Has capitalism (neo-liberalism) failed?

When debating this issue, John Quiggin (September 27, 2008) made the claim that neo-liberalism had failed (relative to social democracy). Paul Frijters (recent Club Troppo piece), on the other hand, dismisses the topic as largely irrelevant.

One reason for this disagreement is that one is defining economic libertarianism and the other is defining economic liberalism. Let me explain.

When Quiggin attacked neo-liberalism, he defined its core on three criteria.

  • to remove the state altogether from non-core functions such as the provision of infrastructure services;
  • to minimize the state role in core functions such as health, education, income security, through contracting out, voucher schemes and so on; and
  • to reject redistribution of income, except as is implied by the provision of basic safety.

On those three grounds, he rightly notes that most democracies, in trying to pursue a free market line, have failed. Social democrats have proved far superior. These are all anti-economic libertarian arguments.

However, I prefer to make a clear distinction between economic libertarianism and economic liberalism.

Economic libertarianism justifies its stance on two grounds:

  • individual liberty is a paramount virtue in itself and should generally override other virtues (a value-based, philosophical case); andso they are willing to support measures which enhance economic freedom even if these offer little or no economic gain or even involve an economic sacrifice.

Economic liberalism is a quite different kettle of fish. They are driven by their professional beliefs which is why we find that a majority of economists embrace many strict left wing views.

Let us look at the three areas that economic liberals like to focus on small government, barriers to intercourse, and labour market regulation.

There is absolutely no agreement between economic liberals and libertarians on the issue of small government low levels of government expenditure and taxes. The reason is simple: neither economic theory nor empirical evidence point firmly to any optimal size of government from an economic viewpoint. Depending on the starting point and, most importantly, on the nature and composition of government spending, smaller government does not necessarily or predominantly produce higher per capital incomes – except at the extreme fringes. So whereas libertarians endorse any proposals which reduce the size of government, economic liberals look at each proposal on its merit to see if it meets their economic test. The most striking example is in the analysis of distribution incomes. Small government is not mainly an issue in economics at all.

Turning to the second proposition (barriers to intercourse), economic liberals often start with the assumption that (subject to the usual provisos about availability of information and third party effects) that individual consumers are the best judges of their interest and that they are able to successfully maximize their utility or preferences (rational man). Even allowing for the new and mushrooming field of behavior economics, these assumptions are seen by economists as offering a sufficient approximation to reality.

This then induces them into reforms designed to remove competition barriers in product, service and financial markets. Economic liberals like such reforms because they believe competitive markets give sellers strong incentives to minimise costs, innovate and to channel goods and services to those consumers who value them most highly all conducive to higher economic welfare and national productivity. And their empirical studies generally show that: removing such barriers to competition does generally deliver better outcomes for employment and per capita incomes.

However, economic liberals differ from libertarians in two key respects:

  • they do not see an expansion of economic freedom as desirable per se: an expansion of freedom only wins their support if it meets the economic test i.e. if it is confidently expected to yield significant net economic benefits; and
  • they are much less cynical and distrustful of the ability of governments to correct market failure.

This means they look very closely at the empirical evidence.

So what has now happened to the idea of financial regulation?

The Campbell Committee of 1981 paved the way for financial deregulation of credit flows, interest rates and exchange rates. These are all just as necessary today as they were then. But the Committee also recognized that a financial system could not operate effectively unless investors at large had confidence in the underlying solvency of financial institutions and in the overall stability of markets. So it insisted on adequate prudential disciplines. Two subsequent Inquiries into the financial system reinforced this message. As a result, we have some very tough prudential disciplines in place (apart from deposit insurance, which has now been rectified).

Unfortunately the rest of the world did not follow suit. It can be said that there is surely now a strong need for additional regulation. However, while market failure and the greed of entrepreneurs are mostly responsible for what has happened, some of the things that went wrong were also due, on a smaller scale, to over-protection of consumers. And many forms of financial regulation such as a permanent ban on short selling would make markets more volatile. And monetary policy has to be held to account to an extent. These are all semi-government failures.

The third gap between libertarians and economic liberals is in the area of labour market freedom. Here too, as with small government, economics potentially clashes with ideology. Libertarians advocate labour market deregulation because it widens individual choice and this is seen as desirable for its own sake. On the other hand, economic liberals support deregulation of the labour market only where it is expected to produce economic benefits. And they know that the relationship between labour market deregulation and economic performance is very complex and does not lend itself to generalisations. In particular, they know that the economic impact depends on what exactly is being deregulated and how much labour market freedom there was at the start.

To sum up, economic liberal arguments still revolve around the case for lowering the barriers to intercourse (lowering protection, freeing up markets etc.) and for or against the dissolution of wage deregulation. The arguments on both these fronts remains wide open.

Although I mostly agree with John Quiggins views on labour market protection, I remain some distance from him on barriers to intercourse except of course in the area of financial deregulation, where trust matters most.

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67 Responses to Has capitalism (neo-liberalism) failed?

  1. Bingo Bango Boingo says:

    Interestingly Quiggin began by asserting that because (1) the USA was ‘neoliberal’ and Europe was ‘social democratic’, and (2) financial institutions in the USA required government assistance but European ones did not, therefore (3) neoliberalism has failed. Here is the relevant quote:

    “On any reasonable interpretation of the terms, the US follows neoliberal policies while most EU countries are predominantly social democratic. In this sense, recent events represent a failure of neoliberalism.”

