Capitalism

The Myth of the Prosperity Generating Free Market Has Been Dispelled. It’s Time for a New New Deal.

A visionary concept that provides guidance and direction is required now.

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By Thomas Fricke

The spell worked its magic for three decades. For three decades humanity believed in the blessings that globalization would bring in its wake. It was assumed that in the end everyone involved will benefit when we remove regulations, when corporations become ubiquitous throughout the world, when the banks have lots of money, when tax havens exist, and of course when government stays out of our hair. What prevailed was the primacy of the economy, whether in Herne, New York or Shenyang. It was as simple as that.

But times have changed. Once considered to be the High Temple of market dogma, the mighty financial world was about to collapse ten years ago, before it had to be rescued by – surprise – the rest of us.

What also collapsed was the myth that markets can regulate themselves. Simmering unrest emerged, borne by diffuse fears, half-knowledge and justifiable rejection of what has gone wrong with globalization. It became an opportune time for con men and authoritarians.

We now see a void that cannot be remedied by trying to fix details. What the world needs instead is a new leitmotif, a new guiding concept. We indeed need it before populists of all stripes fill this void by inciting people against each other. Time is of the essence.

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The tremendous power and impact inherent in such a myth was exemplified when Ronald Reagan relaxed banking regulations in 1982. All of a sudden, the Chicago Boys were considered hip. Supply and demand, so they believed, was the key to resolving anything and everything – whether it concerned a shortage of screws, demand for loans, or the desire to get married. Soon the apostles of the free market ruled everywhere, even in France. Mighty authorities such as the World Bank and the International Monetary Fund (IMF) preached the Washington Consensus; i.e. strict market orientation as a new world religion.

For more than a quarter of a century there was no doubt about what is right: The market trumps the state [no pun intended]. What to do with State-owned enterprises? Privatize them. Your pension? Self-provision through the free market. Unemployment benefits? Curtailments. Opening borders for Eastern Europeans? Certainly. And the next free trade round? Of course. And so forth. In the end, even Social Democrats contributed to lowering top tax rates and making hedge funds happy.

In these times a lot of prosperity was generated throughout the world. The Asians were able to sell off their cheap goods everywhere. And the West benefited from cheap clothing from Vietnam and toys from China. Germany enjoyed an export miracle because everyone needed machines made in Germany.

And yet something seems to have gone awry. There is this unease. There is this resentment. There are these downsides.

The reason why world inequality has fallen is due mainly to the fact that so many Chinese and Indians have experienced a rise in income, as was demonstrated by the former World Bank economist Branko Milanović.

The results elsewhere are less evident. Neither have Americans, Britons and Germans experienced faster growth in their economies compared to the decades prior to 1982. Nor were there fewer crises. On the contrary, the IMF has identified more than 120 banking crises and 200 currency crises since then – a dramatic increase.

True, companies make more profits today, but they invest a lower proportion in machinery and jobs than before. This is in part because in a financialized global economy it is more lucrative to speculate. In part because it is more chic to make a quick buck than to think long-term. To sum this up we see $200 trillion in debt generated in the old system.

More importantly, however, the greatest promise has remained unfulfilled: Half of the Americans today have seen stagnating or even significantly lower real incomes since 1989. In Germany, there are 40 percent who are less well-off in real terms, and half of Germans possess practically no wealth. And nearly one in four Germans works for little pay. Such enormous wealth gaps between the rich and the poor existed in the nineteenth century as well.

Depending on the calculation, progress has thus by-passed a third to half of the population. The Americans and Britons were the first to be jolted by this development through the election victories of Trump and Brexit. Ironically it is those very countries who most eagerly followed the mantra of the free markets that are now confronted with Industry 0.0 and social division. Meanwhile, IMF experts are having to concede that capital markets are probably not so efficient after all. And the once orthodox-liberal OECD is only defining growth these days as good growth if it benefits the poor.

The myth of the past has become passé. What is missing is the new, powerful concept.

Economists have begun to understand what went wrong in recent years. Kenneth Rogoff and Thomas Piketty evaluated enormous sets of data pertaining to financial crises and assets. Nobel laureate Angus Deaton reveals in a new study that in the US, the life expectancy of white men is on the decline in precisely those areas where local companies have been displaced. Robert Shiller and George Akerlof have found main reasons that explain why financial bubbles come about systematically in markets.

There is a growing suspicion that it was perilous to allow the economies to be determined by financial wizards who are incapable of foreseeing their own debacles, who follow every fad, who then in times of crises drive governments on before them.

Could this become the core of a new mantra – one that refrains from turning to financial magic for solutions? Possibly. Bonus calculations for managers should no longer be based on share prices, says Nobel laureate Joseph Stiglitz. Investors should be rewarded when they invest in the long term, says Andrew Haldane, chief economist of the Bank of England. And managers should have to pay back bonuses when it turns out that they made a mess of things. In other words, all incentives investing in human resources and machinery.

