Category Archives: Financial crisis

Challenging the Role of Capital Adequacy using Historical Data

Bank Capital Redux: Solvency, Liquidity, and Crisis
By Òscar Jordà (Federal Reserve Bank of San Francisco and University of California Davis), Bjorn Richter (University of Bonn), Moritz Schularick (University of Bonn) and Alan M. Taylor (University of California Davis).

Abstract: Higher capital ratios are unlikely to prevent a financial crisis. This is empirically true both for the entire history of advanced economies between 1870 and 2013 and for the post-WW2 period, and holds both within and between countries. We reach this startling conclusion using newly collected data on the liability side of banks’ balance sheets in 17 countries. A solvency indicator, the capital ratio has no value as a crisis predictor; but we find that liquidity indicators such as the loan-to-deposit ratio and the share of non-deposit funding do signal financial fragility, although they add little predictive power relative to that of credit growth on the asset side of the balance sheet. However, higher capital buffers have social benefits in terms of macro-stability: recoveries from financial crisis recessions are much quicker with higher bank capital.

URL: http://econpapers.repec.org/paper/nbrnberwo/23287.htm

Distributed by NEP-HIS on: 2017-05-07

Review by Tony Gandy (London Institute of Banking and Finance)

In 1990-1991 I started a new job, having nearly completed my PhD (which I fully admit I took longer than it should). I joined The Banker, part of the Financial Times group, and proceeded to cover bank statistics, research and bank technology (the latter being a bit of a hobby). Thanks to the fine work of my predecessor, Dr. James Alexander, we had been through a statistical revolution and had revamped our Top 1000 listings of the world’s biggest banks, moving to a ranking based on capital rather than assets. This was the zeitgeist of the moment; what counted was capital, an indicator of capacity to lend and absorb losses. We then also ranked banks by the ratio of loss absorbing capital to total assets to show which were the “strongest” banks. We were modeling this on the progress made by the Basel Committee on Banking Supervision in refocusing banking resilience on to this important ratio, so called capital adequacy and the acknowledging the development and launch of the original Basel Accord.

All well and good, the role of capital was to absorb losses. It seemed on the face of it, that whichever bank had the most capital, and which ever could show the best capital adequacy ratio was clearly the most robust, prudent and advanced manager of risk and the one able to take on more business.

As the years progressed, Basel 1.5, II, 2.5, III and, arguably, IV have each added to or detracted from the value of capital as a guide to robustness. However, the principle still seemed to stand that, if you had a very large proportion of capital, you could absorb greater losses making the bank and the wider economic system more robust. Yes, OK there were weaknesses. Under the original Accord, only the only risk being worries about was credit risk and in only a very rudimentary way. This seemed odd given that one of the events which led to the Basel Accord was the failure and subsequent market meltdown caused by the failure of Bankhaus Herstatt [1] (Goodhart 2011), but it was hard to see how that was in isolation a credit event. Nevertheless, through all the subsequent crises and reforms to the Basel Accords, the principle that a higher proportion of quality capital to assets held by a bank was a good thing.

Jordà, Richter, Schularick and Taylor challenge the assumption that greater capital adequacy can deflect crisis, though they do find that higher initial capital ratios have a great benefit in the post crisis environment. In this working paper, Jordà et al. create a data set focusing on the liability side of bank balance sheets covering a tight definition of Common Equity Tier 1 capital (paid up capital, retained profit and disclosed reserves), deposits and non-core funding (wholesale funding). This is a powerful collection of numbers. They have collated this data for 14 advanced economies from 1870 through to 2013 and for three others for a slightly shorter period.

One note is that it would have been interesting to see a little more detail on the sources of the data used. Journal papers and academic contributions are acknowledged throughout, but other sources are covered by “journal papers, central bank publications, historical yearbooks from statistical offices, as well as archived annual reports from individual banks”. Bank statistics can be a complex area, some sources have sometimes got their definitions wrong (one annual listing of bank capital had an erratum which was nearly as long as the original listings, not mine I hasten to add and maybe my memory, as a rival to that publication, somewhat exaggerates!), so a little more detail would be useful. Also, further discussion of the nature of disclosed reserves would be interesting as one of the key concerns of bank watchers in the past has been the tendency of banks to not disclose reserves or their purposes.

Jordà et al.’s findings are stark. Firstly, and least surprisingly, bank leverage has greatly increased. The average bank capital ratio in the dataset shows that in early period it hovered at around 30% of unadjusted assets, falling to 10% in the post war years and more recently hovering around 5-10%.

image1

Source: Jordà et al. (2017)

Next, they consider the relevance of capital adequacy as a protection for banks and a predictor of a banking system’s robustness; does a high, prudent, level of capital reduce the chances of a financial crisis? The authors note the traditional arguments that higher levels of capital could indicate a robust banking system able to absorb unexpected losses and thus reducing the chance of a financial crisis, but also note that high capital levels could equally indicate a banking system taking greater risks and therefore needing greater amounts of capital to survive the risks. They find no statistical link between higher capital ratios and lower risk of systemic financial crisis, indeed, they find limited evidence that it could be the reverse. It’s worth noting a second time: Increasing capital ratios do not indicate a lower risk of a financial crisis

The authors do note, however, that high levels and rapidly increasing loan-to-deposit ratios are a significant indicator of future financial distress. Clearly, funding a bubble is a bad idea, though it can be hard to resist.

However, capital can have a positive role. The paper finds that systems which start with higher levels of leverage (and consequently lower capital ratios) will find recovery after a crisis harder as banks struggle to maintain solvency and liquidate assets at a greater rate. Thus, while a high capital adequacy ratio may not be a protection against a systemic crisis, it can provide some insight into the performance of an economy after a crunch as banks with higher capital ratios may not face the same pressure to sell and further deflate asset prices and economic activity. Therefore, capital can have a positive role!

image2

Source: Jordà et al (2017)

I won’t pretend to understand fully the statistical analysis presented in this paper, however, while many, including those at the Basel Committee, have recognised the folly of tackling only prudential control through a purely credit risk-focus on capital adequacy and have introduced new liquidity, leverage and scenario planning structure to deflect other routes to crisis. Nevertheless, Jordà et al. provide a vital insight into what is still the very core of the prudential control regime: the value, or not, of capital in providing protection to banks and banking systems. Its role may not be what we expected, its value being in a post-crisis environment and not a pre-crisis environment where higher requirements could have been expected to head-off problems. Instead they find that it is credit booms and indicators of them, such as rapidly rising Loan to Deposit ratios which are better indicators of looming crisis, and capital is more relevant to making brief the impact of an unravelling bubble.

On a more practical note, this fascinating paper offer those who teach prudential regulation to bankers or students a wealth of data and challenges to consider, a welcome resource indeed.

