Public Policy Beyond the Financial Crisis : An International Comparative Study [1 ed.] 9781136265273, 9780415674393

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Philip Haynes has produced an important book for anyone who wishes to understand why the global financial crisis developed in the way it did. He explores the reasons why governments throughout the world reacted with certain policies. Haynes takes difficult mathematically-based concepts, such as complexity theory and applies them to deliver an understanding of the policy context for the way the financial crisis developed across a range of countries. He shows the strengths and limitations of markets and policy makers in both the governing institutions and private sectors. It is a clearly written and methodologically and theoretically innovative book; it should be required reading for practitioners and academics alike. Andrew Massey, University of Exeter, UK The global financial crisis continues to cast a long shadow. There are scholarly works on the nature of the crisis of 2008. Philip Haynes takes this further. His articulate and lucid analysis of the original crisis and the manner in which the corporate debt crisis of banks became an issue of sovereign debt and the consequent and current policy options confronting governments makes this book essential reading for all interested in this, the most topical subject of the 21st century. Irvine Lapsley, University of Edinburgh, UK Those of us who wanted the social sciences to take a turn to complexity have always understood that the test of that turn would be the use of complexity ideas in addressing major social and political issues. No issue could be more important than the current economic crisis. In this book Phil Haynes deploys the full repertoire of complexity related methods in a way which greatly illuminates our understanding of what has happened and what might happen going forward. This is an exemplary book in terms of method and a fundamentally important one in terms of its substantive focus. David Byrne, Durham University, UK

Public Policy beyond the Financial Crisis

The economic crisis of 2008–09 and beyond has provided the greatest challenge to public policy in the developed world since the Second World War, as the use of public monies to support banks and declining tax revenues has resulted in rising government borrowing and national debt. This book evaluates the failures of public policy in the half decade before the crisis, using the conceptual framework of complex systems. This analysis reveals the fundamental failings of globalization and the lack of a robust and resilient public sector paradigm to assist countries in economic recovery. The research has benefited from UK Economic and Social Research Council (ESRC) funding for a Knowledge Exchange that applied the most relevant and applied aspects of complex systems theory to contemporary policy problems. Innovative statistical methods are used to profile and group countries both before and after the 2008–09 crisis. This shows the countries that are best prepared for the ongoing and prolonged eurozone crisis of 2010–12. The book proposes a new model of public policy that asserts itself over the paradigm of market liberalism and places the public values of full employment, sustainability and equality at the top of the post-­crisis policy agenda. Philip Haynes is Professor of Public Policy and Head of the School of Applied Social Science at the University of Brighton, UK. His previous books include Managing Complexity in the Public Services (Oxford University Press, 2003) and Complex Policy Planning (Ashgate Publishing, 1999). His research has been funded by the UK ESRC, Joseph Rowntree Foundation and government agencies.

Routledge critical studies in public management Edited by Stephen Osborne

The study and practice of public management has undergone profound changes across the world. Over the last quarter century, we have seen • • • •

increasing criticism of public administration as the over-­arching framework for the provision of public services, the rise (and critical appraisal) of the ‘New public management’ as an emergent paradigm for the provision of public services, the transformation of the ‘public sector’ into the cross-­sectoral provision of public services, and the growth of the governance of inter-­organizational relationships as an essential element in the provision of public services.

In reality these trends have not so much replaced each other as elided or coexisted together – the public policy process has not gone away as a legitimate topic of study, intra-­organizational management continues to be essential to the efficient provision of public services, whist the governance of inter-­organizational and inter-­ sectoral relationships is now essential to the effective provision of these services. Further, whilst the study of public management has been enriched by contribution of a range of insights from the ‘mainstream’ management literature, it has also contributed to this literature in such areas as networks and inter-­organizational collaboration, innovation and stakeholder theory. This series is dedicated to presenting and critiquing this important body of theory and empirical study. It will publish books that both explore and evaluate the emergent and developing nature of public administration, management and governance (in theory and practice) and examine the relationship with and contribution to the over-­arching disciplines of management and organizational sociology. Books in the series will be of interest to academics and researchers in this field, students undertaking advanced studies of it as part of their undergraduate or postgraduate degree and reflective policy makers and practitioners. 1 Unbundled Government A critical analysis of the global trend to agencies, quangos and contractualisation Edited by Christopher Pollitt and Colin Talbot

2 The Study of Public Management in Europe and the US A competitive analysis of national distinctiveness Edited by Walter Kickert 3 Managing Complex Governance Systems Dynamics, self-­organization and coevolution in public investments Edited by Geert Teisman, Arwin van Buuren and Lasse Gerrits 4 Making Public Services Management Critical Edited by Graeme Currie, Jackie Ford, Nancy Harding and Mark Learmonth 5 Social Accounting and Public Management Accountability for the common good Edited by Stephen P. Osborne and Amanda Ball 6 Public Management and Complexity Theory Richer decision-­making in public services Mary Lee Rhodes, Joanne Murphy, Jenny Muir and John A. Murray 7 New Public Governance, the Third Sector, and Co-­Production Edited by Victor Pestoff, Taco Brandsen, and Bram Verschuere 8 Branding in Governance and Public Management Jasper Eshuis and Erik-­Hans Klijn 9 Public Policy beyond the Financial Crisis An international comparative study Philip Haynes

Public Policy beyond the Financial Crisis

An international comparative study

Philip Haynes

First published 2012 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2012 Philip Haynes The right of Philip Haynes to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Haynes, Philip. Public policy beyond the financial crisis : an international comparative study / Philip Haynes. p. cm. – (Routledge critical studies in public management) Includes bibliographical references and index. 1. Economic policy. 2. Global Financial Crisis, 2008–2009. 3. Globalization. I. Title. HD87.H384 2012 320.6–dc23 2012001399 ISBN: 978-0-415-67439-3 (hbk) ISBN: 978-0-203-10825-3 (ebk) Typeset in Times New Roman by Wearset Ltd, Boldon, Tyne and Wear

Contents



List of figures List of tables Acknowledgements List of abbreviations



Introduction

1

1

Complexity theory and public policy: a radical methodology

3

2

Case based methods and national comparisons

25

3

National comparisons: the road to the crisis

32

4

Instability and chaos: the financial crisis of 2008–09

69

5

Intervention: the policy response

94

6

The second crisis: from private debt to public debt

117

7

From austerity to opportunity: the next ten years

139

8

Resilient polices: protection against chaos and shocks

163

9

Conclusion: new methods and new policies

185



Bibliography Index

192 202

x xi xiii xiv

Figures

1.1 A complexity theory framework 1.2 UK inflation, January 1987 to December 2004, by Prime Minister in power 3.1 World Commodity Prices Index, 2005–07 3.2 Total global capital flows, 2003–07 3.3 Scatter plot to demonstrate association between CPI and IR, national averages, annual percentages, 2003–07 3.4 Scatter plot to demonstrate lack of association between national health care expenditure as a proportion of GDP and life expectancy, 2009 3.5 Cluster analysis dendrogram: pre-­financial crisis model of OECD countries 5.1 Percentage undervaluation and overvaluations of currencies against the US dollar, based on The Economist’s ‘Big Mac Index’, January 2010 5.2 Scatter plot to demonstrate weak association between CPI and IR, national averages, annual percentages, 2009–10 8.1 Cluster analysis dendrogram: post-­financial crisis model of OECD countries

5 11 40 41 45 61 65 101 107 164

Tables

1.1 Meadow’s framework for intervening in systems 1.2 Policy interventions: a systemic analysis 3.1 GDP annual percentage change, 2003–07, ranked by five-­year average 3.2 Government current account, annual balance, 2003–07, annual percentage of GDP, ranked by highest average balance 3.3 Government net total debt, 2003–07, percentage of GDP, ranked by highest average five-­year debt (G7 nations) 3.4 Government taxation, 2003–07, as percentage of GDP, ranked by highest five-­year average 3.5 Current account, balance of payments, as percentage of GDP, including trade, 2007, ranked by highest positive balance 3.6 Consumer price inflation, dollar standardized, international relative comparison 2005–07 (2005 = 100), ranked by highest inflation in 2007 3.7 Annual consumer price index, percentage change (in national currencies), 2003–07, ranked by highest five-­year average 3.8 Interest rates, based on annual average bank deposit rate, 2003–07, ranked by highest five-­year average 3.9 Percentage of working-­age population in employment, 2003–07, ranked by highest average 3.10 Percentage of working-­age women in employment, 2003–07, ranked by highest average 3.11 Part time employment as percentage of total working population, 2003–07, ranked by highest average 3.12 Unemployment rate, percentage of work force, 2003–07, ranked by highest average 3.13 Percentage of long term unemployment (>12 months), 2003–07, ranked by country with highest long term unemployment 3. 14 Growth in employment in finance and business services between 2003 and 2007, ranked by highest percentage increase

19 23 34 35 37 38 39 43 44 46 50 51 52 53 54 56

xii   List of tables 3.15 Immigration for employment, including temporary workers, 2003–07, ranked by countries with highest average inflow (000s) 3.16 Income inequality – Gini coefficient scores for working-­age population, ranked by countries with most unequal income distribution 3.17 Higher education attainment rates as percentage of population, 25–64 3.18 Combined ranking of educational performance, based on data collections up to 2007 3.19 Total expenditure on health as percentage of GDP, 2003–07, ranked by highest average 3.20 Average life expectance from birth, ranked by improvements in average 2000–09 3.21 QCA truth table for validation of pre-­crisis clusters 4.1 Key events in financial crisis 4.2 Fluctuations in OECD stock markets, 2005–10, ranked by the largest increase (2005 = 100) 4.3 Systems interventions in 2008–09 crisis 5.1 Policy responses and developments in 2009–10 5.2 Percentage changes in annual GDP in 2008–09, ranked by largest drop in output  5.3 Percentage real house price changes, 2008–09, ranked by largest decrease 5.4 Percentage of working-­age population unemployed, ranked by largest increase between 2008 and 2009 5.5 Annual percentage changes in trade exports, ranked by largest increase in 2010, OECD and BRICs 5.6 Policy analysis – policy developments, 2009–10 6.1 Government current account, annual percentage of GDP, ranked by predicted 2011 annual outturn (June 2011) 6.2 Total government gross financial liabilities as percentage of GDP, ranked by percentage increase between 2008 and 2011 6.3 Balance of payments, current account, as annual percentage of GDP during 2010, ranked by highest positive balance, 2010 6.4 Policy analysis – system interventions, 2010–11 7.1 The opportunity of austerity 8.1 QCA truth table for validation of post-­crisis clusters 8.2 Self-­organized, adaptive public services 8.3 The systemic public policy model

57 58 59 60 62 63 67 76 78 92 95 97 98 99 114 115 118 119 131 136 162 165 179 182

Acknowledgements

This book has been supported by the UK Economic and Social Research Council (ESRC) funded Knowledge Exchange: Systems and Complex Systems. Policy and Practice. Approaches in Public Policy and Practice RES-­192–22–0083. My thanks to all those who contributed to this network and the exchange of ideas between 2010 and 2011, especially the network members: Mary Darking, Ceri Davies, Hilary Edgar, Angela Flood, Doly Garcia, Karen Harris, Joanna Hedges, David Owen, John Patience, Jim Price, Bethan Prosser, Carla Ricaurte Quijano, Julia Stroud, Helen Thomas, Chris Warren Adams and David Wolff. My thanks to Hanne Eis, Helen Basterra and Simon Parkyn for their administrative and technical support. The project website is at www.brighton.ac.uk/sass/complex-­ systems. I am grateful to several international organizations for giving me permission to use their data for analysis in the research reported in this book. The Organisation for Economic Cooperation and Development (OECD) gave permission to use their comprehensive online statistics sources from A to Z, at www.oecd.org/ statistics. The International Monetary Fund (IMF ) gave permission to use their detailed online statistical sources at www.imf.org: the World Economic Outlook Database and the IMF Primary Commodity Prices Database. The World Health Organisation (WHO) gave permission to use their databases at www.who.int/ research/en. The United Nations Statistics Division agreed to the use of their comparative trend data on employment in the Finance Sector in Chapter 3. All these organizations have kindly given me permission to construct my own tables, figures and analysis from these data sources. Figure 5.1 is produced using data from The Economist’s ‘Big Mac Index’, and this data is reproduced with permission. Jane Haynes and Jonathan Haynes provided valuable advice on the development of the manuscript. I am grateful to my colleagues at the University of Brighton who supported this project, in particular to those who encouraged me to take study leave in the late spring of 2011: David Taylor, Stuart Laing, Dawn Stephen and Peter Squires.

Abbreviations

ARM BRIC CCC CDO CPI FCIC FSA GDP GSE IEA IMF IR ISSP NAFTA NGO NPM OBR OECD QCA QE SEC TARP TC TSLF UN WHO

adjustable rate mortgage Brazil, Russia, India and China Committee on Climate Change (UK) collateralized debt obligation consumer prices index Financial Crisis Inquiry Commission (US) Financial Services Authority (UK) gross domestic product government sponsored enterprise International Energy Agency International Monetary Fund interest rate International Social Survey Programme North American Free Trade Agreement non-­governmental organization new public management Office of Budgetary Responsibility (UK) Organisation of Economic Cooperation and Development qualitative comparative analysis quantitative easing Securities and Exchange Commission (US) Troubled Asset Relief Programme (US) transnational corporation (also known as ‘multinational company’) Term Securities Lending Facility (US) United Nations World Health Organization

Introduction

The research in this book aims to apply complex systems theory to understanding the economic crisis of 2007–08 and beyond and to consider the resulting impact on public policy in a globalized world. This leads to an evaluation of the dominant model of public policy in the developed world, with its values taken from marketization and business management, and the severe limits of this model after the economic crisis. Data is used to compare and contrast the economic and public policy performance and resilience of nations before and after the crisis and to examine how this relates to their historical ‘path dependence’ in the five-­year period before the onset of the crisis. Chapter 1 examines the application of complexity science and associated ideas from complex systems theory and chaos theory to the social sciences. It explores the core concepts of complexity theory and their relevance to social science and the difficulties of empirical demonstration of complexity constructs in the applied social science. The application of complexity theory to public policy and public management is considered. The chapter concludes by proposing the theoretical framework used for the research in this book. Chapter 2 explains the methods for the research used in the book to explore complex policy systems and to make comparisons between countries. The primary methods explained, and used later in the research, are cluster analysis and the documentary analysis of the accounts of some of those involved in the financial crisis, this supported by press reports at the time of events. The aim of the research is to seek a coherent understanding of similarity and difference between nation states with regard to the complexity framework proposed in Chapter 1, and also to consider the dominant values and economic theory expressed by key actors and policy makers in their accounts of managing the crisis. Chapter 3 undertakes a statistical analysis of the economic and policy output status of OECD countries in the five years preceding the financial crisis from 2003 to 2007. Cluster analysis is used to compare and contrast the economic characteristics of nations and their level of public expenditure and social policy involvement. The clusters are related to the complexity framework used throughout the book. Chapter 4 explores the emergency crisis in 2007. There is an examination of the key events with the spread of fear about bad debt leading to a lack

2   Introduction of  liquidity in financial markets through 2008, and concluding with the major government interventions in the crisis to rescue some of the worlds’ largest financial institutions in the autumn of 2008. The dominant values of those managing the crisis are considered alongside an assessment of the crisis interventions used. The policy of crisis intervention is evaluated using the complexity framework developed in Chapter 1. Chapter 5 looks at the impact of the crisis management aspects of the policy interventions and the emergence of more deliberated medium term policy developments to reduce the impact of the recession in the period after the crisis (2007–08). This is when emergency interventions move into a more recognizable public policy framework of political debate, planned action and implementation. Chapter 6 seeks to understand the second key crisis of sovereign debt when Greece appeared likely to default on its government debt and this sparked major fears for the euro currency area. There were fears for the solvency of other governments including Ireland, Portugal, Italy and Spain. The ability of the weakened banking sector to cope with losses from their government investments was also called into question. Here the chapter examines how the global indebtedness of the banking and financial institutions had moved to a focus on government debt and the impact on banks and other countries if an OECD country did default. This crisis had a clear impact on the post-­election policies of the new coalition government in the UK and more recently has started to raise questions about the long term viability of the US government debt. Although the US dollar has a status as the largest currency in the world, with it historically being the primary choice as a reserve currency in times of crisis, rising gold prices and the sheer size of US debt in 2011 have caused analysts to ask ever more searching questions about longer term US economic policy. Chapter 7 seeks to examine what fundamental opportunities the aftermath of the financial crisis represents in terms of re-­examining the relationship of the state and the market, private and public sector with regard to the major social, environmental and development issues of the twenty-­first century. This chapter argues that the crisis creates a new opportunity to re-­evaluate the relationship of nation state with the market economy and that a new public policy paradigm is needed for the economic organization of societies. In Chapter 8 the text explores how national level policy can evolve to be more resilient to financial shocks, in terms of strengthening local communities with stable energy and food production, full employment and crucial public services. The argument in this chapter is that market regulation needs to build in local advantages from the bottom up rather than ignoring local, regional and national issues in the use of a global top-­down model. In Chapter 9, conclusions are drawn from the research and application of complexity theory with a review of an overall model for managing and leading public policy in the new global paradigm.

1 Complexity theory and public policy A radical methodology

This chapter explores the evolution of complexity theory and its increasing influence in the social sciences. It moves from the challenges of validating the concepts of complexity used in the natural sciences to the social sciences and proposes a framework of the core concepts to be used in the methodology of this book and its research. Finally the chapter visits the literature on applying complexity concepts to understanding and intervening in public policy systems both at the macro and micro levels.