    To maintain the thesis in the face of financial institution failure/distress in social democracies such as Belgium, France, Germany, Italy, etc. he will simply have to deny that any of the affected EU economics are in fact social democratic. One wonders how he will achieve this without doing great violence to the concept. Perhaps he will simple remain silent on the issue. After all, the triumphalist-driven dichotomy of neoliberal country vs. social democratic country won’t stand much debate or scrutiny, childish and simplistic as it is.


  2. Chris Lloyd says:

    BBB, the crisis has its genesis in the US. To some extent, the Europeans caught the disease from the US. So recent developments do not, by themselves, invalidate JQ’s position.

  3. Rafe Champion says:

    It is a fundamental error to judge the success of economic rationalism or classical liberalism on a comparison of the US and the Scandanavian states because I am advised that on some indicators (tariffs and security of property rights for example) some Scandanavian states score better. Besides the US has massive investment in welfare, public health and education, plus generous tariffs, absurd farm protection and corporate welfare and regulations of all kinds (affirmative action, environmental etc). So the Quggin argument falls over at the first hurdle.

  4. Rafe Champion says:

    This calls for a somewhat detailed post that I don’t have time to write just now but I will argue that classical liberalism is the key to improvement of the human situation, or at least to peace, freedom and prosperity. The major principles of classical liberalism are (1) a suite of freedoms, including free trade across national boundaries, (2) the rule of law, (3) security of property rights, (4) limited government and (5) a robust moral framework including honesty, compassion, enterprise, civility, and community service. Reform movements to date have used a mixed bag of policies, bits of socialism and other things mixed with bits of classical liberalism, however it is likely that the active ingredients that actually produced benefits for the people were the classical liberal components, not the socialist or left-liberal bits.

  5. SJ says:

    Rafe, it sounds like you’re trying to equate economic liberalism with libertarianism, and dismissing the rest of what Fred talks about as being socialism. E.g. regulation = socialism, economic test = socialism, evidence = socialism, prudential supervision = socialism, etc., and further, that you’re saying that all those things are bad.

    I’d say you’re working with completely useless definitions of both “economic liberalism” and “socialism”.

  6. Nabakov says:

    “Id say youre working with completely useless definitions of both economic liberalism and socialism. ”

    Fuck yeah. Anyone still fiddling around with useless “isms” is I venture to suggest either some boring old fart with an ancient itch they still can’t scratch or some young, dumb and full of cum glibertarian. Either way they’re not real players, just twitchy and powerless folks assuming the world should be organised like their desktop. So they can get some.

    Get real. There ain’t nothing pure and linear about how this brawling messy whacky planet actually works. And every time it’s fucked up badly is because of people who think everything should end in “‘ism”. We need more worldly flexible managers and much less systemic and ideological believers.

    “How would you like your century sir?”
    “I’ll have the burnt bits at both ends. With a decent shiraz.”

  7. conrad says:

    Rafe, personally I agree with you that using the US and the Nordic countries as examples of two ends of a continuum is misleading (let alone being able to import such a model to other countries. If we were just looking to import become-rich models, then Singapore is doing exceptionally well for their especially meager resources, but obviously hard work, no minimum wage, and studying hard must be considered too hard and too un-Australian for Australians. We want magic cures after all).

    “a robust moral framework including honesty, compassion, enterprise, civility, and community service”

    Alternatively, this line is making me itchy, just thinking about it. Somehow or other your are reminding me of Malcolm Fraser.

  8. Rafe Champion says:

    Thanks Conrad, Hong Kong under British administration was an even better example than Singapore.

    Don’t get me started on Malcolm Fraser! People were afraid that he was an economic liberal, he was even reputed to be a reader of Ayn Rand!

  9. NPOV says:

    Conrad, there are three other elements of Singapore’s success that would be even more difficult to emulate here: a) having a natural harbour at the center of some of the world’s busiest trading routes b) having a huge supply of cheap labour just across the border and c) very high living density, meaning relatively few resources are used to provide housing and transport.
    Oh and of course the fact that it’s been essentially run as a (mostly) benevolent dictatorship for the last 50 years.

  10. JC says:

    The Bank of News Zealand did a study of comparative systems back in the 90’s. From what I recall Honk Kong came out tops as the amount of capital input was much , much lower than Singapore’s. Singapore was far more wasteful with its capital than Honk Kong.

    If I recall correctly the study tried to work out how much capital input was required to produce a given amount of GDP. Honk Kong with its far more liberal economic system came out tops as it was able to allocate capital far more efficiently than anyone else.

  11. pedro says:

    This seems an arid debate when, in truth, even the US is more social democracy that economic libertarian. It is a funny definition of failure when neoliberalism struggles at the ballot box. How many people would be surprised that a majority can be found to support redistributionist policies?

    More disturbing is the starting point that deregulation needs to be justified by economic benefits. Surely freedom is the starting point and regulation needs to be justified by economic benefits. Deregulation is justified simply by a lack of general utility from the regulation in question.

  12. Tom N. says:


    Although the labels “neo-liberalism”, “economic liberalism”, “economic rationalism” and so forth are used by different people to mean, or allude to (or dog-whistle at) different things, I agree with the one of the thrusts of Fred’s post – which I take to be that Quiggin’s depiction of certain “isms”, and their relationship to actual policy making, is simplistic and misleading.

