The ‘credit crunch’ and the SAD economy

The current economic crisis is a product of feeble political leadership and the hollowing out of Western economies.

Phil Mullan

3rd November 2008

Over the next two weeks, spiked will be publishing a series of articles based on talks given at the Battle of Ideas festival, which took place on 1 and 2 November at the Royal College of Art in London. Here, Phil Mullan explains why the current financial crisis reveals both a failure of leadership in the West and an underlying weakness of the major economies.

The current financial crisis now appears certain to translate into a very severe downturn. That’s going to mean a lot of hardship for people. But this is also an opportunity for people who are interested in the development of ideas.

We have had a quarter century of the depoliticisation of the economy. The economy has been turned into a technical, micromanagement issue. This has been one of the problems for those now running the economy and helps to explain why they’ve not been able to cope with what has been going on. The current situation gives us an opportunity to repoliticise the economy and raise some profound questions about the nature of capitalism.

The state of the crisis

Things have got worse; worse, I must admit, than I thought they would get a year ago. We have seen the mushrooming or morphing of a sub-prime debt crisis in America into an all-embracing financial crisis and then into a banking crisis that has effected the whole of the Western financial system, and which is now spreading elsewhere. In turn, this has led to generalised economic recession. I’m not sure all those steps were necessary.

Why are these things happening? What it reflects is a fundamental atrophy of economic activity in the West combined with the inability of Western leadership to cope with this economic crisis. While it is often dangerous to make predictions about the future, I believe that the authorities will now find it very difficult to contain these problems.

The actions of politicians and senior bankers have been the expression of an out-of-touch leadership. Many people have greeted the huge injections of cash by governments on both sides of the Atlantic as examples of decisive action. However, the reality is that the response has been schizophrenic. The financial authorities and politicians have oscillated between putting their heads in the sand and hoping the problem will go away – while declaring that ‘the fundamentals are sound’ – or they have engaged in fitful fire-fighting.

For example, the $700billion bailout in the US has been put forward as an instance of decisive leadership. But leadership requires being resolute and consistent. When the authorities oscillated backwards and forwards, not really deciding whether or not there was a real problem, or whether or not to put money into the system, then it was pretty much in the script that the bailout would be rejected by Congress.

When you look at the major economic problems we face in a very technical way, the supposedly bold move to pour $700billion into the economy was devoid of any sense of political leadership or establishing any sense of urgency. Policymakers could then pursue their own agendas and so Congress rejected the original plan. That is not the definition of resolute activity.

Even what the bailout was supposed to do changed very quickly. Originally, the money was going to be spent on buying up toxic financial instruments – effectively worthless IOUs – from the banks rather than to put those funds into the banks themselves to recapitalise them. A few days later, the authorities flip-flopped again and are now buying shares in the banks. The whole crisis has been a catalogue of indecision and a sad reflection on the state of political leadership.

I don’t agree with a lot of what George Soros says, but in a recent interview he pointed out that consistently, from day one, the authorities have been behind the curve on this. While very few commentators predicted that things would get this bad, it is also legitimate to call those who are supposed to be leading society to account for their failures.

This is not to suggest some fundamental intellectual deficiency on the part of Hank Paulson or the other senior bankers and politicians. The intellectual atmosphere across Western society has been that there is no alternative to the market and therefore that economic matters should be treated entirely in technical terms.

Nonetheless, more could surely have been done. Heizo Takenaka, the former Japanese economy minister and one of the people identified with ending the 10-year banking crisis in Japan, was asked last week by the Financial Times what he thought should be done about the current crisis. His reply was: ‘More intellectual effort.’ I think he was referring to the problem of finding out where the toxic assets are. He has a point: a bit more intellectual effort would have shown we were facing a more substantial problem than was being suggested a few months ago.

The underlying problems

Looking at growth statistics for the past decade or so for the UK, it would appear that the country has been doing well. However, looking at the quality of that growth, it is clear that there has not been that much wealth creation in the West. Instead, there have been three aspects to growth.

Firstly, rising property values have fuelled consumption and boosted the retail sector.

Secondly, the production of goods and services has been displaced by financial activity. Thirty years ago, financial services accounted for about 15 per cent of the UK and US economies. That has now grown to over 30 per cent of the economy. Shuffling money around, and the business services that go with that, has become a significant part of the economy. Meanwhile, the productive, industrial part of the economy has shrunk as much as financial services have grown. Manufacturing in America, for example, is now just 12 per cent of the economy.

Around 20 years ago, about a fifth of the profits of US corporations could be attributed to financial activity. Now, if you add up the profits of financial institutions and the financial activities of non-financial companies, it is about 50 per cent of the economy.

Thirdly, there has been growth in public spending. With the collapse of property prices and the chaos in the financial system, all that is left is public spending. In fact, it is possible to see the potential for a financial crisis to be converted into a state deficit crisis as governments attempt to pump-prime their economies. The productive part of the economy has been hollowed out.

As the Lex column in the FT noted in the summer, when an economy doesn’t make much of anything anymore, and the property, retail and financial sectors implode, what’s left – other than to reap the benefit of value production in Asia?

America: in hock to China

China has been keeping the West afloat. This is the opposite of what economics textbooks say should be happening. Money is supposed to flow from rich countries to developing countries, but the reverse has been happening. Value production is going on in the East, so even if banks in the West have been making profits until recently, this has not been based on new value creation but on their ability to cream off profits made elsewhere in the world.

Meanwhile, America has become the most indebted nation in the world. Any individual can keep living on zero income as long as he or she has access to a credit card – until the bill comes in and the bailiffs come round. Likewise, America has been living on credit from the rest of the world.

We can thus look at the crisis at two levels. We can examine the situation now in terms of the credit crunch and we can look at what’s going on underneath. The problem is that the politicians do not recognise that situation as it really is.

What we have had for the past 15 years or so is what I call a SAD economy: stable, anaemic but durable. From the end of the 1980s through to the middle of this decade, the West has been able to cope with its difficulties like low productive investment and a moribund productive sector that has never been forcibly restructured. That is partly because of the credit, but another factor has been the absence of any major challenges to the system, either domestically or internationally. This has been a breathing space in which the Western economies have been able to muddle through without really doing anything to solve their problems.

What capitalism needs to get going again is a more profound period of restructuring. Instead, what has been happening is the application of one sticking plaster after another to the financial system.

A feeble critique

Another group deserving of criticism are the critics of capitalism. There is now a clear opportunity to call into question a system that can only move forward by perennial cycles of destruction. But the nature of the current criticisms of capitalism are such that, if anything, it is better for us to emphasise the positive aspects of capitalism today. The main critics of the market suggest that the problem is that capitalism has been moving forward too rapidly, generating too much wealth and being too ambitious – yet these are the most progressive aspects of capitalism.

The highpoint of anti-capitalist critique at the moment seems to be to accuse bankers of being greedy. Such attacks are glib and unhelpful. The changing focus of the last week or so has been from one bunch of greedy people – the City of London ‘fat cats’ – to another: overpaid television presenters like Jonathan Ross.

In order to solve the current crisis, we need to have a much better intellectual understanding of what is actually happening – especially if we want to have any hope of putting forward a coherent alternative to capitalism.

Phil Mullan is the author of The Imaginary Time Bomb: Why an Ageing Population Is Not a Social Problem, IB Tauris, 2000 (buy this book from Amazon (UK) or Amazon (USA)).