The Formerly Advanced Economies

by Robin Hahnel

Just as the European settler economies in North America grew to eclipse the economic power of “Old” Europe during the twentieth century, at least some of the BRICS – Brazil, Russia, India, China, and South Africa – were already on a trajectory to rise relative to both North America and Europe in economic power during the twenty-first century. However, a natural process that would have taken five decades or more may now be shortened to only a decade or two as the elites in charge of economic policy in the North Atlantic region seem hell bent on committing economic suicide.

During the twentieth century it was common to distinguish between the “advanced” or “more developed” economies, and the “under” or “lesser developed” economies. Soon it may become commonplace to refer to Europe, the US, and Canada as the formerly advanced economies. What follows is a brief anatomy of econo-cide being committed by ruling elites in a region which long dominated the global economy but soon no longer will.

Escalating Inequality

What most distinguishes more advanced from less advanced economies is the size of the middle class. During the middle third of the twentieth century political victories by progressive movements raised a significant portion of the workforce to middle class status in Europe, the US, and Canada as productivity gains from new technologies and expansion of education were more widely shared than ever before. Unfortunately, this trend came screeching to a halt at the end of the 1970s, and ever since we have experienced the most dramatic increase in economic inequality in world history. Not only is this terribly unfair, it has also proved to be destabilizing.

When wages rise along with increases in productivity, demand for goods and services, and the labor to make them tends to keep pace with productive capabilities. But when the top 1% appropriate the lion’s share of productivity gains, as they have now for over thirty years, more and more income goes into purchasing assets rather than more production, creating two problems: Unemployment – which further aggravates the lack of demand for production -- and asset bubbles -- which eventually burst, destroying illusions of wealth.

Financial Deregulation

Whatever one may think about the pros and cons of markets in general, there should be no doubt that free market finance is an accident waiting to happen! Theory predicts it, and history has proved it time and time again. Whenever the financial industry is allowed to do as it pleases it will engage in activities that increase their leverage and are highly profitable for them, but create ever greater “systemic” risk for the rest of us. Only when the financial industry is subject to competent regulation can the risk of financial crises be reduced to socially acceptable levels.

In the aftermath of the financial crisis of 1929 which triggered the Great Depression, governments in the North Atlantic region imposed competent regulations on their financial industries which produced decades free from major financial crises in our advanced economies. But the financial industry predictably chafes under regulation since restrictions prevent them from engaging in activities they know to be highly profitable. So the financial industry constantly searches for ways around existing regulations and lobbies politicians relentlessly to remove restrictions. And the more successful they are, the more profits they have to ply the political system to further de-regulate their activities. As a result, eighty years after the crash of 1929 the financial system in the North Atlantic region was once again an accident waiting to happen.

However this time there was one big difference. Instead of a massive financial crisis giving rise to successful political efforts to erect a competent regulatory system to prevent recurrence, Wall Street’s influence with both major political parties was so great that it easily forestalled meaningful regulatory reform. The Dodd-Frank “Wall Street Reform and Consumer Protection Act” was neither. Instead it was a toothless fig leaf providing cover for politicians but no real protections. Three years after the crash of 2008 systemic risk in the financial system is just as great as it was before, consumers of financial services are still without effective protection, and taxpayers are still “on the hook,” as former Treasury Secretary Hank Paulson put it when explaining to Congress in November 2008 that the big Wall Street Banks were too big for the rest of us to allow them to fail.

Ignoring Keynes at Our Peril

Paul Krugman summed it up well in his New York Times column on December 29:

Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way. Unfortunately, in late 2010 and early 2011, politicians and policy makers in much of the Western world believed that they knew better, that we should focus on deficits, not jobs, even though our economies had barely begun to recover from the slump that followed the financial crisis. And by acting on that anti-Keynesian belief, they ended up proving Keynes right all over again.