Evolution of complexity theory from the sciences into the social sciences Complexity theory originated in the natural sciences and is linked to chaos theory. Chaos is the idea that instability results from small changes in initial conditions, but the instability is nevertheless deterministic and caused by simple rules. It is determined by the initial condition rather than random events. It has been suggested that the discovery of chaos predates complexity. For example, the French mathematician Jules Henri Poincaré (1854–1912) is sometimes referred to as the father of chaos theory. He argued that the instability of the so-­ called ‘three body problem’ where the relationship between three objects cannot be reliably predicted but some order and attraction to a pattern is still evident given the unpredictable relationship between them. Nevertheless, despite Poincaré’s observation, in the first half of the twentieth century much applied work in mathematics continued to use linear prediction. When data used in linear prediction did not fit a generalized model this was considered as due to measurement imprecision, unknown contributing variables, or so-­called noise (small variations caused by unreliable measurement or invalid aspects of measurement). In time researchers began to see these aspects as critical elements for further consideration and an invitation to further consider the causal complexity and variable interactions of what was being modelled and explained. During the 1960s, some key developments contributed to a paradigm shift in scientific methodology. In 1960, Benoît Mandelbrot studied changes in cotton prices in the USA and challenged the statistical orthodoxy that they were normally distributed over time. Instead he proposed that prices followed more

4   Complexity theory and public policy complex patterns including periods of relative stability and relative instability and a greater possibility of prices moving outside of the normal distribution that had previously been envisaged. Subsequently he explored these patterns as types of repeated simple structures and argued that they implied some higher element of structure and understanding to change over time, rather than change that was just random. The idea of an unpredictability that could not be understood within the normal distribution of observations gave his work a clear link with chaos theory and the observations of Poincaré. In 1961, Edward Lorenz stumbled on a demonstration of chaos somewhat by accident while running an early computer model of a weather system in an effort to improve forecasting. What he discovered when computing the same data with a small different computation of decimal points was that very different results occurred. Small changes in initial conditions had exponential results. He spoke of a butterfly flapping its wings in Mexico and causing a hurricane in Texas. This implied that medium term weather forecasting of any local detail was impossible and that the only useful way forward was the comparison of historical patterns and trends, but always with some probability that different outcomes might start to evolve at any new time point. In Giles Foden’s novel Turbulence Henry Meadows, a maths prodigy from the London Meteorological Office, has to work with a reclusive academic named Wallace Ryman to apply his theory of weather systems to a prediction of the probability of stormy weather in the English Channel at the time of the 1944 ‘D Day’ allied landings in occupied France. Shortly before the invasion the protagonists are arguing over the correct theoretical method for understanding weather. The scientific traditionalists argue that if only enough reliable data were available an accurate medium term prediction would be possible, but Meadows has learnt much from Ryman and concludes: Future weather is a judgement of probabilities based on the physical principles which are reducible to mathematical formulae . . . forecasts were accurate for the first day, but became increasingly less reliable after that. For the second day they were merely useful. By the third, fourth and fifth days . . . they had entered the realms of speculative fiction. (Foden, 2009: 260–262) The link between chaos and complexity theory originates in the contrasting periods of stability and instability that both Mandelbrot and Lorenz had observed. While the instability of chaos was seen as surprising, given an apparently relatively simple system with a limited number of variables, part of the epistemological condition was that these systems were less simple than first thought and characterized by deeper levels, or scales, of complexity, in part to do with their existence in time and space. For example, the key variables in a weather system like the wind speed and barometric pressure are subject to important and complex variations in both time and space. Likewise cotton prices will vary across time and space. Similarly these specific systems can be linked to

Complexity theory and public policy   5 holistic wider system influences, such as the behaviour of the sun and ocean currents when understanding the weather and the prices of other goods and technological changes when understanding cotton prices. It is this holistic and wider systems view that moves a focus on chaos and instability to the conceptual and theoretical constructs of complexity theory. Figure 1.1 indicates the main framework of complexity concepts used in this book to apply complexity methodology in the international comparison of national public policy.

Stability and instability A first key defining feature of complexity theory is the interplay of stability and instability. As Peterson (1998: 65) notes: ‘In all its complexity, life requires both stability and change.’ Instability can be defined in two separate ways: either random instability or chaotic instability. Random instability has no observed interaction with other factors, to the extent that forecasting is impossible (Dooley and van de Ven, 1999). As argued above, chaotic instability may appear to be random, but it can be shown to have interactions with other factors and so is influenced and determined by history. Chaos results in observable similar patterns at certain periods of time, but these patterns are impossible to predict with any high degree of certainty about when exactly they will reoccur. A weather system is a classic example of chaos. Prediction is only reliable for very short time periods and based on comparing similar past patterns. Chaos theory has been developed to assist our understanding of those elements of large subsystems (like economies, societies or government policy systems) that are unstable but that do have some element of historical influence. Previous work by the author has argued this to be demonstrated in the privatization and marketization of social care policy in the UK (Haynes, 2007 and 2008). In these research articles it was demonstrated that radically new national public policies tend to be chaotic in their immediate affect with a few variables influencing dynamic change, while over a longer period of time, policy systems reverted to complexity where numerous confounding variables mitigated and stabilized the more un­stable aspects of change (see also Dooley and van de Ven’s (1999) definition of Instability – chaos Power law

Instability (relative to stability) Nested systems

Scaling Rules

Attractors

Positive feedback Negative feedback Self organization

Figure 1.1  A complexity theory framework.

Interaction

Complexity

6   Complexity theory and public policy o­ rganizational complexity). Policy systems can have periods of instability but they will also have periods of stability. This evaluation of when stability occurs will be ‘relative’ in the social world. For example, cotton prices can only be judged to be stable on the basis of comparing them with periods and measurements of previous instability. In this sense, stability and instability in human systems – like policy systems – is subjective and relies on relative judgements, whereas instability in physical systems can be demonstrated to be determined by a few simple rules that create disorder, with large differences occurring because of small differences in the initial conditions (Peterson, 1998: 139). Given the difficulty in demonstrating scientific physical chaos in complex human policy systems, with many variables influencing the system, the author’s preference as a social scientist and policy analyst is to describe and analyse contrasting patterns of stability and instability rather than to attempt to prove via measurement that scientific chaos is present. Therefore quantitative data is used to explore qualitative social and economic patterns, not to prove empirically that the patterns exist. This debate about the extent to which the scientific method of deterministic chaos can be reliably demonstrated in the social sciences was well rehearsed in Kiel and Elliot’s (1997) edited volume. As Harvey and Reed (1997: 297) conclude: If the actual mathematical models of deterministic chaos and the concrete findings of the physical sciences have limited value in their direct application to the social sciences, they can still provide a rich heuristic base from which social scientists can work. Edge of chaos Given the interest of complexity theory in understanding the interplay of instability and stability a major point of empirical focus and observation is the ‘tipping point’ between them. Some theorists have referred to this as observing systems or parts of systems on the ‘edge of chaos’. Others link such instability and its consequences with the dynamics of dissipative structures in the natural sciences and the concept of a ‘bifurcation’ where a spontaneous different structure emerges (Rhodes et al., 2011: 15). Some describe key moments in the changing dynamics of systems as ‘tipping points’. Events in the recent global financial crisis (2008–09) can be viewed as potential tipping points, for example, the bankruptcy of Lehman Brothers Investment Bank in the US in September 2008 that led to unprecedented state intervention in financial markets. Or instability might be argued to emerge from a relatively short period of intense change, such as the global financial market panic and loss of confidence in the winter of 2007–08, when banks and financial institutions realized the US housing market was in decline and that their mortgage backed securities could not recover. Instability can be primarily political rather than economic, such as the uprising of populations demanding franchise in the Middle East after living under years of dictatorship. At the more local level of public policy, policy makers can observe

Complexity theory and public policy   7 instability in the form of shifting population changes, the closure of local industry, or weather related events, such as earthquake and flooding. Instability comes in many forms and at different levels of intensity, but it undermines the ability of the policy maker to deliver rational medium and long term plans. The policy maker and policy manager have to be highly adaptive. This has implications for the way policy systems are organized. Maclean and MacIntosh (2011: 238) argue that organizational systems on the edge of chaos ‘appear to constantly adapt to ensure compatibility with their ever changing environment’. Such organizations therefore tend to move away from traditional fixed structures and experiment with flexible forms of organization. This might lead to a preference for networking and task based groups to solve particular challenges and problems rather than waiting for institutionalized committees with rigid rules and written procedures to slowly adapt. Policy formulation is inevitably institutionalized in modern democracies and this is an important part of transparency and accountability in terms of mapping the reasons for decisions and the responsibility attached to them. However, one premise of the new public management (NPM) literature from 1980 onwards (Haynes, 2003: Ch. 1) was that politicians attempted to focus on strategy and strategic decisions, while looking to delegate the implementation of operational detail to managed agencies. This trend is also linked to the increased marketization of policy delivery and the possibility that delivery may be contracted to the market place. Arguably the importing of business management methods as part of NPM with the increased business contracting of annual service agreements has placed the public service experience more on the edge of chaos for front line operational managers and professionals. This needs to be contrasted with the pre-­1980 documentation of public policy as organized in predominantly stable institutions of public administration. Here stability is argued to be characterized by ‘path dependency’ where systems settle into a particular set of characteristics in part determined by early events and their sensitivity to initial conditions (Rhodes et al., 2011: 14). Maclean and Macintosh (2011) note the difference between organizations that find themselves on the edge of ‘chaos’ (because of market conditions or political instability), with organizations where managers seek to move the system towards the edge of chaos to get their workers to embrace external change. Having studied 18 private and public organizations, they concluded that organizations do not naturally always exist on the edge of chaos, but more naturally seem to move between states of instability and stability over time. It was therefore difficult for managers to artificially keep an organization or part of it permanently on ‘the edge’, even if they wished to do this to achieve change. Given that being in a period of instability, or on the edge of one, was associated with increased stress for the workforce, the authors concluded that most managers and organizations act to implement stability rather than more instability, although they did find a small number of exceptions. The exceptions were two private companies; one was pharmaceuticals and the other electronic. In these companies instability was deliberately created by frequent restructuring and job rotation. Even worse,

8   Complexity theory and public policy senior managers fed misinformation, manipulated events and spread negative rumours about the scale of external change that was faced. No evidence was available about the long term outcome for the organizations concerned. In five of the six public organizations studied, the trigger for change was external and driven by the external political context. The one local authority example they studied (that appeared to choose change to improve the quality of service) could also be argued to be acting indirectly to external pressures. In conclusion the experience of many public organizations is that they constantly struggle to meet external drives for change while seeking to retain elements of stability that ensure a reasonable degree of stability of function for the complex public goods they provide. This is similar to the findings (Haynes, 2003) that major organizational restructuring either enforced top-­down by politicians, or chosen by senior managers as a method to cope with external change, was unlikely to be optimal and that adaptive, evolutionary change was more likely to prove resilient in the longer term. It is important to note the link in complexity theory between the edge of chaos and the ‘emergence’ of new forms of order. Emergence is often discussed in its own right as a subconcept of complexity theory, or even as an evolutionary theory in its own right (for example, see Johnson, 2002: 18, who defines emergence as ‘the movement from low-­level rules to higher-­level sophistication’). Another concept often referred to in relation to the edge of chaos and emergence of new forms of order is ‘fitness peaks’. This is the idea that organizations and societies reach a historical point of success where they ‘get stuck’ and fail to continue to evolve to fit with the changing world around them. This allows other competing groups to overtake them and this may threaten their ultimate existence if they continue to refuse to move off that peak (see Kauffman, 1995). We can draw parallels here with the economic decline of certain major nations and need for indebted nations like the US and UK to revisit their social, political and economic purpose after the 2008–09 economic crisis.

Nested systems A second key feature of complex systems is that they have characteristics that are nested or defined by scaling. In other words, patterns present at the most holistic and generalized level will be reproduced at other micro and local levels in the system. This is similar to Mandelbrot’s concept of fractals where basic patterns are found to reproduce themselves within systems to create a patterned order. The term ‘fractal’ comes from the Latin word fractus, meaning broken or fractured. The concept was developed by scientists to describe things that reproduce themselves with similar patterns and representations at different hierarchical levels. In the natural sciences a fractal is a pattern that reproduces itself with very similar structures at different levels. Examples would be mountains, coastlines and certain plants. Plants like cauliflowers and ferns have the same structure both as an overall plant, but also demonstrated in their branches and flowers.

Complexity theory and public policy   9 This is also referred to as self similarity. Mandelbrot, the French mathematician – sometimes referred to as the father of fractals – defines fractal geometry as the study of patterns, in space and time, that remain the same even as the scale of observations changes. Fractals are defined ‘recursively’, that is by reference to their own basic structure. And so a core structure or pattern is then reproduced in similar ways, many times over and at different levels or scales. In economic systems price variation patterns may demonstrate such characteristics (Mandelbrot and Hudson, 2008), and the organization of policy itself in democracies and institutions may be observed to copy similar core ideas, practices and values at continental, national and local levels. Fractals provide an interesting metaphor for exploring policy processes. It is possible to recognize organizations and structures in the global policy processes that are analogous and often reproduced in similar but non-­identical ways. Examples would be committees, teams, delivery systems etc. But these different substructures of the policy process do not separate into isolation; they are constantly connected with each other. They interact and feed back into some overall grand narrative of the policy process. The effectiveness of one level is always interdependent with other levels. So while there are many differences in the forms of organization in a complex society there are also many similarities. These similarities give us some order and stability of structure that help society to function. Luhmann (1995) says that larger social systems exist on the surface of small scale systems. Scaling Scaling is similar to the concept of fractals. The same types of structures and dynamics are reproduced in social hierarchies. Mandelbrot and Hudson (2008: 243) apply this to price changes in a financial market: the distribution of prices in a financial market scales . . . so the proportion of big changes to small changes in a financial market follows a consistent pattern – and it results in wilder price swings than you might otherwise expect. Large price rises can result in even higher price rises, rather than an immediate drop towards a normal distributed trend average. For this reason, Mandelbrot and Hudson argue that we experience the occurrence of bubbles in property, stock or bond prices rather more often than expected from classical statistical financial models. Nicholas Taleb (2005; 2007) has argued similar ideas in his books Fooled by Randomness and The Black Swan. Power laws Power laws can be used to understand the process of scaling. This is the idea that the occurrence of differentiation of levels, or the hierarchical presentation of different proportions of these scales, can in part be determined by a mathematical

10   Complexity theory and public policy equation. This equation can aid understanding of where levels and scales occur in the consideration of complex systems. For example, Vilfredo Pareto suggested that wealthy people were likely to be a consistent and much smaller proportion than poorer people in a given society, but the further up the income tree one travelled the better the possibility of becoming richer still. Mandlebrot and Hudson (2008: 157) have described this as: The absolute odds of being a billionaire are very low, but according to Pareto’s formula, the conditional probability of making a billion dollars once you have made half a billion is the same as that of making a million once you have made half a million. If a population income is plotted as a distribution curve or boxed histogram it typically shows longer tails than a normal distribution, especially at the side of the distribution that demonstrates higher than average incomes. This is because the length of the tail of those with high incomes is more variable and diverse than one would expect if the distribution was behaving normally. Pierpaolo and McKelvey (2011: Ch. 15) have articulated this type of social occurrence as a power law science. The focus of the researcher shifts from the average central tendency to the extreme outcome, or outlier. Pierpaolo and ­McKelvey distinguish between regularities that are predictable over time and fit a normal distribution of occurrences, and ‘scale free’ regularities where the distribution of occurrences cannot be demonstrated over time to fit into a normal distribution but the plotted distribution has more outliers and extreme occurrences.

Attractors The third key concept referred to is the attractor. A mathematical attractor is a notional central point, within an unstable pattern of data. It is a form of central tendency, the exploring of a central point in relation to the boundaries of the data recorded and the plotted changing and emerging patterns over time. But it is the unstable form, structure and pattern of data around a notional inner point that is of interest, rather than the actual central point itself. An attractor helps us to understand order in disorder, to evaluate the edge of chaos and to make subjective judgements about when a system has moved from chaos to stability or the reverse. Figure 1.2 shows an attractor plot for the monthly changes in UK prices where each value is the change from the previous month. The three different shadings represents the time periods of the three different prime ministers who led UK governments in that period of history. The greatest instability (shown by the outer range of orbit in the darkest solid line) was during the Thatcher Conservative governments. Overall the swirling periodic movement of the price change plots is cyclic and stays within boundaries, but the shape is not symmetrical or orderly. In some circumstances attractors can be linked to ‘rules’ applied to a system, for example, inflation in an advanced economy is likely to be linked to central bank interest rates. These interest rate rules can be argued to be helping

Complexity theory and public policy   11 4

Conservative Thatcher Conservative Major

3

Labour Blair 2

1

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0.0

1.0

2.0

3.0

4.0

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Figure 1.2 UK inflation, January 1987 to December 2004, monthly change (t–1), by Prime Minister in power (source: Bank of England, monthly price changes, 2009).

create some attraction to order when plotting the changes in price inflation. An attractor is, therefore, ‘an attraction to order’, but this type of order is rarely uniform in pattern and never fully optimal or easily predictable in final outcome. Another way to understand the attraction to order in an unstable policy environment is to apply Kontopoulous’ (1993) Logics of Social Structure. This is a qualitative theoretical approach rather than plotting quantitative information. He wrote of the competing logics in social organizations and the fact that some logics come to dominate policy practice in given periods, even though alternative perspectives are still expressed and exist. For example, in the rapid evolution of social care policy in England after 1980, the logic of marketization came to dominate in the privatization of care homes in the 1980s (Haynes, 2007). Other policy logics still existed, but a strong idea of creating consumer power to facilitate individual choice began to have more direct influence on the formulation and practice of policy than other logics. Other logics were still apparent in practice, sometimes in direct conflict and contrast to marketization at the local level. But over time it became increasingly difficult for local policy to escape the dominant attraction of marketization. Another key logic in the development of policy at this time was the growing practice of market manageralism, with ideas of policy implementation taken from business and private organizations. Values about the contribution of public professionals as the custodians of social care were less audible – and while still operating to some extent – had less influence on the manifestation of policy and its most visible outputs. To quote the French Sociologist, Pierre Bourdieu (1977: 10),

12   Complexity theory and public policy ‘an economy of logic allows fuzzy action’. In the policy world there are always many contradictions and challenges, and no opportunity to find complete and fully robust arguments, but an overriding, dominant and evolving ideological paradigm usually provides the foundation for long time periods of policy organization and direction, even if it is fraught with periods of doubt and instability. Kaletsky (2010) describes the post-­1980 supply side market revolution that deregulated the private sector and moved the values of the public sector towards market forms of operation. It represents the major paradigm that has driven public policy for 30 years. He calls this paradigm ‘Capitalism 3.0’. Like many writers, and similar to the exploration of this book, he asks the question: is the dominant paradigm now shifting?

