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21st Century Global Economic Crisis: Relevance to the New Deal
SALEEM M. KHAN E-mail: [email protected]
Operational practices of the 21st Century global economic crisis are grounded in constantly changing economic and political landscapes. Added to this climate are some elements of confusion and voracity of internal and external special interests. Another key factor in this episode is the current management of globalization, being conducted within the approaches of free trade and free markets. Modern macro-economic knowledge, and some of its theories, instruments and policies, applied in managing the complex situations are relatively new and untested, therefore, are not effective.
The current global economic crisis has to be examined in the light of the new challenges and changed economic and political climates over the past seven decades, since the crisis of the 1930s. In the new setup of political and business governance, combined with the power of internal and external interest, economic management has been subdued by myriad influences undermining the mechanics and power of market forces. Consequently, we have at our hands not only a one time crisis but a specter of perpetuity of economic shocks, especially without any prior warnings. My thoughts in this paper are organized in the sphere of economic and political analysis. The sequence is the following: return of the nineteenth century economic liberalism; New Deal, 1933-41, and its impact; Crash of 1929 and the Great Depression; 21st Century economic/financial crisis; and Summary and conclusion.
Nineteenth Century Economic Liberalism
Since the end of the Cold War, a concerted effort has been waged to transform the world economic order into a capitalistic globalization one, with special focus on the road map of free trade and a free market. Nobel Laureate economist Joseph Stiglitz has characterized it as a market fundamentalism. This trajectory is on the model of 19th century economic liberalism, a doctrine of free trade and economic freedoms; neo-liberalism is its new face. To tackle
the modern day economic crisis using the strategies of neo-liberalism, the instrument of free trade, privatization and deregulations have been applied. Reintroductions of the old remedies of the classical doctrine and its intellectual orientation have given in not only to the ancient mercantilist spirit but also to a new creed of materialism. Under the neoliberal programs and policies due to the economic dominance of special interests, gains from free trade and the free market are not being fully realized. Notwithstanding the lessons of the Crash of 1929 and the Great Depression of 1930s that had brought the capitalist world to an abyss, it is ironic that the same old strategies have been rehabilitated. A new era of lopsided distribution of growth gains and rising inequalities point to the return of the gilded age.
Crash of 1929 and Great Depression
On October 29, 1929, the American Stock Market crashed. Its impact was of an historic event termed «Black Tuesday». This economic shock plunged the U.S. economy into a serious downturn and engulfed the world into a chronic slump. This was obvious from the interdependence of the global market system and its strong ripple effects turning the Crash into an international phenomenon and Great Depression. Both the people and the world economy were caught up in a stubborn spiral of economic slump and poverty.
The early period of capitalism and its success in the U.S. owed to capital investment activities of the entrepreneurial elite of the Rockefellers, Fords, Carnegies and colonial exploits. Shared private and public investment in development infrastructure, industry, and modernization of agriculture paved economic foundations of the U.S. economy. The same approach was also pursued in promoting human capital formation, and R&D. The result was rapid growth and enormous wealth creation. North America, Europe and Japan benefited from the shared investment efforts in both economic and social arenas. (Note 1) The emerging economic prosperity inspired interest in freedoms and knowledge.
The advent of economic renaissance and enlightenment energized peoples' political impulses and their struggle for liberty and freedoms came in the open. The evolving system of institution building, responsible governance and economic prosperity laid the foundations for rule of law and accountability in political governance. The revolutionary initiatives of economic foundations and social democracies required even more wealth. Additional wealth came from distant lands. In contrast to the revolutionary politico-economic changes in the empires, no significant events of democracy and economic foundations were obvious in the colonies. The developments at home did not go as planned either. The pillars of the gilded age strengthened as income disparities widened. Democratic aspirations were choked by the power of special interests and rising influences of lobbying regimes.
The discipline of economics was also changing. Innovations, advances and sophistication in modern economics were transforming it into a science parallel to natural sciences. This development in economic discipline prompted, as well as promoted, the beliefs in positive analysis (focus on the facts). From this professional-centered obsession the discipline remained deprived of normative values (value judgment). In this process purely materialistic pursuits and free market orientation have often depreciated the key goals of shared prosperity and social democracy. The ideals such as justice, fairness and prosperity under such pressures have been pushed back. This road map has encouraged «accumulation». Market trained economists and policymakers especially in the developing world fell into market mindset and even today continue to claim the ownership of this model. However, they have seen weakening market discipline, less convincing development outcomes and strengthening material mindset.