    On a post on his own blog (‘We are all socialsts now’, 10 Oct), Quiggin said:

    But it [aspects of the meltdown] does mean, for quite some time to come, the end of neoliberalism (or free-market liberalism or whatever you want to call the set of ideas centred on the proposition that markets can do a better job than governments in managing risks of all kinds).

    When I pulled him up on this, pointing out that no economists where I work hold that set of ideas, Quiggin reformulated as follows:

    Tom, if you want to me rephrase the argument in a more nuanced way, let me say “the idea that we should be relying more on markets and less on governments to manage risks of various kinds is unlikely to survive this crisis”. I think it’s fair to say that this idea has been dominant in public policy circles for some decades now…

    But even this somewhat weaker formulation is, in my view, not very helpful. This is because the professional policy economists who I know and work with reach their recommendations for less intervention – in those cases where that is what they recommend – on the basis of a weighing up many detailed considerations surrounding the particular market or issue they are considering: not from some overarching view or starting point that there should be less government intervention or that there should be more reliance on markets than on governments.

    In these ways, I see Quiggin’s “grand narratives” of the free-marketeers versus the interventionists as being somewhat remeniscent of Michael Pusey’s work – satisfying, perhaps, to a soft-left lay audience seeking to have their prejudices confirmed, but largely empty for serious policy practitioners. This stream of Quiggin’s output is unfortunate because, without wanting to sound unduly fawning, he is undoubtedly brilliant and overall makes a very valuable contribution to the public sphere.

    Tom N.

  13. Fred,

    you are right, I do see this as a largely irrelevant set of distinctions and discussions. Apart from the many sensible things that Tom N already says in his comment above about the irrelevance for these labels for policy land, I can add two more general observations:

    1. These labels are almost irrelevant for economic academia. I wouldnt be able to give a single example of a decent journal that uses these terms regularly in their contributions. If there is one, let me know.

    2. Like Tom, I see no relevance of these distinctions in Australian public policy either. Let me suffice with one set of statistics. According to the 2005 Business Council of Australia report, the 1980s, the great era of deregulation in Australia in terms of reduced tarriffs and the opening of the labour market, saw an increase in the total pages of new legislation passed as law from about 15,000 in the 1970s to 30,000 in the 1980s. This doubled again in the 1990s and stayed up there in the early 2000s. What this shows is that the Keating and Howard years were, from an historical perspective, both full of additional regulation despite the differences in ideological outlook ascribed to them. The general trend of icnreased regulation in the last few decades is quite global.

    Where Fred has a point is that political debate is full of terms, but beneath the surface of differeing ideological labels its ‘more regulation as usual’ whilst we keep expecting our economic growth to come from the pursuit of private gain by competing actors. Even our levels of transfers havent changed that much in the last 40 years, not even in the US (it just gets shifted around). Perhaps we should start looking at other indices. I would want to see the number of lawyers no part of the civil service who write up all this legislation. It doesnt exist, but I expect a ‘Lawyer Concentration Index’ to be highly relevant.

  14. Fred Argy says:

    Only two of the comments received address the essential distinction I tried to make between economics liberalism and economic fundamentalisms. They are JC and Tom N. They both appear to accept that economic liberals focus on the economic issues without any overarching view or starting point that there should be less government intervention or that there should be more reliance on markets than on governments.

    I too believe that John Quiggin has been fairly successful in attacking fundamentalism (his argument being that we are all predominantly “social democrats”) – but that he has not focused his attack on economic liberalism, which is the predominant way of thinking.

    Paul Frijters, I too endorse many forms of “regulation” – but not the one relating to financial regulation, which is now the main centre of international attention.

    As for many of the other contributors, they can dream on about the merits of their particular breed of puritan economics.

  15. Rafe Champion says:

    Fred, I am struggling to make sense of your distinction between economic liberalism and economic fundamentalisms. This may be because you are fundamentally confused about the situation so your distinctions are not helpful. You wrote “while market failure and the greed of entrepreneurs are mostly responsible for what has happened…”. You are apparently prepared to ignore the influence of government inferference in the housing market and this oversight calls into question the whole point and purpose of your argumnent.

    You also ignore the larger agenda of classical liberlism, where economic policy is a part of a package. If you and others like John Quiggin are not prepared to address the larger package then you will inevitably offer a distorted verion of liberalism, though I appreciate that for polemic purposes it is convenient attack a straw dummy.

  16. SJ says:

    Rafe, you seem to only be able to conceptualise things as black or white.

    Fred’s post is about how the real world is gray. That’s how it is, how it’s always been, and how it always will be. We can adjust the shade of gray, but to you it’s still going to look gray, and you’re never going to be happy.

    That’s just too bad, sport. Get over it.

  17. Rafe Champion says:

    SJ I am happy to live with gray but you and Fred need to acknowledge that among the gray there is classical liberalism which is helpful, progressive and rubust in contrast to socialism and economically illiterate forms of conservatism.

    I will be interested in Fred’s response.

  18. Patrick says:

    For Rafe’s help I will translate as I understand it, and hopefully someone will correct me if I get it wrong.

    Fred’s economic fundamentalists (why ‘economic’? surely libertarian or free-market?) are economists with free-market hammers: every problem looks like a regulatory nail. Fred’s economic liberals are really just sceptics working in, or at least opining on, economics.