Interaction and feedback A fourth feature of complexity systems is that they are defined by the interaction of their components, this rather than one component simply having a hierarchical and deterministic causal effect on another. These interactions between components lead to feedback loops both positive and negative. Positive feedback is where particular interactions get reproduced rapidly. Negative feedback is where one component receives a negative message from another, thus closing down reinforcement. The difficulty with using positive (and negative) feedback concepts in the analysis of social systems is that they are not necessarily positive in a normative sense of outcome, and indeed positive feedback can have highly negative normative results. For this reason, Meadows (2009) calls positive feedback, ‘reinforcing feedback’ and negative feedback, ‘stabilizing feedback’. An economic bubble is a good example of reinforcing feedback. Positive reinforcement builds up in part of the global economic system to encourage people to buy property with borrowed money. People copy one another, believing a positive result is certain. Neighbours believe house prices will rise while they benefit from the utility of their home and lenders are confident that the value of their investment is protected in the growing asset price. This leads to a price bubble that is not based on a sound long term assessment of value. Wider system behaviour requires that one asset cannot continue to grow in continuous value against other assets, as each asset has a practical limit to its comparative value to others. Reinforcing feedback ultimately results, therefore, in instability and a collapse of that part of the system (Meadows, 2009: 155). In the example of the 2008–09 global financial crisis, house prices and home ownership started to decrease with major consequences for other parts of the social and economic system. As Skidelsky (2010: 43) says: ‘Mistaken opinions about markets reinforce each other. Positive feedback loops lead to cumulative movements up or down . . . momentum carries markets far from equilibrium territory.’ The ending of a reinforcement feedback loop often happens abruptly and with a swift and chaotic correction in the related systems. This correction can be referred to as ‘tipping point’ as the system rapidly evolves into a new dynamic state and various interrelationships and reinforcements are fundamentally changed. The impact of the 2008–09 financial crisis is having such an effect on global economic and social systems.

Complexity theory and public policy   13 Luhmann (1995) observed that social systems are best understood by their communications, rather than variables such as people and places. He noted that communication was not the simple passing of information but required mutual understanding by the parties. His major sociology work, although traditionally seen outside the sphere of complexity theory, has important epistemological relevance if social science is to deal appropriately with social systems and their major differences to physical systems. Luhmann observed that individuals are members of several different social systems, but he argued the social interconnections between these systems were limited, despite the apparent physical movement of people between them. For Luhmann, what prevented more open overlap of social systems was their codes of communication and specific rules of conduct, and these in essence were designed to restrict and control social movement and communication and keep a dominant form of social order. For example, he noted how contact with two systems like the economy and law was subject to a specific context of ‘structural coupling’ based on precise rules and specialist language. In other words, the two separate subsystems could only communicate in specific agreed ‘corridors’ of communication. Luhmann’s analysis raises a challenging interpretation of the matrix of complex modern societies that implies they follow closed and restrictive social practices. This may help to explain why events such as the mass mis-­selling of mortgage backed securities by investment banks to other institutional investors can take place with such ease and escalation without politicians and regulators understanding and intervening before a catastrophe of economic collapse has occurred.

Self-­organization A further feature of complex systems is their tendency for bottom-­up self-­ organization driven by the phenomena or actors contained within each system or sub system. Therefore, the order and behaviour of the whole system and its parts may evolve from local developments and interaction, rather than being determined by top-­down hierarchical system based rules. In the natural sciences, commentators have noted the principles of self-­organization used by animals as they form herds and flocks, but arguably the most influential scientific work to underpin the concept of self-­organization was the Nobel prize winner Ilya Prigogine’s discovery of ‘dissipative structures’ (see Prigogine 1977). He demonstrated in chemical reactions that the interaction between substances could be unpredictable, forming novel structures, and unpredictable patterns from within, rather than repeated deterministic patterns. A related idea ‘autopoiesis’ was used by Maturana and Varela (1980) to refer to cells that are independent and closed systems, and have the ability to maintain and regulate themselves. They are, however, paradoxically coupled to other cells in a larger environment. Here then are some scientific discoveries and theories that emphasize the bottom-­up interaction of entities and their independence and spontaneity rather than a world that was predetermined by higher rules and environmental determinism.

14   Complexity theory and public policy In the social scientific study of organizations it is widely accepted that the culture of an organization is more substantial than its hierarchical structure and this is because of the values and informal rules of behaviour that determine how actors and workers actually behave. Informal codes and methods of communication and conduct become more influential on the workers than formal structures, hierarchies and rules of engagement (Haynes, 2003: Ch. 3). This is because a human worker constantly seeks to make sense of their behaviour and adapt to their environment. Local interaction provides the possibility for insight and self-­ organized direction that is potentially more productive than senior management structures and rules that will not have experienced the finer detail of local operations. It is impossible to completely control the worker in both the private and public sectors. Actors in complex policy systems are constantly seeking to survive by exploring the dynamic tensions that surround them. ‘The concept of self-­organization captures the process of autonomous development and the spontaneous emergence of order out of chaos’ (Teisman et al., 2009: 9). The existence of self-­organization, however, does not ensure that self-­ organization is always functional and optimal from the organization’s normative point of view. It is important to recognize that self-­organization might also lead to behaviour patterns that are dysfunctional for the whole organization, such as defensiveness, dislocation from other parts of the organization and low productivity. However, by using systems interventions that mitigate between the different subgroups and parts of an organization, there are possibilities for working with the forces of self-­organization rather than an organization pitting itself against them through hard and intrusive management approaches (Seddon, 2008; Stacey and Griffin, 2006). In a recent comprehensive volume of public sector case study research, Teisman et al. (2009: 9), note: The use of the term self organisation challenges the assumption that an external or internal agent is or can be held responsible for guiding directing or controlling in highly organised systems such as governance networks. Lipsky’s (1980) seminal study of public sector professionals noted how they modified the impossible demands placed on them by their managers and political masters. They did this to make their job operationally possible on the ground, this alongside the need for them to preserve and survive the conflicting work pressures. This included modifying their own high ideals and ambitions as picked up during their training. Lipsky concluded that managers and politicians only had limited abilities to drive the behaviour and outputs of public sector professionals. This led to a literature that explored ‘bottom-­up policy making’ where the emphasis was on the behaviour of the micro policy actor rather than the top-­down commands and controls of the politician and central civil servant (Hill, 1997). Social scientists and management academics influenced by complexity theory have started to produce a range of case studies to try and understand these bottom-­up processes better, and their contribution to organization development and production. The Sage Handbook of Complexity and Management, edited by

Complexity theory and public policy   15 Allen et al. (2011), contains some useful revisions and updates on the methodological dilemmas of comparing self-­organization in physical systems with those in human systems, but the large volume is light on drawing conclusions about where the application of complexity has recently progressed into practice. At best Thietart and Forgues (2011: 54) conclude: ongoing interactions may generate any form of organisation . . . once put into motion, entities within a system seem to adapt to the outcomes of their prior interactions. It is in the zone of instability, far from equilibrium, that changes take place, allowing some order to emerge. The author’s own previous attempt at applying complexity theory to public service management (Haynes, 2003) concluded that because of the self-­ organizing and inevitable micro behaviour of public servants the best approach was to ‘design in’ constructive and reflexive human relations approaches to operational management. This was argued to facilitate the creative and best aspects of the bottom-­up reality, but it could only happen by instigating a human relations renaissance over the command and control performance driven ideology of many recent political approaches to increased business and managerialism in public agencies. The major and recent public sector study of Boons et al. (2009: 235–236), that includes several policy case studies, concludes that self-­organization in the context of public policy has four dimensions: 1 2

3

4

Self Organisation is a driving force of governance processes that sheds light on why government steering ambitions often fail. Self Organisation causes processes to follow unexpected trajectories. Self organisation stems from the free choices of people in charge often oriented at maintaining their position and stability, but occasionally oriented at chance and adjustment to new demands or circumstances. Self Organisation can and often will be driven by the ambition or need to survive (often this is called self interest; we use the complexity theoretical term autopoietic or conservative self-­organisation), but also by the ambition to contribute to and have an impact on a larger system (often this is called public interest; we use the term adaptive or dissipative self organisation). Self Organisation is closely related to the boundary judgements regarding the system as defined by the actors in a certain case. Boundary judgements that are based on partial knowledge and that are poorly investigated tend to generate discontinuities and conflicts or non-­ interaction between systems, while more holistic judgements could help to generate synchronicity.

While these conclusions are welcome there is little reflection on whether it is appropriate and possible to optimize policy design and implementation in some

16   Complexity theory and public policy way so as to best deal with these realities and, similarly, if there is any baseline skills deficit in public servants – such as negotiation skills – that can be recommended to progress self-­organization in normative ways that bring benefits in practice. These reflections augment a wider problem, the tendency of complexity theory to lead to impressive real world analytical descriptions and exploration, but little confidence in articulating prescription or applied lessons and tools for improvement. Of course, these are often criticisms of academic work.

Limitations of applying complexity theory to social systems There are a number of recognized epistemological problems with applying complexity and chaos theory that have been developed in the natural sciences to the social sciences. First, the social sciences have strong normative elements where values influence and interact with the development of theory and practice. Social science cannot be ‘value free’; it will always be influenced by social values about what is morally right for society and what policy and political methods and approaches are ethically justifiable. Indeed the academic researcher has to recognize their own value bias in this respect. Therefore, when applying concepts like power laws, there is the ethical requirement to consider the social consequences, for example will the presentation of Pareto’s power laws merely reinforce the idea that wealth inequality is self perpetuating and will this defer policy intervention and political intervention into poverty and its alleviation? The application of complexity requires normative sensitivity. The second problem for social science and complexity theory is the tension of description versus prescription. Description involves observing and understanding while prescription involves constructing hypotheses and applications from these observations so as to promote intervention to alter the physical and social world. The two methods are linked, and to a large extent the dilemmas of intervention are ethical for scientists as well as social scientists. Some scientific observation does not require intervention – for example, understanding the weather – but interventions develop that may influence decisions of human behaviour, such as the cancellation of an event due to a weather forecast. The dilemmas for social scientists when applying complexity theory to policy interventions are stark given the underlying methodology of uncertainty and the ­inability to predict with a high degree of confidence. Complexity requires ­cautionary applications that conversely do not constantly seek to elude responsibility on the grounds that no action can be logically determined to have a known outcome. In part this problem is connected with the holistic scope of complexity theory and it being the antithesis of Newtonian reductionism where simple linear and casual laws are demonstrated. The holism and interdependence and interconnectivity argued by complexity theory make it fundamentally difficult to reveal sharp conceptual definitions with an empirical demonstration. For some, these theoretical limitations mean that the concepts cannot be adequately validated in

Complexity theory and public policy   17 the social sciences and as a result should be referred to as metaphors. Pollit (2009: Ch. 12) has written what is probably the best intellectual summary of the limitations of applying complexity theory to public administration. He is frustrated with its ‘descriptive conceptualization of the backdrop to action’ (229), and argues for it to become more focused in its epistemological clarity and to develop more systematic and testable methods.

Intervening in complex policy and management systems This chapter has begun to summarize the progress to date of the formidable challenge of validating, demonstrating and transferring concepts from the complexity theory approach to scientific methodology to the social sciences. Clearly much has been written and attempted and this includes some empirical work to attempt to demonstrate the concepts. In addition to research that attempts to demonstrate and validate the concepts in the social sciences, some work has been done to take general principles from the methodology that can be applied to a holistic approach to systems intervention. Ralph Stacey (2001, 2007, 2011), based in the UK, but also well known in Scandinavia, has done extensive work to consider how strategic management methods should be adjusted to become adaptive in practice so they can cope with the reality of complexity. More recently his work has focused on interventions to improve the quality of human communication and leadership in organizations given the strong theme of communication and interaction present in complex systems approaches. David Snowdon is an international management consultant specializing in both complexity applications and knowledge management. He also has strong links with the academic community and holds a number of visiting academic positions across the globe. In addition to experience with IBM where he leads a successful knowledge management institution, he has more recently founded Cognitive Edge. A summary of his approach is that he has collected numerous personal accounts and stories from a variety of organizations and he places personal management and leadership development in the context of the challenges of organizational complexity. Like Stacey, he has some high degree of sympathy with the need for clear communication and reflective understanding given the high degree of complexity in modern organizations and work processes. Nevertheless, he demonstrates a clear commitment to developing analytical frameworks and structures through which to categorize and place these personal and contextual accounts. The most recent analytical framework ‘Cynefin’ was explained in an award winning article in the Harvard Business Review (Snowden and Boone, 2007) and has subsequently been supported by commercial software to assist with using the process. In that article the authors suggest that issues and problems facing leaders (they prefer the term ‘leader’ to ‘manager’) can fall into five categories of the assessment of cause and effect (derived from complexity theory): simple, complicated, complex, chaotic and disorder. Each categorization needs the leader first to diagnose the underlying degree of cause and effect

18   Complexity theory and public policy successfully and then to apply an appropriate course of action. Snowden’s action based work is characterized by a pragmatic desire to move away from eternal academic debate over the validity and empirical realization of complexity science concepts in social organizations. He is also committed to understanding, through the action of trial and error, the reality that managers, leaders and politicians have to act and decide and cannot endlessly reflect on theoretical issues. The late Donnella Meadows (1941–2001) was an American environmental activist and lead author of The Limits to Growth (Meadows et al., 1972). She has also published one of the best known and widely read pieces on intervening in systems (Meadows, 1999), as well as a primer on systems thinking (Meadows, 2009). Her background is more rooted in systems consultancy than academia and this is indicated in her pragmatic and action based approach. She proposes twelve different methods for intervening in systems, this is based on a diagnosis of what is wrong with the system of interest. (In a first version of the paper she proposed nine places to intervene but later revised and expanded this to 12.) Meadows notes that key points of intervention include: managing material stocks and flows with regard to levels of inputs and reserves, negative feedback, positive feedback, using information, changing the system rules and facilitating self-­ organization. A more detailed presentation of her conclusions is presented in Table 1.1. In a study of the implications of complexity science for leadership roles and approaches, Marion and Uhl-­Bien (2011: 396) conclude that leadership is characterized by interdependence and the use of informal dynamics. Enabling leadership is associated with managerialism and ‘fostering, framing and guidance’. Alternative adaptive leadership is defined as ‘collective, embedded and interactive’. This latter form of dynamic and creative interaction is proposed as the most suitable for highly complex and rapidly involving context (for a similar approach, see also Haynes, 2003: Ch. 3). Azadegan and Dooley (2011) explored centralized and distributed control approaches in operations management as associated with production. They aimed to explain why a global shift from central control to distributed control and outsourcing had evolved. They concluded that distributed control emerged as the best method for dealing with complexity where there were many actors and agents and a relative abundance of capacity and resources. The authors concluded that distributed control and outsourcing perform best where there is resource abundance, plurality of agents and network connectivity and, if these preconditions were not met in the future due to any chaos and instability in global and local markets, a return to more central control might prove functional and necessary. The development of knowledge management practice to deal with complexity is explored by Boisot (2011: 436–450). Knowledge management is a diverse range of concepts and approaches that has largely developed in response to the growth of information and knowledge frequently linked to the proliferation of information technology. Boisot proposes the concept of an Information Space (I-­Space) for knowledge management where information and different types of

Version 1

Change the system parameters, e.g. interest rates

Size of stocks as buffers, e.g. energy reserves create price stability Takes time to build buffers

Control systems for distortions and dysfunctions, e.g. taxation on excessive profits

Reduce gain in positive feedback, e.g. housing bubbles need checking with taxes or similar

Making sure people have the accurate information they need: add or change information

Rules change behaviour

Adding and returning to items 4–9 lower in the scale and levels of the system

What are the higher goals? – profit or greater collaboration?

What are the core values and ideas of the system?

Type of intervention

9. Constant inputs and parameters

8. Material stocks and flows

7. Checking stabilizing feedback

6. Regulating reinforcing feedback

5. Information flows

4. System rules

3. Self-organization

2. System goals

1. System paradigm

Table 1.1  Meadow’s framework for intervening in systems

Subdivides into: Mindset of paradigm Power to transform paradigm

Subdivided into: Lengths of delays Strength of stabilizing feedback loops

Subdivided into: Size of buffers Size of material stocks and their flows

Version 2

Culture Beliefs Difficult to change Political projects

Is population persuaded by the strategic goal? Political role

Encouraging diverse responses from bottom up. Local activity Consumer activitism

Beware when rules are dysfunctional

Information as accountability

Watch for point where small further increase creates instability and chaos

Strength of stabilizing feedback loop, relative to its impact

Buffer too big – creates inflexible system, e.g. large gas reserves mean gas is the strong preference over other energies

Changing numbers implies changing something else – like a rule?