The much promised new world order of 21st century of democracy and freedom could not be realized because the material mindset has found strong allies among the elites of the politics, banking and finance. At this time two other events of significance were at work, deregulation and globalization. The deregula-tory regime, which I will profile later in the paper, had exploded business mergers, and had helped establish «too big to fail» financial enterprises. The contemporary phase of globalization supported free trade under which export promotion thrived. This event created a glut of international savings and supply of cheap money, dragging interest rates down
to a low level of liquidity trap. Inflow of huge sums of money from surplus countries enabled the U.S. banks to take risks by investing it in more complex and less understood financial instruments. Financial investments in untested markets failed to make quick profits. Professor Annat Admati, Stanford University, makes a forceful argument that «the corruption associated with «too big to fail» guarantees are best handled by high equity requirements which force banks to face the full consequences of their decisions' (FT. Jan 20th, 2011). This was the beginning of the 21st century financial crisis and Great Recession, 2007-10.
New Deal, 1933-41 and Impact The New Deal, 1933-40, of President Roosevelt is cited as a dynamic initiative that saved the day for the U.S. economy by most economists. It also pulled the world economy out of the Great Depression during the 1930s. Over the years there has been a continuous and significant debate, especially among profession economists, whether the New Deal was a major vehicle in the rescue of the world economy and in offering relief to the people affected by the Great Depression. The reviews reflect the ideological biases among the economists. There is a new debate whether remedies similar to the New Deal can guard the «new economy» from reoccurring global economic crises, present and future.
It is not unusual to expect from any economic shock, however big or small, that the people and economies often get affected. The Great Depression and the New Deal were big factors. Roosevelt wasted no time in facing the gigantic challenge of his presidency in March 1933. His immediate action was to rescue the people from misery and suffering, as his 1938 speech is emphatic in support of citizen-centered strategies.
In the words of President Roosevelt, in his address to the Congress in 1938:
Government has a final responsibility for the well-being of its citizenship. If private co-operative endeavor fails to work for the willing hands and relief for the unfortunate, those suffering hardship from no fault of their own have a right to call upon the government for aid; and a government worthy of its name must make fitting response.» (Polenburg, 2000).
Soon after taking oath in March 1933, to put his words into action, Roosevelt declared a four day
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bank holiday. To free the U.S. from the constraints of international agreements, in April he opted out America from the interwar gold exchange standard. Several other measures were also taken to revive the financial sector and to stabilize it in the coming years. Three among them were particularly noteworthy. First was the intensification of activity of the Reconstruction Finance Corporation to supply large sums of needed liquidity. Second was the creation of deposit insurance to stop runs on banks (some 9,000 American banks failed between 1929 crash and the establishment of the FDIC in 1933). Third was the Securities Exchange Act of 1934 which established margin requirements. (Parker, 2007).
Other key steps taken to revive the economy were, i) The National Industrial Recovery Act (NIRA) enacted on June 6, 1933. It was designed to raise prices and wages to combat deflation. ii) The Agricultural Adjustment Act was enacted in 1933. Its goal was to reduce yield and raise prices in the farming sector. Other measures, iii) the Tennessee Development Authority, iv) the Public Works Administration, and v) the Federal Emergency Relief Administration and grants to states were adopted. There were additional steps taken such as enacting the Social Security Act and the National Labor Relations Act between 1933 and 1935. These Acts were considered central to job creation and to provide relief to the suffering citizens. It is widely recognized that these steps would reflect the Keynesian reconstruct of the macroeco-nomic thought enshrined in The General Theory, published in 1936. A combined package of economic programs, policies, and financial reforms are milestones of the New Deal. The New Deal was recognized as being hugely effective.