    Back to Quiggin. Fred, you haven’t told us what Quiggin is. He clearly isn’t a free-market fundamentalist, and doesn’t come across as very sceptical.

    On the sceptical note, since I can no longer click through to quiggin’s site (not sure why!!), can someone explain to me how this ‘crisis’ has anything to do with social democracy? Maybe someone can explain this to a dope like me!

  19. Rafe Champion says:

    I appreciate that it is not possible to say everything about a complex topic at once but it does not help to simplify the situation to a point where significant elements are missing. The point of economic analysis (leaving aside all the isms) is to work out WHICH factors are most significant in a given situation and WHAT UNINTENDED CONSEQUENCES will result from State intervention.

    On the first point I think Fred has fundamentally missed the point on the US financial crisis. On the second it is apparent in the local context that some of the crash moves by the Rudd government are causing problems that would have been anticipated with more thought and more consultation.

  20. Fred Argy says:

    Rafe, you say I am apparently “prepared to ignore the influence of government interference in housing”. Sorry, I do not.

    After mentioning that “market failure and the greed of entrepreneurs are mostly responsible for what has happened”, I also note (a)the influence of “over-protection of consumers”;(b)the fact that some forms of financial regulation, such as on short-selling, are bad for volatility and finally (c) “that monetary policy has to be held to account”. I therefore concede that government failure was partly to blame.

    The difference between you and I is that, whereas I look at the entire empirical evidence (and I could be proved wrong on this), you prefer to dwell on only a few one-dimensional aspects. That is the essential difference between fundamentalism and economic liberalism.

  21. Tom N. says:

    Actualy Patrick, you won’t find many professional policy economists who apply free-market hammers to everything – that tends to be the province of keen right-leaning amateurs, or certain academics who have the luxury of irrelevance, “opining on economics”. Fred’s “economic liberals” – and in my view that’s not necessarily a useful descriptor, but let’s keep it for now anyway – are, I think, just mainstream policy economists.

  22. NPOV says:

    Fred, what exactly are you referring to when you say “over-protection of consumers”? An article I posted here recently described how many consumer advocate groups were raising the alarm over the pressure politicans were putting on lending institutions to lower standards. It doesn’t seem to me the government was terribly concerned about “protecting” consumers.

  23. Patrick says:

    Sorry, Tom – I didn’t mean to imply that I thought there were any such! I agree with your comment.

  24. Fred Argy says:

    What did I mean by “consumer-protection”? I was referring to various forms of additional government interference in the housing market. I know it is a vague term – but there is enough evidence of this to justify some concern.

  25. NPOV says:

    Well I agree there was a fair bit of misguided interference in the housing market, but it seems to me the problem was *lack* of consumer protection rather than over-protection. There’s surely plenty of ways governments could have worked to help lower-income families into houses that would have kept consumers (and the economy) protected.

  26. Rafe Champion says:

    Sorry Fred, you are still not talking out loud about the gorilla in the room, the political push to promote lending to bad risks and the biparatisan effort to refrain from rendering transparent the burden of bad debts in the Fannie and Freddy portfolios. When you come to grips with those political factors in the equation we can start talking seriously about the situation. Or do you realise that the pyramid of rhetoric about “neoliberal fundamentalism” will fall down like a card house when you recognise the presence of the gorilla?

    “Market failure” is supposed to refer to the failure of free markets. You can’t accuse free markets of failing when they are manifestly not free.

    As an aside, do you think that rampant free markets caused the Great Depression?

  27. melaleuca says:

    “Market failure is supposed to refer to the failure of free markets. You cant accuse free markets of failing when they are manifestly not free.”

    Some Marxists like to say Communism has never failed since it has never truly been implemented- the Soviet Union was of course an example of State Capitalism.

    You are remarkably unconvincing, Rafe.

  28. JC says:

    It’s truly amazing reading about the end of capitalism . We were taught in both high school economics and uni that the western economies experience periodic downswings in economic activity called “recessions”. We are more than aware than stock markets correct and revert to the mean especially when there is the possibility of a recession being discounted.

    And now faster than a speeding bullet we’re hearing about the end of capitalism or more accurately “American style capitalism”. It would it a little hard to explain how 6% unemployment in the US and a 30% correction in the stock market is somehow seen Armageddon.

    The IMF is suggestion that global GDP will rise (approx) 3.25% next year. Our GDP will be around 1.7 while the US and Europe’s are going to be around zero.

    Here’s a gentlemans bet. The Dow Jones in 2025 will be close to 24,000. Our all ords will be 10,000. That’s a compound growth rate of 5% and doesn’t include dividends.

  29. SJ says:

    NPOV Says:

    what exactly are you referring to when you say over-protection of consumers?

    Fred’s already answered this in the Oz context, but the thing I immediately thought of was the non-recourse nature of (most) first mortgages in the US.

    There’s effectively a put option built into the loan, which is good for consumers. The problem is that nobody writing the loans seemed to be pricing or accounting for it properly, or else (pretty much correctly) figured that the US govt (i.e. taxpayers) were paying for it. In which case the US govt, as agents for for those taxpayers, stuffed up big time.

  30. Patrick says:

    SJ, third alternative, that it was assumed that property prices would increase, and thus the put never put the lender out of the money.

    Albeit, as I understand it excessive puts actually would reduce sub-prime CDO values, which were cash-flow derived, and thus generate mark-to-market losses, without necessarily increasing the chance of actual default of the CDO materially. SOunds impossible but as far as I can gather this was simply ignored, see above re property prices and assumptions.