In futile attempts to reduce deficits, the Tory government in the UK and the Conservative government in Canada have subjected their own middle and lower classes to crushing fiscal austerity. Hard line fiscal conservatives in power at the European Commission and European Central Bank have visited even more draconian austerity policies on the citizens of the so-called PIGS – Portugal, Ireland, Iceland, Greece, and Spain – in exchange for financial bailouts that have proven time and time again to be too little, too late. Germany, sheltered from unemployment by favorable trade surpluses with the rest of the Euro Zone, steadfastly refuses to engage in fiscal stimulus. And when Obama aided his mortal Republican enemies by pivoting from an inadequate fiscal stimulus in 2009 to deficit reduction in 2010 the entire North Atlantic economic region was united in fiscal austerity. Unfortunately, what was, and still is desperately needed is exactly the opposite – fiscal stimulus!

When consumers are tapped out, when businesses have little reason to invest in new plant and capacity since they can’t find customers to buy what they are already producing, government needs to step up to the plate and provide the necessary demand for goods and services to get the economy going again. That was Keynes’ great truth. Instead, ruling elites in the North Atlantic region have united to reject the advice of Keynes and instead repeat Herbert Hoover’s mistake. Instead of fiscal stimulus they are giving us ever more draconian fiscal austerity. This, more than any policy failure, has the North Atlantic region on the road to recession and mass unemployment without end. As a result, for the first time in many generations citizens of the formerly advanced economies are left to ask ourselves: “How does it feel/ To be on your own/ With no direction home/ Like a complete unknown/ Like a rolling stone?”

Robin Hahnel is Professor of Economics at Portland State University. His most recent book is Economic Justice and Democracy and he is co-author with Michael Albert of The Political Economy of Participatory Economics. This column originally appeared in Portland's 'Street Roots' newspaper and exclusively available online at NLP.

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First published: 07 February, 2012

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4 Comments on "The Formerly Advanced Economies"

By Patrick Chalmers, on 07 February 2012 - 10:46 |

This is interesting, of course, but what about the question of unsustainable debt, which this article doesn’t address?

Keynes or Hoover is one thing but where does either leave the question of fractional reserve banking and its endless creation of debt piles that subsequently collapse? This, coupled with uncontested notions that our economies must “grow”, is what has put our planet’s resources under so much pressure. We need to rethink our money systems, not argue over these two men’s conflicting visions for growth.

Keynes did of course address money systems though you haven’t mentioned that here.

Inequality levels are widening, definitely and alarmingly. Adopting the Keynes remedies you specify should not be anything more than emergency room treatment.

I sense you’re shying away from suggesting parecon solutions as the longer-term remedies here. Is that right?

By Robin Hahnel, on 07 February 2012 - 22:18 |

(1) On Debt: Some of the international debt out there right now is unsustainable. In the case of Ireland and Greece, for example, much of it should be cancelled and the bondholders should be forced to take the loss. Not only is this the only equitable solution, it is the only practical solution. However, much talk of unsustainable debt as a rationale for reactionary fiscal austerity is fear mongering. The US debt is sustainable. Even the UKs debt is sustainable. One indication of whether or not a government’s debt is sustainable is what interest rates private capital markets are requiring to finance it. In the US deficit financing has seldom been cheaper than it is right now! I’m not sure what current interest rates on UK treasury bonds are, but I don’t believe the UK is facing the rates that Greece, Ireland, or Spain are. (Which mostly has to do with the fact that the UK still has its own currency, and bondholders know it can print it up to pay bondholders off if worst comes to worst, and therefore will never default, whereas all the PIGS facing unsustainble interest rates cannot print up money.) (2) There is no such thing as banking that is not fractional reserve banking. So if you want private banks at all you must be prepared to put up with fractional reserve banking. I am more than ready to fire the entire private financial sector, including all the privately owned banks, and take them over to be run as public banks and financial institutions. I’m sure as public enterprises they could perform their only useful social function which is to channel savings safely into the most social productive investments far better than Wall Street has. But unless we are going to eliminate banks we had better subject them to competent regulation—which is what Keynes said on this subject. (3) Many reforms are bandaids. Many reforms provide serious relief. Mild Keynesian reforms would barely take us back to the 1970s, which is not nearly good enough, and obviously does not provide any permanent protection against neoliberalism rising again. That’s why we need to eventually go beyond reforming capitalism and instead replace it altogether. (4) For what it’s worth:  I feel more sure than ever that there IS a viable and highly desirable replacement for capitalism—including social democratic, Keynesian, capitalism. Moreover, I’m more sure than ever that the replacement should look more like participatory economics than some verison of market socialism, some version of “community based economics,” or some less coherent version of democratic national planning. In this context I see the elements of what is now called “the new economy” as part of a helpful and necessary transition to a new economic system something along the lines of participatory economics.

