This debit crisis is following same path as one 30 years go. Time to rethink how economics is taught to avoid another lost decade
Monday marks a significant anniversary in recent economic history for it was on this day in 1982 that Mexico announced a moratorium on its international debts. The default marked the start of what became known as the third world debt crisis.
Three decades later that crisis is now the first world debt crisis. For Mexico read Greece. For American, British and Japanese banks recycling the 1970s windfall profits of oil producers to sub-prime Latin American governments read US and European banks pumping out cheap credit to sub-prime mortgage holders. For the syndicated loans that allowed banks to lend recklessly without the necessary prudential checks read the securitisation of loans that allowed banks to bundle up the good mortgages with the bad and sell them.
The policy response to the crisis has also been identical. In 1982, Latin American governments were lent money by the International Monetary Fund so that they could pay back the banks that were threatened with going bust as a result of their stupidity. As in Greece today, the money was given with one hand and taken away again with the other.
Draconian conditions were imposed on these loans, which resulted in a lost decade of high unemployment, increased poverty and contracted output. In 1990, the output of Latin America was 8% smaller than it was in 1980. Governments paid a high price for their bailouts because the IMF was concerned that too soft an approach would lead to a problem of “moral hazard” – instead of learning from their mistakes, countries such as Mexico and Brazil could be encouraged to go on another borrowing binge.
The debt burden on the affected countries did not go down as a result of this shock treatment; it went up. Mexico’s debt to GDP ratio doubled in the five years after 1982 because its economy collapsed. Belatedly, there was a recognition at the IMF and in western capitals that the debts were unpayable and had to be written down. From small beginnings, the campaign for debt relief flourished in the 1990s, with its focus moving from Latin America to sub-Saharan Africa. Despite fears that debt amnesties rewarded bad behaviour, governments have – by and large – learned harsh lessons. Moral hazard has not been a problem.
Except, of course, for the banks, who were treated with kid gloves following their excesses in the late 70s and early 80s. Far from tightening up regulation and supervision, governments in the west continued to dismantle controls. Controls on capital were abolished both within countries and across national borders. Measures put in place after the great depression to limit the size and the scope of banks were abolished. Banks became bigger, more powerful and extended their global reach. It was the heyday of financial liberalisation, and its architects insisted it would lead to more efficient use of capital, faster growth and greater prosperity for everyone.
What financial liberalisation actually led to was a concentration of power exercised without restraint, the enrichment of a small elite, moral hazard on a colossal scale and a series of crises that became ever more serious as they burrowed their way from the periphery of the global economy to its core.
There are two obvious lessons for the present day from the Latin American debt disaster. The first is that there will be a further writedown of Greece’s debts, either through a debt amnesty or through a default that may take place inside or outside the eurozone. Greece’s economy is now around 20% smaller than it was three years ago, and that means the debt arithmetic does not add up.
The second lesson is that leaving the financial system untouched, unreformed and unpunished almost guarantees another severe debt crisis. This might look unlikely at the moment because the banks are currently reluctant to lend, but sooner or later memories of past speculative excesses will fade, as they did after Dutch tulips, the South Sea bubble and the Wall Street crash.
Can anything be done to prevent this happening? One thing that would help would be a rethink of the way economics is taught, since the messianic belief in abstract – and failed – models coupled with a complete absence of historical perspective increases the danger of mistakes being repeated.
In a new collection of essays about the teaching of economics after the fall, the Bank of England’s Andrew Haldane says the crisis was an analytical failure or intellectual virus. “This virus had contaminated almost everyone by 2007, causing them to view the pre-crisis world through spectacles far rosier than subsequent events have shown was justified.”
There was no sense of the risks that were being run. On the contrary, it was assumed that the global economy had achieved a state of bliss, in which the models “proved” that all the big problems of the past had now been solved. Some basic knowledge of the teachings of Adam Smith, Karl Marx, Friedrich Hayek and Maynard Keynes might have prevented the groupthink.
Smith warned about the dangers of monopoly power, while Hayek said the price system would only work its magic if competition prevails. Marx said history was moving towards a system of monopoly capitalism, and Keynes said this was particularly dangerous when it took the form of financial speculation.
All these great thinkers would have their own take on the crisis. Smith would want to see multinationals broken up, Hayek would be arguing that it would be better to allow banks to fail than to keep them in a zombie-like state, and Keynes would want to see finance become the servant of industry not its master.
The Marxist perspective, exemplified in a new book by John Bellamy Foster and Robert McChesney, is also useful. This argues that the strong western growth rates in the middle of the 20th century were something of a mirage, caused by high military spending, postwar reconstruction, higher welfare spending and the investment in road networks that allowed the full flowering of the age of the automobile.
Since then, a number of things have happened. There has been a concentration of capital but a shortage of profitable investment opportunities. So far, there has not been a wave of innovations like the car, the plane, cinema and TV to give the global economy a shot in the arm, although it is possible that digital, robotics, genetics and green technology could act as a catalyst. The result has been a declining trend rate of growth, and the increased financialisation of western economies as the surpluses have been re-cycled through the banks in a search for yield. Hence the Latin American debt crisis. Hence the sub-prime mortgage crisis. Hence the inability of the global economy to emerge from its torpor.
• What’s the Use of Economics; edited by Diane Coyle; published 15 September by London Publishing Partnership
• The Endless Crisis; John Bellamy Foster and Robert McChesney; Monthly Review Press; September 2012
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