Putting the financial genie back in the bottle: the Euro crisis demands bold Keynesian solutions

The ascendancy of the financial markets which developed in the 1980s must be put into reverse.  The genie must be put back in the bottle. A Keynesian ‘euthanasia of the rentier’ is now essential for both growth and democracy.

Graham Room
3 May 2012

At the end of 2011, the European Union took one further step – albeit without the UK – towards a fiscal union, the latest stage in its efforts to satisfy the markets and bring back stability for the Euro. New rules of fiscal prudence are being put in place: national finances will be in a German straitjacket.  True, it was the Germans and the French who first showed that the fiscal rules of the Euro (current account deficit no more than 3% of GDP) could be set aside when recession threatened. No matter, the new rules will be enforced on all. 

Political rumblings have continued through the early months of 2012.  Most recently, the success of Hollande, in the first round of the French Presidential election, seems in part due to his pledge to re-examine the Merkozy fiscal pact.  Nevertheless, let us assume that the EU minus the UK implements its fiscal union.  And let us assume that this will progressively calm the markets and take the heat off individual national treasuries. What then? 

The German approach, as consolidated over the post-war period, was one of classical fiscal prudence, little influenced by Keynes. In an important sense it did not need Keynes. Year after year, an export surplus in manufactures meant that a gently deflationary fiscal stance at home was not inappropriate.  The Germans never had to face the progressive loss of overseas manufacturing markets that afflicted the UK, her political leaders struggling to maintain good levels of employment by demand management without too much inflation. 

Now the German model will be imposed on countries whose situation is as tortured – in terms of economic and social re-structuring – as was the British.  It remains to be seen how far the German model, set in a Europe-wide context, will allow for proactive public investment programmes of the sort that Keynes envisaged. Without this, the EU is likely to face general deflation and zero or low growth for the rest of this decade.       

It is important to be clear as to what the Keynesian message was and was not.  Keynes in his General Theory faced an economy with high unemployment, but no confidence among businesses that it made sense to invest.  Government had to take the initiative and engage in programmes of public investment: these would not only generate activity and incomes in the here and now, but would also give businesses confidence themselves to invest, confident that those investments would yield returns by the time they came on stream, because of the improved economic situation. 

There is a form of Keynesianism – what Joan Robinson used to refer to as ‘bastard Keynesianism’ – that reduces his advice to giving out pound notes on the street; and indeed, Keynes would agree that even that would have some beneficial effect. But public investment programmes were key.  (This of course then raises long-term strategic questions about the content of such programmes: should they focus on railways and roads, skills and education, nuclear or tidal power?)

This was only part of the Keynesian message however. In How to Pay for the War, Keynes no longer faced an economy with under-utilised resources of unemployed workers and idle factories. Instead he faced the dangers of supply bottlenecks and resource ceilings. No less than the Bundesbank and ECB today, he was vitally concerned to avoid inflation. This required an appropriate mix of industrial planning, consumer rationing, price controls and taxation. (It also required a proper system of economic and industrial statistics: modern systems of national statistics date from then, and were another legacy of Keynes.) 

In short, Keynes called for active government to address the challenges of both economic depression and expansion. He sought less to abolish capitalism, more to save it from itself. Market economies could not be expected to look after themselves.     

Today’s concern with appeasing the markets would therefore have seemed strange to Keynes, with his memory of how badly the markets had served the western economies, during the depression of the 1930s and the mobilisation of resources for total war. Keynes called for the ‘euthanasia of the rentier’: the sidelining of finance capital and its subordination to the public investment programmes of the active state. Since the 1980s, we have instead seen the progressive euthanasia of the political, with markets ascendant both nationally and internationally and the State retreating to its ‘night watchman’ role. That euthanasia is now vividly displayed in the parachuting of ‘technocrats’ into government in Greece and Italy and central bank presidents displacing sovereign nations at the top decision-making tables of the EU.

This is of concern in terms of democratic government.  It is also however of concern in terms of the future of the euro and global monetary stability. Only with a 21st century equivalent of Keynes’ ‘euthanasia of the rentier’ will active government be possible.  The ascendancy of the financial markets which developed in the 1980s must be put into reverse. The genie must be put back in the bottle.