Many reasons point to the assumption that we would face fewer debts if, for instance, banks were required to provide more funds – especially when it comes to pure financial transactions as well as in times of distorted lending. The Bonn-based economic historian Moritz Schularick found that in the run-up to nearly all financial crises too many loans had been taken out on real estate. This problem could be solved if the loan portion for the purchase of a house was limited to around, let’s say, 50 percent.

And what about the pitfalls of free trade? According to Harvard professor Dani Rodrik, trade agreements in the future will have to be equipped with explicit clauses to enable import restrictions, if necessary. This would be the case, for example, when cost benefits are attributable solely to disregard for human rights in the countries of origin, however, not when the productivity is lower. When it is foreseeable that low-cost competition threatens to devastate entire industries. Thus, far more free trade could be rescued than through Trumpian protectionism, which comes with a high risk of escalation.

Moreover, it would be advisable to clarify what issues in a better world actually demand regulations on a global scale – climate protection would be an example. And in which cases, beyond the crude good vs. evil dichotomy, state government is actually useful. Experts today can determine with much more clarity which investments are worthwhile and which are not. And which expenditures on railroads, schools or research will ultimately bring the finance minister greater return on initial investment because they initiate growth and generate more tax revenues. Such projects could, under strict supervision, be exempted from rules limiting fiscal deficits. This would be a more farsighted approach than formally striving to balanced budgets every year. The innovation researcher, Mariana Mazzucato, has demonstrated how strongly government agencies have enhanced the development of technologies without which devices like the iPhone would not exist: A good reason to start making those dull authorities more attractive to top researchers.

Some of these ideas have already matured, others are still in their inception stage. What we need to find is a unifying formula to define the new paradigm: the leitmotif.

Finding it is a tremendous challenge. It cannot be as simple as the market-works-wonders formula. Yet it must be simple enough to make it plausible to everyone. The solution probably lies somewhere in the middle: in a better controlled, enlightened globalization that can do without the compulsion to standardize everything throughout the world. What is needed is a new balance of liberties with built-in safeguards against excesses. And an environment in which politicians can again shape and decide on policies instead of rescuing banks or states without having much choice in the matter.

This requires an economy that is more dynamic and innovative than in the imposter years – for the very reason that more money will flow into real projects and that higher incomes will increase sales. A good 80 years ago one myth already had to be replaced in the wake of a crash and a failed attempt at globalization. This brought populists to power, nourished nationalism and ended in a trade war and ultimately a world war.

At those times it was US President Franklin Roosevelt who coined a new slogan: the phenomenal New Deal, which embraced the losers of the economic crisis, placed bounds on the financial world, ensured investments in the future, and demonstrated political control: A model for the post-war world, during which almost everyone benefited for decades.

High time to draw our lessons from this.

Originally published at the Institute for New Economic Thinking.

2017 May 28


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  • GaryReber

    The author states that it is time to draw our lessons from history and calls for a “visionary concept that provides guidance and direction” but then provides no visionary concept or an agenda of solutions to fundamental economic inequality.

    Repeatedly, I have provided the visionary concept on my blog site (www.foreconomicjustice.org) and as commentary on Facebook (https://www.facebook.com/editorgary and https://www.facebook.com/For-Economic-Justice-347893098576250/), as well as The Huffington Post, that is needed and the solutions to put our nation on a path to inclusive prosperity, inclusive opportunity, and inclusive economic justice. Yet the same old calls for a destruction of private property principles and income redistribution policies is the prominent message pushed by the authors who are published by Evonomics, rather than explore means in which EVERY citizen can be a productive contributor to the economy and society through their OWNERSHIP of wealth-creating, income-producing capital assets, as well as work contributions.

    The visionary concept that achieves inclusive prosperity, inclusive opportunity, and inclusive economic justice are explored in the following works:

    The Agenda of The JUST Third Way Movement at http://foreconomicjustice.org/?p=5797, http://www.cesj.org/resources/articles-index/the-just-third-way-basic-principles-of-economic-and-social-justice-by-norman-g-kurland/, http://www.cesj.org/wp-content/uploads/2014/02/jtw-graphicoverview-2013.pdf and http://www.cesj.org/resources/articles-index/the-just-third-way-a-new-vision-for-providing-hope-justice-and-economic-empowerment/.

    Monetary Justice at http://capitalhomestead.org/page/monetary-justice.

    The Capital Homestead Act (aka Economic Democracy Act) at http://www.cesj.org/learn/capital-homesteading/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-a-plan-for-getting-ownership-income-and-power-to-every-citizen/, http://www.cesj.org/learn/capital-homesteading/capital-homestead-act-summary/ and http://www.cesj.org/learn/capital-homesteading/ch-vehicles/.

  • Robert DeLorey

    The “New New Deal” in a word – “Sustainabiltiy”, AKA “Steady State Economy”

  • Steve

    Wisdomics/Gracenomics is the new integrative theory that commits monetary and financial paradigm change and out of which a new ethic and greater ecological rationality can emerge.

    wisdomicsblog.com

  • Douglas Levene

    Most of this is so silly it doesn’t require a response. I would like, however, to respond to one point. The author suggests that “managers should have to pay back bonuses when it turns out that they made a mess of things.” Yes, of course that’s possible, but if you make manager compensation more contingent, you will have to increase the amount to make it worth the same. This is elementary economics, a function of risk aversion. So, ask yourselves, do you really want to see manager bonuses go through the roof?

