Delivering an ‘Aftershock’ to the economic debate
Philippe Legrain’s Aftershock is a lucid and open-minded introduction to the world economy. But it makes the common mistake of blaming bankers for the current economic crisis.
Anyone attempting to write a primer on the current state of the global economy faces an incredibly difficult task. Not only is there an immense amount of complex information to master, but the general reader is likely to find the subject matter forbidding.
Few writers feel comfortable either with developing a broad view of the global economy or relaying their arguments in accessible terms. Philippe Legrain’s skill at both helps make Aftershock one of the best books of its type.
Legrain has several advantages as an economics writer that make him well suited to the task. In terms of his writing style, the influence of his early job as a writer on international economics for The Economist is clear. As in that newspaper (The Economist prefers not to call itself a magazine), the emphasis in Legrain’s writing is on expressing difficult ideas as simply as possible.
Even more importantly, Legrain recognises that his readership is likely to be anxious about the state of the world: ‘Aftershock is aimed at a global audience, but in particular at people in rich countries who are fearful about the future’, he writes. Much of the thrust of the text is therefore aimed at showing the existence of practical solutions to pressing problems.
The global character of Legrain’s outlook is another central part of his work. He resolutely refuses to take a narrow nationalistic perspective on any question. Instead, his concern is to show how a flourishing of the world economy can benefit humanity as a whole.
Protectionism and curbs on immigration are particularly abhorrent to him. Legrain, whose previous book was on migration, sees both measures, quite rightly, as standing in the way of generating a more prosperous economy for all.
There is always room for debate on exactly which topics a book on the current world economy should cover, but Aftershock tackles many of the key areas. These include the troubles of the financial system, the rise of emerging economies, green technology, and the backlash against Chinese investment. The book ends, unusually in these pessimistic times, with a chapter about embracing progress.
The main weakness of Aftershock is one it shares with virtually every other contemporary text of its type: a tendency to treat the financial sector as an autonomous realm whose activity undermines the rest of the economy.
Even here, however, Legrain’s argument never descends into moralistic outrage against ‘greedy bankers’. Instead he argues that the problem was what economists sometimes refer to as an asymmetric compensation structure. In other words, bankers were remunerated handsomely if their bets paid off, but if they performed badly they were likely to be bailed out. Under such circumstances it was not surprising that bankers were often reckless.
There are two additional elements to his argument. Bankers, like anyone else, can get caught up in the irrational exuberance of surging markets – growing ever-more confident that asset prices can only rise. In addition, the huge lobbying power of the banks ensured that the regulatory regime was constructed to suit them.
Yet Legrain’s approach artificially separates the rise of the financial sector over several decades from developments in the broader economy. The most important factor in the huge increase in the importance of finance was the relative decline in productive activity.
From the 1970s onwards, it became increasingly attractive for businesses to play the financial markets rather than reinvest in production. Speculative capital spontaneously found its way into financial assets because an atrophied real economy could not provide sufficient profitable investment opportunities. This was the main impetus behind the huge growth in financial markets from the 1970s onwards.
Legrain does recognise the relative decline of manufacturing in the West, but he sees it as a largely technical matter. For him, rapid productivity growth meant that manufacturing inevitably accounted for a smaller share of the economy over time. Workers are increasingly replaced by machines as a natural part of the process of economic growth.
There are several reasons to question this straightforward account. First, although productivity growth arguably leads to a fall in manufacturing employment, there is no automatic reason why manufacturing should fall as a share of GDP. As Legrain points out elsewhere in his book, there is no set limit to how much the world can produce. Even the rise of the emerging economies does not necessarily mean that the developed economies must devote a smaller share of their economies to production.
Second, it is harder to draw a line between finance and the real economy than the conventional view suggests. The productive sector is a broader category than manufacturing. It includes, for instance, the transport sector and other parts of the economy which help facilitate the process of production.
Similarly, finance has become a much broader grouping than banks or even financial institutions more generally. Firms supposedly involved in manufacturing or services increasingly developed their own financial operations. For instance, car companies developed large financial services arms and most companies of any size set up substantial risk-management operations.
Most importantly, there is the fundamental problem of how the market system regenerates itself. From month to month, and year to year, the capitalist economy is in a state of flux. If this process is not working smoothly, it can generate many forms of economic instability.
These are complex questions which need to be examined in more detail to be fully understood. Cowardly Capitalism, my 2001 book, looks more closely at the troubled relationship between finance and the real economy.
In recent years, state attempts at muddling through have reinforced the bloating of the financial sector. For example, in the run-up to the 2008/2009 financial crisis, the American authorities pursued policies that helped create a credit boom. The goal was to maintain economic momentum by the easiest means available. Interest rates were kept low, lending rules were relaxed, and public spending was kept high. Eventually the boom was bound to lead to bust – but to blame the troubles largely on the banks is one-sided. The authorities played a key role and they were in turn trying to find ways of countering a weak economy.
On the political side, Aftershock also underestimates the difficulty in cutting through the contemporary sense of deep social pessimism. It is not enough to show empirically that there are ways round today’s economic problems – although that is a good starting point.
For instance, it is clearly important to show, as Legrain does well, that there are plenty of possible technological solutions to the problem of climate change. But green thinking cannot be refuted simply by challenging its lack of imagination in practical terms. The essence of environmentalism is the notion that human activity is constrained by natural limits. If human activity is unconstrained, then, in the green view, it will exhaust scarce resources, destroy biodiversity and even lead to catastrophic climate change.
To counter such arguments effectively, it is not possible to sidestep the hard political arguments and simply present technological solutions. The whole notion of a natural limit needs to be made explicit and challenged, and it needs to be shown that what appear to be fixed, inviolable limits can in fact be overcome. To the extent that constraints exist, they are the product of a lack of sufficient economic development and a dearth of imagination. They are not fixed limits imposed by God or Gaia.
These criticisms should not detract from what is a fine book overall. In such a vast subject area, there are bound to be differences of opinion. For its global perspective and embracing of progress alone, this book is highly recommended. It is a great starting point for anyone seeking to start grappling with the problems of the world economy.
Aftershock: Reshaping the World Economy After the Crisis, by Philip Legrain, is published by Little Brown. (Buy this book from Amazon(UK).)
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