By Patrick Chalmers, on 08 February 2012 - 17:38 |

Thank you Robin - a very thorough set of answers.

With regard to fractional reserve banking/banking plain and simple the question concerns the inevitable bubble effect of taking a handful of dollars in deposits to lending out several times that amount in loans. Conventional thinking about our whole economic edifice demands a return on capital invested, usually at rates far exceeding government bonds, which means the deepening pool of money created by bank landing puts unsustainable and ever-increasing pressure on real-world resources. The evidence is there to see in species extinctions, resource depletion and habitat destruction.

Private banks, or more specifically those beholden to private owners/shareholders, are obliged to maximise their returns those shareholders. They are under greatest pressure to pump out the loans and crank up the money production. Government treasuries busy with their money printing are causing much the same sort of damage. Public banks, at least, could be run so as to have far broader aims than that, not to say that anyone’s doing that. Public or private, I’m not sure it’s wise to have any system of money creation that works in this way. We need alternative thinking on money creation, systems that aren’t designed for boom and inevitable bust.

By Robin Hahnel, on 09 February 2012 - 19:40 |

I know it is now popular on the left to finger “fractional reserves”—which is to say banking—and central bank money creation for all our woes. In truth, banks and economists have only themselves to blame for this. It is true that the behavior of banks DOES bear a major responsibility for creating the conditions for, and then triggering our present economic crisis. It is true that central banks have engaged in endless bailouts of major banks at taxpayers’ expense without demanding needed quid pro quo changes in their behavior. And it is true that mainstream economists have worked overtime to systematically root out common sense economic wisdom from the profession, leaving an empty vacuum to be filled by amateurs.

However, most of what amateurs are writing about fractional reserves and money creation these days is, to be blunt, pure poppy-cock. The global economy is not on an environmentally unsustainble trajectory BECAUSE of fractional reserve banking and central bank money creation. The primitive notion that in a finite world nothing can grow without limit —and therefore limitless pursuit of profit (which is what all capitalist companies pursue, not just banks) and a constantly growing money supply must be what is damaging the environment—is just that—primiitive and highly misleading.

There is an unhealthy and environmentally damaging growth imperative in our global capitalist sytem. And the financial sector is right now a particularly disfunctional part of that global capitalist system. But we are on a trajectory to commit ecocide because of deep seated biases in the defining institutions of capitalism—private enterprise and markets—not because we have fractional reserve banking and central banks increase money supplies. What is putting the natural environment at risk are biases against leisure in favor of consumption, biases against collective consumption and in favor of individual consumption, biases favoring production and consumption of goods with negative external effects and against goods and services with postive external effects.

Don’t get me wrong: The financial sector has been permitted to go berserk and unleashed incredible additonal destruction. And nationalizing the financial sector would be good policy. But publicly owned banks would still loan out some of their deposits and therefore keep only a fraction of their reserves on hand—just as publicly owned and operated “development” banks have always done. The difference, hopefully, would be in what kinds of loans publicly owned banks would make—loans for socially productive investments instead of speculating on asset bubbles. And the difference would hopefully be that absent pressure from stockholders to increase profits by increasing leverage publicly owned banks would have no difficulty keeping sufficient reserves and capitalization to operate safely. The difference would NOT be that publicly owned banks abandoned fractional reserves which is synonymous with banking of any kind.

Moreover, right now what is needed from the ECB if Europe is to recover from its recession rather than decend into a nasty double dip, is expansionary monetary policy. When leftists argue that when governments print money they also lead us to ruin they only add fuel to reactionary arguments for terribly counterproductive monetary austerity.

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