Please Take Them To The Morgue
Photo Credit :
In the light of the recent financial crisis, Quiggin indulges in some exfoliation of their logic with impunity, which is largely entertaining, though one-sided. The reader may not agree with him as, at times, his examples are selective.
The great moderation, made popular by Ben Bernanke, currently chairman of the US Federal Reserve, was an eyewash, which created a delusion that the business cycle was dead and growth was there to stay. Policies were formulated to support this feeling. It led to Ponzis being created by making capital cheap. When momentum was created, they came in as those deadly, exotic derivative products.
Quiggin is even harsher when it comes to the efficient markets hypothesis, where prices embed all possible information in a perfect manner. As this can never be so, markets have to be inefficient. But then all other fancy models such as the Black-Scholes pricing of options or capital asset pricing model are based on premises that turned catastrophic. With a wry twist of humour, he talks a lot on the concept of the ‘Greenspan put', named after Alan Greenspan, which is an interesting ‘option' where markets are bailed out in case of financial failure.
The third zombie idea is the DSGE model. Quiggin takes us through vintage theory from Say's law to new classical economics, which is déjà vu stuff. His contention, however, is we cannot elevate micro-economic theories to the macro level. The DSGE models did not quite provide solutions and every crisis invariably had us turn back to Keynes for a solution as they understated the crisis until it hit us hard.
The trickle-down theory, another bastion of economic liberalism, is a mirage, and we should not be carried away by the goodies that are accessible to the poor. Theory says if we concentrate on efficiency, equity would automatically follow in the long run. But taxes fall on wage earners as the rich do not consume all their income and consumption taxes are high. While the rich benefit from zero or low capital taxes, the poor lag in healthcare, education and social cohesion as governments spend less. Not unsurprisingly, income inequality has increased in the past four decades with the income of the top echelons multiplying several times, while those below have witnessed only marginal increases.
Privatisation is the last zombie, which was part of Thatcherism in the 1980s. The idea was to collect funds by selling government companies on grounds of efficiency. Government's role was relegated to being a provider of public services and the fall of the Soviet bloc and the beginning of the Washington Consensus only supported this zombie idea. This served everybody; public servants got better-paid jobs, while private entrepreneurs are able to buy cheap and then sell dear. Quiggin calls it a policy in search of a rationale. The ultimate irony was when the financial crisis led to the re-nationalisation of capitalist enterprises such as Citigroup, Bank of America and General Motors.
How then do we put these pieces together? The book works on the premise that risk managed by financial markets under economic liberalism outperforms the government, leading to optimal solutions that create the illusion of great moderation. This had the DSGE models inbuilt, which was supported at the micro level by the efficient-markets hypothesis. Privatisation was at the heart of this ideology where the entire model was reinforced by the trickle-down theory. Alas, the financial crisis dealt a big blow to this structure, and it is time for us to review it, and probably go back to the government and Keynes.
Australian economist John Quiggin is professor at the University of Queensland. He blogs regularly on economic issues and is a regular contributor to Crooked Timber. Quiggin also writes a fortnightly column in The Australian Financial Review. His books include Great Expectations: Microeconomic Reform And Australia (1996) and Taxing Times: A Guide To The Tax Debate In Australia (1998).
Sabnavis is chief economist at CARE Ratings
(This story was published in Businessworld Issue Dated 02-05-2011)