    JC – I agree, I don’t understand how it is the end of capitalism nor how it tells us anything about social democracy, except possibly that social democracy is a bad system for regulating banks. I also agree with your gentleman’s bet, pity no-one is silly enough to sell me a CFD on that timeframe for a few bob! So one bets as one can – buying equities, very slowly.

  31. SJ says:

    In writing the above, I think I twigged to what it was that bothered me about Tom N.’s and Paul Fritjer’s comments. It’s a US/Oz problem.

    Tom and Paul make sense if Australia is the sole object of study (and only then if the NSW treasury is excluded). The situation in the US vis-a-vis “professional policy economists” is that they don’t exist any more in the same way as they do in Australia. They’re part of academia, sure, and they’re influential to some extent, but they’re not part of the federal administration, by design.

    Maybe that’s why John Quiggin’s remarks seem odd to you two. It doesn’t gel with your local experience. But remember that this is a global problem caused in large part by policies in the US. It makes more sense to look at what’s going on over there rather than here.

  32. SJ says:

    SJ, third alternative, that it was assumed that property prices would increase

    No, that’s just mis-pricing. It’s trivially false that property prices always increase.

  33. SJ says:

    And now, for Patrick and JC’s benefit, I’ll try and translate again.

    The US made a sudden break with laissez-faire (means “hands off”) in the 1930s. In the last couple of decades, and more particularly in GWB’s time, they’ve been trending back towards laissez-faire.

    Forget for the moment any arguments about whether laissez-faire is better or worse than some other thing you can think of.

    What people like John Quiggin are examining is whether the trend toward laissez-faire has been reversed, and whether another trend away from it will begin.

    It’s certain that the trend has been reversed. What’s uncertain is the direction of the new trend. It could be just a resumption of the old trend.

  34. Rafe Champion says:

    Re 27, Mel there have been innumerable examples of closing and opening markets. We can see that whatever they tried in the name of communism did not work and you can say much the same for nationalisation of industries in Britain and other places. In contrast, the experiments in deregulation in Australia, and more recently in India, China and Vietnam have worked well. There are very few knock-down arguments in this area due to the number of factors that are in play, the partial nature of all deregulation and the mistakes that are made in the process. Then there are the mistakes that are made in freshly deregulated industries, like the Australian banks, when they had to learn how to operate in the new environment. Many mistakes were made, especially by the State banks and by people like Bond operating with Government backing. Lessons were learned and now our banks look good. It is a nice point whether this is a result of learning or regulation.

    Re 33 and the “sudden break with laissez faire in the 1930s”, are you suggesting that there was no constraint on markets until the 1930s? No tariffs? No cenral bank? No labour unions prepared to use violence on the picket lines to enforce strikes? And how did the US economy perform under the increased constraints of the 1930s? 30% umemployment, practically zero capical growth for the decade under the New Deal. What does that tell you about reducing the freedom of markets?

  35. JC says:


    The amusing thing about all this is that people are suddenly surprised… no shocked… that banks can actually go broke. Banks… nearly every bank… eventually goes broke. Our banking system was basically broke with a few exceptions in the 90’s as every one of the majors needed a major recap of some sort.

    When investors demand a 20% return, banks will eventually lose all their capital as their leverage of around 12:1 will mean they hit a wall at some time. Instead of calling it what it is we now call it a “capital infusion”.

    Who was it recently…. the ANZ required a ” small” capital infusion and there’s more to come.

  36. Rafe Champion says:

    I was just about to make a point about “creeping regulation” but it has already been made at 13. Regulation creeps in at all three levels of government and it is seldom subjected to critical analysis, partly because there are not enough economists in the nation to even start on the job. In addition to regulation, or cognate with it is the demand for information, records, surveys etc which place significant demands on business quite likely with zero benefit for the public. On the topic of housing, there are rapidly increasing levies that are placed on property developers, and recently it has turned up that some states (especially SA and NSW) have put additional regulations onto the unified national building code, higher ceilings for example, which increase the cost of housing.

    The point of this is to raise the question: if the regulators (social democrats?) are winning the battle with the deregulators (neoliberals?), who is better off as a result?

  37. SJ says:

    Re 33 and theare you suggesting that there was no constraint on markets until the 1930s? No tariffs? No cenral bank? No labour unions prepared to use violence on the picket lines to enforce strikes? And how did the US economy perform under the increased constraints of the 1930s? 30% umemployment, practically zero capical growth for the decade under the New Deal. What does that tell you about reducing the freedom of markets?

    You have a real problem with this black and white thing. I never suggested that what existed prior to the 1930s was what you would regard as pure black or pure white, or as your preferred shade of gray, i.e. pure “laissez faire”. There was step-change away from laissez faire in the 1930s. Do you dispute this?

  38. SJ says:

    Ah, I realise my error now. I should’ve listened to Nabakov @6.

  39. JC says:


    To be honest the only thing we’ve seen at this stage is the promise of more regulation, but other than that we have only seen bank recaps (EU/US) and guaranteeing the liability side of bank’s balance sheets. This is quite possibly the creation of the biggest moral hazard in our lifetimes and something we will end up deeply regretting. I really dont see how they can remove it in a few years time as the financial system will increasing become dependent on it more and more as time goes by.