Notes:

[1] The other main response was the more appropriate formation of the first netting services and then the Continuously Linked Settlement Bank as a method of improving operations to remove the risk which became known as “Herstatt Risk”.

References
Goodhart, Charles (2011) The Basel Committee on Banking Supervision: a history of the early years, 1974–1997. Cambridge University Press, Cambridge, UK

 

No man can serve two masters

Rogue Trading at Lloyds Bank International, 1974: Operational Risk in Volatile Markets

By Catherine Schenk (Glasgow)

Abstract Rogue trading has been a persistent feature of international financial markets over the past thirty years, but there is remarkably little historical treatment of this phenomenon. To begin to fill this gap, evidence from company and official archives is used to expose the anatomy of a rogue trading scandal at Lloyds Bank International in 1974. The rush to internationalize, the conflict between rules and norms, and the failure of internal and external checks all contributed to the largest single loss of any British bank to that time. The analysis highlights the dangers of inconsistent norms and rules even when personal financial gain is not the main motive for fraud, and shows the important links between operational and market risk. This scandal had an important role in alerting the Bank of England and U.K. Treasury to gaps in prudential supervision at the end of the Bretton Woods pegged exchange-rate system.

Business History Review, Volume 91 (1 – April 2017): 105-128.

DOI: https://doi.org/10.1017/S0007680517000381

Review by Adrian E. Tschoegl (The Wharton School of the University of Pennsylvania)

Since the 1974 rogue trading scandal at Lloyds’s Lugano branch we have seen more spectacular sums lost in rogue trading scandals. What Dr Catherine Schenk brings to our understanding of these recurrent events is the insight that only drawing on archives, both at Lloyds and at the Bank of England, can bring. In particular, the archives illuminate the decision processes at both institutions as the crisis unfolded. I have little to add to her thorough exposition of the detail so below I will limit myself to imprecise generalities.

Marc Colombo, the rogue trader at Lloyds Lugano, was a peripheral individual in a peripheral product line, in a peripheral location. As Schenk finds, this peripherality has two consequences, the rogue trader’s quest for respect, and the problem of supervision. Lloyds Lugano is not an anomaly. An examination of several other cases (e.g. Allied Irish, Barings, Daiwa, and Sumitomo Trading), finds the same thing (Tschoegl 2004).

In firms, respect and power come from being a revenue center. Being a cost center is the worst position, but being a profit center with a mandate to do very little is not much better. The rogue traders that have garnered the most attention, in large part because of the scale of their losses were not malevolent. They wanted to be valued. They were able to get away with their trading for long enough to do serious damage because of a lack of supervision, a lack that existed because of the traders’ peripherality.

In several cases, Colombo’s amongst them, the trader was head of essentially a one-person operation that was independent of the rest of the local organization. That meant that the trader’s immediate local supervisor had little or no experience with trading. Heads of branches in a commercial bank come from commercial banking, especially commercial lending. Commercial lending is a slow feedback environment (it may take a long time for a bad decision to manifest itself), and so uses a system of multiple approvals. Trading is a fast feedback environment. The two environments draw different personality types and have quite different procedures, with the trading environment giving traders a great deal of autonomy within set parameters, an issue Schenk addresses and that we will discuss shortly.

Commonly, traders will report to a remote head of trading and to the local branch manager, with the primary line being to the head of trading, and the secondary line being to the local branch manager. This matrix management developed to address the problem of the need to manage and coordinate centrally but also respond locally, but matrix management has its limitations too. As Mathew points out in the New Testament, “No man can serve two masters, for either he will hate the one, and love the other; or else he will hold to the one, and despise the other” (Matthew (6:24). Even short of this, the issue that can arise, as it did at Lloyds Luggano, is that the trader is remote from both managers, one because of distance (and often time zone), and the other because of unfamiliarity with the product line. A number of software developments have improved the situation since 1974, but as some recent scandals have shown, they are fallible. Furthermore, the issue still remains that at some point the heads of many product lines will report to someone who rose in a different product line, which brings up the spectre of “too complex to manage”.

The issue of precautionary or governance rules, and their non-enforcement, is a clear theme in Schenk’s paper. Like the problem of supervision, this too is an issue where one can only do better or worse, but not solve. All rules have their cost. The largest may be an opportunity cost. Governance rules exist to reduce variance, but that means the price of reducing bad outcomes is the lower occurrence of good outcomes. While it is true, as one of Schenk’s interviewees points out, that one does not hear of successful rogue traders being fired, that does not mean that firms do not respond negatively to success. I happened to be working for SBCI, an investment banking arm of Swiss Bank Corporation (SBC), at the time of SBC’s acquisition in 1992 of O’Connor Partners, a Chicago-based derivatives trading house. I had the opportunity to speak with O’Conner’s head of training when O’Connor stationed a team of traders at SBCI in Tokyo. He said that the firm examined too large wins as intently as they examined too large losses: in either case an unexpectedly large outcome meant that either the firm had mis-modelled the trade, or the trader had gone outside their limits. Furthermore, what they looked for in traders was the ability to walk away from a losing bet.

But even small costs can be a problem for a small operation. When I started to work for Security Pacific National Bank in 1976, my supervisor explained my employment benefits to me. I was authorized two weeks of paid leave per annum. When I asked if I could split up the time he replied that Federal Reserve regulations required that the two weeks be continuous so that someone would have to fill in for the absent employee. Even though most of the major rogue trading scandals arose and collapsed within a calendar year, the shadow of the future might well have discouraged the traders, or led them to reveal the problem earlier. Still, for a one-person operation, management might (and in some rogue trading scandals did), take the position that finding someone to fill in and bring them in on temporary duty was unnecessarily cumbersome and expensive. After all, the trader to be replaced was a dedicated, conscientious employee, witness his willingness to forego any vacation.

Lastly, there is the issue of Chesterton’s Paradox (Chesterton 1929). When a rule has been in place for some time, there may be no one who remembers why it is there. Reformers will point out that the rule or practice is inconvenient or costly, and that it has never in living memory had any visible effect. But as Chesterton puts it, “This paradox rests on the most elementary common sense. The gate or fence did not grow there. It was not set up by somnambulists who built it in their sleep. It is highly improbable that it was put there by escaped lunatics who were for some reason loose in the street. Some person had some reason for thinking it would be a good thing for somebody. And until we know what the reason was, we really cannot judge whether the reason was reasonable.”

Finally, an issue one needs to keep in mind in deciding how much to expend on prevention is that speculative trading is a zero-sum activity. A well-diversified shareholder who owns both the employer of the rogue trader and the employers of their counterparties suffers little loss. The losses to Lloyds Lugano were gains to, inter alia, Crédit Lyonnais.