    • Paulo

      Haven’t they gone through the roof already?

      • Douglas Levene

        There is no roof, no potential upper limit.

  • “What we need to find is a unifying formula to define the new paradigm: the leitmotif. Finding it is a tremendous challenge”.

    Hardly a challenge. All we have to do is study China’s model–something our economists resolutely refuse to do.

  • Macrocompassion

    The macro-economy is being deliberately warped and economists are being confused so that any useful suggestion as below, will not be see as any better than the rest of the twaddle, but it is. We need to stop taxing productive processes and begin to tax potentially productive ones which have not been properly used. In particular our income and purchase taxes are reducing the ability for demand to meet supply and consequently the output of both consumer and durable goods and their services is being curtailed. Since this productive effort necessitates the use of natural resources, specifically the land, any limitation on its use (and consequent sharpening of the competition for its access), drives up the cost for it where production does occur and simultaneously reduces the numbers who are needed to work there. because the prices of produce depend on the resulting greater production costs.

    Instead of taxing output we should tax the potential for input of the opportunity, some of which is going to waste. With a tax on land values, there will be a strong tendency to cease speculation in its value (holding it unused until the region develops and the price goes up) and to share the opportunities it provides with those who need it for use.

    This is not a new deal nor a new,new one but was proposed by Henry George 140 years as a cure for poverty and a means for faster progress. A very few countries have adopted this tax regime and they are the most prosperous in the world, like Estonia, Hing Kong and Singapore.
    TAX LAND NOT LABOR; TAX TAKINGS NOT MAKINGS!

  • Tincho Moretti

    Very sad article, once again.

    You rest on Mazzucato, who has been proved to be mistaken in this essay in spanish, that she said she’d look but never replied. https://www.juandemariana.org/sites/default/files/investigacion/20160803-mitos-y-realidades-estado-emprendedor_0.pdf

    You rest on Piketty, who has also been proved to be mistaken many times, and whose data has been proved to be manipulated to fit with his wrong theory http://aida.wss.yale.edu/smith/piketty1.pdf / https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2543012 / https://www.imf.org/external/pubs/ft/wp/2016/wp16160.pdf

    You rest on Milanovic, whose data base shows that all deciles of all countries, except Japan and USSR’s ex-countries, had won with globalization and international free trade, specially the poorest. http://www.resolutionfoundation.org/app/uploads/2016/09/Examining-an-elephant.pdf

    But the worst: you talk about the financial sector, the most intervened and overregulated sector of the world – in a world with central banks! – and then say free markets cause bubbles? Then you say baks “had to be saved”. Well, how can you blame free markets at the same time you force people to save a bank? In a free market, if you fail, you fail. You don’t have a “right” to be saved from competition. This whole article is not honest at all.

    • Strlngerbell

      It is equally as sad when one thumbs up their own comment.

  • Texas 2 Step

    Without global labor rights and a global minimum wage, there is no such thing as FREE trade. Free trade costs the working poor a fortune.

  • Dances with Coyotes

    The author of this piece is not sincere — but in any case, you don’t understand the situation because your knowledge BEGINS with the New Deal. No one living in America today has ever seen an authentic free market:

    When a private corporation with secret shareholders controls the money supply, any industry or corporation can be advanced or destroyed simply by creating money from nothing and deciding who to loan it do. The tyranny that we live under today is the byproduct of a private monopoly on currency. The New Deal would not have been necessary without the Federal Reserve banking cartel.

    “Banking establishments are more dangerous than standing armies; and the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale.” —Thomas Jefferson to John Taylor, 1816

    https://www.goodreads.com/book/show/66499.The_Creature_from_Jekyll_Island
    https://duckduckgo.com/?q=“report+from+iron+mountain”

    • Strlngerbell

      I haven’t seen an authentic free market, but I have seen a unicorn once.

  • How about a social market economy as instituted in Germany after WWII?
    It works reasonably well.

    From wikipedia:
    “Social market economies aim to combine free initiative and social welfare on the basis of a competitive economy.[20] The social market economy is opposed to laissez-faire policies and to socialist economic systems[21] and combines private enterprise with regulation and state intervention to establish fair competition, maintaining a balance between a high rate of economic growth, low inflation, low levels of unemployment, good working conditions, social welfare, and public services.[22] The term “social” was established by Adenauer to prevent further reference to “christian Socialism”,[23] which was used in the early party agenda “Ahlener Programm” in 1947.[24]”

    https://en.wikipedia.org/wiki/Social_market_economy

  • PimptasticJedi

    How much did the old new deal cost then and how much would it cost now? We have little inflation left to spend? Can we go to 500%GDP to pay for a new deal?