The elegant escape from reality

[written prior to the first G20 meeting to establish anti-crisis measures, March 2009]


'[O]ur most prestigious form of fraud, our most elegant escape from reality...' This was how J.K. Galbraith characterised the idea that a central bank has any ultimate control over the vicissitudes of a modern economic system. His argument is simple, and even verges on the self-evident: interest rates have no discernible effect on the fluctuations of the economic cycle; when times are good, firms borrow money to satisfy demand, reasonably assured of making a significant profit, whereas in a slump or recession, no matter how 'cheap' money is, firms will not borrow it to expand an output for which there is simply no demand. Likewise, although lower interest rates take the edge off a recession for mortgage holders, the amount of capital thus released is effectively negligible, as is the consumption it enables.

He cites as example the inability of the FED, since its inception just before the First World War, to effect any serious change in the financial cycle. Recessions come and go according to their own elemental logic, and at the end of each one the FED claims praise for once again saving the economy; this despite the fact that, for Galbraith, its actions rarely transcend a profound inconsequence.

It could be argued that this case is overstated. But the central point is one worth making: the idea that anything as complex and inscrutable as the financial system can be 'managed' by a small group of establishment academics is absurd, and belongs 'not to the real world, but to that of hope and imagination'. With an ironist's flourish, Galbraith concludes that the FED's impotence is, in fact, so irrelevant that we could simply tolerate it as a comforting mythology.

Galbraith's arguments are given considerable weight by the instrumental role he played in American economic and political life for much of the Twentieth Century, not least as president of the American Economic Association. Another insider turned apostate who raised his voice against the economic establishment is Joseph Stiglitz, onetime head of the World Bank. In his Globalisation and Its Discontents ('Over 1 million copies sold worldwide!') he attacks the idées fixes of the so-called Washington Consensus, particularly as they are forcibly applied by the IMF in developing countries.

These ideas basically constitute an overzealous emphasis on liberalisation, privatization and fiscal austerity. Stiglitz' key argument (by now well known) is that the deployment of a 'one-size-fits-all' approach, as exemplified by IMF policy, is inevitably destabilising, particularly for developing countries in the grip of recession.

Stiglitz and Galbraith both foreground the dual consequences of a centralised, universalising tendency in economic policy. The first of these is the sense of security, if not arrogance, generated by the idea that a small group of experts are capable of controlling and understanding how money works. For Galbraith, in the example of the FED, this is a more or less harmless predilection: if the FED can't do anything anyway, then where is the problem if people give its pronouncements credence? For Stiglitz, however, this feeling of omniscience is the root of the deeply damaging effects of the IMF. He cites example after example of countries whose financial situations have been worsened by the IMF's bullying demands for 'reform'. He makes the point that the IMF is so steeped in a particular vision of economic success (i.e. that of America and Europe) that it cannot envision other possible factors or approaches to development: in fact, it denies developing countries the sort of possibilities (such as import tariffs or government control of banks) which were the sine qua non of the West's own development. This leads us to the second key criticism of over-centralised economic policy: it simply doesn't work. In the case of the FED, this results in a marked inconsequentiality. The IMF, however, is arguably the most powerful and influential global financial institution, and it has a concomitant capacity to do profound damage. Thus, if its policies 'don't work' - as they didn't during, say, the Asian economic crisis of the late 1990s - they can affect the lives of hundreds of thousands of people.

The failure of the Doha Round of trde talks amply illustrated both of these tendencies. The talks failed to effect any meaningful reform of global trade precisely because the richer countries would not put in place the same changes as they were demanding of developing countries. It is ironic that in the context of the current crisis, protectionism is being cited as the greatest possible economic evil, when the Doha Round and its predecessors furnish copious examples of the most craven, self-interested protectionism since the 1920s. Perhaps it is acceptable when what are protected are the interests of the developed world against those of poor countries.

Stiglitz' recommendations for reform are, again, more or less self-evident. The IMF (not to mention the World Bank) should devote more time and attention to tailoring its prescriptions to the country in hand. It needs to explicitly acknowledge the failure of the doctrine of 'shock therapy', and accept that for some countries development must be gradual, and based on individual sectors - in a word, bottom-up. It needs more people on the ground. As the volume of calls for reform of the IMF increases, and a reformulation of the Washington credos seems increasingly likely, it remains to be seen whether world leaders will take meaningful steps in this direction.

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But don't hold your breath. In advance of next week's G20 meeting the finance ministers of participating countries produced a joint statement (http://www.g20.org/Documents/2009_communique_horsham_uk.pdf) in which the usual calls are made for co-ordinated action to resuscitate the world economy through interest rates cuts and increased government spending, and a strengthening of international banking regulations urged (cue Private Eye headline: 'G20 - BROWN PROMISES NEW STABLE DOOR').

The notion of a global reform of banking regulations is manifestly unworkable, and will result in nothing more than such cosmetic, crowd-pleasing gestures as the abolition of tax havens. The USA would never accept an external body dictating its most intimate financial policy, any more than, say, China would. And consider the EU: in recent months, the majority of EU leaders have taken to making deadpan assurances of fidelity in front of the cameras and one another's faces, whilst shamelessly instigating protectionist measures behind the European Commission's back (Sarkozy's offer of subsidies to homecoming French car makers being not even a particularly egregious example). Clearly, each of the 'old' European states hopes the others will subsume their autonomy to centralised control, leaving them free to pursue their individualist course.

If such a homogenous and well-established grouping as the EU cannot agree on a common ground at the first whiff of a recession, then to think that the global finance system could be brought to heel is, to repeat, absurd. And here we come to the second main thrust of the ministers' manifesto: the amplification of the IMF's funding and influence. This is something that can be achieved relatively painlessly, and with a semblance of unanimity. What it won't do, however, is change anything. Just ask the Russians.

No-one would argue that a globally coherent financial system is not desirable, or that trade should be ghettoised, or protectionism allowed to run riot. But as world leaders clog the front pages with talk of 'a new financial order', lessons learnt from previous failures of totalising economic reform programs should not be forgotten. The Asian crisis, and the IMF's manifest failure to prevent or alleviate it, or even to identify its causes, must be at the front of every leader's mind; pumping money at the IMF does not constitute a vision of reform, and will fool no-one.

The present crisis was provoked by a monumental failure to see beyond the shiny surface. If the G20 is to do anything meaningful, it must avoid another such escape from reality, however elegant it may seem.