Notes

20   Complexity theory and public policy knowledge are processed by the organization (or policy process) and communicated as coherent messages. Knowledge is then absorbed by actors and has a policy or organizational impact. The process of codification in the organization reduces complexity before the knowledge is widely used. But conversely the author noted that deliberately allowing more complexity in how knowledge is used and interpreted at the point of impact may be an important strategy. This is likely to be the case when an organization’s impact with the outside world is changing and subject to instability and uncertainty. There is a difference here between considering management issues internal to the organization or policy process and considering external engagement with levels of exterior complexity. This managerial tension between the production of knowledge and its codification inside an organizational process, compared with the applied use of knowledge in an external environment, is summarized by Boisot (2011: 450): ‘The management of knowledge is co-­existence with the management of complexity.’ Similar to Snowden and Boone’s (2007) premise above, different management approaches are required depending on the assessment of the context. Policy management in a complex world needs to be highly adaptive. Rhodes et al., 2011, has presented an applied model based on complex adaptive systems (CAS) theory to aid the analysis of public management case studies. Their ‘6 + 4’ analytical framework puts much emphasis on the internal interactions in a policy system where dynamic and adaptive communications take place and are influenced by external factors. They provide case study illustrations of the influence of theoretical CAS features including path dependency, adaptation, bifurcation and emergence. Intervening on the demand side Seddon’s (2008) work in the UK as a management consultant focuses on intervening in what he argues are dysfunctional management approaches based on classical approaches of command and control; for example, setting a large number of performance indicators that have unintended effects. Although Seddon’s work has its roots in systems approaches to management rather than complexity theory there are important areas of conceptual overlap with theoretical approaches based on complexity science. Seddon positions his own work with that of ‘lean systems’ and the revolution in devolved car production led by Toyota over 30 years ago. His intervention aims to get workers to identify what he describes as ‘demand failures’, usually by involving them in redesigning their part of the service or workflow process (the antithesis of a top-­down redesign of an organization’s structure and work processes). Demand failures are where human services like those providing social care or renting social housing get processed erroneously when a user first makes contact with the host organization. This results in unintended processing activities, organizational waste and an increasingly frustrated service user. Seddon’s work has many examples where efficiency is argued to have been improved by making the first point of contact inter-­relational and with value added. This therefore promotes the knowledge

Complexity theory and public policy   21 and contribution of both the operational front line worker and the service user. This Seddon sees as the route to overcoming demand failure. Seddon has been forthright in this criticism of centrally driven performance targets because of their unintended effects and disruption of front line motivation and problem solving. He is critical of overly standardized and fixed processing of work as it comes into an organization: ‘the computer says no’ phenomenon. The best known economist attempting to analyse and propose policy solutions based on complexity science is Paul Ormerod. His first best selling book The Death of Economics (1994) offered a fundamental cross-­examination of the discipline and its historical attempt to use classical mathematics and statistics without adequate reflection on the unpredictability and irrationality of human market interactions, organization and behaviour. In his next book, Butterfly Economics (1998), he attempted to develop this as a new general theory arguing the importance of government policy setting the right overall policy for the given context rather than trying to micro manage specific aspects. For example, he argued (1998: 187): ‘Governments should accept that inflation does move up and down over the business cycle, but provided that the conditions for a low inflation regime overall remain in place, this is nothing to worry about.’ Similarly, he argued that governments should mitigate the consequences of the business cycle rather than attempt to remove it. His paradigm makes two major theoretical points: agents in the economy have imperfect information and therefore make decisions with limited information and using so-­called ‘rules of thumb’; and at any one time the economic system has the dynamic potential to change along numerous paths and therefore defies accurate prediction. The New England Complex Systems Institute (NECSI) on the east coast of the US has used applied economic research to argue directly for specific interventions in government economic policy and intervention. In 2007 the NECSI published a study indicating that the US stock market ‘uptick rule’ should be reinstated. The uptick rule was originally implemented after the crash of 1929 as one of a number of policy measures to try and prevent a repeat of the Great Depression. It was designed to prevent new short selling of a stock when its share price was already in decline. The US Securities and Exchanges Commission (SEC) asked the US government to repeal the rule in 2005 believing it to be no longer necessary on the basis of their own statistical research on its contribution to price movements and market stability. No doubt they were lobbied hard by the US investment banks about this, as subsequent reviews of the financial crisis of 2008–09 show that investment banks made rich pickings from such behaviour (Lewis, 2010a). The research at NECSI found that the SEC pilot data had been collected and analysed at a time of overall stability for the market when the majority of prices were rising. Their own NECSI research concluded that a very different effect was present in an unstable market and that in such circumstances the absence of the rule was amplifying deterioration in prices and further increasing the level of market instability (Harmon and Bar-­Yam, 2008). The research was successful in getting the uptick rule restored and it seems likely that this contributed to some much needed stability at the time.

22   Complexity theory and public policy The Nobel Prize winning author Paul Krugman has emerged as one of the key proponents of Keynesian government demand stimulation after the financial crash of 2008–09. US policy moved more in this direction after 2010 than European policy. Krugman’s argument is that national economies are still predominantly closed systems sensitive to negative feedback despite their interconnection with the global economy. His argument is that business is more transnational than government and therefore national economies will still perform to certain equilibrium whereas business will not. For example, he says ‘the balance of payments is a closed system: the inflow of capital is always matched by the trade deficit so an increase in that inflow must lead to an increase in that deficit’ (Krugman, 2009: 40). This implies that the inflow of capital investment into the US from China must inevitably lead to a larger trade deficit. He ignores the interconnected flow of goods, services and investments between a large group of countries and the inevitable time lag on these interactions reaching equilibrium, and the fact that it matters a lot whether they reach equilibrium via gradual evolution or sudden adjustment (the consequences being different). Also his arument ignores the exchange rate fluctuations that occur during the time period of reaching equilibrium that in themselves also contribute to the type of equilibrium that is obtained. In short, the system closure on national economies is not direct or precise although its theoretical existence is important. The time scale of monetary flow is important. The effect of a long time delay in correcting imbalances in economic systems is referred to by Keynesians as ‘the distinction between the long run and the short run’ (Skidelsky, 2010: 30). Nevertheless Krugman’s approach does show the positive intervention potential of national economies as both stabilizing forces and relative closed systems. This he compares with the activities of transnational companies (TCs) that operate in a relatively open system. Krugman provides us with an insight into how the global economy can be better stabilized through more informed intervention in relatively closed national economies.

Conclusions Despite over 30 years of research and writing published about complexity science and its application to the social and management sciences it is frustrating that progress to agree a theoretical schema and fundamental definition of concepts is making slow progress. It is still all too easy to find descriptive examples where the same abstract concept is argued to have different features, although sometimes these are juxtaposed and workable. Prescriptive interventions based on complexity theory are still rare, although Meadows’ work sets down some clear principals in that respect, albeit without adequate empirical and case study examples given to test the toolkit she has constructed. Michael Baranger (2006), at MIT, and Paul Cilliers (1998), University of Stellanbosch, are two theorists who have done more than many to reduce complexity to some clear summary propositions. Combining these, the following summary is produced to describe public policy systems:

Behaviours that check other behaviours, i.e. symmetrical interactions

Rapidly growing behaviour, i.e. bubbles

Set control parameters on the system and its operation

Use of information can change agent behaviour

Setting policy at continental, national, subnational or local levels

Discretionary behaviour and local/ Seek to facilitate best aspects of localized contextual judgements of policy actors behaviour, by encouraging responsibility and professionals and transparency

Stabilizing feedback

Regulating reinforcing feedback

Setting operating parameters

Use of information

Managing ‘levels’

Leading selforganization

Weak currency reduces imports and inward investment and sees a stabilization of new exports

Reward and publish excellence in professional practice, including partnerships with the public Sanction negative adaptation

Deprived areas get commercial tax breaks to stimulate local business in depressed areas

Source: Adapted from Meadows, 1997, 1999. See also ‘ESRC Systems and Complex Systems Knowledge Exchange’ at www.brighton.ac.uk/sass/complex-systems/.

Change national taxation policy but allow more diversity in tax rates at local level

Government warns lenders and consumers Confidence in borrowing declines and that interest rates will eventually rise there is less demand for finance

Low cost of loans fuelled debt crisis in US Raise central bank interest rates, so it and UK in late 2000s causes lenders to raise commercial interest rates

US housing market and house prices grew Introduce more regulation and controls, exponentially from 2000 to 2005 like increased deposit required on residential loans

Increased imports and widening trade deficit stabilize by increased inward investment or exchange rate depreciation

Uptick rule in US stock market to prevent shorting in a declining market

Shorting of declining stocks creates market instability and gives some investors unfair advantage

Use of legalization and other policy rules

System rules

Marketization of public administration in US and UK Creation of ‘internal markets’ in public services that could not be fully privatized

Intervention example

Marketization from 1980s onwards made ‘market values’ more primary in public policy

Core values that cause action Contradictions in values Dominant logics and values that drive policy change

Ideological paradigm of operation

Real examples

Conceptual examples in public policy

Intervention

Table 1.2  Policy interventions: a systemic analysis

24   Complexity theory and public policy 1 2 3 4 5 6

Complex policy systems are dynamic and not static. They have interplay with chaos and non chaos: that is, an interplay with instability and stability. This tension between stability and instability is also referred to as being on the ‘edge of chaos’. In these systems there is no predictable equilibrium, no guaranteed return to a balanced point. There is a constant entanglement and interaction of competition and cooperation. This results in novel actions and behaviours and actions that evolve from the micro forms of self-­organization, cooperation and agent behaviour. There are multiple levels. An emerging behaviour in one level usually results from behaviour at another level. This is often referred to as nested systems.

These six summary points produce a clear framework for using the powerful concepts and metaphors of complexity theory to study the major instability in public policy across the globe and the attempt to find new and socially acceptable forms of stability in the midst of economic crisis. Building from these core theoretical propositions and with reference to Meadow’s seminal framework for intervening in complex systems, the schema presented in Table 1.2 will be used in this book to assess the function and dysfunction of policy interventions.

2 Case based methods and national comparisons

Introduction This chapter explains the development of case based methods and their ability to cope with social complexity because of their unique approach to the use of qualitative and quantitative data and their ability to promote the uniqueness of the case over variable parameters. This chapter draws extensively on the seminal text edited by Byrne and Ragin (2009) on case based methods. The research in this book seeks to combine documentary analysis and the exploratory use of quantitative data in an effort to understand the similarities and differences between countries as they approach and experience the economic crisis of 2008–09.

Case based methods Case based methods are useful because of their ability to preserve the integrity of each unique case. This is important because many quantitative methods favour instead the discovery of aggregate variable and multivariate scores that are argued to represent a summary of all cases. Given such attempts to represent the ‘typical case’, aspects of case difference may not be adequately understood. As an alternative, case based methods are particularly useful when trying to understand both similarities and differences in the comparison of cases, and when analysing relatively small datasets like a sample of countries. Byrne and Ragin (2009), in their seminal textbook of case based methods, encourage the exploration of a complementary range of methods that can be used for case based approaches. This includes both quantitative and qualitative methods. In addition, the case based approach lends itself to some innovative methods that overlap both qualitative and quantitative methods, for example qualitative comparative analysis (QCA). QCA at first appears as a quantitative approach because in its rawest form it works with dichotomous categorical variables where variables are either above or below threshold in their definition of the case. This can result in the use of Boolean algebra to understand the patterns and overlapping sets created from a series of ones and zeros (Gullberg, 1997: 252–256). Different patterns can be linked to the same outcome variable, thus demonstrating multi routes to causation rather than single aggregate linear scores with numerous residual effects. As Byrne and Ragin (2009: 2) also notes:

26   Case based methods and national comparisons It is rather that different methods may produce the same outcome – the complete antithesis of the form of understanding that is implicit in, and foundational to, traditional statistical modelling’s search for the – that is to say the universal, always and everywhere, nomothetic – model that fits the data. The ability of QCA to observe the complexity amongst cases and that different clusters or sets of cases may have different features but the same outcome, is a good illustration of the advantages of using a case based method. Case based analysis creates an important opportunity for combining both qualitative and quantitative sources of data, for as Byrne (2009: 9) says: case based methods are useful and represent among other things, a way of moving beyond a useless and destructive tradition in the social sciences that have set quantitative and qualitative modes of exploration, interpretation and explanation against each other. Case based methods therefore create a view of social complexity that is not possible when using explanatory statistical modelling which uses approaches like linear regression, logistic regression and discriminant function analysis. In these classical models, the data is aggregated to an ideal model or ideal type that is based on assumptions about the independent variables used. As an alternative, when undertaking a statistical approach to case study research, hierarchical cluster analysis is identified as a good method for dealing with small datasets where there is a need to be flexible with the clustering of cases and where cases may belong to overlapping and complex clusters (Norušis, 2010: 363). Here the computer modelling works towards putting similar cases together in logical ways, rather than making one summary statement about all cases. Quantitative, comparative case studies are best supplemented with additional contextual information. This is especially so with country level cases where arguments about similarity and difference need to be contingent on the integrity of the case. When considering the performance of countries at policy level there are important points of cross triangulation with the statistical evidence used and argument resulting from it. Supporting documentation such as previous academic literature and research, policy documentation, quality media representations of national issues and the policy responses all offer potential triangulation.

The challenges of comparative research The comparison of countries as cases has its own unique methodology challenges, in particular their lack of consistent realism. Countries cannot be assumed to be historically permanent. While they appear to be geographically defined and this is the more obvious method for classifying them, the depth of the country case is in their cultural history and the political constructions and collaborations of their peoples. Countries have complex levels and scales: subnational and regional classifications, local and parochial identities. They also belong to higher level

Case based methods and national comparisons   27 associations and collectives, either geographical or political, or both. When studying countries, it is important to recognize that there are problems with the integrity of the case, but when applying the pragmatics of realism we can observe the level of abstraction and thereby make reasonable judgements about how best to apply social and economic questions to comparing countries. The right kind of research questions have to be asked. We can observe that countries are real because TV news and newspapers talk about them constantly, armies fight over their territories, they have their own (or shared) currencies, similarly they can link directly to specific languages as a core method of communication for their citizens. Mahoney and Larkin Terrie (2010) discuss the growth of comparative historical analysis in the post-­war period. They note some of the key methodological criticisms of the comparative approach given its dependence on small samples and numerous confounding variables. This means that to achieve validity and robustness the comparative historical method must combine multi methods. It is common to combine the use of quantitative data with documentary and personal accounts from those within the country (Haynes et al., 2010), but data can also include individual micro level comparisons (where citizens are individually compared and their nation of residency is only one aspect of analysis). This is different to national comparison where the indicator records an average or similar aggregate score for the whole country. Optimizing the reliability of measures and their cross-­cultural validity is a vital element in considering the method of country comparisons. As Kennett (2001: 43) says: In order to compare something across systems it is necessary to have confidence that the components and their properties being compared are the ‘same’ or indicate something equivalent. Various attempts have been made to construct international indicators for national comparison where the concepts can be argued to be valid for comparison and are reliable in how this measurement is carried out. The International Social Survey Programme (ISSP) is a longstanding attempt to collect micro level social science data that is comparable between member countries (see www.issp. org). It currently includes 47 countries. The United Nations (UN) has been collecting a range of national level data since its establishment in 1945; the data is now managed via its statistical division (see http://data.un.org). Similarly, the World Health Organisation (WHO) has a Department of Health Statistics that produces extensive comparable data on its 193 member states. The Organisation of Economic Cooperation and Development (OECD) was formed in 1960 and currently has 34 member countries. It has a strong reputation for a wide range of social and economic comparative data collection and research with a focus on comparability, reliability and validity of the data, with the result that not all countries are included in each round of data collection or research analysis. The particular approach in this book is to identify macro national patterns of similarity that result from countries’ experience of the 2008–09 financial crisis.

28   Case based methods and national comparisons Given the complex systems methodology outlined in Chapter 1, it is useful to return to the analogy of the weather forecast (as a complex system) and to draw on Heidenheimer, Heclo and Adams’ (1990: 5) helpful description of the task of comparative policy: Like comparative policy scholars, meteorologists differ about how to weigh and evaluate the factors that produce a colder or warmer winter. But what general weather patterns are to the one, policies are to the other: namely an overall configuration of movement and activity. Both must be flexible observers, concerned primarily with the larger, general trends.

Cluster analysis The methods used in this book are to enable the formation of patterns of countries that have similar policy and economic profiles. This is done using cluster analysis. The theoretical assumption behind the use of cluster analysis (Aldenderfer and Blashfield, 1984: 20) is that similar and dissimilar cases (countries) exist rather than all being randomly different and heterogeneous. Cluster analytical methods do not use inferential statistics but are classified as numerical algorithms (Pastor, 2010). This is suitable for the exploration of groups of countries such as those that are members of the OECD where the aim is not to generalize results from a small sample to a bigger population of countries. Patterns are built by simultaneously modelling key variables. Cluster analysis reduces data into groups (clusters) where similar cases are placed together (Norušis, 2010; Uprichard, 2009). Clusters formed are dependent on the vari­ ables entered. Hierarchical cluster analysis enters all variables simultaneously, and looks for a maximum number of groupings starting with an argument for the maximum number of most likely clusters, but then using simplifications and group reductions. The clusters are therefore ‘fuzzy’ and not one dimensional and ‘crisp’. So, for example, whilst 24 countries might be first argued to represent six different cluster sets, computer analysis can also observe higher sets, such as three cluster groups of eight countries, and two cluster groups of twelve. Hierarchical analysis has been argued to be an appropriate form of analysis with small data sets, such as trying to observe the differences between countries where an aim is to keep a sense of the integrity of the case rather than just producing aggregate scores as a sum of the characteristics of all cases. Hierarchical cluster analysis can proceed with either all cases separated, or all cases together. Where each case is separated the method is termed agglomerative as the computer analysis is working to agglomerate and gather together the cases by use of a logical mathematical method. Divisive analysis works in the opposite form and the computer places all cases together in one cluster and then seeks to separate them, with each stage of the analysis adding a new layer of clusters to the hierarchy until the cases are separated and no longer linked in any way. Agglomerative is the preferred method in this book, this being based on the assumption that countries are essential complex individual and unique cases that can only be argued