Professor Parker's review of research cited in his book, The Economics of Great Depression, confirms some of these conclusions:
The NBER business cycle chronology shows continuous growth from March 1933 until May 1937, at which time a 13-month recession hit the economy. The business cycle rebound in June 1938 and continued on its upward march to and through the beginning of the United States' involvement in World War 11. The recovery that started in 1833 was a welcome economic reversal with real GNP experiencing annual rates of growth around 10 percent between 1933 and December 1941, excluding the recession of 1937-38 (Romer, 1993).
Successive economic programs with social orientations, fiscal initiatives and banking/financial regulatory reforms were commissioned and sustained for over four decades. The longevity of economic health, economic performance and relief to citizenry that were achieved during the president's tenure were largely due to the economic relief package. Another key factor which came to prominence was the political will and presidential leadership of the successive U.S. administrations. The specific programs launched by «President Franklin Roosevelt's New Deal, President Harry Truman's Fair Deal, President John F. Kennedy's New Frontier, President Lyndon Johnson's Great Society, (and I must add President Jimmy Carter's Job Creation policies) and defended by President Bill Clinton, sharply limited the negative effects of economic downturns and poverty (De-Long, 2013).
Twenty First Century Economic/ Financial Crisis
Origins of the «Great Recession,»2007-2010, can be traced to a number of political decisions by the U. S. Congress and fast moving economic events. Most instrumental among them were a chain of hastily enacted deregulations during the period between 1980 and 1999; accelerated pace of globalization; poor governance; and scandalous corporate behavior. The deregulatory period that started with the Monetary Act of 1980 ended with the Financial Services Modernizing Act of October 22, 1999. This process of deregulation scratched Regulation O, cancelled the Glass-Steagall Act of 1933. A voided Glass-Steagall Act resulted in removing restrictions on the integration of banking, insurance and stock trading. The Glass-Steagall Act was one of the central pillars of Roosevelt's New Deal. Overall, holes in corporate governance and lack of official oversight are largely to blame.
Inadvertently the Congress had removed many restrictions from the financial institutions. In the wake of the Monetary Act of 1980 the U. S. Government had to deal with a massive Savings and Loan Crisis in 1982. Public funds over 200 billion dollars were paid to bail out U.S. banking industry to cover its huge losses and bad loans. Globalization's fast-tracked export-led expansion ((derive))) and increase in commodity prices led to massive surpluses for some countries and consequently to a glut of savings in the international markets. Party-based federal governance opened the doors for political
gridlock delaying or slowing critical economic decisions. A lax oversight allowed corporate excesses emerging in the accounting scandals in the early 2000s and the financial crises of the late 2000s (note 2). Under the U. S. Treasury's Troubled Assets Relief Fund (TARF) and Fed's Quantitative Easing (QE) program both the institutions used over two trillion dollars of tax payers' money to stimulate the economy and to recue car industry, banks and Wall Street.
The questions currently being debated among the economists and policymakers are «what about the future?» Only determined political action of the kind exhibited by President Roosevelt in the New Deal initiatives that created economic relief programs and reconstruction of macroeconomic thought (Keynes) and reconstruction of economic and financial institutions can insure the long-term dynamism and stability of the U.S. economy, and protection to the citizenry against the loss of employment and income.
Before I draw my own conclusions on the crisis, its aftermath, and workable responses, I would like to quote several reputed macro economists and monetarists on the Subject. Professors Joseph Stiglitz and Paul Krugman are macroeconomists. Both of them are Nobel Laureates and strong supporters of economic stimulus and recommend policymakers to do much more in the way of fiscal expansion. Stiglitz had predicted the financial crisis and had forewarned of its adverse effects on the economy and the people. He is a critic of management of globalization and concerned about its potential of creating future crises. Kraugman is a major rethinker of economic knowledge. His stance, in addition to fiscal expansion, is that currently the U.S. economy is in a liquidity trap and many of the rules of economics are in abeyance as long as the trap lasts. He argues that when the economy is in a monetary trap and (((sustained budget deficits))), for example, these conditions don't drive up interest rates and create inflation. Moreover, reducing government spending during the recession has negative effects on income and employment.