There is leakage. Some of the gainers are privately held hedge funds and the like. Traders at the counterparties receive bonuses not for skill but merely for taking the opposite side of the incompetent rogue trader’s orders. Lastly, shareholders of the rogue traders firm suffer deadweight losses of bankruptcy when the firm, such as Barings, goes bankrupt. Still, as Krawiec (2000) points out, for regulators the social benefit of preventing losses to rogue traders may not exceed the cost. To the degree that costs matter to managers, but not shareholders, managers should bear the costs via reduced salaries.

References

Chesterton, G. K. (1929) ‘’The Thing: Why I Am A Catholic’’, Ch. IV: “The Drift From Domesticity”.

Krawiec, K.D. (2000): “Accounting for Greed: Unraveling the Rogue Trader Mystery”, Oregon Law Review 79 (2):301-339.

Tschoegl, A.E. (2004) “The Key to Risk Management: Management”. In Michael Frenkel, Ulrich Hommel and Markus Rudolf, eds. Risk Management: Challenge and Opportunity (Springer-Verlag), 2nd Edition;

Debt forgiveness in the German mirror

The Economic Consequences of the 1953 London Debt Agreement

By Gregori Galofré-Vilà (Oxford), Martin McKee (London School of Hygiene and Tropical Medicine), Chris Meissner (UC Davis) and David Stuckler (Oxford)

Abstract: In 1953 the Western Allied powers implemented a radical debt-relief plan that would, in due course, eliminate half of West Germany’s external debt and create a series of favourable debt repayment conditions. The London Debt Agreement (LDA) correlated with West Germany experiencing the highest rate of economic growth recorded in Europe in the 1950s and 1960s. In this paper we examine the economic consequences of this historical episode. We use new data compiled from the monthly reports of the Deutsche Bundesbank from 1948 to the 1960s. These reports not only provide detailed statistics of the German finances, but also a narrative on the evolution of the German economy on a monthly basis. These sources also contain special issues on the LDA, highlighting contemporaries’ interest in the state of German public finances and public opinion on the debt negotiation. We find evidence that debt relief in the LDA spurred economic growth in three main ways: creating fiscal space for public investment; lowering costs of borrowing; and stabilising inflation. Using difference-in-differences regression models comparing pre- and post LDA years, we find that the LDA was associated with a substantial rise in real per capita social expenditure, in health, education, housing, and economic development, this rise being significantly over and above changes in other types of spending that include military expenditure. We further observe that benchmark yields on long-term debt, an indication of default risk, dropped substantially in West Germany when LDA negotiations began in 1951 and then stabilised at historically low rates after the LDA was ratified. The LDA coincided with new foreign borrowing and investment, which in turn helped promote economic growth. Finally, the German currency, the deutschmark, introduced in 1948, had been highly volatile until 1953, after which time we find it largely stabilised.

URL: http://EconPapers.repec.org/RePEc:nbr:nberwo:22557

Distributed by NEP-HIS on 2016-09-04

Review by Natacha Postel-Vinay (LSE)

The question of debt forgiveness is one that has drawn increased attention in recent years. Some have contended that the semi-permanent restructuring of Greece’s debt has been counterproductive and that what Greece needs is at least a partial cancellation of its debt. This, it is argued, would allow both faster growth and a higher likelihood of any remaining debt repayment. Any insistence on the part of creditors for Greece to pay back the full amount through austerity measures would be self-defeating.

One problem with this view is that we know very little about whether debt forgiveness can lead to faster growth. Reinhart and Trebesch (2016) test this assumption for 45 countries between 1920-1939 and 1978-2010, and do find a positive relationship. However they leave aside a particularly striking case: that of Germany in the 1950s, which benefited from one of the most generous write-offs in history while experiencing “miracle” growth of about 8% in subsequent years. This case has attracted much attention recently given German leaders’ own insistence on Greek debt repayments (see in particular Ritschl, 2011; 2012; Guinnane, 2015).

Eichengreen and Ritschl (2009), rejecting several popular theories of the German miracle, such as a reallocation of labour from agriculture to industry or the weakening of labour market rigidities, already hypothesized that such debt relief may have been an important factor in Germany’s super-fast and sustained post-war growth. Using new data from the monthly reports of the Deutsche Bundesbank from 1948 to the 1960s, Gregori Galofré-Vilà, Martin McKee, Chris Meissner and David Stuckler (2016) attempt to formally test this assumption, and are quite successful in doing so.

By the end of WWII Germany had accumulated debt to Europe worth nearly 40% of its 1938 GDP, a substantial amount of which consisted in reparation relics from WWI. Some already argued at the time that these reparations and creditors’ stubbornness had plagued the German economy, which in the early 1930s felt constrained to implement harsh austerity measures, thus contributing to the rise of the National Socialists to power. It was partly to avoid a repeat of these events that the US designed the Marshall Plan to help the economic reconstruction of Europe post-WWII.

versailles-hitler

 

Marshall aid to Europe between 1948 and 1951 was less substantial than is commonly thought, but it came with strings attached which may have indirectly contributed to German growth. In particular, one of the conditions France and the UK had to fulfil in order to become recipients of Marshall aid was acceptance that Germany would not pay back any of its debt until it reimbursed its own Marshall aid. Currency reform in 1948 and the setting up of the European Payments Union facilitated this process.

Then came the London Debt Agreement, in 1953, which stipulated generous conditions for the repayment of half the amount due from Germany. Notably, it completely froze the other half, or at least until reunification, which parties to the agreement expected would take decades to occur. There was no conference in 1990 to settle the remainder.

just-wanted-to-point-out

Galofré-Vilà et al. admit not being able to directly test the hypothesis that German debt relief led to faster growth. Instead, making use of simple graphs, they look at how the 1953 London Debt Agreement (LDA) led to lower borrowing costs and lower inflation, which comes out as obvious and quite sustained on both charts.

Perhaps more importantly, they measure the extent to which the LDA freed up space for social welfare investment. For this, they make use of the fact that Marshall aid had mainly been used for infrastructure building, so that the big difference with the LDA in terms of state expenditure should have been in terms of health, education, “economic development,” and housing. Then they compare the amount of spending on these four heads to spending in ten other categories before 1953, and check whether this difference gets any larger after the LDA. Perhaps unsurprisingly, it does, and significantly so.

This way of testing the hypothesis that the LDA helped the German economy may strike some as too indirect and therefore insufficient. This is without mentioning possible minor criticisms such as the fact that housing expenditure is included in the treatment, not control group (despite the 1950 Housing Act), or that the LDA is chosen as the key event despite the importance of the Marshall Plan’s early debt relief measures.