Case based methods and national comparisons   29 to be similar according to a limited number of variables and that they ultimately remain separate national geographical places with their own cultures, histories, languages and institutions. In essence, they will always be more different than they are similar. A limitation of the method is identified by Norušis (2010: 363): ‘Agglomerative hierarchical clustering doesn’t let cases separate from the clusters that they’ve joined. Once a cluster, always in that cluster.’ Hierarchical cluster analysis retains the judgement with the researcher about which cluster solution, or number of clusters, to use in the final model. This is different to non-­hierarchical cluster analysis where a mathematical calculation optimizes the number of clusters to be used. Nevertheless, the decision by the researcher about what number of clusters to use in a model can certainly be informed by the mathematical information available. In addition, the patterning of countries within hierarchical cluster analysis can be argued to add quality to the modelling development in that the observed hierarchy of groupings may well add to the qualitative observations about how countries are linked and how groupings subdivide. So, for example, it may be useful to know that all Scandinavian countries cluster together, but that two subclusters within that grouping are also formed before the computer merely identifies them as separate and individual entities. As Norušis (2010: 364) argues: There is no right or wrong answer as to how many clusters you need. It depends on what you’re doing with them. To find a good cluster solution, you must look at the characteristics of the clusters at successive steps and decide when you have an interpretable solution or a solution that has a reasonable number of fairly homogeneous clusters. In this book the method of cluster analysis is used with continuous, interval variables. Very often these are percentage scores as derived from comparative international sources such as the OECD or the International Monetary Fund (IMF ). When using combinations of variables to explore the resulting clustering of countries, scores are standardized using the method of Z scores. This reduces the chances of the characteristics of the internal range in one variable having more influence on the clustering than a variable with a contrasting range. But Aldenderfer and Blashfield (1984: 20) and Pastor (2010: 43) have identified that transformations may have some undesirable effects, such as reducing the influence of key variables with large ranges that reflect ‘real’ substantial economic and social effects. For this reason the key cluster patterns developed in this book and argued to be of social and economic significance are checked for differential effects that result from variable transformations pre-­clustering. Resulting anomalies can then be repeated with different attempts at analysis. The PASW statistics package is used to analyse the data and produce statistical evidence (Norušis, 2010: Ch. 16). The fundamental mathematics of cluster analysis is a measuring of either the distance between objects or a measure of how similar they are. When two cases are similar this will be reflected in the strength of their similarity measurement while the distance measured will

30   Case based methods and national comparisons conversely be small. A well known measure of similarity and difference is the Euclidean distance which is ‘the sum of the squared differences over all of the variables’ (Norušis, 2010: 365). In PASW a proximity matrix can be generated to show the squared Euclidean distance between each pair of cases based on the variables input. This matrix output allows the researcher to see where the greatest difference is (the two countries that are least similar) and where the most similarity is (the two countries that are most similar). Understanding the matrix is very similar to understanding a correlation coefficient matrix as the value of the relationship a case has with itself is always zero and all scores are then repeated across the zero diagonal line. The key difference between a proximity matrix and a correlation matrix is that the value of the scores between pairs is variable, and will not be fixed between zero and one. Proximity matrix scores will normally be positive, although this depends on there being no variables with negative values. Correlation scores can be negative, even when variables are defined as positive scores. Cluster analysis is more complex than understanding the relationship between pairs of cases because the approach is to cluster groups of cases that are greater than mere pairs. There are several mathematical ways to cluster groups beyond pairs. It is possible to either average the difference between all pairs of cases or take the smallest or largest difference. A useful visual tool for seeing how the larger clusters are formed in agglomerative hierarchical clustering is the Icicle Plot as available in PASW. Starting at the bottom of the plot, the rows show the maximum number of hierarchical clusters formed. Each row above demonstrates an agglomeration of clusters, as one cluster gets reduced at each higher row. Another graphics tool used and preferred in this book is the dendrogram. This shows the hierarchical production of the clustering of cases and the overlapping process. Byrne (2011: 136) says on the relationship between complex methodology and cluster analysis that ‘In cluster analysis we identify sets of cases which have membership of multiple categories which in the language of complexity we might equate with attractor locations for those cases in a multi-­dimensional state space’. When cluster analysis is formed the variables are combining to act as an attractor and to locate the cases together as a group. But it is important to remember the attractors in the cluster models are entirely constructed from the data in the variables input. When examining the cluster models used in this book, qualitative comparative analysis (QCA) is also used to explore the influence of variables on the resulting clusters of countries. Documentary analysis In addition to analysing quantitative data this book analyses documentary sources. The primary documentary sources used are the independent inquiries into the financial crisis in the US and the UK (Financial Crisis Inquiry Commission, 2011; House of Commons Treasury Committee (2009a, 2009b, 2009c) and the autobiographies of those who took a lead part in trying to understand and resolve the crisis through the use of policy interventions (i.e. Paulson, 2010;

Case based methods and national comparisons   31 Brown, 2010; Darling, 2011). In the methods literature four key factors are relevant when analysing official documents and the accounts of political actors (Haynes, 1999: 77) 1 2 3 4

The organizational history and context of the production of the documents in question and the relationship of the document with others; The document as a statement about its organization and authors, its dominant actors and their values; The version of social reality presented by the document; The relationship of the document with time and space.

Conclusion In summary, the aim of the research in this book is to form a theory of the evolution of the dominant model of public policy in the period of the financial crisis of 2008–09 and beyond, with a view to evaluating the fitness for purpose of the dominant model of public policy and recommending how the dominant model needs to evolve after the crisis.

3 National comparisons The road to the crisis

Introduction This chapter examines the social and economic condition of key countries before the start of the financial crisis of 2008–09. The aim of the chapter is to examine the economic and social profile of developed countries and to explore the similarities and differences between them. The role of the nation state is one key element in the debate about globalization and its effects. Another key aspect of the debate concerns the role of transnational corporations (TCs) (also known as multinational corporations). These organizations often have assets and balance sheets worth more than smaller national economies. For Dicken (2003), globalization is not a single deterministic force, but a series of interconnected developments of increasing complexity and instability. Dicken (2003) argues that globalization also needs to be understood through the role that the evolution of new technological developments plays in the communications of dialogue, collaboration and conflict between nation states and TCs. But the state and national governments are the most important key determinants in the outcome of globalization, especially when acting in cooperation with each other through transnational forums and global institutions of governance like the International Monetary Fund (IMF ) and World Bank. In this sense, nation states have the potential to lay more claims on the direction of evolution that globalization takes, but they fear to act alone, anxious that they will be outwitted by their opponents. They fear losing their individual ability to collaborate with TCs and that this will weaken their fiscal income and damage their economy. This implicit fear of the consequences of being an isolated nation in the midst of a liberal global market has arguably led to the convergence of political ideology and towards less state intervention and more similar economic and social policies (Deacon et al., 1997). National governments see globalization like a wave or tide coming in that is impossible to swim against, it being such a powerful evolutionary process. But TCs do not have the motivation or foresight to make a moral intervention in the flow of globalization, they are inevitably riding the ‘wave’ to seek greater profitability through the domination of existing markets, the establishment of new markets, and new collaborations through mergers and acquisitions. Their driving

National comparisons   33 force is much simpler than the nation state: TCs focus on capital accumulation and profitability. National governments are accountable to their public voters and will usually be required to deliver on a complex and demanding number of short term requirements, including social protection and social inclusion. Participative and representative democracy should ensure that the nation state has a strong collective purpose and that politicians are accountable for the protection and inclusion of their citizens. This makes the economic and social mission of the nation state markedly different to TCs. The nation state, and the cooperation between them, is the best hope that we have if global society is to make progress in amending the instabilities of globalization of the last three decades. For this reason, this chapter examines the statistical evidence of government economic and social performance in the run up to the crisis of 2008–09, so as to inform via quantitative analysis what happened in the key developed nations in the run up to the crisis. The analysis looks with the benefit of hindsight for clues of the causes of the crisis and how states compare in both their economic and social policy performance. More post-­crisis policy debate is analysed in later chapters. The focus of the quantitative analysis is countries available in the main OECD datasets through their OECD membership, although some important developing economies are also included where comparable data is available.

Economic data The period 2003–07 was overall a period of strong growth and prosperity for the developed countries of the global economy. Table 3.1 shows the average annual GDP percentage growth figure for each of developed economies from 2003 to 2007 ranked by growth performance. Average annual growth for this period is 3.4 per cent with accumulative growth over the five years having a mean average of 16.9 per cent. Trend growth is stronger in 2004–06 as some countries emerge from recession. By 2004 all countries have positive growth and are no longer in decline following the recession at the start of the millennium. The Asian countries of Hong Kong, Singapore, Taiwan and South Korea grew particularly strongly. This performance is noteworthy following the Asian financial crisis of the late 1990s (Stiglitz, 2002). Ireland and Iceland are two European countries with the strongest growth in Table 3.1, both of whom had rapidly developing banking and finance sectors at this time. Growth slows dramatically in Iceland in 2007, one of the first indications of the coming crisis in 2008–09. Ireland and Iceland are two European countries to have suffered greatly as a result of the crisis. They are closely followed in the table ranking by Greece. Greece was benefiting from their 2001 entry to the euro, and they borrowed heavily at this time, leveraging on the euro’s benefits as an international currency underpinned by the large German economy and the German tradition of strict controls of inflation and monetary expansion. For Greece, this unparalleled opportunity for cheap credit later had the major consequences of a subsequent public debt crisis resulting in the 2010–11 interventions from the EU and IMF when it could no longer pay for its public sector. In hindsight the rapid growth in Table 3.1 was

34   National comparisons built on sand because it was driven by leverage (Lynn, 2011). Similarly high growth in Ireland saw rapid inward investment and cheap credit after it joined the euro, and this lead to bubbles in the markets for property and financial services. High growth in Iceland, a small country with a population of approximately one quarter of a million, less than many large European cities, relates to an opportunistic move into banking and financial services. Sweden, Finland and Canada perform strongly in Table 3.1. All were recovering from previous financial crises of their own. The Canadian government’s post-­1993 policy had made reductions to total government national debt a major political policy priority due Table 3.1  GDP annual percentage change, 2003–07, ranked by five-year average

Slovak Republic Hong Kong Singapore Czech Republic Poland Ireland Chile Slovenia Taiwan Iceland South Korea Greece Israel Luxembourg Hungary US Spain Australia Sweden Finland Canada UK New Zealand Norway Japan Denmark Austria Belgium Netherlands France Switzerland Germany Italy Portugal Average

2003

2004

2005

2006

2007

Average

SD

CoV

4.8 3.2 2.9 3.6 3.9 4.3 4.0 2.8 3.4 3 3.1 4.8 1.5 2 4.0 2.5 3 3.1 1.7 1.8 1.8 2.7 3.4 1.1 1.8 0.7 1.1 0.9 0.3 1.1 –0.3 –0.2 0 –1.1 2.3

5.1 8.6 8.7 4.5 5.3 4.3 6.0 4.3 6.1 8.2 4.7 4.7 4.8 4.2 4.5 3.9 3.1 3.5 3.7 3.5 3.3 3.3 4.4 3.1 2.3 1.9 2.4 2.4 2 2 2.1 1.2 1.1 1.2 4.0

6.7 7.3 6.4 6.3 3.6 5.5 5.5 4.5 4.1 5.5 4 3.7 5.2 4 3.5 3.2 3.4 2.5 2.7 2.9 2.9 1.9 2.3 2.3 2.6 3.2 2 1.5 1.5 1.2 1.9 0.9 0 0.4 3.4

8.5 6 6.9 6.8 6.2 5.8 4.6 5.9 4 4 5 3.7 4.1 4 3.3 3.4 3.4 3.1 4 3.5 3.1 2.7 1.3 2.4 2.7 2.7 2.8 2.7 2.9 2.4 3 2 1.5 1.2 3.8

10.5 5.5 4.5 6.1 6.8 5.6 4.6 6.9 4.2 1 4.3 3.5 4.4 3.8 0.8 2.9 3 3.5 2.2 2.5 3 2.7 1.7 2.8 2.1 2.3 2.3 2.1 2.9 2.3 1.9 1.3 1.3 1.5 3.4

7.1 6.1 5.9 5.5 5.2 5.1 4.9 4.9 4.4 4.3 4.2 4.1 4.0 3.6 3.2 3.2 3.2 3.1 2.9 2.8 2.8 2.7 2.6 2.3 2.3 2.2 2.1 1.9 1.9 1.8 1.7 1.0 0.8 0.6 3.4

2.2 1.8 2.0 1.2 1.3 0.7 0.7 1.4 0.9 2.4 0.7 0.6 1.3 0.8 1.3 0.5 0.2 0.4 0.9 0.6 0.5 0.4 1.1 0.7 0.3 0.8 0.6 0.6 1.0 0.5 1.1 0.7 0.6 0.9

0.3 0.3 0.3 0.2 0.2 0.1 0.2 0.3 0.2 0.6 0.2 0.1 0.3 0.2 0.4 0.1 0.1 0.1 0.3 0.2 0.2 0.2 0.4 0.3 0.1 0.4 0.3 0.3 0.5 0.3 0.6 0.7 0.8 1.0

Source: IMF (2011) World Economic Outlook Database (May, 2011).

National comparisons   35 to a concern about the country’s status of having a higher total debt to GDP ratio than any other major economy in the early 1990s. Sweden and Finland both experienced local banking crises, between 1991 and 1993, and this required large public interventions to prevent banks from failing. This explains their cautious fiscal approach in Table 3.2. Several other European countries have strong growth profiles. The largest instability is evidenced in the coefficient of variance (CoV) scores in the bottom half of Table 3.1. The central and southern European countries Table 3.2 Government current account, annual balance, 2003–07, annual percentage of GDP, ranked by highest average balance

Norway Chile Singapore New Zealand Finland South Korea Denmark Australia Canada Sweden Iceland Ireland Spain Belgium Hong Kong Slovenia Switzerland Luxembourg Austria Netherlands Taiwan Slovak Republic UK France Czech Republic Germany Italy US Israel Poland Greece Portugal Japan Hungary Total

2003

2004

2005

2006

2007

Average

SD

CoV

7.5 – 5.7 3.4 2.3 2.7 –0.1 1.1 0 –0.1 –2 0.2 0 0.1 –3.3 –1.3 –1.4 0.2 –1.7 –3.2 –2.8 –2.8 –3.3 –4.2 –6.6 –4 –3.4 –4.8 –6.7 –6.2 –5.8 –5.5 –8.1 –7.2 –1.9

11.4 – 6 4.6 2.1 2.3 1.7 1.7 0.7 1 0.3 1.5 –0.1 0 –0.3 –1.3 –1.2 –1.1 –1.2 –2.1 –2.9 –2.3 –3.2 –3.7 –2.9 –3.7 –3.4 –4.6 –5.1 –5.9 –6.9 –5.3 –6.3 –6.4 –1.1

16.2 4.7 6 4.8 2.5 2.1 3.9 2.3 1.7 1.4 3.2 1 1.1 0.1 1 –1 –0.6 –1.9 –1.6 –0.1 –2.4 –2.8 –3.3 –2.9 –3.6 –3.3 –4.1 –3.7 –2.7 –4 –4.5 –6 –5.6 –7.9 –0.3

17.7 7.8 4.3 4.4 2.7 2.4 2.6 2.2 1.1 0.7 2.1 0.7 1.3 0 0.5 –0.8 –1 –1.7 –1.8 –0.8 –1.7 –3.2 –3.2 –2.7 –2.6 –2.9 –4 –3.1 –3 –3.6 –2.8 –4.6 –5.2 –9.3 –0.2

20.4 8.3 4.5 3 3.3 2.5 2.5 2 1 1.1 –0.8 –0.4 0.9 –0.7 0.7 0.3 –0.8 –1.9 –0.9 –0.8 –1.7 –1.8 –2.8 –2.6 –0.6 –2.4 –4.1 –3.2 –3 –1.9 –2.7 –3.7 –4.9 –4.9 0.1

14.6 6.9 5.3 4 2.6 2.4 2.1 1.9 0.9 0.8 0.6 0.6 0.6 –0.1 –0.3 –0.8 –1 –1.3 –1.4 –1.4 –2.3 –2.6 –3.1 –3.2 –3.3 –3.3 –3.8 –3.9 –4.1 –4.3 –4.5 –5 –6 –7.1 –0.6

5.2 2.0 0.8 0.8 0.5 0.2 1.5 0.5 0.6 0.6 2.1 0.7 0.6 0.3 1.8 0.6 0.3 0.9 0.4 1.2 0.6 0.5 0.2 0.7 2.2 0.6 0.4 0.8 1.7 1.6 1.8 0.9 1.3 1.5

0.4 0.3 0.2 0.2 0.2 0.1 0.7 0.3 0.7 0.8 3.5 1.2 1.0 –3.0 –6.0 –0.7 –0.3 –0.7 –0.3 –0.9 –0.3 –0.2 –0.1 –0.2 –0.7 –0.2 –0.1 –0.2 –0.4 –0.4 –0.4 –0.2 –0.2 –0.2

Source IMF (2011) World Economic Outlook Database (May, 2011).

36   National comparisons were in recession at the start of the period and have the lowest average growth figures. This previous recession was caused by a number of overlapping pressures in the global economy: implementation of the euro, investment in Eastern European countries following the end of the Warsaw Pact resulting in high public expenditure and debt servicing in Germany, a slowing down of the economy in the US caused by the ‘dot.com’ bubble and 9/11 terrorist attacks, and, at the end of the 1990s decade, the suspension of payments on Russian government debts, and the Asian credit market bubble. These problems limited manufacturing exports from France, Germany and Italy. The UK escaped this recession because the Labour government chose to increase public expenditure with fortuitous timing, having maintained tight fiscal discipline for its first two years in office (1997–99). The US implemented interest rate and tax cuts after the dot.com stock market collapse and the 9/11 terrorist attacks – economic policies that were advantageous in the short and medium term but are now argued to have built towards the later global credit crunch of 2007–09 (Authers, 2011a: 26). In hindsight low interest rates in the US helped fuel a bubble in property prices and this linked to unethical and problematic financial services associated with the unrealistic purchase of property by America’s poorest households. Table 3.2 examines government current account balances as a percentage of GDP, for each of the selected countries in the five years before the financial crisis 2008–09. Norway, Singapore and Korea are running consistent current account surpluses, as are Australia and Canada to a lesser extent. Norway is a small country benefiting from its vast energy reserve exports in oil and gas. Singapore and Korea are running positive balances to protect themselves from currency speculation and inward investment of the type that had provoked the Asian crisis in the late 1990s (Stiglitz, 2002). The Scandinavian countries that had experienced local credit crises in their banking sectors in the 1990s are all running less large but clear positive balances over the medium term having seen their public finances suffer in the previous decade. Hong Kong and Taiwan are adjusting to their trading situation with their rapidly growing neighbour and continental partner, mainland China. Most Western European countries are running relatively small current account deficits, the majority are readjusting to the euro and increased European Union integration, including new members, and some extra public investment to exit the European market recession at the start of the new millennium. The UK had a deliberate policy of increased investment in public services at this time and chose not to increase taxation despite a growing economy, a decision that since the financial crisis looks unwise. Iceland and Ireland’s government accounts move from surplus into deficit in 2007 as these small countries, with large financial services and inflated property prices, begin to experience the financial crisis. Japan has the biggest annual deficit following its so-­called ‘lost decade’, when the government responded too slowly to a banking crisis and then the economy could not grow even with negative interest rates because of a loss of confidence in investing and spending. Instead a fiscal policy of government investment gradually pulled the country back to some normality (Turner, 2008).