Paul Volcker and Alan Blinder are both monetarists. Paul Volcker, former Chairman of the Federal Reserve System, is credited for taming inflation in 1980s by using the instruments of tight monetary policy. He had brought inflation under control in 1980s and has recommended strong remedies for the current and future financial crises. He has argued that speculative activity played a key role in the
financial crisis. He is the author of the Paul Volcker Rule. The rule recommends a ban on proprietary trading by commercial banks, whereby deposits are used to trade on the bank's own account. This rule restricts the U.S. banks from making certain kinds of speculative investments that don't benefit their clients and can be instrumental in preventing the future financial crisis.
Alan S. Blinder is another well-known monetarist. In his recent book «After the Music Stopped» he has made detailed analysis and recommendations for financial reform:
In «After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead, reviewed by Professor Delong in Foreign Affairs,» Blinder frames his recommendation for reform in 10 commandments: three are addressed to the government and seven are addressed to financiers. The first set urges policy makers to remember that the cycle of profit, speculation, exuberance, crash, bankruptcy, panic, and depression has been a constant feature of industrial market economies since at least 1825; that self-regulations by financiers is a disaster; and that financiers should have very strong incentives not to walk up to the edge of defrauding the public. The second set of commandments exhorts financiers to remember that their shareholders are their real bosses, that managing and limiting risk are essential, that excessive borrowing is dangerous, that complex financial instruments are equally dangerous, that trading should be carried out using standardized securities in public markets, that the balance sheet is a picture of a firm's position and not a toy, and, finally that perverse compensation systems must be fixed... Mindful that his prescriptions might not take hold and that another calamity could well befall the economy. Blinder concludes his book by suggesting policymakers ought to act during the next crisis: they must focus on heading off risks before they materialize, communicate their policies clearly, make sure to distribute pain fairly, and never promise that there will be less pain than there will be (Delong, 2013).
Two more concerned professionals have their take on the on-going economic and financial crises. Professor James Galbraith drawing on meticulous academic research comments on rising inequality. Financial analyst Gillian Tett of Financial Times cautions on the role of free marketers:
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Galbraith maintains that the main source of growing inequality across the world in recent years has been not industrial change, educational reforms, or geopolitical shift but the financialization of the modern world. Gillian Tett, US Managing Editor of the Financial Times (Foreign Affairs, 2012), alerts that to pay homage to free markets in their political rhetoric, US policy makers must ensure that markets are truly free in the sense of being open and competitive. That means making finance dramatically more transparent and simple and ensuring financial institutions are small and self-contained enough to fail without bringing the entire system down. Without such market discipline, it is impossible to have efficient market system. Above all else, policymakers must prevent powerful cliques of bankers and banks from dominating the system for their own ends, skimming off outside margins because nobody else can work out what they are doing or because the barriers to entry are too high for anyone else to compete. And last but not least, governments should make sure the banks pay for the risk they pose to the system, or recognize the cost they could potentially pose, by imposing taxes or fees (Tett, 2012).
Summary and Conclusion
Romanticizing with the 19th contrary (century?) economic liberalism and considering it an effective remedy for the economic ills of modern economies, are off the mark as answers to the current challenges. Today's complicated economic relations, not so transparent business activities, citizen's activism and rising expectations of justice and fairness demand creative ideas and innovative approaches to today's challenges. In this regard, voices of the people, economists and social scientists should be the part of national debate and of official deliberations. The lessons learned from the New Deal and from the subsequent economic programs introduced by various administrations should be serious lessons. The making of the twenty first century world order, as was publicized and popularized in the last quarter of twentieth century pronouncements in statesmen's speeches, public forum discussions, media reporting must be allowed to become a reality.
The responsibility for change requires team work and a universal effort. In the edicts of the realpolitik and in the arena of democratic order, people are the bosses and have the duty of holding elected politicians accountable. In the corporate world
shareholders must assert their rights of ownership and direct the managers, those who work for them, to carry out the policies and tasks of the enterprise as dictated. Consumers have the power to control market forces through their inherent mastery of the market as Adam Smith has shown through «consum-er's sovereignty.» It is obvious that if collective responsibility is not exercised then the game to bring needed change is seriously weakened. The democracies have so frequently experienced these effects.
