This is the provocative question that Martin Wolf poses in a recent commentary in the FT, reflecting on an essay by former IMF Chief Economist, Simon Johnson, which compares the crisis in the US to past financial crises in emerging economies.
In ‘The Quiet Coup’ Simon Johnson points to several striking similarities: profligate spending by the elites, massive pile-up of national debt, and elite capture of government demonstrated in the bending of regulatory systems in their favour. Pat Oliphant’s cartoon in yesterday’s International Herald Tribune is a stabbing illustration of this view:
Here is his description of the typical emerging economy financial crisis:
Typically, these countries [seeking IMF assistance] are in a desperate economic situation for one simple reason–the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit–and, most of the time, genteel–oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon–correctly, in most cases–that their political connections will allow them to push onto the government any substantial problems that arise.
Substitute Wall Street for the Russian oligarchy and you get a compelling narrative of the unravelling of the financial crisis in the US.
Johnson points out that between 1973 and 1985 the financial sector never earned more than 16% of domestic corporate profits but by the 2000s this figure reached a staggering 41%. Refreshingly, Simon Johnson doesn’t indulge in the invective ridden mud-slinging between left and right or in the kind of fat-cat bashing that has become a national sport in America. Instead he looks at structural and cultural factors which led to the ascendance of a financial elite so powerful that it came to dictate policy – not directly through corruption or coercion, but indirectly by spreading a belief in the wisdom and foresight of unfettered markets. Particularly interesting is Simon Johnson’s insights in to the way Wall Street culture spread to Capitol Hill – with an effective revolving door operating between the two spheres. This was lent further intellectual legitimacy by a raft of academics personally vested in the promotion of that culture. The assumption took root that whatever was good for Wall Street was good for the American economy, by definition. As Simon Johnson explains:
From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:
• insistence on free movement of capital across borders;
• the repeal of Depression-era regulations separating commercial and investment banking;
• a congressional ban on the regulation of credit-default swaps;
• major increases in the amount of leverage allowed to investment banks;
• a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement;
• an international agreement to allow banks to measure their own riskiness;
• and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.
The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights.
Although I believe he rather underplays the significance of housing policies in setting the stage for the mortgage crisis, Simon Johnson makes a very valid and important point about the need to apply some anti-trust medecine (surgery?) to the financial sector. His answer to the current mess is very much in sticking with America’s trust-busting instincts: break up the financial oligarchy:
Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. […] Ideally, big banks should be sold in medium-sized pieces, divided regionally or by type of business. […] this may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole.
This is exactly the kind of medicine that was prescribed to – or rather forced upon – emerging economies by the IMF with the US’s full backing. Paraphrasing Joseph Schumpeter, Johnson comments that ‘everyone has elites; the important thing is to change them from time to time.’ Not surprisingly, he is pessimistic about the US’s economic prospects.
