The swing back to laissez-faire markets

The Reagan-Thatcher Revolution, aka as the Washington Conccensus

The world economy 1980s to 2007

1. The end of the Keynesian balance.

2. The surge of the Market Economy.

3. Signals of risk to the Market Economy model.

4. Financial crisis 2007 and swing back to Government intervention.

1. The end of the Keynesian balance.

• Break-down of Phillips curve – rising inflation had diminishing effect on reducing unemployment; and slowing down of output gap and productivity growth.

• Prices and Income policies failed, by misleading Govts about extent of demand pressures.

• US and UK were most affected by persistent inflation, and both eventually tightened fiscal and monetary policies sharply.

• Led by President Reagan/PM Thatcher, both countries proceeded to policies of liberalisation, deregulation and privatisation…heading back to Market Economy and ‘Small” Government.

2. The surge of the Market Economy.

Washington Consensus:Ten points:• Fiscal discipline – towards balanced budgets.• Targeted social protection vs. public subsidies.• Tax reform: broad tax net, low marginal rates.• Freeing Interest rates.• Competitive Exchange rate.• Trade liberalisation.• No barriers to FDI(Foreign Direct Investment).• Privatisation.• Deregulation: removing barriers to entry and exit.• Property Rights.The term “WC” really applies to all those actions that let Market lead the

Economy, with minimal Government intervention.

Contd). The period 1980 to 2007 saw:• Rapid acceleration in Globalisation of Trade and Investment

as Fcy controls lifted and FDI encouraged.• Open trade fostered huge export surpluses in Asian

countries, and contributed substantially to fast GDP growth in China, as well as LA countries (Brazil, Chile).

• Easy US monetary policy created low interest rates everywhere, while growing Trade, based on comparative advantage of labour costs, helped contain global inflation.

• Private sector everywhere increased its economic presence very significantly, and Investment levels as % of GDP rose to 35% in India, and 50% in China.

Contd).

• High productivity gained from globalisation of Supply-chains, improvements in cost and quality.

• Most regulation made ‘light-touch’, particularly in Financial markets, encouraging huge capital accumulation in Stock Markets and Real Estate.

• The period 1980 to 2005 may be termed the “Golden Age of the Washington Consensus”.

3. Signals of risk to the Market Economy model.

The issue was: could markets self-regulate; could they correct automatically, without Government intervention?

Against this standard, major risks had appeared in the financial markets throughout the period 1980 to 2005 that prompted Government intervention.

If large Banks/other Fis failed, the domestic and even the world economy – via Globalisation – could face major risk to sustainability to growth.

The Market Economy failed the self Regulation test, resulting in massive Government intervention in the US/UK/Euroland starting 2008, to forestall the risk of another Great Depression.

Contd).Banking crises post 1980:• ‘81-’85: Latin American Debt crisis, eventually supported by IMF/IBRD/US, via

Brady Bonds.• ‘89-92: US recession brought about by collapse of S@Ls/RE market/Leveraged

debt, eventually paid for by Govt bailouts at taxpayer cost.• ‘93-’03: Japanese ‘lost decade’, long recession brought about by Bank overlending

against Stocks/RE; GOJ had to support, Govt debt rose to 200% of GDP.• ‘94: Mexican debt crisis: US Govt arranged $50bn bailout, incl. IMF, primarily to

support US Banks and NAFTA.• ‘97: Asian Crisis: overborrowing from foreign Banks, by banking systems in T/I/K,

during fixed exchange rate regimes; devaluation caused huge losses: eventually, IMF stepped in with highly controversial programme.

Contd).• Others: Russia;Argentine;Turkey.

In all cases, Market was unable to regain balance without Government support.

Costs of crises were substantial.Yet US/UK/Euro regulators- in particular the US – continued to

relax restrictions on Banks/FIs. Rejection of appointment of Regulator for Derivatives, by the

US Fed and major US Banks, contributed substantially to the 2007 Financial crisis.

Costs of bailouts undertaken by Governments post ‘07 – and still continuing in Europe – exceed $2trn, plus lost growth between 1% and 2% of GDP for US/UK/Europe.

4. Financial crisis 2007 and swing back to Government intervention.

• In the financial sector, market failure was abundantly clear, with potentially catastrophic consequences.

• There were two types of failure in Governance of Banks: a) failure of Board/Senior Mngmnt to supervise Risk; and,b) failure of Regulators to treat Banks as, ultimately, Public-Utilities –

who’s high leverage and asset-liability mismatch posed huge risks to the economy. Regulators overlooked explosive growth in risky derivative positions, and dangerous, risk-encouraging, trends in Banks’ compensation system.

• For foreseeable future, Banks will under heavy Regulatory enforcements: higher Capital; restriction on Proprietary creation of leveraged positions(Hedge Funds etc); separation of Investment, from Commercial, Banking; etc.

Conclusion:

• Has Keynesianism come back?• If so, than why the austerity pressure on Southern

Europe?• If not, then how is huge Government intervention

in the bigger Western economies explained?• The fact is that the world is moving away from blind

confidence in self-adjusting financial markets, and Banks will be managed more as Public Utilities than freewheeling private entities for the near future.