Governments must take charge where markets have failed
March 6, 2009
From time to time in human history there occur events of seismic significance, when one orthodoxy is overthrown and another takes its place.
Today, the scale of the financial crisis demands that we re-evaluate the economic policy and philosophy that brought us to this point.
Investor George Soros has said that "the salient feature of the current financial crisis is that it was not caused by some external shock; the crisis was generated by the system itself". Soros is right.
This crisis is the culmination of a 30-year domination of economic policy by a free market ideology that has been variously called neo-liberalism, economic liberalism or economic fundamentalism.
The central thrust of this ideology has been that government activity should be constrained, and ultimately replaced, by market forces.
In the past year we have seen how unchecked market forces have brought capitalism to the precipice. Instead of distributing risk throughout the world, the global financial system has intensified it.
Neo-liberal orthodoxy held that global financial markets would self-correct - the invisible hand of unfettered market forces would find their own equilibrium.
But as economist Joseph Stiglitz has caustically observed: "The reason the invisible hand often seems invisible is that it is not there."
Just as it fell to former president Franklin D Roosevelt to rebuild US capitalism after the Depression and to the US Democrats to rebuild post-war domestic demand, to engineer the Marshall Plan to rebuild Europe and to set in place the Bretton Woods system to govern international economic engagement, so it falls to a new generation to reflect on and rebuild our economic systems.
If centrist governments are to save capitalism they face three challenges.
First, to use the state to reconstitute properly regulated markets and rebuild demand. With the demise of neo-liberalism, the role of the state has been recognised as fundamental.
The state has been the primary actor in rescuing the private financial system from collapse, in providing direct stimulus to the real economy because of the collapse in private demand and in the design of a regulatory regime where the government has ultimate responsibility to determine and enforce the rules.
The second challenge for social democrats is not to throw the baby out with the bath water. As the crisis unfolds and the impact on jobs is felt by families across the world, the pressure will be great to retreat to a model of an all-providing state and to abandon open, competitive markets.
Protectionism has begun to make itself felt, albeit in softer and more subtle forms than the crudity of the Smoot-Hawley Tariff Act of 1930.
Soft or hard, protectionism is a sure-fire way of turning recession into depression as it exacerbates the collapse in global demand. Social democracy's claim to political legitimacy is its capacity to balance the private and the public, profit and wages, the market and the state.
That philosophy once again speaks with clarity and cogency to the challenges of our time.
Another challenge is the almost unprecedented global dimensions of this crisis. Governments must craft consistent global financial regulations to prevent a race to the bottom, where capital leaks out to the areas with the weakest regulation.
We must establish stronger disclosure standards for systemically important financial institutions. We must also build stronger supervisory frameworks to provide incentives for more responsible corporate conduct, including executive remuneration.
The world has turned to co-ordinated government action through the Group of 20 leading industrial nations to provide liquidity to the financial system, co-ordinate sufficient fiscal stimulus to respond to the growth gap arising from the recession, redesign global regulatory rules and reform global public institutions to provide them with the powers and resources necessary for the demands of the 21st century.
The governance of the International Monetary Fund must be reformed. If we expect fast-growing developing economies such as China's to make a greater contribution to multilateral institutions, they should gain a stronger decision making voice.
The longer-term challenge is to address the imbalances that destabilise the global economy - in particular, the imbalances between large surplus economies such as China's and large debtor nations such as America.
The magnitude and global spread of the crisis means that minor tweakings of long-established orthodoxies will not do. Two unassailable truths have already been established - that financial markets are not always self-correcting or self-regulating and that the government can never abdicate responsibility for economic stability.
For governments, it is critical that we get it right - not just to save the system from self-destruction but also to rebuild confidence in properly regulated markets.
Governments must get it right because the stakes are so high - there are the economic and social costs of long-term unemployment, poverty again expanding across the developing world and the impact on long-term power structures in the international order.
Success is not optional. Too much rides on our ability to prevail.
This is an edited extract from an essay by Prime Minister Kevin Rudd of Australia, published in the Australian magazine The Monthly
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