Nevertheless testing such a hypothesis is necessarily a very difficult task, and Galofré-Vilà et al.’s empirical design can be considered quite creative. They are of course aware that this cannot be the end of the story, and they are careful to caution readers against hasty extrapolations from the post-war German case to the current Spanish or Greek situation. Some of their arguments have somewhat unclear implications (for instance, that Germany at the time represented 15% of the Western population at the time, whereas the Greek population represents only 2%).

germany-wwii-debts

Perhaps a stronger argument would be that Germany’s post-war debt was of a different character than Greek’s current debt: some would even call it “excusable” because it was mainly war debt; it was not (at least arguably) a result of past spending excesses. For this reason, one may at least ask whether debt forgiveness in the Greek context would have the same — almost non-existent — moral hazard effects as in the German case. Interestingly, the authors point out that German debt repayment after the LDA was linked to Germany’s economic growth and exports (so that the debt service/export revenue ratio could not exceed 3%). This sort of conditionality is strangely somewhat of a rarity among today’s sovereign debt contracts. It could be seen as a possible solution to fears of moral hazard, thereby mitigating any differences in efficiency of debt relief emanating from differences in the nature of the debt contracted.

 

References

Eichengreen, B., & Ritschl, A. (2009). Understanding West German economic growth in the 1950s. Cliometrica, 3(3), 191-219.

Guinnane, T. W. (2015). Financial vergangenheitsbewältigung: the 1953 London debt agreement. Yale University Economic Growth Center Discussion Paper, (880).

Reinhart, C. M., & Trebesch, C. (2014). A distant mirror of debt, default, and relief (No. w20577). National Bureau of Economic Research.

Ritschl, A. (2011). “Germany owes Greece a debt.” in The Guardian. Tuesday 21 June 2011.

Ritschl, A. (2012). “Germany, Greece and the Marshall Plan.” In The Economist. Friday 15 June.

Lessons from ‘Too Big to Fail’ in the 1980s

Can a bank run be stopped? Government guarantees and the run on Continental Illinois

Mark A Carlson (Bank for International Settlements) and Jonathan Rose (Board of Governors of the Federal Reserve)

Abstract: This paper analyzes the run on Continental Illinois in 1984. We find that the run slowed but did not stop following an extraordinary government intervention, which included the guarantee of all liabilities of the bank and a commitment to provide ongoing liquidity support. Continental’s outflows were driven by a broad set of US and foreign financial institutions. These were large, sophisticated creditors with holdings far in excess of the insurance limit. During the initial run, creditors with relatively liquid balance sheets nevertheless withdrew more than other creditors, likely reflecting low tolerance to hold illiquid assets. In addition, smaller and more distant creditors were more likely to withdraw. In the second and more drawn out phase of the run, institutions with relative large exposures to Continental were more likely to withdraw, reflecting a general unwillingness to have an outsized exposure to a troubled institution even in the absence of credit risk. Finally, we show that the concentration of holdings of Continental’s liabilities was a key dynamic in the run and was importantly linked to Continental’s systemic importance.

URL: http://EconPapers.repec.org/RePEc:bis:biswps:554

Distributed on NEP-HIS 2016-4-16

Review by Anthony Gandy (ifs University College)

I have to thank Bernardo Batiz-Lazo for spotting this paper and circulating it through NEP-HIS, my interest in this is less research focused than teaching focused. Having the honour of teaching bankers about banking, sometimes I am asked questions which I find difficult to answer. One such question has been ‘why are inter-bank flows seen as less volatile, than consumer deposits?’ In this very accessible paper, Carlson and Rose answers this question by analysing the reality of a bank run, looking at the raw data from the treasury department of a bank which did indeed suffer a bank run: Continental Illinois – which became the biggest banking failure in US history when it flopped in 1984.

images

For the business historian, the paper may lack a little character as it rather skimps over the cause of Continental’s demise, though this has been covered by many others, including the Federal Deposit Insurance Corporation (1997). The paper briefly explains the problems Continental faced in building a large portfolio of assets in both the oil and gas sector and developing nations in Latin America. A key factor in the failure of Continental in 1984, was the 1982 failure of the small bank Penn Square Bank of Oklahoma. Cushing, Oklahoma is the, quite literally, hub (and one time bottleneck) of the US oil and gas sector. The the massive storage facility in that location became the settlement point for the pricing of West Texas Intermediate (WTI), also known as Texas light sweet, oil. Penn Square focused on the oil sector and sold assets to Continental, according the FDIC (1997) to the tune of $1bn. Confidence in Continental was further eroded by the default of Mexico in 1982 thus undermining the perceived quality of its emerging market assets.

Depositors queuing outside the insolvent Penn Square Bank (1982)

Depositors queuing outside the insolvent Penn Square Bank (1982)

In 1984 the failure of Penn would translate into the failure of the 7th largest bank in the US, Continental Illinois. This was a great illustration of contagion, but contagion which was contained by the central authorities and, earlier, a panel of supporting banks. Many popular articles on Continental do an excellent job of explaining why its assets deteriorated and then vaguely discuss the concept of contagion. The real value of the paper by Carlson and Rose comes from their analysis of the liability side of the balance sheet (sections 3 to 6 in the paper). Carlson and Rose take great care in detailing the make up of those liabilities and the behaviour of different groups of liability holders. For instance, initially during the crisis 16 banks announced a advancing $4.5bn in short term credit. But as the crisis went forward the regulators (Federal Deposit Insurance Corporation, the Federal Reserve and the Office of the Comptroller of the Currency) were required to step in to provide a wide ranging guarantee. This was essential as the bank had few small depositors who, in turn, could rely on the then $100,000 depositor guarantee scheme.

053014_fmf

It would be very easy to pause and take in the implications of table 1 in the paper. It shows that on the 31st March 1984, Continental had a most remarkable liability structure. With $10.0bn of domestic deposits, it funded most of its books through $18.5bn of foreign deposits, together with smaller amounts of other wholesale funding. However, the research conducted by Carlson and Rose showed that the intolerance of international lenders, did become a factor but it was only one of a number of effects. In section 6 of the paper they look at the impact of funding concentration. The largest ten depositors funded Continental to the tune of $3.4bn and the largest 25 to $6bn dollars, or 16% of deposits. Half of these were foreign banks and the rest split between domestic banks, money market funds and foreign governments.

Initially, `run off’, from the largest creditors was an important challenge. But this was related to liquidity preference. Those institutions which needed to retain a highly liquid position were quick to move their deposits out of Continental. One could only speculate that these withdrawals would probably have been made by money market funds. Only later, in a more protracted run off, which took place even after interventions, does the size of the exposure and distance play a disproportionate role. What is clear is the unwillingness of distant banks to retain exposure to a failing institution. After the initial banking sector intervention and then the US central authority intervention, foreign deposits rapidly decline.

It’s a detailed study, one which can be used to illustrate to students both issues of liquidity preference and the rationale for the structures of the new prudential liquidity ratios, especially the Net Stable Funding Ratio. It can also be used to illustrate the problems of concentration risk – but I would enliven the discussion with the addition of the more colourful experience of Penn Square Bank- a banks famed for drinking beer out of cowboy boots!