    What are they going to do about regulation? I-banks have gone. Commercial banks were basically leveraged at 10-12:1, which is a level I don’t see being reduced. In fact the CB’s are acting as though they are deadly afraid this level being stepped down.

    Are they going to tell the banks to lend less in real estate? Don’t think so. Again there is nothing the government would like to see than the banks start lending to this sector again. So leverage isn’t going to come down and the governments are certainly not going to try and limit their profitability as they are now in it too. So the regulation schtik is basically a big boo hoo as nothing is going to come out of it.

    The US is not going back to regulation Q that directed interest rate levels on both sides of the balance sheet prior to the late 70’s, so the idea that we will return that that era is laughable.

    Securitization? Well it was the regulators prompting after the S&L debacle that encouraged the banks to securitize as it was felt one of the causes of that fiasco was illiquidity on the asset side of the balance sheet.

    The only thing that I see happening is actually a good thing from a regulatory point of view. We actually may begin to see real time examination of the banks books overnight which is something I read recently and doesn’t sound like a bad thing.

    What we should be worried here is that a tiny credit union now has a better rating than BHP in the credit markets. This is where the real problems will start and where the next really big crash will come from. The lack of risk stratification will end in tears in a huge way and the government wont be able to open the bag.

  40. Nabakov says:

    To give SJ a comment he or she can reference without long term embarrassment, I proffer a more coherent version of what I was I getting at before.

    Which is that no economic-political theory maintains any purity of execution after prolonged contact with human nature.

    However I think we all enjoy Rafe Champion flapping through this current complex and whacko global scenario like a white dove during the Somme in mid-July 1916. Always harmless and occasionally entertaining. But not on purpose.

  41. Rafe Champion says:

    SJ, nobody is disputing that there was a move away from laissez faire and free trade in the 1930s, the question is whether you are happy with the result in the US – 30% unemployment and the depression locked in place for the decade?

    The question is, are you interested in learning from the results of different experiments that have been conducted in regulation and deregulation?

    What has the left learned from the experience of the 1930s? What is the left learning from the latest example of government failure in the US?

  42. Patrick says:

    SJ, thanks. That sounds like an eminently reasonable proposition and one I would have no difficulty accepting. But it sounds awfully positive, whereas Quiggin’s claim sounded awfully normative. Which I think is why I agree with your statement and don’t understand Quiggin’s.

  43. Sj,

    re your comment 31. I indeed do not have first-hand experience of policy making in the US (do you?), but I do observe the outcomes to be similar to that in Australia: increased regulation since the 1960 by whomever is in power. An when I refer to academia, that of course is heavily influenced by the Americans.

    Hence, again, whilst ‘shades of liberalisms’ matter as labels in political debates in ways Fred and others in the thread know better than I do, I simply dont see the relevance of these labels when looking at the actual policies taken on the ground. Where is the laisser faire attitude in coopting private banks in America (Freddie May/Mac) to underwrite risky assets? Where is the laisser faire in the US when it comes to health, welfare, housing, pensions, schooling, defense, police, etc? Ther reality there as here is that it was a mixed economy with increased regulation. It was never a truly meaningful label to describe the US as laisser faire when it has a tax burden not that much lower than Australia. Just as it was never very useful to think about the economy as laisser faire in the past, so too is it ridiculous to speak about the end of capitalism now. In the scheme of things, its a minor and possible temporary shift of power in favour of the regulators within the state bureaucracy.

  44. NPOV says:

    Rafe, you ask “What is the left learning from the latest example of government failure in the US?”

    Even if I bought the line that the crisis is largely the result of government intervention gone wrong, all it would is further strenghten my belief in the need for better government, because the sorts of interventions that went on are ones that it’s unlikely genuinely left-wing governments would pursue anyway. There’s no good left-wing justification for maintaining an absurdly easy money supply for so long. There’s no left-wing justification for talking up the virtues of lenders being able to provide lower-income families (who are obvious candidates for decent public housing) with mortgages big enough to afford over-sized McMansions. So trite as it may sound, a genuinely left-wing government simply wouldn’t have had any good reason to make the sorts of interventions that contributed towards the crisis.

  45. Ingolf says:

    You wield a lovely stiletto, Nabakov. Very nice image. And you’re dead right that theories get messed up pretty quickly once they venture out into the real world.

    Rafe doesn’t need anyone defending him but I’m going to put my oar in anyway. He said this on a recent thread:

    Ken, I object to your misrepresentation of my position as well.

    Quite likely I have not explained it carefully enough but I seem to recall saying something like here we have common ground to work towards effective regulation.

    The common ground is the understanding that markets are not perfect (who ever said they are?) and at the same time, intervention is fraught with the risk of unintended consequences.

    He probably gets frustrated (as I sometimes do) that markets are the whipping boy du jour while less regard is paid to the contribution that regulations and perverse incentives make to what are in due course perceived as market failures. Markets are just the messenger boy, a clearing house for our individual and collective actions, both sane and insane. Since Rafe definitely hails from the markets are good side of the tracks, I guess this frustration often tempts him into oversimplifying his case, leaving himself wide open to the occasional stiletto between the ribs. And cuff to the head, of course, although I much prefer the former.

    NPOV, I also think the left-right terminolgy has outlived whatever usefulness it may once have had. The “right” in the US today if anything seems more corporatist, almost soft fascist in nature. It sure as hell isn’t laissez-faire and bears no resemblance to its old, conservative, isolationist self, now rebranded as paleo-conservative and close to extinct.