To stabilize economies and put them on the path of sustained growth, high employment and incomes, poverty reduction programs, and to respect freedoms and fairness the following framework of short-term and long-term policies and programs can reinforce the current efforts:
First, reconstruction of the macroeconomic thought and institutional restructuring are critical to tackle complex economic problems. In this context an effort and boldness at the level exhibited by John Maynard Keynes in 1936 is an example worth emulating by the economists today. This is an effective way to counter stubborn constraints and to bring about a worthwhile socio-economic change.
Second, without a clear vision of the future and its challenges, all efforts end up in an «Alice in Wonderland» syndrome. A politician's horizon is short-termism and a politician's preoccupation with winning elections engages them in political manipulations. Managing the complex societal tasks and economic organization require a long view of the challenges and programs. Long-term approaches provide a clear view and plenty of time for rethink and deliberations.
Third, economic and financial regulatory reforms are critical, but they need fresh ideas and expert review. Experts should carefully evaluate the relevance and benefits of the existing rules and change them if redundant, outdated or resulting in high cost to the industry. New and efficient regulations should be enacted for each industry and economic activity. In making new regulations, politicians should proceed with caution and prudence. Good examples in this context are to pursue Paul Volcker rules and relatively high capital requirements by the commercial banks.
Fourth, an effective legal framework is a fundamental requirement for the efficient functioning of a market economy. In its absence or lax, enforcement of market's rules of the game and lack of government
< 50
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oversight opens the doors of malpractices such as accounting scandals and inside-trading (Hubbard and O'Brian, 2010). In an effective legal framework regime, the world economy would have continued to grow fast and recent financial crisis and economic slowdown could have been avoided.
Fifth, a comprehensive social program for the young and the old and the unemployed is a pride of the modern societies. This is essential not only to preserve democratic ideals of human respect and dignity but also for the realization of a greater economic potential by a society. Adam Smith in Moral Sentiments has warned against injustice and social ills as damaging for the health of a society and economic growth.
Last, an efficient and responsible system of governance is must to create a healthy political and economic climate. The reigns of governance need to be freed from the tight grips of special interests and lobbyists. Responsible governance strengthens participatory political systems, holds the supremacy of the rule of law, and evolves social harmony. These ingredients indeed deliver a strong and stable economy and a happy and contended people.
Note:
1. The entrepreneurial success is a shared phenomenon between private and public investments. Early on the development efforts were waged in the today's industrially advanced countries by building development infrastructure in social and physical areas. In both these areas government played a key role in direct research and generous funding. In North America public investments in education, health services, energy and railroad were significant. In Europe these investments continue to date. Japan invested heavily in both areas starting in early 19th century. South Korea, Malaysia and China had a late start in this field and their economies are rapidly converging with the other developed countries. Recent history of the entrepreneurial success in the U.S. is due to government funding
R&D. Private business success would have been impossible without the active role of the government. For example, «The armed forces pioneered the internet, GPS positioning and voice activated «virtual assistants.» These inventions led to today's consumer-electronics revolution. Development of the Apple's smartphones became possible because of research in defense labs. Google's search algorithm was finance by a grant from the National Science Foundation. Pharmaceutical industry is a big beneficiary of state research and funding leading to many of the new age drugs (The Economist, August 31st 2013).
2. In the early 2000s, the top managers of the several large and well-known firms, including Enron, an energy trading firm, and WorldCom, a communications firm, were shown to have falsified the firm's financial statements in order to mislead investors about how profitable the firms actually were. Beginning in 2007 and lasting into 2009, the U.S. economy suffered the worst financial crisis since the Great Depression of 1930s. At the heart of the crisis was a problem in the market for home mortgages (Hubbard and O'Brian, 2010). Surplus supply of money in the world markets pushed down interest rates to their lowest, less than two percent and borrowing for all purposes increased.
References
1. DeLong, Bradford, (2013), The Second Great Depression, Foreign Affairs, July/August.
2. Financial Times, (2013), New York.
3. Hubbard Glen and Anthony O'Brian (2010). Macroeconomics, Prentice Hall, New York.
4. Parker, Randall (2007). «The Economics of the Great Depression». Edward Elgar, Cheltenham, UK.
5. Polenburg, R. (2000), The Era of Franklin D. Roosevelt, 1933-1945, Bedford/St. Martin's, Boston.
6. Romer, C.D. (1993), The Nation in Depression, Journal of Economic Perspectives, Spring.
