Hasta la vista, modern economics

Voice of the people: anger directed at our banks - but they are the product of modern economic practice

MY FELLOW editor David Jones asked a very pointed question on this site earlier this week: Should we have known better? At a recent seminar in Germany I heard a leading British economist say that international finance was largely beyond the understanding of economists. Another academic put it this way: banks and other financial institutions that were too big to fail were also too big to know. I don’t think the average house-buying punter had much chance and no wonder few of us ever thought that “the market has gone crazy, I’ll sit this out”. Otherwise we would not have bought a house or flat for years. Those who needed to buy had only one market available to them.

Markets are elusive things. The assumption that free markets are always efficient and set fair prices is now questioned even by the most ardent of capitalists. Value is not predetermined as some Platonic ideal. Far from it, in times of crisis prices can inflate or deflate at alarming speed. Many things, we now realise, are safer than houses.

Regulated markets can help in areas where they are feasible. But even then there is a danger that the system can be circumvented. This is pretty much what happened in the banking sector as financial products proliferated at mesmerising speed, making regulation a hopeless game of catch-up. And when regulated markets work at all, they can have a deadening effect on enterprise by excluding new entrants and competition. What is clear is that once people doubt the stability of prices or the value of financial assets, real trouble starts. As a neo-Keynesian Red Tory capitalist, I find it profoundly unsettling that the economic fog is thicker now than at any time since the 1930s. Who would have thought that so many UK high street banks could have become near functionally bankrupt if not bailed out by the taxpayer? These are hard times indeed.

The Minsky thesis seems to loom ominously in the mist. Economic prosperity generates financial instability which leads to asset price bubbles. When credit is easily available and emerging economies like Russia and China suddenly invest large sums abroad, large flows of money chase a trickle of assets. Asset prices go up and less investment goes towards real, wealth-creating enterprises. Flats in Cardiff Bay may be a long way from Moscow or Shanghai, but their price was influenced by decisions taken there and elsewhere in the global economy.

Yet something has made this crisis worse than other financial upheavals such as the dot.com crash of 2000-2002. The complexity of international finance has worked profoundly against the average citizen. House prices have crashed and pensions lost value. Meanwhile youthful bankers still get paid 40 times the average wage or more. And these bonuses are not generated by honest risk taking because the losses are ultimately insured by the taxpayer. Such private profit-public loss equals a crisis in capitalism. Polite economists call it moral hazard. The customers in the Dog and Duck use an earthier description.

As a Conservative I do not believe in a profound measure of material equality. The cost to liberty is prohibitive. But massive inequality is just as pernicious to the operation of free markets. In the US over the last 30 years nearly 60% of real income growth has gone to the top 1% of households. The UK has also seen the gap between rich and poor widen considerably. The very viability of free and competitive markets is brought into question by such income inequality.

This truth was grasped by many skillful reformers in the 20th century. Teddy Roosevelt broke up many US monopolies; Lloyd George put labour on a more equal footing with property; FDR restored faith in capitalism after it had been debilitated by the Great Depression; and Attlee showed that a mixed economy could work. Not all of these prescriptions apply as effectively today but their genius lay in trying to make the citizen a bigger player in the economy.

That we need radical solutions today is accepted by those on left and right of the political spectrum. The deepest challenge is how to tax the wealthy effectively – that is in a manner which upholds social cohesion without undermining entrepreneurship. The relative political stability that followed the end of the Cold War has created global markets for skills and capital. Many wealthy people can locate for tax purposes in some safe haven or other. Only vigorous international co-operation can eradicate this vice. Meanwhile, immobile taxes – VAT and income tax on those of us who must stay put – have become the mainstay of taxation policy and made taxation a dirty word among many electorates in western countries. Things have got to change; perhaps the Tobin tax is a good idea after all.

The wider challenge is how to put citizens in greater control of economic life? We need to start with the obvious: pay, pensions, and housing. The Tory-Lib Dem coalition is surely right to take more low earners out of tax altogether. Pensions will need to reflect the demands of the 21st Century, including average life-spans approaching 100-years-old. Here the gap between private and public sector provision must be closed. Most attention should go to constructing reliable long-lived financial products. And housing: go back to basics and over time (it might take 10 years) aim to bring house prices back to three-to-four times the average wage. It may be time to place limits – or increase taxes – on non-EU citizens owning property in the UK.

Citizens need basic material security to enjoy healthy, productive lives. It is time to remember Burke’s little platoons – the building blocks of healthy communities. More economic activity needs to be rooted in villages, towns and city neighbourhoods. An early response to the impersonal forces of industrialisation was the co-operative movement. It remains a powerful model and together with the wider concept of social enterprise can again humanise capitalism. If we allow banking to be the dark, polluted preserve of bankers we are asking for trouble. It is a terrible irony that what caused much of this financial catastrophe was something as humdrum and local as mortgages that were wrapped up into investment vehicles of supposedly near no risk (what a laugh!) and sold globally. Let credit unions bloom and send mutuals back onto the high street. I don’t want my mortgage owned by a Russian billionaire.

Communities will thrive if their skills remain relevant and competitive. For too long we have allowed decision makers to do thing to communities and not with them. Skills co-operatives could be an answer where local communities identify and invest in their own skills needs. They might also support – with credit unions – local SMEs. Community assets could be run by local people – leisure facilities, libraries, even schools. Globalisation has brought more benefits than dangers but it has distanced people from the economic forces that shape much of life. We cannot hope for an existence free of economic vicissitude, but we can channel and mitigate some of the market’s fiercer forces.

Blame the bankers? Well, yes I do, mostly. We still need them, of course. But we should make them read Studs Terkel’s heart-wrenching but life-affirming account of the 1930s depression in the US, Hard Times. After that, if they still don’t get the point that it is people who matter, I really will give up and move to Cuba.