References

Federal Deposit Insurance Corporation, 1997. Chapter 7 `Continental Illinois and `Too Big to Fail’ In: History of the Eighties, Lessons for the Future, Volume 1. Available on line at: https://www.fdic.gov/bank/historical/history/vol1.html

More general reads on Continental and Penn Square:

Huber, R. L. (1992). How Continental Bank outsourced its” crown jewels. Harvard Business Review, 71(1), 121-129.

Aharony, J., & Swary, I. (1996). Additional evidence on the information-based contagion effects of bank failures. Journal of Banking & Finance, 20(1), 57-69.

Neoliberalism: A Cultural Social Construction

Crisis Without End: Neoliberalism in a Globalized Environment

by Richard N. Rambarran (University of Hyderabad)

Abstract: Since the 1970’s, both politically and theoretically, neoliberalism as an ideology has been on a persistent rise to the point where, in the twenty first century, it has garnered hegemonic dominance. Despite several recurring crises in countries since the ascendance of neoliberalism, we yet remain reluctant to point out the political economy philosophy as a root cause of the crises. Instead, many of the academics within Economics prefer to offer bouts of highly technical reasons for the downturn – this is especially true and almost solely applicable to those who practice within the ‘neoclassical’ conjecture of Economics. In a typical Marxian sense, one would have to look no further than the economic system to determine both economic and social outcomes of a country. What dictates that economic system however is the political philosophy of the leaders who guide the economic system – the policy makers. This paper attempts to show the neoliberal political philosophy, as the common thread for major crises within the last two decades. It also proposes a societal trinity for which change is driven through complex interactions among the political, economic and social spheres.

URL: http://EconPapers.repec.org/RePEc:pra:mprapa:67410

Circulated by nep-his on: 2015-10-25

Revised by: Stefano Tijerina

Richard Rambarran joins an emerging group of scholars that are spearheading an aggressive global criticism of modern capitalism, and particularly the impact that neoliberalism has had on its most recent methods of implementation within the international system. Thomas Picketty’s Capitalism in the Twenty-First Century has lead the way in recent times. Nevertheless Rambarran’s contribution to the discussion is welcomed because it points out that the economic political philosophy behind the social construction of neoliberal ideals is the determinant factor in preserving <status quo, even after numerous economic crises.

Richard Rambarran Research Fellow at The Social Economy Research Group (SERG)

From Rambarran’s point of view, the neoliberal principles have become an “ingrained” ideology fomented by economists, local politicians and bureaucrats, domestic and multilateral institutions, academic institutions, mass media, corporations, and the consumer.[1] He further argues that today’s mainstream professional economist has perpetuated this social construction using its mathematical and econometric technical rhetoric to distance itself not only from the public sphere but also from the critical role once played by the “Classical economists.”[2] The complacency in the professional sphere has permeated the public sphere, where the collective political and social conscience is more concerned in pursuing the possibility of “wealth and great opulence,” occasionally reacting to economic crises like the one in 2008 only to quickly return to the initial passive approach once individual financial issues are partially resolved.[3]

Rambarran centers on the 1997 East Asian crisis and the 2008 Global Financial Meltdown in order to illustrate how the economic political philosophy has come to dictate “the very mechanics of our lives” through its systemic and institutional framework. He argues that contrary to the views of many scholars that the rise of neoliberalism came with the emergence of political leaders Ronald Reagan and Margret Thatcher, the foundations of the political philosophy and its social construction emerged in the post Great Depression era.[4] The solutions to the 1997 and 2008 crises therefore represent a series of theoretical models constructed since the first modern global financial crisis in order to scientifically justify the perpetuation of neoliberalism.

'Well what a coincidence! I'm a financial regulator too!'

‘Well what a coincidence! I’m a financial regulator too!’

The ingrained idea that “human well-being and social welfare” are best advanced by the deregulation of the institutions, programs, and norms that once regulated the capitalist machine, seems to be an unquestionable thought. [5] To get to this social reality, argues Rambarran, classic liberal ideas of John Locke, Adam Smith, David Ricardo and the like had to be dismantled in order to neoliberalism to surge. According to Rambarran, neoliberalism is “not simply a minutely revised version of classic liberalism,” it is a new version of capitalism that reduces the role of the state to its minimal.[6] The business-government alliance that pushed neoliberalism forward after the 1930s slowly twisted the idea that “liberating individual and entrepreneurial freedoms and skills” through institutions, programs, and a normative systems “characterized by strong private property rights, free markets, and free trade” were actually responsible for the debacle of the market system in 1997 and 2008, and that greater privatization of services and deregulation for the business sector was the only solution moving forward.[7] These are the principles of nation state building under globalization, the basic political economic structures of nations that welcome open market and free trade, the minimal parameters for participating in the global market system; ideas that, as indicted by Rambarran, are part of the subconscious decision making dynamic between politicians, the private sector, and consumers.[8]

The current realities of this “macroscopic trinity” indicate that the business class, defined by Rambarran as the “intellectual class,” heavily influences political, economic, and social perceptions of nation building under a globalized system.[9] An intellectual class responsible for the cultural social construction of neoliberal principles that originated in the industrial world during the first half of the twentieth century and that began to spread across the developing world after the Second World War.

Macroscopic TrinityNeoliberal economists obsessed with breaking the chains of state regulatory systems and interested in returning to the deregulated conditions of the pre Great Depression era used theoretical models to debunk Keynesian economics.[10] During the 1970s and 1980s neoliberal principles became the formula for stagflation in the highly developed countries, and the remedy for the increasing external debt crisis across the developing world. The effective release of the forces of the market justified the dismantling of the social welfare state and the institutional and programmatic bodies that awarded citizens levels of accountability within the triangular dynamic of government-business-constituent relationships across the world. Nationalist development models based on Import Substitution Industrialization were dismantled and replaced by the principles of deregulation, privatization, and the strengthening of private property rights.

According to Rambarran, the implementation of the neoliberal experiment across the world produced mixed results, but the ability of the intellectual class to market success stories through its propaganda machine in order to justify the long-term preservation and expansion of neoliberal principles across the world gave birth to the Asian miracle.[11] Foreign direct investment and the “inflow of speculative money” would be the driving force behind the miracle, as capitalists in the industrial world shifted their production and manufacturing operations to newly unregulated regions of the world while at the same time taking advantage of the liberalization of capital accounts, escaping the already fragile regulatory systems in their own nation states, and setting the tone for the initial stages of accelerated “neoliberal globalization.”[12] Once the “speculative bubble…popped” foreign investors quickly pulled their money from the region, decreasing confidence in the East Asian region.[13] The neoliberal experiment had revealed the need for regulatory systems in order to impede the emergence of new unregulated speculative markets across the world under a more interdependent global market system, but the reshuffling of capital back into the industrial economies allowed the neoliberal propaganda system to quickly market the success of Free Trade zones.

