certainly increase over the next few decades. The big question for the early twenty-first century is whether China will use its newfound position to help stabilize the international system, or pursue more narrowly nationalistic policies.

  China’s economic rise was coincident with the era of globalization in the latter quarter of the twentieth century. Globalization and its relationship to the global financial crisis is a complex phenomenon and a thorough discussion is well beyond the scope of this chapter. Globalization has both cheerleaders and detractors, backed by arguments both legitimate and strained. Since globalization is synonymous with liberalized trade and capital flows, it has always had a strong Anglo flavor. Can globalization continue? Andrew Gamble contends that the greatest danger stemming from the crisis is the potential return to protectionism (Gamble, 2009a). Niall Ferguson sees the symbiotic relationship between these two economies – ‘Chimerica’ as he calls it – as the key to determining the future direction of the global economy. If they fall out, globalization is done for (Ferguson, 2009). Neither side has moved in that direction, but the dangers are evident. America needs to save more and consume less – and stop borrowing money from China to do so. China needs to rely less on exports and promote domestic consumption, reducing the surpluses it has been recycling overseas. Whether leaders in either state have the wisdom or the will to push these systemic needs against domestic pressures is uncertain. Even if so, managing such a transition in an orderly manner is difficult. As the US economy continues to stagnate, the Federal Reserve may feel bound to pursue further quantitative easing. Doing so will exert downward pressure on the dollar. How long will Chinese officials be willing to hold on to tens of trillions of dollars in Treasury bonds if the value of those assets is steadily declining?

  Without a doubt, closer integration into global markets has created positive gains, especially for countries like China, while wreaking havoc in others, such as Thailand in 1997 and Argentina in 2001. But for all that, the most recent era of globalization saw hundreds of millions of people lifted out of poverty. To see that process reversed would be perhaps the most unfortunate legacy of the crash.

  Final thoughts

  At the end of the day, we are left with far more questions than we have confidence of answers. This in itself should not be too surprising. After all, we are only three years out from the crash. Think of someone scanning the horizon in 1932, three years after ‘Black Thursday’ in 1929, trying to chart the course of events 20 years hence – the incredible depths of the Great Depression, the political extremes that this wrought, the cataclysmic world war, and yet ultimately the stunning revival of the western economies. One would have to have been quite the Nostradamus indeed to have foreseen all of that. The contributors to this volume can thus legitimately plead humility and eschew any claim to be able to project the specific contours of the political economy of the UK and the US in 2021 or even 2031.

  As discussed in this volume, the sources of this crisis were many and complex. At root, however, the problem was that too many people – and too many people who should have known better – failed to distinguish between risk, which is probable and measurable, and uncertainty, random events which strain the strictures of homo economicus (Ferguson, 2008, p. 343). Thus when extreme uncertainty entered the system in the fall of 2008, they were ill prepared to deal with it. As Carmen Reinhardt and Kenneth Rogoff (2009) argue in their study of financial crises, the prerequisite for calamity is a sense that ‘it cannot happen here’. Financial leaders and policy-makers had convinced themselves that the sophistication and complexity of financial markets following a diversity of strategies rendered a systemic collapse, in all probability, a very low risk. To the shock and horror of all concerned, it was quickly discovered that the system was not at all diversified; financial actors were, in fact, quite synchronized in their behavior (Rajan, 2005, p. 318). And once the major players started to fall, capped by the collapse of Lehman Brothers, everyone else was dragged down with them. At the very least, then, one would hope that the primary legacy of the crash is to demolish the sense that ‘it cannot happen here’ and that politicians, financiers, and even individual consumers will adjust their behavior accordingly. Then perhaps we can hope it will not happen again.

  Notes

  1. Data from the International Monetary Fund (IMF), World Economic Outlook Database, April 2011.

  2. Data from the IMF, World Economic Outlook Database, April 2011.

  3. Officially known as U-6, this includes total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers.

  4. Data from the US Bureau of Labor Statistics.

  5. Based on the 20-city Composite Case-Schiller Housing Index released in April 2011.

  6. Ironically, many with subprime mortgages escaped the worst. They had put little money into their homes, so when the value plummeted, they just walked away.

  7. High inflation and the Exchange Rate Mechanism prevented interest rates from being lowered in the early 1990s, increasing negative equity and repossessions.

  8. After a Q&A session with David Cameron in Nottingham in March 201
1, Liberal Democrat leader Nick Clegg was caught on a still live microphone telling the PM, ‘If we keep doing this we won’t have anything to bloody disagree on in the bloody TV debates.’

  9. About three-quarters of this debt is in mortgages. Data from the Organization for Economic Cooperation and Development (OECD).

  10. In 1960, UK per capita GDP stood at 108 percent of West German income and 129 percent of France. By 1980 UK per capita GDP had fallen to 87 percent compared to Germany and 91 percent compared to France. The respective figures were 103 percent and 111 percent in 2007. Data from the US Bureau of Labor Statistics.

  11. In 1990, the UK’s GDP per hour worked was 77 percent of France’s, 81 percent of Germany’s, and 87 percent of the EU-15 average. In 2010 those figures were 93 percent, 95 percent, and 100 percent, respectively. Data from the Total Economy Database, The Commerce Board/Groningen Growth and Development Centre (www.ggdc.net).

  12. The Green Party scored the victory of leader Caroline Lucas in the Brighton Pavilion constituency in the last election. But it was the only seat they won. Nationally they only secured one percent of the vote in the 2010 general election, far fewer than UKIP (3.1 percent) or the BNP (1.9 percent).