  46. JC says:

    Has Capitalism failed? It has for Merrill and UBS employees now treated like 2nd class citizens. The horror.

    UBS, Merrill Said to Ask Bankers to Fly Economy to Cut Costs

    Oct. 22 (Bloomberg) — Merrill Lynch & Co. and UBS AG have asked senior bankers in Asia to fly economy on short-haul flights and reduce non-essential travel as falling revenues force cost cuts, bankers at the firms said.

    UBS this month advised bankers to travel economy class for flights of up to five hours, two officials at the biggest Swiss bank said, asking not to be identified because it’s an internal policy. Merrill employees have been asked to travel economy for flights of as much as three hours since mid-September, two executives at the firm said.

    The world’s largest banks and securities firms are tightening costs to survive the financial-market meltdown that toppled Lehman Brothers Holdings Inc. and forced Merrill Lynch to sell itself to Bank of America Corp. The financial-services industry has cut more than 140,000 jobs since a surge in subprime mortgage delinquencies began to roil global debt markets in 2007.

  47. Rafe Champion says:

    Good one Nab, I like the image of the white dove of peace!

    Would you like to think of yourself as a spent shell case rusting in the mud?

    NPOV, I will be truly interested in your explanation of the Democrat moves to push people into homes that they can’t afford, and then to block moves to reveal the extent of exposure of Fannie and Freddy.

  48. NPOV says:

    Rafe, I don’t have an explanation for those moves (which were hardly the sole province of the Democrats, mind you). They’re not ones motivated by anything even vaguely ‘left-wing’ that I can see. Yes, it’s primarily a left-wing notion that the less well off need special assistance (a notion I strongly support), but you don’t go about it by dismantling regulations that are there to ensure responsible lending standards are being adhered to.

  49. Rafe Champion says:

    What regulations were in place to ensure responsible lending standards were being adhered to?

  50. NPOV says:

    I’ve posted several articles describing many of the various regulations, at state and federal level, that were relaxed in order to lower lending standards.
    If I get time I can go back through them and produce a summary list, but to what avail would this be exactly?

  51. Rafe Champion says:

    It would help you to understand the extent of government failure in this episode.

  52. Patrick says:

    but you dont go about it by dismantling regulations that are there to ensure responsible lending standards are being adhered to.

    wtf? do you really believe that statement other than as a vague normative ideal?

  53. NPOV says:

    Rafe, I’ve already spent as much time as I can reasonably justify reading various opinions and accounts as to what has led to the current situation.
    Yes, there was huge government failure – not only in pushing for laxer regulations, but also in consistently attempting to keep the housing bubble inflated by keeping interest rates artificially low and pushing more and more people into it who were really in no position to afford to be. i.e., it’s the worst possible kind of government intervention, the results of which really should have been fairly predictable. But the logical response to that isn’t that “government intervention is nearly always more likely to be counterproductive”, it’s that government intervention needs to be done carefully and only when there’s good reason to suppose that not intervening will cause undesirable consequences.

    And Patrick, yes of course I believe that statement. Are you questioning whether in fact regulations were relaxed in order to encourage lenders to target non-credit-worthy borrowers?

  54. NPOV says:

    This is the WSJ article I mentioned earlier outlining the degree to which governments (particularly at the state level) folded under pressure from lenders to relax borrowing regulations:


  55. NPOV says:

    Another good WSJ article here, pointing out that another part of the problem was a failure to regulate lending institutions that didn’t fall under existing federal laws:


  56. Patrick says:

    Sorry, I meant do you really believe that relaxing regulations notionally designed to protect people is not a predictable reflex response from in-the-hock politicians?

    Normatively, sure, one should not. Practically, it seems, one invariably does either that or positively regulates to even worse effect.

  57. NPOV says:

    Patrick, ok, fine but how is that an example of “government intervention”? The regulations were already a form of intervention – relaxing them surely means reducing the degree of government intervention in the economy?

    And if you’re going to claim that “practically, governments are going to do XYZ anyway”, then what is the point of arguing any sort of ideological position over how much regulation is desirable?

  58. Rafe Champion says:

    Interference in the political process beats regulation every time!

    Still waiting for Fred to acknowledge the full extent of political interference that led to the train smash.


  59. Fred Argy says:

    Rafe, I don’t really understand what you want from me. Let me just say that
    a large majority of economists (including various Nobel award recipients) have very different views to yours on financial regulation.

    The macro-consequences are well understood. A financial system needs to work well – with full trust – so as to avoid hurting lenders and borrowers but also innocent bystanders. No democratic government can sit idly by while there is such suffering.

    As well, there are greater market imperfections in the financial system. They arise from a lack of competition (a product of information imperfections and deficiencies in the banking system); a lack of poorly designed incentive structures (a number of institutions are too big to fail and have rewards which encourage risk-taking and short-sighted behavior); lack of transparency (again due to information imperfections and asymmetries) and outright fraud in manipulation of derivatives. What is of interest is that most of these features are at the centre of financial markets

    On the other hand, deregulation provides great opportunities for enterprise and innovation. And it legitimately raises some important issues of moral hazard.