Crisis 1997 Rambarran misses the opportunity to explain the historical developments that took place between the Asian crisis of 1997 and the 2008 Global Financial Crisis that pushed neoliberalism further into the collective subconscious. Discussions about the emergence of the Canada-United States Free Trade Agreement, the North American Free Trade Agreement, and the consolidation of the European Union would have allowed the author an opportunity to illustrate how neoliberal intellectuals engineered and marketed to their constituents the illusion of a globalized economy for the sake of the consumer and the domestic worker.

The author’s lack of historical evidence makes his argument less convincing. The 1997 and 2008 crises help illustrate how neoliberal forces are able to perpetuate their principles even after severe global economic, political, and social damage, but he is not able to explain how the intellectual forces within his “macroscopic trinity” were able to create the social cultural construction that turned neoliberalism into an unquestionable economic political philosophy.

For example how neoliberal economists such as Milton Friedman and Lauchlin Currie together with multilateral organizations engineered the expansion of neoliberalism to markets across the world. How marketing and public relations intellectuals such as Philip Kotler and Daniel Edelman perfected the use of mass media in order translate the principles of neoliberalism to consumers, distancing them from their role as constituents and shifting their agency toward the world of consumption. How the roles of politicians and bureaucrats was redefined by Thatcher and Reagan in order to reinvent the democratic relationship between representative and constituent, and how the educational system at all levels was reengineered in order to replicate and export neoliberal ideals across the world.

A more detailed explanation of the concepts behind his “social trinity” would have clarified the dynamics between the intellectual class, and political, economic, and social actors. Why is there a one-way communication dynamic between economic actors and society? Why is the communication between political and economic actors a one-way dynamic? And why is the intellectual class not present within the political, economic, and social realms but separate from them? I would argue that the success of the expansion of neoliberal thought is that they now represent government, economic policy, and the collective social conscience. It is why it is more prevalent then ever before to see private sector representatives running for office, managing government institutions, and redefining the nature of once sacred social institutions such as universities. It is not a phenomenon of the industrial world but a common trend across the global system.

References

Duménil, G. & Levy, D. “Neoliberal (Counter) Revolution.” In D. Johnston & A. Saad-Filho, Neoliberalism: A Critical Reader. London: Pluto Press, 2004, pp. 9-19.

Harvey, D. A Brief History of Neoliberalism. London, United Kingdom: Oxford University Press, 2007.

Rambarran,R. “Crisis without End: Neoliberalism in a Globalized Environment Modeling the Historic Rise of Neoliberalism and its Systematic Role in Recent Economic Downturns,” Munich Personal RePEc Archive, October 22, 2015.

Palley, T. I. “From Keynesianism to Neoliberalism: Shifting Paradigms in Economics.” In D. Johnston & A. Saad-Filho, Neoliberalism: A Critical Reader. London: Pluto Press, 2004, pp. 20-29.

Picketty, T. Capitalism in the Twenty-First Century. Cambridge MA: Harvard University Press, 2014.

[1] Rambarran, “Crisis without End”, p. 1.

[2] Ibid.

[3] Ibid.

[4] For more information see Harvey 2007, Palley 2004 and Dumeril & Levy 2004.

[5] Rambarran, 2.

[6] Ibid.

[7] Ibid., 3.

[8] Ibid.

[9] Ibid.

[10] Ibid., 4.

[11] Ibid., 10.

[12] Ibid., 11.

[13] Ibid., 13.

By failing to prepare, you are preparing to fail

The European Crisis in the Context of the History of Previous Financial Crisis

by Michael Bordo & Harold James

Abstract – There are some striking similarities between the pre 1914 gold standard and EMU today. Both arrangements are based on fixed exchange rates, monetary and fiscal orthodoxy. Each regime gave easy access by financially underdeveloped peripheral countries to capital from the core countries. But the gold standard was a contingent rule—in the case of an emergency like a major war or a serious financial crisis –a country could temporarily devalue its currency. The EMU has no such safety valve. Capital flows in both regimes fuelled asset price booms via the banking system ending in major crises in the peripheral countries. But not having the escape clause has meant that present day Greece and other peripheral European countries have suffered much greater economic harm than did Argentina in the Baring Crisis of 1890.

URL: http://EconPapers.repec.org/RePEc:bog:spaper:18

Circulated by NEP-HIS on: 2015-01-26

Reviewed by: Stephen Billington (Queen’s University of Belfast)

Summary

In this paper Bordo and James seek to analyse the impact of the financial crisis of 2007-8 in the context of previous crisis. Specifically by comparing the experience of periphery countries of the Eurozone with those of the “classic” Gold Standard.

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In their paper Bordo and James give a synopsis of the similarities which emerged between both monetary regimes. By adhering to a gold parity there was an expansion in the banking system, through large capital inflows, which was underpinned by a strong effective state to allow for greater borrowing. A nation was effective if it held an international diplomatic commitment, which in turn required them to sign into international systems, all the while this played into the hands of radical political parties who played on civilian nationalism[1]; these events combined lead to great inflows of capital into peripheral countries which inevitably led to fiscal instability and a resulting crisis. Similar dilemmas occurred within the EMU, but much more intensely.

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This brings me to the main point that the authors emphasize, that of the contingency rule of the classic gold standard. The latter allowed member countries a “safety valve for fiscal policy”. Essentially this was an escape clause that permitted a country to temporarily devalue its currency in an emergency, such as the outbreak of war or a financial crisis, but would return to normalcy soon after, that is, they would return to previous levels. Bordo and James’ argument is that this lack of a contingency within the EMU allowed for a more severe financial crisis to afflict the periphery countries (Greece, Ireland and Portugal) than had affected gold standard peripheries (Argentina, Italy and Australia) as modern day EMU countries did (and do) not have to option to devalue their currency.

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Bordo and James point out that crisis during the gold standard were very sharp, but did not last as long as the 2007-8 crisis. This because the exclusion clause during the gold standard enabled a “breathing space” and as a result most countries were back to growth within a few short years. The EMU story is quite different, say Bordo and James. Mundell (1961) argued that a successful monetary union requires the existence of a well-functioning mechanism for adjustment, what we see in the EMU are a case of worse dilemmas due primarily to this absence of an escape clause.

“Gold outflows, and, with money and credit growth tied to gold, lower money and credit growth. The lower money and credit growth would cause prices and wages to fall (or would lead to reductions in the growth rates of prices and wages), helping to restore competitiveness, thus eliminating the external deficits”

The above quote provided by Gibson, Palivos and Tavlas (2014) highlights how the gold standard allowed a country to adjust to a deficit. This point reinforces how Bordo & James argue that due to the constricting nature of the EMU there is no “safety valve” to allowed EU countries to release the steam from increasing debt levels. With respect to the Argentine Baring Crisis of 1890, while the crisis was very sharp in terms of real GDP, pre-crisis levels of GDP were again reached by 1893 – clearly a contrast with the Euro as some countries are still in recession with very little progress having been made as suggested by the following headline: “Greece’s current GDP is stuck in ancient Greece” – Business Insider (2013).