At Bretton Woods Keynes argued for a strong international monetary authority which would, in effect, act as the central bank of the central banks. National governments would have drawing rights up to agreed limits. More than this, those nations with sustained surpluses on external accounts would have to recycle these through the international monetary authority, so as to stimulate economic activity in debtor countries, even as they made efforts to put their domestic finances in order. 

Something like this may now emerge within the EU, with Germany (as the country with a sustained surplus) recycling some of those surpluses to the weaker economies, countering the deflationary consequences of the fiscal tightening they are required to put in place. How far this happens remains to be seen: Germany gives little sign that it understands. 

There remains a strong need for a global authority of the sort that Keynes proposed. Bretton Woods did of course set up an emaciated version, in the form of the IMF. That, however, has acted primarily as an ambulance service for nations in crisis, not as the proactive enabler of global growth and prosperity that Keynes envisaged. What happens – or fails to happen - at global level will strongly affect how the European experiment develops. Europe cannot sort its house out alone: because that house is interconnected with the global village.

The problem is the volatility of the genie which Europe is desperate to appease.  The genie is in part the pension funds and the other institutional investors, seeking to protect the interests of millions of ordinary people, and therefore running from any investment that suddenly seems risky. The genie is also, however, the hedge funds and the insider traders who bet that particular sovereign debts will be losers and welcome the volatility, knowing that it only increases their opportunities for agile predation.        

Plenty of European sovereign debt is becoming re-payable during the early months of 2012. Countries are paying off the bond issues they made some years ago: to do this, they need financial investors willing to purchase new bond issues. This is crunch time. In the middle of April, Spain stumbled; in late April, the Netherlands fared better.  

What is needed is to take sovereign debt out of the financial markets. This is not of course sufficient – there is still a need for better regulation of the banks (including the separation of retail and investment banking) and a Tobin tax on financial transactions, if it can serve as a buffer that reduces the volatility of financial flows. Nevertheless, if sovereign nations are to act as the ultimate guarantors of financial stability, it makes no sense for their own debt to be surrendered to the volatility of those same financial markets. 

Faced with political rumblings across the Continent, and faltering economic recovery, a priority for European politicians must be reform of the international monetary system, along the lines Keynes indicated. This would most likely be through reform of the IMF. Such reform would involve substantial expansion of the credit lines available to countries and the scope for the IMF to lend. It would continue to demand programmes of fiscal belt-tightening from debtor nations. 

It would also however – and this would be more tricky - be allied to programmes of public investment. These would be geared to general economic development of a sustainable sort worldwide. Thus for example the Durban summit in December reached an agreement, modest but better than expected, on global climate change policy. International programmes of public investment in green technologies, funded in part by German and Chinese surpluses, might now be used to kick-start global economic recovery. They would, not least, draw on the technological capacities of major debtor countries, so as to offset their fiscal belt-tightening.

Such global programmes would be classically Keynesian: they would provide a stimulus to a depressed world economy at precisely the time that it is needed. Unlike the present situation however, where sovereign debt is mediated through the markets, such programmes would not provide a new target for global investment volatility, because this particular genie would be back in the bottle. 

This will of course be more easily said than done. Powerful financial interests underpin the present regime and the opportunities for predation it presents.  Even in the present recession the rich get richer and richer. Taking sovereign debt out of the market will limit the financial pickings for the City and London, the paramount national interest that the UK government has chosen to defend.  Fiscal reform and tightening will still be required in many countries. 

But this will be much easier if global economic growth can be re-started: Keynes teaches us that if we take care of growth, the deficit will take care of itself. Fiscal reform can in any case mean many things. It may mean cutting back on public services and support for the poor. But it can also mean cutting back on fiscal welfare for the rich and the closing of tax havens. Politics will be back.

It was on the same December weekend that the EU confronted the financial chaos and the obduracy of the UK in Brussels, and also climate change and the obduracy of the US, Canada, India and Saudi Arabia in Durban. In both conferences it could celebrate a small and partial if inconclusive victory. 

It is therefore perhaps worth re-stating: it is probably only by getting economic growth going again that we can hope for effective measures to tackle climate change. Economic depression discourages investment in new technologies and focuses ordinary people’s attention on their personal economic insecurity. It is a recipe for resistance to change and the development of divisive loyalties and conflict. But if economic growth is to be a path to a sustainable future, it needs to be uncoupled from the volatility of financial markets and the avarice of the super-rich which have brought us to the present impasse.

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