    It follows that one needs to weigh the costs and benefits of deregulation. In some cases the macro-economic risks are small and the internal efficiencies are also small. So deregulation might offer good net benefits. In other cases, the consequences of financial distrust are far from small and the costs of financial deregulation could prove horrendous.

    No one is suggesting that because our markets have failed and failed miserably, we should abandon a fully market-based economy. We should look at things empirically.

    This is the economic liberal view and it is the predominant stance of most economists, whether of the right or left.

    On the other hand, the fundamentalist starts with a philosophically preconception against financial regulation, because it interferes with freedom.

  60. NPOV says:

    Rafe, lobbying of governments to block regulation happens all the time. Indeed, it’s one of the reasons a government really doesn’t need to adopt an ideological position opposed to regulation in general – because there’s already powerful forces lobbying to keep regulation to a minimum. The fact that the lobbying in question was on behalf of a government-sponsored corporation makes it all the more insidious, and tends to suggest that such GSEs aren’t a particularly justifiable use of taxpayer dollars, if they’re still going to behave with a ‘profit at any cost’ mindset.

  61. NPOV says:

    BTW, I have to say kudos to Greenspan for now admitting that much of his faith in deregulation of financial markets has now shown to be misplaced. It’s interesting that he feels that most of the pressure on lending institutions to lower standards came not from politicians but from Wall St.

  62. JC says:


    Greenspan was also the guy telling us that CDO’s were almost as good as government bonds in 2003 to thereabouts. He ought to be the last person anyone ever should listen to. In fact he ought to be used as a reverse indicator.

  63. melaleuca says:

    JC says:

    “Greenspan was also the guy telling us that CDOs were almost as good as government bonds in 2003 to thereabouts. He ought to be the last person anyone ever should listen to.”

    You along with Jason Soon in October last year dismissed any talk of an impending financial crisis in the US as a leftist beatup. Why should anyone listen to you or your mini-me? :)

    ps. Apparently the unregulated Rating Agencies were prepared to give ratings to investments structured by cows- http://www.abc.net.au/lateline/content/2008/s2399644.htm


  64. NPOV says:

    JC, Greenspan has every motivation to try to place the blame elsewhere. He hasn’t, and in my book, that says a lot.

    Greenspan’s decision to keep rates so low so long and his endorsement of CDOs and ARMs no doubt were pivotal mistakes in the crisis, but his reputation as somebody who knows what he’s doing was already was hardly without basis, given how long he’d been at the helm of the Fed.

  65. Rafe Champion says:

    Fred, it seems that I have not made my position clear about regulations, I though I explained clearly enough that I am prepared to stand on common ground with anyone here who is prepared to look for regulations that produce the desired effects. I would not dream of objecting to regulations in principle on the airy fairy ground that they interfe with freedom, you must know that I am in favour of the rule of law as an alternative to barbarism.

    I want you to acknowledge the extent to which political pressures overwhelmed all the other factors in the equation, including tens of thousands of pages of regulations. There is a point in regulation where more means less, people have to go through the motions of doing stuff that achieves nothing, like the pages and pages that have to preface financial agreements. Talk to Nicholas Gruen about that:)

  66. JC says:

    Greenspans decision to keep rates so low so long and his endorsement of CDOs and ARMs no doubt were pivotal mistakes in the crisis, but his reputation as somebody who knows what hes doing was already was hardly without basis, given how long hed been at the helm of the Fed.

    One of the congressman should have asked him if the 1% interest rates had a hand in setting up the loan teaser loan rates. And seeing he should have seen the level of demand coming for teaser ARM’s should he have raised rates quickly?

  67. Tel_ says:

    No one is suggesting that because our markets have failed and failed miserably,

    And what proof that the markets have failed? Given the dodgy behaviour of both banks and regulators alike in recent years, a large correction was in order. Maybe one could argue that the correction didn’t come soon enough, but certainly the current lack of trust is a completely rational response to the discovery that many players (including the US treasury) do not deserve trust. This is exactly the job that the market is designed to do. Sorry you don’t like the conclusion the market came to, but then again, why should I believe your alternative conclusion?

    Banks and regulators have failed, and the market merely pointed out the fact, and so it will continue doing.

    The thing is, people will always trade. They will find a way to exchange what they have with other people, one way or another. You can regulate trade to some extent — while the majority of the participants get some value from the regulations, they continue to support the regulations, and they continue to trade under those regulations. You cannot regulate to stop trade (or even to substantially obstruct trade), it simply doesn’t work. The USSR tried it and all that happened was the local merchant became the local blatnoy instead and trade continued. They had crackdowns on corruption and people died and the corruption just got deeper, because the blatnoy were the only people who had the freedom to actually get anything done. When the crackdowns came, the corrupt officials were in a better position to protect themselves by throwing some innocent into the firing line.

    You can make a decision whether you would like to live in a country where the criminals are more successful than any legitimate business and where officialdom is riddled with corruption, but you cannot decide to stop trade. Stalin couldn’t stop it, neither can you. But a lot of people might get hurt relearning an old lesson.

    Let us not also forget that the US government pursued a deliberate policy of using military force to take control of natural resources (oil in particular) and that they ran up the biggest government debt in all history and those expensive wars have produced little or no economic return. Gradually but surely, all parties involved are looking for ways to get uninvolved, because the whole thing was a massively mismanaged mistake at the taxpayer’s expense. And yes, screw-ups on the order of half a teradollar will tend to have consequences, which in turn will ripple out into other walks of life.

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