The following graph highlights the issue that in Europe most countries are still lagging behind the pre-crisis levels of GDP.

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Bordo and James clearly support this argument. Delles and Tavlas (2013) also argue that the adjustment mechanism of core and periphery countries limited the size and persistence of external deficits. They put forward that the durability of the gold standard relied on this mechanism. This is reinforced by Bloomfield (1959) who states it “facilitated adjustments to balance of payments disequilibrium”.

Vinals (1996) further supports the authors’ sentiments by arguing that the Treaty of Maastricht restricts an individual member’s room to manoeuvre as the Treaty requires sound fiscal policies, with debt limited to 60% of GDP and annual deficits no greater than 3% of GDP – meaning a member cannot smooth over these imbalances through spending or taxation.

Gibson, Palivos and Tavlas (2014) state “a major cost of monetary unions is the reduced flexibility to adjust to asymmetric shocks”. They argue that internal devaluations must occur to adjust to fiscal imbalances, but go on to argue that these are much harder to implement than in theory, again supported by Vinals (1996).

Comment

Bordo and James focus primarily on three EU periphery countries which are doing badly, namely Greece, Ireland and Portugal. However they neglect the remaining countries within the EU which can also be classed as a periphery. According the Wallerstein (1974) the periphery can be seen as the less developed countries, these could include further countries such as those from eastern Europe[2]. By looking at a more expansive view of peripheral countries we can see that these other peripherals had quick recoveries with sharp decreases in GDP growth, as in the case of the Gold standard countries, but swiftly recovered to high levels of growth again while the main peripheral countries the authors analyse do lag behind.

Untitled2See note 3

Bordo and James do provide a strong insight into the relationship between an adjustment mechanism to combating fiscal imbalances as a means of explaining the poor recovery of certain peripheral countries (i.e. Greece, Ireland, Portugal) and highlight the implications of this in the future of the EMU. If the EMU cannot find a contingency rule as the gold standard then recessions may leave them as vulnerable in the future as they are now.

Notes

1) This process can be thought of as a trilemma, Obstfeld, Taylor and Shambaugh (2004) give a better explanation. In the EU the problem was intensified as governments could back higher levels of debt, and there was no provision for European banking supervision, the commitment to EU integration let markets believe that there were no limits to debt levels. This led to inflows in periphery countries where banks could become too big to be rescued.

2) Latvia, Lithuania, Slovakia, Slovenia, and even Cyprus can be included based on low GDP per capita which is equivalent to Greece.

3) Data taken from Eurostat comparing real GDP growth levels of lesser developed countries within the Eurozone who all use the euro and would be locked into the same system of no adjustment.

References

Bloomfield, A. (1959) Monetary Policy under the International Gold Standard. New York: Federal Reserve Bank of New York.

Business Insider (2013). Every Country in Europe Should be Glad it’s Not Greece. http://www.businessinsider.com/european-gdp-since-pre-crisis-chart-2013-8?IR=T [Accessed 19/03/2015].

Eurostat, Real GDP Growth Rates http://ec.europa.eu/eurostat/tgm/graph.do?tab=graph&plugin=1&pcode=tec00115&language=en&toolbox=data [Accessed 21/03/2015].

Dellas, Harris; Tavlas, George S. (2013). The Gold Standard, The Euro, and The Origins of the Greek Sovereign Debt Crisis. Cato Journal 33(3): 491-520.

Gibson, Heather D; Palivos, Theodore; Tavlas, George S. (2014). The Crisis in the Euro Area: An Analytic Overview.Journal of Macroeconomics 39: 233-239.

Mundell, Robert A. (1961). A Theory of Optimum Currency Areas. The American Economic Review 51(4): 657-665.

Obstfeld, Maurice. Taylor, Alan. Shambaugh, Jay C. (2004). The Trilemma in History: Trade-Offs among Exchange Rates, Monetary Policies and Capital Mobility. National Bureau of Economic Research (NBER working paper 10396).

Vinals, Jose. (1996). European Monetary Integration: A Narrow or Wide EMU?. European Economic Review 40(3-5): 1103-1109.

Wallerstein, Immanuel (1974). The Modern World-System I: Capitalist Agriculture and the Origins of the European World-Economy in the Sixteenth Century. New York: Academic Press.

The Neoliberal Model is not Sustainable but State Driven Models have not Proven to be Any Better: How About We Just Redistribute the Wealth?

State Versus Market in Developing Countries in the Twenty First Century

by Kalim Siddiqui (University of Huddersfield)(k.u.siddiqui@hud.ac.uk)

Abstract:
This paper analyses the issue of the state versus the market in developing countries. There was wide ranging debate in the 1950s and 1960s about the role of the state in their economy when these countries attained independence, with developing their economies and eradicating poverty and backwardness being seen as their key priority. In the post-World War II period, the all-pervasive ‘laissez-faire’ model of development was rejected, because during the pre-war period such policies had failed to resolve the economic crisis. Therefore, Keynesian interventionist economic policies were adopted in most of these countries.

The economic crisis in developing countries during the 1980s and 1990s provided an opportunity for international financial institutions to impose ‘Structural Adjustment Programmes’ in the name of aid, which has proved to be disastrous. More than two decades of pursuing neoliberal policies has reduced the progressive aspects of the state sector. The on-going crisis in terms of high unemployment, poverty and inequality provides an opportunity to critically reflect on past performance and on the desirability of reviving the role of the state sector in a way that will contribute to human development.

URL: http://econpapers.repec.org/paper/peswpaper/2015_3ano96.htm

Revised by: Stefano Tijerina (University of Maine)

This paper was distributed by NEP-HIS on 2015-04-19. In it Kalim Siddiqui indicates that the global economic crisis that began in 2007 “provides an opportunity” to reconsider Keynesian interventionist models, thus “reviving the role of the state sector” for purposes of protecting the interests of the majority. Siddiqui centers his argument on the modern economic development experiences of the developing world, juxtaposing it with the experiences of advanced industrialized nations. He particularly emphasizes the economic development experiences of the United States and the United Kingdom, in efforts to advance the argument that Keynesian interventionist policies and protectionist agendas are instrumental in securing a transition into advance industrialization. He argues that the developing world needs to experience a similar transition to that of the UK and the US in order to achieve similar levels industrial competitiveness. However the neoliberal discourse promoted by the industrial powers and the multilateral system after World War Two, and the implementation of neoclassical liberal policies after the 1980s, impeded the developing world from moving in the right direction.