National comparisons   37 The annual government debt reflects underlying high total national debt (see below). The US current account reduced slightly but remains high in comparison to other economies. Greece and Portugal have large average government deficits between 2003 and 2007, but for different reasons, despite the homogeneity of joining the euro. Greece has strong growth (Table 3.1) but fails to collect adequate tax receipts, a lost opportunity it must now regret (Lynn, 2011), but conversely Portugal is bottom of the growth in Table 3.1 and does not seem to have fully emerged from the last recession, creating a long lag on public expenditure with government debt increasing. Table 3.3 shows the total net debt as a percentage of GDP for the historically biggest national economies in the world, the G7. National debt as a percentage of GDP increases for all these countries from 2003–07, despite the strong growth performance indicated in Table 3.1. The exception is Canada. Canada starts the five-­year period with high total debt relative to GDP, but continues a direct policy begun by prime minister Jean Chrétien, 1993–2003, of paying off its debt to support lower taxes. A slowly growing current account surplus is therefore indicated in Table 3.2 as it reduces its total national debt in proportion to a growing GDP. Japan’s very large national debt reflects its long period of economic stagnation against global economic trends and so it is an outlier when compared to many of the countries considered in the 2003–07 analysis. Its national debt is 95 per cent owned by domestic investors (Cox and Hutchinson, 2011: 2) and this in part explains the stability of its high total debt. Table 3.4 shows the proportion of fiscal government revenue taken from the economy as a proportion of GDP for the period 2003–07. The data is ranked by the countries with the highest average proportion of tax over the five-­year period. The mean average for all countries is close to a third of GDP and there is a clustering close to the mean that includes most European countries with Canada and New Zealand. The highest fiscal take is in countries in Scandinavia and Western Europe and the lowest (with below 30 per cent of GDP) are – with the exception of Switzerland – outside of Europe. The coefficient of variance statistics in the final column for each country show how stable the data is for each national Table 3.3 Government net total debt, 2003–07, percentage of GDP, ranked by highest average five-year debt (G7 nations)

Japan Italy Canada Germany France US UK Average

2003

2004

2005

2006

2007

Average

167.6 104.3 92.1 62.8 62.3 61.9 39.3 84.3

178.6 103.9 87.8 64.8 64.5 62.6 40.8 86.1

181.7 106.4 84.8 66.4 66.7 62.7 42.7 87.3

181.8 107.5 79.6 68 64.5 62.5 43.1 86.7

181.8 108.6 74.6 68.5 64 63.4 44.2 86.4

178.3 106.1 83.8 66.1 64.4 62.6 42.0 86.2

Source: IMF (2011) World Economic Outlook Database (May, 2011).

38   National comparisons pattern. Each country has an annual fiscal plan that provides stable continuity. The most striking characteristic of the data in Table 3.4 is the wide average range, with a variation from countries that intervene to take nearly 50 per cent of GDP in taxation compared with countries outside of Europe that take less than one-­third. This divergence in the percentage of taxation taken from GDP in the countries of developed governments is a key difference and one of the defining features of modern public policy; it will be investigated later in the book, and with regard to the consequences of the recession. Table 3.5 shows the current account balance of payments for a larger selection of nations ranked by the size of the positive or negative balance. This account includes both visible trade in commodities and manufactured goods and also services including profits and interest earned overseas. It has been argued Table 3.4 Government taxation, 2003–07, as percentage of GDP, ranked by highest fiveyear average

Denmark Sweden Belgium Finland France Norway Austria Italy Iceland Slovenia Netherlands Hungary Czech Republic Spain UK New Zealand Germany Portugal Canada Poland Greece Slovak Republic Ireland Australia Switzerland Japan US South Korea Chile Averages

2003

2004

2005

2006

2007

Average

SD

CoV

48.0 47.8 44.3 44.1 43.2 42.3 43.8 41.7 36.7 38.2 36.9 37.8 37.3 34.2 34.3 33.8 35.5 33.6 33.7 32.6 32.0 33.1 28.4 29.8 29.2 25.7 25.5 24.0 19.3 35.4

49.0 48.1 44.5 43.5 43.5 43.3 43.4 41.0 38.0 38.3 37.2 37.4 37.8 34.6 34.8 34.8 34.8 32.8 33.6 31.7 31.1 31.7 29.9 30.1 28.8 26.3 25.7 23.3 19.8 35.5

50.8 48.9 44.6 43.9 43.9 43.5 42.4 40.8 40.6 38.6 38.4 37.4 37.5 35.7 35.7 36.7 34.8 33.7 33.4 33.0 31.8 31.5 30.4 29.8 29.2 27.4 27.1 24.0 21.6 36.1

49.6 48.3 44.3 43.8 44.0 44.0 41.9 42.3 41.5 38.3 39.1 37.2 37.0 36.6 36.5 36.1 35.4 34.4 33.3 34.0 31.7 29.4 31.8 29.3 29.3 28.0 27.9 25.0 23.2 36.2

49.0 47.4 43.8 43.0 43.5 43.8 42.1 43.4 40.6 37.8 38.7 39.7 37.3 37.3 36.2 35.1 36.0 35.2 33.0 34.8 32.3 29.4 30.9 29.5 28.9 28.3 27.9 26.5 24.0 36.4

49.3 48.1 44.3 43.7 43.6 43.4 42.7 41.8 39.5 38.2 38.1 37.9 37.4 35.7 35.5 35.3 35.3 33.9 33.4 33.2 31.8 31.0 30.3 29.7 29.1 27.1 26.8 24.6 21.6 35.9

1.0 0.6 0.3 0.4 0.4 0.7 0.8 1.1 2.0 0.3 1.0 1.0 0.3 1.3 0.9 0.3 0.5 0.9 0.3 1.2 0.3 1.6 1.3 0.3 0.2 1.1 0.3 1.3 0.3

0.02 0.01 0.01 0.01 0.01 0.02 0.02 0.03 0.05 0.01 0.03 0.03 0.01 0.04 0.03 0.03 0.01 0.03 0.01 0.04 0.01 0.05 0.04 0.01 0.01 0.04 0.04 0.05 0.10

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

National comparisons   39 that a current account surplus is a form of national savings and that it represents investments in overseas assets, while a deficit represents a form of debt borrowing from overseas. Although globalization has made the analysis and understanding of the impact of current account statistics on the wider economy more opaque, they are linked to a sum of global imbalances in imports and exports that leads to major structural problems in the global economy if allowed to grow excessively without attempts at rebalancing (Blanchard and Milesi-­Ferretti, 2011; Edwards, 2007, 2006, 2005). Such concerns about balance have been a strong feature of the post-­2008–09 recession reflections and the G20 made rebalancing a core aim of its post-­crisis strategy. However, commentators are divided over how a rebalance can begin to be achieved. Short term changes and instabilities in the current account can be connected with commodity markets and the instability of commodity prices and supply. For example, Figure 3.1 shows that from 2005 to 2007, immediately before the 2008–09 crisis there was increased speculative activity on commodity markets and spikes in prices. Global commodity prices rose dramatically. In two years (2005–07) the industrial raw materials index price rose over 50 per cent, while fuel rose over 30 per cent, and food over 20 per cent. The combined global commodities prices index increases by one-­third in the two-­year period. This is reflected in the positive balance of payment accounts of Norway, Russia, Chile and Indonesia shown in Table 3.5, while the positive outturn in Sweden, Table 3.5 Current account, balance of payments, as percentage of GDP, including trade, 2007, ranked by highest positive balance Country

Surplus

Country

Deficits

Norway Luxembourg Sweden Switzerland Germany Netherlands Russia Japan Chile Finland Austria China Israel Indonesia South Korea Belgium Denmark Canada

14.1 9.6 9.2 9.0 7.5 6.7 5.9 4.8 4.6 4.2 3.5 3.3 2.6 2.4 2.1 1.7 1.3 0.8

Mexico France Italy United Kingdom Czech Republic Slovenia Poland United States Slovak Republic Ireland Turkey Australia Hungary New Zealand Spain Portugal Greece Iceland Estonia

–0.9 –1.0 –2.4 –2.6 –3.2 –4.5 –4.7 –5.1 –5.2 –5.3 –5.9 –6.2 –6.9 –8.1 –10.0 –10.1 –14.3 –16.5 –17.3

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

40   National comparisons Germany, Finland and China is linked to the export of manufactured goods such as cars and electronics. The negative performance of southern and Eastern European countries relates to their increasing movement away from agriculture to primary manufacturing and services, but requiring imported technology, commodities and specialist labour services so as to be competitive. It is likely too that the strong export performance of Germany facilitated the smaller euro/EU partner countries of Greece and Portugal to increase imports on credits, in part made easier by the free trade area of the European single market and the extensive mobile labour market of the EU. This allowed labour to migrate from southern and Eastern Europe towards the wealthy EU countries. In this sense, the continental trade alliances of the period (the European single market and euro currency, the North American Free Trade Agreement (NAFTA) and an increasing number of agreements in the Asia Pacific region) may have helped to mitigate the effects of trade and service imbalances in the medium term, despite the growing global imbalances between the West and Asia that have become much more recognized as problems to be solved in the post-­crisis world. Before the crisis there was a tendency for national governments to ignore planned interventions to mitigate current account imbalances. They believed they would be self corrected over the medium term by global market forces through changing capital flows (Krugman, 2009). Economists first grew complacent about the current account balance as an important indicator after global market deregulations in the 1980s and 1990s, believing that global investment and financial flows were much more important and to a large extent self regulating when countries and industries became inefficient. Competition was seen as the primary 160

World commodity prices index

150

140

130

Commodity Price Index, all Non-fuel Industrial inputs (raw materials) Fuel (energy) Food and beverage prices

120

110

100

2005

2006

2007

Figure 3.1 World Commodity Prices Index, 2005–07 (2005 = 100) (source: IMF (2008) Primary Commodity Prices Database, May 2011).

National comparisons   41 regulator, this reflected in global capital flows and the movement of US and European TCs’ production facilities to developing economies. Floating exchange rates were also believed to help self stabilize any current account imbalances, but this ignored the fact that not all countries floated their currencies, and after the 1990s Asian crisis, developing economies increasingly intervened to stabilize their currencies, for example by buying up increased amounts of foreign reserves. Table 3.5 shows that a number of the countries whose economies have suffered disproportionate stress during the 2008–09 crisis and its aftermath were running relatively high current account balance of trade deficits in 2007 at the onset of the crisis. Spain, Portugal, Greece and Iceland have deficits above 10 per cent of GDP, and the US and Ireland had deficits of above 5 per cent of GDP. Figure 3.2 shows the growth of total capital financial flows during 2003–07 in $ trillion. The growth is extraordinary, reaching a total peak in 2007 before the global recession of 2008–09. Debt portfolios, however, begin to decline in 2007, as evidence about the toxicity of mortgage backed securities in the US begins to emerge. The most stable growth is in equities and these reach a plateau in 2006–07. Dicken (2003) analysed global trade flows including direct investment and concluded that the greatest direct investment flows were between the European Union and US, with a moderately higher inward flow into the US. The biggest 3.5

2003 2004 2005 2006 2007

3.0

Trillion ($)

2.5 2.0 1.5 1.0 0.5 0.0

Direct investments

Equities

Reserves

Other

Debt portfolio

Figure 3.2 Total global capital flows, 2003–07 ($ trillion) (source: based on data from Furceri et al. (2011) Medium-Term Determinants of International Investment Positions: The Role of Structural Policies, OECD Economics Department Working Papers, No. 863, OECD Publishing. http://dx.doi. org/10.1787/5kgc9kzsm19x-en, accessed on 3 January 2012).

42   National comparisons imbalances he noted were with Japan, with limited direct flows from the US and Europe into Japan, but much larger flows out of Japan into the US and Europe. These outward flows helped support Japan’s strong exports to both continents by ensuring adequate funds and wealth in those countries to purchase its goods. Krugman (2009: 40) notes that ‘the balance of payments is a closed system: the inflow of capital is always matched by a trade deficit, so an increase in that inflow must lead to an increase in that deficit.’ The US and UK’s high importing of cheap manufactured goods in the last two decades has depended upon inward investment of a variety of forms, including Asian companies directly setting up business in the US and UK, but also via financial investments of the kind that grew exponentially in the years immediately before the financial crisis of 2008–09. TCs based in the US and UK were also investing in foreign production facilities in new developing economies at this time and so exporting capital to increase profit. All this demonstrates the complexity of understanding balance of payment indicators, but policy makers were wrong to ignore the importance of the final indicator balance. Consumer price index (CPI) was relatively stable across the globe between 2003 and 2005, especially in the largest economics of the G7 and China (see Tables 3.6 and 3.7). Table 3.6 uses a comparative methodology that measures inflation on a dollar standardized index where prices in the countries selected are compared to their starting value against the dollar in 2005. Therefore countries whose currencies devalued against the dollar in the period shown (2005–07) can be seen as having a declining inflation, even though they may have experienced some inflation in prices denominated in their own currency. Table 3.7 shows CPI as measured in the individual country’s own currency. China, Hong Kong, Russia and Cyprus are not included in the more sophisticated OECD measurement in Table 3.6 and therefore can only be judged against their own currency in Table 3.7. For those countries presented in both tables, the differences in ranked order do not vary greatly. Countries showing the most differences between the two measures include Iceland. Iceland shows deflation against dollar pricing, but rising while not excess inflation in its own currency (the Icelandic Krona) between 2003 and 2007, rising to 5.1 per cent per annum in 2007. Iceland was severely affected by the 2008–09 banking crisis, given the very large expansion in its banking sector in the period before the crisis. This resulted in its financial services sector being worth considerable more than its annual GDP. The differences in Iceland’s position in the Tables 3.6 and 3.7 illustrate the volatility of its small trading currency against other major currencies. Immediately before the financial crisis of 2008 the Icelandic Krona was considered overvalued against the dollar, with a ‘Big Mac’ hamburger costing almost twice the equivalent price in Iceland when compared with the price in New York. But this discrepancy was more than corrected by the currency’s spectacular fall from grace after the financial crisis. Conversely the USA’s deteriorating currency in the period 2003–07 is reflected by its lower position in Table 3.6 compared with Table 3.7. Between 2003 and the spring of 2007 the US dollar lost over 30 per cent of its value

National comparisons   43 against the euro and approximately 25 per cent against the British pound. These declines in the dollar represented an unrealistically low interest rate policy set to protect the US economy from the effects of the ‘dot.com’ boom and the terrorist attacks of 9/11. They were dramatically reversed once the financial crisis had occurred in 2008, as the dollar then became the international currency of reserve and still seen as a safe haven for investors (Mackintosh, 2011: 24). The weakness of the dollar before the crisis, combined with a cocktail of tax cuts and low interest rates, provided the underpinnings of the growth of the unsustainable US housing market prior to the 2008–09 crisis. Both the US and UK Table 3.6 Consumer price inflation, dollar standardized, international relative comparison 2005–07 (2005 = 100), ranked by highest inflation in 2007

Slovak Republic Canada Czech Republic Turkey South Korea Ireland Hungary Australia Poland Spain Greece Luxembourg Chile UK Slovenia Portugal Israel Belgium Germany Italy Sweden Finland Denmark France Austria Netherlands New Zealand Norway Iceland US Switzerland Japan

2006

2007

105.4 105.6 105.5 99.7 107.8 101.8 95.4 99.9 102.2 101.5 100.9 100.9 104.0 100.6 99.8 100.6 99.7 99.7 99.4 100.0 99.6 99.0 99.7 99.6 99.4 99.0 93.2 99.9 93.7 99.3 97.4 90.5

116.1 109.6 108.3 108.1 107.1 106.9 106.3 105.9 105.7 103.0 102.6 102.3 102.1 102.1 101.6 101.2 100.6 100.5 100.5 100.5 100.5 100.3 100.2 99.9 99.8 99.8 99.7 99.7 97.5 95.1 93.2 83.0

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011. Note Competitiveness-weighted relative consumer prices in dollar terms.

44   National comparisons experienced moderately rising inflation in 2005–07, a factor that in hindsight looks likely to be linked to the peak of international financial flows indicated in Figure 3.2, creating high bonuses and associated consumer expenditures. Another factor in the discrepancies between Tables 3.6 and 3.7 was the increase in world oil prices that occurred up to 2007 (followed by a major correction in 2008). These prices affect non-­oil producing countries whose economies are dependent on imported oil. Table 3.7 Annual consumer price index, percentage change (in national currencies), 2003–07, ranked by highest five-year average

Turkey Russia Hungary Slovak Republic Iceland Slovenia Ireland Spain Greece UK South Korea US Chile Cyprus Australia Portugal New Zealand China Luxembourg Italy Canada Belgium Poland Czech Republic Austria France Denmark Netherlands Germany Norway Sweden Finland Switzerland Israel Hong Kong Japan Average

2003

2004

2005

2006

2007

25.3 13.7 4.6 8.6 2.1 5.6 3.5 3.0 3.5 2.9 3.5 2.3 2.8 4.1 2.8 3.3 1.5 1.2 2.0 2.7 2.8 1.6 0.8 0.1 1.4 2.1 2.1 2.1 1.0 2.5 1.9 0.9 0.6 0.7 –2.5 –0.2 3.2

10.6 10.9 6.8 7.5 3.2 3.6 2.2 3.0 2.9 3.0 3.6 2.7 1.1 2.3 2.3 2.4 2.6 3.9 2.2 2.2 1.9 2.1 3.6 2.8 2.1 2.1 1.2 1.2 1.7 0.5 0.4 0.2 0.8 –0.4 –0.4 0.0 2.7

10.1 12.7 3.6 2.7 4.0 2.5 2.4 3.4 3.5 2.8 2.8 3.4 3.1 2.6 2.7 2.3 3.2 1.8 2.5 2.0 2.2 2.8 2.1 1.8 2.3 1.7 1.8 1.7 1.6 1.5 0.5 0.9 1.2 1.3 0.9 –0.3 2.7

10.5 9.7 3.9 4.5 6.7 2.5 3.9 3.5 3.2 3.2 2.2 3.2 3.4 2.5 3.5 2.7 3.2 1.5 2.7 2.1 2.0 1.8 1.1 2.5 1.4 1.7 1.9 1.1 1.6 2.3 1.4 1.6 1.1 2.1 2.0 0.2 2.9

8.8 9.0 7.9 2.8 5.1 3.6 4.9 2.8 2.9 4.3 2.5 2.9 4.4 2.4 2.3 2.8 2.6 4.8 2.3 1.8 2.1 1.8 2.4 2.9 2.2 1.5 1.7 1.6 2.3 0.7 2.2 2.5 0.7 0.5 2.0 0.1 3.0

Source: IMF (2011) World Economic Outlook Database (May, 2011).