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Siddiqui begins the construction of his argument by providing a brief history of the modern economic development patterns of both the UK and the US. This lays the foundation for his main argument that developing nations should return to the Keynesian patters of economic development in order to achieve advanced levels of industrialization that will eventually allow them to correct present market failures, reducing unemployment, poverty, and environmental degradation.

He points out that in the 1970s and 1980s the UK and US moved away from interventionist policies and adopted a neo-classical model of economic development in response to “corruption, favoritism, and other forms of self-seeking behavior,” that lead to the economic crisis of the times. This model would then be promoted across the international system by the economists of the World Bank and the IMF who found in the same neo-classical model an explanation for the failed Import Substitution Industrialization (ISI) policies implemented across the developing world to cope with the crisis of the 1970s and 1980s.

Kalim Siddiqui

Kalim Siddiqui

What Siddiqui does not address is that the failure of the implementation of the ISI policies across the developing world were the direct result of the same corruption and self-centered tendencies of leadership that forced a move away from interventionist policies in countries like the UK and the US. I agree with Siddiqui that the structural changes introduced by the multilateral financial agencies did more damage than good, however I disagree with his idea that the developing world should return once again to Keynesian solutions, since the implementation of these structural adjustment programs were in fact forms of interventionism that catapulted most of these economies into debt.

Siddiqui then lays down a series of reasons why the role of the state should be reconsidered across the developing world, highlighting that greater interventionism would be more beneficial than an increasing role of the market system. He uses the recent success stories of state driven capitalist experiments such as China’s, Brazil’s, India’s, and Malaysia’s, disregarding the fact that these state driven models continue to be tainted with problems of corruption and self-rewarding management styles that are inefficient and wasteful. For example, he points out the success of Petrobras in Brazil, not following up on the fact that the state-run oil company is now under investigation for high levels of corruption that has sent its stock price in a critical downward spiral.

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At the end Siddiqui’s argument is debunked by more contemporary realities; including decreasing global unemployment patters, economic recovery, and the downfall of state run economies such as those that moved to the Left in Latin America during recent times. Moreover, the bailout policies implemented by the United States and the European Union during the peak of the latest financial crisis contradicts Siddiqui’s argument that neoliberal economies “do not countenance any economic intervention by the state.” I argue that interventionism is an integral part of the advancement of neoliberal agendas; the question that Siddiqqui should be asking is what degree of interventionism is ideal for the developing world under a global neoliberal reality that is inevitable to avoid?

Siddiqui’s work represents yet another criticism to neoliberal capitalism, centering on the agendas set by the administrations of Margaret Thatcher and Ronald Reagan in the 1980s. It does not provide a convincing method or strategy for reviving state driven capitalism under an increasingly intertwined global economic system. It is rich in criticism but short of offering any real solutions through state interventionism. Current case studies that have returned to interventionist models, as in the case of Brazil or India, have failed once again to resolve issues of poverty and income inequality. I agree with the author’s conclusion that the implementation of neoliberal models across the developing world has distorted inequality and social justice even further but disagree with the simplistic solution of increasing state interventionism in the management of market driven economies for the sake of it. More so when the historic evidence indicates that the leadership across the developing world has consistently pursued self-interests and not the interests of the masses. From my point of view, the revival of interventionist models across the developing world will just complete the vicious cycle of history one more time, particularly now that the interests of private global actors has permeated the internal political economy decision making processes of the developing world. If in the early stages of the modern economic development of the developing world foreign political and business interests directly and indirectly penetrated local decision making, thanks in part to the intervention of the World Bank and the IMF as it was pointed out by Siddiqui, then it is inevitable to impede such filtrations under a global system, unless the nation state is willing to pay the high costs of isolationism.

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Siddiqui indicates that self-marginalization from the market system worked for the UK and the US, allowing them to strengthen their internal market and generate the technological and human capital capabilities necessary for advanced industrialization, but that was more than one hundred years ago when the globalization of the market had not reached the levels of sophistication of today. If these industrial powers were to try this same experiment today, the outcome would have been very different. In the past decade developing nations such as Venezuela, Argentina, Bolivia, and Ecuador have experimented with Siddiqui’s model and the results have been no different than the old experiments of Import Substitution Industrialization and other interventionist approaches of the post-Second World War Two era. Corruption, political self-interest, lack of internal will to risk investment capital, lack of infrastructure, lack of an internal sophisticated consumer market, the absence of technology and energy resources, and the inability to generate short-term wealth for redistribute purposes in order to guarantee the long-term projection of the interventionist model has resulted in failed revivals of the Keynesian model. It is the reason why Cuba is now willing to redefine its geopolitical strategy and reestablish relations with the United States; clearly the interventionist model is and was not able to sustain a national economy under a market driven international system.

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The solution lies inside the market system. It is futile to denigrate neoliberalism unless the developing world leadership is willing to construct a parallel market system, as once envisioned by Hugo Chavez, but we are far from that reality. Instead each nation state should reevaluate its wealth distributive and resource allocation policies, moving away from defense spending and refocusing on infrastructure, technology, human capital, health, and the construction of a solid and self-sustainable middle class. Van Parijs’s pivotal work, Real Freedom for All speaks to this idea, indicating that the solution to securing policies that center on what Siddiqui calls the majority, lies in capitalism and not in socialism. If, through a more equal distribution of capital across all sectors of society, capitalism is able to outperform any socialist or interventionist model, then there is no need to attack capitalism and its neoliberal ideas. A replication of this model across the developing world would boost economies into a more sophisticated level of economic development. More competition among states’ private sectors would lead to a more efficient international system, a dynamic that would be enhanced even further by less and not more government intervention. However, the current realities pointed out by Siddiqui indicate that political and corporate elites are not willing to redefine their views on capitalism and therefore we need greater government intervention for redistribute purposes. The redistribution of the pie is the only way to avoid Marx’s inevitable revolution, I agree with Siddiqui. But I do not trust the role of the state as a redistributive agent. I am more in favor of what Michael Howard calls “basic income capitalism” that secures sustainable expendable income in the hands of all consumers through the market system. The dilemma of interventionism continues to be at the forefront, yet it could easily be resolved by the market itself, as long as the actors, workers and owners of capital, are willing to redefine the outreach and potential of capitalism; as long as the social construction of freedom of capital is redefined?

References

Michael W. Howard, “Exploitation, Labor, and Basic Income.” University of Maine (work in progress).

Kalim Siddiqui, “State Versus Market in Developing Countries in the Twenty First Century,” Institute of Economic Research (working paper), submitted at VIII International Conference on Applied Economics, Poland, June 2015, p.1.

Van Parijs, P. Real Freedom for All: What (If Anything) Could Justify Capitalism. Oxford: Oxford University Press, 2005.