Average

SD

CoV

13.1 11.2 5.4 5.2 4.2 3.5 3.4 3.2 3.2 3.2 2.9 2.9 2.9 2.8 2.7 2.7 2.6 2.6 2.3 2.2 2.2 2.0 2.0 2.0 1.9 1.8 1.7 1.6 1.6 1.5 1.3 1.2 0.9 0.8 0.4 0.0 2.9

6.2 1.8 1.7 2.4 1.6 1.1 1.0 0.3 0.3 0.5 0.5 0.4 1.1 0.7 0.4 0.4 0.6 1.4 0.2 0.3 0.3 0.4 1.0 1.0 0.4 0.3 0.3 0.4 0.4 0.8 0.7 0.8 0.2 0.8 1.7 0.2 0.2

0.5 0.2 0.3 0.5 0.4 0.3 0.3 0.1 0.1 0.2 0.2 0.1 0.4 0.2 0.2 0.1 0.2 0.5 0.1 0.1 0.1 0.2 0.5 0.5 0.2 0.1 0.2 0.2 0.2 0.5 0.6 0.7 0.2 1.0 0.7 0.0 0.1

National comparisons   45 Many of the euro currency member countries had below average CPI from 2003–07 assisted by the strong currency and tight monetary policy, but exceptions were Ireland, Spain and Greece, countries that have experienced subsequent greater challenges after the 2008–09 crises. Germany’s remarkable stable management of inflation can be seen in Table 3.7, with average inflation of 1.6 per cent and a low coefficient of variance at 0.2, further demonstrated in Table 3.6 where price stability is maintained against the dollar despite the considerable appreciation of the euro against the dollar. The lowest levels of inflation are in Scandinavia, Hong Kong and Japan. Japan continued to experience some deflation following an earlier credit and liquidity crisis in the 1990s, a crisis that proved impossible to extract itself from rapidly (Turner, 2008). It is also important to note the consistently low inflation in Scandinavian countries: Denmark, Norway, Sweden and Finland (with only Finland being a member of the euro single currency in this geographical area). Table 3.8 shows central bank interest rates in OECD countries between 2003 and 2007. Figure 3.3 illustrates the strong association between the average interest rate for each country over these five years, and the average rate of CPI for the

9.0 R2 � 0.9284

8.0

Average interest rates (2003–07)

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

0

2

4

6 8 Average CPI (2003–07)

10

12

14

Figure 3.3 Scatter plot to demonstrate association between CPI and IR, national averages, annual percentages, 2003–07 (36 countries) (source: IMF (2011) World Economic Outlook Database, May 2011).

Turkey Iceland Hungary New Zealand Russia South Korea Israel Slovenia Australia Slovak Republic Chile Cyprus Canada US Poland UK Denmark Netherlands Italy Greece Portugal

37.7 5.1 11 5.1 4.5 4.3 6.6 6 3.3 5.3 2.7 3.6 3 1.4 3.7 1.2 2.4 2.5 2.3 2.5 2.3

2003

24.2 6.2 9.1 5.8 3.8 3.9 3.6 3.8 3.6 4.1 1.9 3.8 2.7 2.1 3.8 1.6 2.2 2.3 2.1 2.2 2.1

2004 20.4 9.1 5.2 6.7 4 3.7 3.2 3.2 3.7 2.4 3.9 3.8 3.5 4 2.8 3.5 2.2 2.3 2.2 2.1 2.1

2005 21.6 12.4 7.4 6.9 4.1 4.5 4.3 2.8 4 3.6 5.1 3.4 4.5 5.3 2.2 5.2 3.2 3 3.1 2.8 2.9

2006 22.6 14 6.8 7.8 5.1 5.2 3.5 3.6 4.7 3.7 5.6 3.4 4.5 5.1 4.4 5.3 4.3 3.9 4.3 3.9 4

2007

SD 7.1 3.8 2.2 1.0 0.5 0.6 1.4 1.2 0.5 1.0 1.6 0.2 0.8 1.8 0.9 1.9 0.9 0.7 0.9 0.7 0.8

Average 25.3 9.4 7.9 6.5 4.3 4.3 4.2 3.9 3.9 3.8 3.8 3.6 3.6 3.6 3.4 3.4 2.9 2.8 2.8 2.7 2.7 0.3 0.4 0.3 0.2 0.1 0.1 0.3 0.3 0.1 0.3 0.4 0.1 0.2 0.5 0.3 0.6 0.3 0.2 0.3 0.3 0.3

CoV

Table 3.8  Interest rates, based on annual average bank deposit rate, 2003–07, ranked by highest five-year average

note 7 note 1 note 1

2007 (money market rate) note 5 note 6

note 3

note 2

note 4 note 7

Notes

2.1 2.3 2.3 2.2 2.2 2.2 2.2 2.3 2 2.7 3 1.3 0.1 0.2 0 4.0

1.5 2 2 1.9 1.9 2 2 2 2.3 2.3 2 1.3 0 0.2 0.1 3.3

1.8 2 2.1 2 2 2 2.1 2.1 2.3 2.1 1.5 1.2 1.3 0.5 0.3 3.3

Notes 1 Deposits for corporations and new business, up to one year. 2 Deposits – one year or more. 3 Bank rate – end of period. 4 Deposits – three months. 5 Euro dollar, London. 6 After 2004, call money rate. 7 Money market rate. 8 Deposits for corporations and stocks, up to two years.

Source: IMF (2011) World Economic Outlook Database (May, 2011).

Norway Belgium Luxembourg Finland Germany Spain Austria Ireland China France Sweden Czech Republic Hong Kong Switzerland Japan Average

3.1 2.7 2.8 2.8 2.8 2.8 2.9 2.8 2.5 2.4 2.5 1.2 2.7 1.4 0.7 4.1 4.9 3.8 3.8 3.9 3.9 3.9 4 4 4.1 2.9 3.5 1.3 2.4 2.1 0.8 4.9

2.7 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.5 2.5 1.3 1.3 0.9 0.4 3.9 1.4 0.8 0.7 0.8 0.8 0.8 0.8 0.8 0.8 0.3 0.8 0.1 1.3 0.8 0.4 0.7

0.5 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.1 0.3 0.0 1.0 1.0 0.9 0.2 note 3

2006 (call money rate) note 1 note 1 note 1 note 1 note 1 note 1 note 8

48   National comparisons same time period. This is evidence of the strong influence of inflation targeting as the dominant evolution of monetary economic policy for that time period (Stiglitz, 2010: 262), in particular, influenced by the introduction of the European currency and the determination of the European Central Bank to maintain low inflation following the tradition of the German Bundersbank. In part, as a result of the more relaxed monetary policy in the US and the declining value of the dollar, the new euro currency performed strongly in the five years before the 2008–09 crisis, this despite the challenges for it to become trusted and established when it was admitting late new members (Greece, Slovak Republic, Estonia, Slovenia). Major public investment programmes were needed to assist the new member countries of the EU from Eastern Europe: they needed assistance via the structural and cohesion funds. Figure 3.3 shows the majority of countries are very close to the line or above it, but Iceland and Turkey are outliers with high CPI and high interest rates. Bank interest rates below inflation mean that savers are at risk of seeing their investments lose real value over the medium term as asset and consumer prices rise. But the relatively high interest rates in Iceland continued to feed the rapid increase of its financial services industry, as investments from overseas saw Iceland as attractive while the Krona retained its high value. The combination of high interest rates and a high currency value ensured that savings could be easily traded back into other currencies. Therefore the period of economic policy in the world’s largest and most developed countries for the five years before the crisis is characterized by stable growth, relatively low inflation, and the dominance of monetary policy approaches over fiscal intervention, although in the latter case there was still considerable diversity in national approaches to taxation and public investment, as illustrated in Table 3.4. Nevertheless, beyond the key national economic indicators of monetary orthodoxy, there was a growing imbalance of world trade and financial transfers that were to bring major global and continental instabilities. After 2009 this was to make national and continental attempts to manage inflation via tight monetary policy largely inconsequential. In 2009 the fear of economic crisis dictated that global economic policy shifted from a focus on managing inflation to trying to prevent deflation.

Social data The analysis of economic data so far in this chapter has demonstrated a convergence of national economic policy towards monetary approaches where interest rates were used to try and control price instability and with some apparent success (Figure 3.3). But in contrast there was a continuing diversity of fiscal policy, even within the euro currency area (see Table 3.4). This next section aims to form an overview assessment of public policy goals in the wealthiest OECD nations for the same time period 2003–07. The first variable examined is employment and unemployment, as this variable relates to the interaction of economic and public policy and the social objectives of policy perhaps more than any other.

National comparisons   49 Employment Employment, and the aspiration to achieve full employment, is at the core of the modern welfare state. The political ideology of the ‘third way’ (Giddens, 1998) in the 1990s was influential in arguing that full employment, and an individual’s labour contribution, should be at the core of the concept of citizenship and welfare entitlement. This resulted in changes in unemployment benefit entitlement in many countries, with benefit payments linked to availability for immediate work, flexibility in the labour market, and a requirement to undertake labour market retraining if necessary. This welfare paradigm was accompanied by a period of global growth, assisted by a convergence towards low inflation in most developed countries, but with a divergence of other economic characteristics. For example, advanced and developed countries varied in terms of their specialist manufacturing and its labour requirements, the extent to which women undertook paid employment, and the speed with which jobs were created in the finance and business services. Full employment is a key public policy aspiration because high unemployment is linked to numerous social problems like poverty, child poverty, increased alcoholism, rising crime, deteriorating health and marital breakdown (Linn et al., 1985; Edmark, 2005; King et al., 2006). Unemployment results in increased public expenditure to pay welfare benefits and to provide public services for dealing with the negative social consequences of unemployment. Employment trends Table 3.9 shows the percentage of working-­age population in employment for the period 2003–07 ranked by the highest average for that time period. The overall trend is slowly upwards for the five-­year period. Scandinavian nations have the highest performance with approximately three-­quarters of their working-­age populations in employment. In general, the Catholic countries of central and southern Europe have lower percentages of the population in employment, although there is diversity in this group and in Ireland, Austria and Portugal over two-­thirds of the working population are in employment. The biggest growth in the percentage working between 2003 and 2007 is in Ireland, Germany, Slovenia, Estonia, Spain and Poland. Table 3.10 shows the percentage of working-­age women in employment and Scandinavian countries are also at the top of this table with the highest averages over the five-­year period. This accounts for the higher overall figures in Table 3.9 for the Scandinavian countries. The countries with the largest increases over the five-­year period are Spain (+8.7 per cent), Estonia (+6.9 per cent), Ireland (+5.2 per cent) and Luxembourg (+5.2 per cent). The overall average rise in the percentage of working-­age women in employment for all countries rises at 4.4 per cent for the five-­year period and at a slightly faster rate than the percentage rate for the working-­age population of both sexes (Table 3.9). The increasing growth in the number of women working was a significant continuing trend.

50   National comparisons Table 3.11 shows part time employment as a percentage of the total employment population in each country. There has been considerable debate over the increase in part time jobs in the last two decades, with classical economists arguing it is an essential part of a rapidly evolving economy that is efficient and effective at adjustment to changes in market conditions. The counter-­argument is that an increase in part time employment undermines the quality of social benefits linked to employment, including pensions. It is argued that the increase in part time working increases income inequalities and penalizes women who are Table 3.9 Percentage of working-age population in employment, 2003–07, ranked by highest average

Iceland Switzerland Denmark Norway Sweden New Zealand Netherlands Canada UK US Australia Japan Austria Finland Portugal Ireland Germany Slovenia Estonia Czech Republic Spain South Korea France Luxembourg Belgium Greece Mexico Slovak Republic Italy Hungary Israel Chile Poland Turkey Averages

2003

2004

2005

2006

2007

Average

SD

CoV

84.1 77.9 75.1 75.8 74.3 72.2 72.6 72.2 72.6 71.2 70.0 68.4 68.9 67.9 68.0 65.2 64.6 62.6 62.9 64.9 60.7 63.0 63.3 62.2 59.6 58.7 58.8 57.7 56.2 57.0 55.0 53.5 51.4 45.5 65.1

82.8 77.4 75.7 75.6 73.5 73.2 71.8 72.5 72.7 71.2 70.3 68.7 67.8 67.8 67.8 65.9 65.0 65.3 63.0 64.2 62.0 63.6 63.1 62.5 60.3 59.4 59.9 57.0 57.4 56.8 55.7 53.6 51.9 44.1 65.3

84.4 77.2 75.9 75.2 73.9 74.3 71.9 72.5 72.6 71.5 71.5 69.3 68.6 68.5 67.5 67.5 65.5 66.0 64.4 64.8 64.3 63.7 63.2 63.6 61.1 60.1 59.6 57.7 57.5 56.9 56.7 54.4 53.0 44.4 65.9

85.3 77.9 77.4 75.5 74.5 74.9 73.2 72.9 72.5 72.0 72.2 70.0 70.2 69.6 67.9 68.5 67.2 66.6 68.1 65.3 65.7 63.8 63.3 63.6 61.0 61.0 61.0 59.4 58.4 57.3 57.6 55.5 54.5 44.6 66.7

85.7 78.6 77.1 76.9 75.7 75.2 74.8 73.6 72.3 71.8 72.8 70.7 71.4 70.5 67.8 69.2 69.0 67.8 69.4 66.1 66.6 63.9 64.0 64.2 62.0 61.4 61.1 60.7 58.7 57.3 58.9 56.3 57.0 44.6 67.4

84.5 77.8 76.2 75.8 74.3 74.0 72.9 72.7 72.5 71.6 71.4 69.4 69.4 68.9 67.8 67.3 66.3 65.6 65.6 65.0 63.9 63.6 63.4 63.2 60.8 60.1 60.1 58.5 57.6 57.1 56.8 54.7 53.5 44.6 66.1

1.1 0.5 1.0 0.7 0.8 1.2 1.2 0.6 0.2 0.3 1.2 0.9 1.4 1.1 0.2 1.7 1.8 1.9 3.0 0.7 2.5 0.4 0.3 0.8 0.9 1.1 0.9 1.5 1.0 0.2 1.6 1.2 2.3 0.5

0.01 0.01 0.01 0.01 0.01 0.02 0.02 0.01 0.00 0.00 0.02 0.01 0.02 0.02 0.00 0.03 0.03 0.03 0.05 0.01 0.04 0.01 0.01 0.01 0.02 0.02 0.02 0.03 0.02 0.00 0.03 0.02 0.04 0.01

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

National comparisons   51 more likely to enter the labour market in a part time mode because of society’s dependence on their caring role. It is seen as an erosion of worker and citizen rights. Academic literature shows a definitional problem with comparative research on part time employment, given that working part time means different things in different societies (O’Reilly and Fagan, 1998; Kalleberg, 2000). In Table 3.11 Eastern European countries have the lowest levels of part time employment. Netherlands is an outlier at the high end of the distribution with one third of the employed being in part time jobs. The data is fairly dispersed Table 3.10 Percentage of working-age women in employment, 2003–07, ranked by highest average

Iceland Norway Sweden Denmark Switzerland Canada New Zealand Finland UK US Netherlands Australia Estonia Austria Portugal Slovenia Germany France Japan Ireland Czech Republic Belgium Luxembourg Israel South Korea Slovak Republic Spain Hungary Poland Greece Italy Mexico Chile Turkey Averages

2003

2004

2005

2006

2007

Average

SD

CoV

81.2 72.7 72.8 70.5 70.7 67.9 65.5 65.7 66.4 65.7 64.7 63.0 59.0 61.6 61.4 57.6 58.7 57.6 56.8 55.5 56.3 51.8 50.9 50.6 51.1 52.2 46.8 50.9 46.2 44.3 42.7 39.1 35.8 25.2 57.0

79.4 72.7 71.8 71.6 70.3 68.4 66.1 65.5 66.6 65.4 64.1 63.0 60.0 60.7 61.7 60.5 59.2 57.7 57.4 56.1 56.0 52.6 51.9 51.0 52.2 50.9 49.0 50.7 46.4 45.2 45.2 40.9 36.7 22.3 57.3

81.2 72.0 71.8 71.9 70.4 68.3 67.6 66.5 66.7 65.6 64.8 64.6 62.1 62.0 61.7 61.3 59.6 58.0 58.1 58.2 56.3 53.8 53.7 52.5 52.5 50.9 51.9 51.0 47.0 46.1 45.3 41.6 38.0 22.3 58.1

81.6 72.3 72.1 73.4 71.1 69.0 68.2 67.3 66.8 66.1 66.4 65.5 65.3 63.5 62.0 61.8 61.4 58.2 58.8 59.1 56.8 54.0 54.6 53.3 53.1 51.9 54.0 51.2 48.2 47.4 46.3 42.9 39.2 22.7 59.0

81.7 74.0 73.2 73.2 71.6 70.1 68.7 68.5 66.3 65.9 68.5 66.1 65.9 64.4 61.9 62.6 63.2 59.4 59.5 60.7 57.3 55.3 56.1 54.6 53.2 53.0 55.5 50.9 50.6 47.9 46.6 43.6 40.4 22.8 59.8

81.0 72.8 72.3 72.1 70.8 68.7 67.2 66.7 66.6 65.7 65.7 64.4 62.4 62.4 61.7 60.8 60.4 58.2 58.1 57.9 56.5 53.5 53.4 52.4 52.4 51.8 51.4 50.9 47.7 46.2 45.2 41.6 38.0 23.1 58.2

0.9 0.8 0.6 1.2 0.5 0.8 1.4 1.2 0.2 0.3 1.8 1.4 3.1 1.5 0.2 1.9 1.9 0.7 1.1 2.1 0.5 1.3 2.1 1.7 0.9 0.9 3.6 0.2 1.8 1.5 1.6 1.8 1.9 1.2

0.01 0.01 0.01 0.02 0.01 0.01 0.02 0.02 0.00 0.00 0.03 0.02 0.05 0.02 0.00 0.03 0.03 0.01 0.02 0.04 0.01 0.03 0.04 0.03 0.02 0.02 0.07 0.00 0.04 0.03 0.03 0.04 0.05 0.05

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

52   National comparisons with the total results for all countries showing a five-­year mean average 14.3 per cent and a standard deviation 7.2 per cent. Table 3.12 shows the percentage of the work force unemployed between 2003 and 2007. Southern and Eastern European countries tend to appear in the top half of the table with mean average unemployment during the five years of above 6 per cent. The overall trend is for falling unemployment with the mean average dropping from 7.4 per cent in 2003 to 5.9 per cent in 2007 and the distribution (standard deviation) of the data for all countries included also falling. The two Table 3.11 Part time employment as percentage of total working population, 2003–07, ranked by highest average

Netherlands Switzerland Australia UK New Zealand Germany Norway Ireland Belgium Canada Japan Denmark Iceland Austria Israel Mexico Italy Sweden Luxembourg France US Finland Poland Spain Portugal South Korea Slovenia Chile Estonia Turkey Greece Czech Republic Hungary Slovak Republic Averages

2003

2004

2005

2006

2007

Average

SD

CoV

34.5 25.1 24.3 23.5 22.2 19.6 21.0 18.9 18.3 18.9 18.2 16.2 16.0 13.7 15.0 13.4 11.7 14.1 13.3 13.0 13.2 11.3 11.5 7.8 9.9 7.7 5.0 5.7 7.5 6.0 5.6 3.2 3.2 2.3 13.8

35.0 24.9 23.8 23.6 21.9 20.1 21.1 18.9 18.5 18.5 18.1 17.0 16.6 15.4 15.0 15.1 14.7 14.4 13.2 13.2 13.2 11.3 12.0 8.4 9.6 8.4 7.5 6.6 6.8 6.1 5.9 3.1 3.3 2.8 14.2

35.6 25.1 24.0 23.0 21.6 21.5 20.8 19.3 18.5 18.3 18.3 17.3 16.4 16.3 15.0 – 14.6 13.5 13.9 13.2 12.8 11.2 11.7 11.0 9.4 9.0 7.4 7.2 6.7 5.6 6.4 3.3 3.2 2.6 14.4

35.4 25.5 23.9 23.2 21.2 21.8 21.1 19.5 18.7 18.1 18.0 17.9 16.0 16.8 15.0 – 15.0 13.4 12.7 13.2 12.6 11.4 10.8 10.8 9.3 8.8 7.8 7.7 6.7 7.6 7.4 3.3 2.7 2.5 14.4

35.9 25.4 23.7 22.9 22.0 22.0 20.4 20.0 18.1 18.2 18.9 17.3 15.9 17.3 14.6 – 15.2 14.4 13.1 13.3 12.6 11.7 10.1 10.7 9.9 8.9 7.8 8.0 6.8 8.1 7.7 3.5 2.8 2.6 14.5

35.3 25.2 24.0 23.2 21.8 21.0 20.9 19.3 18.4 18.4 18.3 17.2 16.2 15.9 14.9 14.3 14.2 14.0 13.2 13.2 12.9 11.4 11.2 9.7 9.6 8.5 7.1 7.0 6.9 6.7 6.6 3.3 3.0 2.6 14.3

0.5 0.3 0.2 0.3 0.4 1.1 0.3 0.5 0.2 0.3 0.3 0.6 0.3 1.4 0.2 1.1 1.5 0.5 0.4 0.1 0.3 0.2 0.8 1.5 0.3 0.5 1.2 0.9 0.3 1.1 0.9 0.2 0.3 0.2

0.02 0.01 0.01 0.01 0.02 0.05 0.01 0.02 0.01 0.02 0.02 0.04 0.02 0.09 0.01 0.08 0.10 0.03 0.03 0.01 0.03 0.02 0.07 0.16 0.03 0.06 0.17 0.13 0.05 0.16 0.14 0.05 0.09 0.07

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

National comparisons   53 outlier countries with highest employment at the top of the table make a major contribution to this overall fall. Unemployment in Poland falls from 2003 to 2007 by 10.3 per cent and in the Slovak Republic by 6.5 per cent. Other countries experiencing noticeable declines are Estonia by 5.5 per cent, Spain by 3.0 per cent and Israel by 3.5 per cent. Unemployment is also falling consistently in Finland from 2003 to 2007 from 9 to 6.9 per cent as it continues its long term recovery from a national economic crisis in the 1990s (Koskela and Uusitalo, 2003). It is important to note that unemployment rises for some countries Table 3.12 Unemployment rate, percentage of work force, 2003–07, ranked by highest average

Poland Slovak Republic Turkey Germany Spain Greece Israel France Chile Finland Belgium Estonia Portugal Italy Czech Republic Hungary Canada Sweden Slovenia US Australia UK Austria Denmark Ireland Japan Luxembourg Netherlands Switzerland New Zealand Norway South Korea Mexico Iceland Averages

2003

2004

2005

2006

2007

Average

SV

CoV

20.0 17.6 10.8 9.4 11.4 9.9 10.9 8.5 8.7 9.0 8.2 10.3 6.6 8.7 7.8 5.9 7.7 5.8 6.8 6.1 6.0 4.9 4.3 5.5 4.7 5.4 3.7 4.0 4.2 4.8 4.5 3.7 3.1 3.4 7.4

19.3 18.2 11.1 10.4 11.0 10.7 10.5 8.9 9.1 8.9 8.4 9.9 7.0 8.1 8.4 6.1 7.3 6.6 6.4 5.6 5.5 4.7 5.0 5.6 4.6 4.9 5.1 5.0 4.4 4.1 4.5 3.8 3.8 3.1 7.5

18.0 16.2 10.9 11.3 9.2 10.0 9.2 8.9 8.3 8.4 8.5 8.1 8.1 7.8 8.0 7.2 6.8 7.8 6.7 5.1 5.1 4.7 5.2 4.9 4.8 4.6 4.5 5.1 4.5 3.9 4.7 3.9 3.6 2.7 7.3

14.0 13.3 10.5 10.4 8.6 9.0 8.5 8.8 7.9 7.7 8.3 6.0 8.1 6.9 7.2 7.5 6.3 7.1 6.1 4.7 4.9 5.4 4.8 4.0 4.7 4.3 4.7 4.2 4.1 3.9 3.5 3.6 3.3 3.0 6.6

9.7 11.0 10.5 8.7 8.3 8.4 7.4 8.0 7.4 6.9 7.5 4.8 8.5 6.2 5.4 7.4 6.1 6.2 5.0 4.7 4.4 5.3 4.5 3.8 4.7 4.1 4.1 3.5 3.7 3.8 2.6 3.4 3.5 2.3 5.9

16.2 15.3 10.8 10.0 9.7 9.6 9.3 8.6 8.3 8.2 8.2 7.8 7.7 7.5 7.3 6.8 6.8 6.7 6.2 5.2 5.2 5.0 4.7 4.7 4.7 4.7 4.4 4.4 4.2 4.1 3.9 3.7 3.4 2.9 7.0

4.3 3.0 0.3 1.0 1.4 0.9 1.4 0.4 0.7 0.9 0.4 2.4 0.8 1.0 1.2 0.8 0.7 0.8 0.7 0.6 0.6 0.4 0.4 0.8 0.1 0.5 0.6 0.7 0.3 0.4 0.9 0.2 0.3 0.4 0.9

0.27 0.20 0.03 0.10 0.15 0.09 0.15 0.04 0.08 0.11 0.05 0.31 0.10 0.14 0.16 0.11 0.10 0.11 0.12 0.11 0.12 0.07 0.08 0.17 0.02 0.12 0.13 0.16 0.08 0.11 0.23 0.05 0.08 0.15 0.12

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

54   National comparisons towards the end of the period in the table (2006–07) and as countries begin to experience the beginning of the financial crisis. Mexico, UK and Luxembourg experience unemployment growth between 2006 and 2007. Portugal and Hungary experience opposite trends to the data set with persistent increases in unemployment through the five-­year period. Table 3.13 shows the percentage of unemployed who are long term unemployed where the definition of longer term unemployment is being without paid work for over one year. Again there is diversity in the data with the mean five-­ year average at 32 per cent and a standard deviation of 17.4 per cent. Eastern Table 3.13 Percentage of long term unemployment (>12 months), 2003–07, ranked by country with highest long term unemployment

Slovak Republic Germany Greece Czech Republic Italy Estonia Belgium Slovenia Poland Hungary Portugal France Netherlands Switzerland Turkey Spain Japan Ireland Israel Austria Luxembourg Finland UK Denmark Australia Sweden US New Zealand Norway Iceland Canada Mexico South Korea Average

2003

2004

2005

2006

2007

Average

SD

CoV

61.1 50.0 54.9 49.9 58.1 45.9 45.4 52.8 49.7 42.2 35.0 41.0 27.8 26.1 24.4 39.8 33.5 32.8 25.0 24.5 24.7 24.7 21.5 20.4 21.5 17.8 11.8 13.6 6.4 8.1 10.0 0.9 0.6 30.4

60.6 51.8 53.1 51.8 49.2 52.2 49.0 51.5 47.9 45.1 44.3 40.9 34.2 33.5 39.2 37.7 33.7 34.9 32.5 27.6 21.0 23.4 20.6 21.5 20.7 18.9 12.7 11.7 9.2 11.2 9.5 1.1 1.1 31.9

68.1 53.0 52.2 53.6 49.9 53.4 51.7 47.3 52.2 46.1 48.2 41.4 40.2 39.0 39.4 32.6 33.3 33.4 32.5 25.3 26.4 24.9 21.1 23.4 18.3 – 11.8 9.7 9.5 13.3 9.6 2.3 0.8 33.2

73.1 56.4 54.3 55.2 49.6 48.2 51.2 49.3 50.4 46.1 50.2 42.2 43.0 39.1 35.7 29.5 33.0 32.3 32.6 27.3 29.5 24.8 22.3 20.8 18.1 – 10.0 7.8 14.5 7.3 8.7 2.5 1.1 33.3

70.8 56.6 50.0 53.4 47.4 49.5 50.4 45.7 45.9 47.5 47.1 40.4 39.4 40.8 30.3 27.6 32.0 30.0 30.9 26.8 28.7 23.0 23.8 16.2 15.4 13.0 10.0 6.1 8.8 8.0 7.5 2.7 0.6 31.1

66.7 53.6 52.9 52.8 50.8 49.8 49.5 49.3 49.2 45.4 45.0 41.2 36.9 35.7 33.8 33.4 33.1 32.7 30.7 26.3 26.1 24.2 21.8 20.5 18.8 16.6 11.2 9.8 9.7 9.6 9.1 1.9 0.8 32.0

5.1 2.6 1.7 1.8 3.7 2.7 2.3 2.6 2.2 1.8 5.3 0.6 5.4 5.4 5.7 4.6 0.6 1.6 2.9 1.2 3.0 0.8 1.1 2.4 2.1 2.6 1.1 2.7 2.6 2.3 0.9 0.8 0.2 1.2

0.08 0.05 0.03 0.03 0.07 0.05 0.05 0.05 0.04 0.04 0.12 0.02 0.15 0.15 0.17 0.14 0.02 0.05 0.10 0.04 0.12 0.03 0.05 0.12 0.11 0.16 0.10 0.27 0.27 0.24 0.10 0.40 0.29 0.04

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

National comparisons   55 European, central and southern European countries have high proportions of their unemployed as long term unemployed while non-­European countries have much lower levels. Scandinavian countries and the UK are in contrast to the other European nations with levels below 25 per cent. In the detail of the data are some important differences in the five-­year trend: large increases in long term unemployment are experienced by Switzerland, Portugal and the Netherlands (here the proportion of long term unemployed increased by over 10 per cent between 2003 and 2007); that contrasts with Italy and Spain who have reduced their long term unemployed by over 10 per cent in the same time period. In combination, these differences form some medium term convergence amongst the central and southern European countries rather than creating further divergence. There has been considerable discussion in the last decade about the link between long term unemployment, being unavailable for employment due to ill health (questioning entitlement to long term sickness and disability benefits) and early retirement. In the main, the complex debate and discussion about the nature of this relationship has led to governments increasing policies to enable those with sickness and/or disability to remain in some form of work, via training if necessary, and to prevent early retirement. Indeed, since the financial crisis of 2008–09 there has been a growing emphasis on extending the retirement age and preventing employers from terminating employment due to the worker reaching a prescribed retirement age. The main motivation for these changes is fiscal austerity with pressures on growing retirement costs for both employers and the state, although there have also been strong special interest lobbies arguing that those with a disability and older workers have many skills to offer the economy. Growth in employment related to financial and business services was a key element in the economic activity of the period 2003–07. This is illustrated in Table 3.14 which shows financial and business services employment growth ranked by the highest percentage increase in these specialist jobs in each country. Data is available for 28 developed economies and the combined job growth in the sector for all the countries is 7.8 million, with 2.4 million jobs added in the US and over half a million in each of the UK, Spain and South Korea. Within individual nations the sector expands most rapidly in Chile, Poland, Slovak Republic and Spain with growth of over 30 per cent. There is only 2 per cent growth in Japan, a country that had already suffered a major financial crisis. The ability to attract inflows of migrant labour in key skills with competitive labour costs has been argued to be a key element in achieving rapid growth at times of economic change. Table 3.15 shows net inflows of labour for 23 OECD countries, 2003–07, ranked by the five-­year average. Most of the G7 large economies form a clear cluster in the top half of the table with the exception of France, and joined by Spain that had one exceptional inflow year in 2005. The UK is at the bottom of the leading economies with an average inflow of 89,000 (the data does not include inflows for asylum seekers, students or those with family reasons).

56   National comparisons One key goal of public and social policy is to prevent income and wealth inequalities from undermining the participation and political rights that give all people some ability to achieve notions of citizenship in society. The balancing of individual rights of liberty against the collective right of all to take part in society and meet their basic human needs is at the core of political and social science debates in the post-­war period. The need to at least limit the extremes of market forces to protect the poorest and most vulnerable is still recognized as a necessary government action by the majority of applied social scientists. In a recent seminal text, Wilkinson and Pickett (2010) reconstitute this applied social science argument. They make the case that notions of equality are in the interests of all citizens and by this they mean restricting growing extremes of wealth and income distributions. Their argument is that psychological damage is inflicted on a society that is overly competitive and individualized and therefore this is ecoTable 3.14 Growth in employment in finance and business services between 2003 and 2007, ranked by highest percentage increase

Chile Poland Slovak Republic Spain South Korea Ireland Norway Luxembourg New Zealand Cyprus Czech Republic Denmark Finland Belgium Hong Kong Slovenia Greece Canada Austria Estonia Sweden UK Germany US Italy France Hungary Japan Total

2003

2007

443,000 975,800 182,039 1,870,700 2,477,400 229,358 279,000 74,700 228,900 33,700 548,217 387,000 280,000 765,500 474,000 113,680 354,486 2,656,626 544,193 52,000 619,800 5,903,000 6,127,000 23,709,000 3,355,000 4,385,414 337,983 2,725,000 60,134,499

618,440 1,315,100 241,549 2,438,100 3,159,326 291,033 352,000 93,300 278,800 40,700 656,045 462,000 327,700 893,000 552,400 132,262 409,856 3,046,739 621,932 58,900 700,900 6,644,000 6,821,000 26,153,000 3,697,900 4,829,720 366,173 2,781,000 67,984,882

Source: United Nations Statistics Division, 2011.

increase 175,440 339,300 59,510 567,400 681,926 61,675 73,000 18,600 49,900 7,000 107,828 75,000 47,700 127,500 78,400 18,581 55,370 390,113 77,739 6,900 81,100 741,000 694,000 2,444,000 342,900 444,306 28,190 56,000 7,850,378

% increase 0.40 0.35 0.33 0.30 0.28 0.27 0.26 0.25 0.22 0.21 0.20 0.19 0.17 0.17 0.17 0.16 0.16 0.15 0.14 0.13 0.13 0.13 0.11 0.10 0.10 0.10 0.08 0.02 0.19

National comparisons   57 nomically inefficient. Table 3.16 shows income inequality as measured by Gini coefficient scores for the working-­age population; the results are ranked by countries with the most unequal income distribution. Scandinavian countries perform well as a group and European countries tend to do better than non-­European countries. The key trends in employment before the crisis can be summarized as: • • • • • • •

Increased percentage of women entering the workforce, thus raising the proportion of women in the total workforce; Persistent differences in inequality of income between wealthier nations; Growing percentage of the population employed over the economic cycle; Increase in migrant labour force; Increase in skills and qualification in the labour force; Increased proportion of workers in part time employment; Rapid growth of workers in services and finance and banking in G7 countries.

Table 3.15 Immigration for employment, including temporary workers, 2003–07, ranked by countries with highest average inflow (000s)

US Germany Spain Canada Japan Australia New Zealand Italy UK Hungary Netherlands Switzerland Norway Ireland Luxembourg Austria France Finland Portugal Poland Belgium Sweden Denmark Slovak Republic Totals

2003

2004

2005

2006

2007

Average

SD

CoV

434 372 73 103 156 75 74 – 86 57 38 35 25 48 23 24 17 14 16 19 5 10 2 – 1,706

552 380 155 113 159 91 85 – 89 79 44 40 33 34 23 25 17 15 19 12 4 8 4 3 1,986

635 – 643 123 125 102 103 75 86 73 46 40 28 27 25 23 19 19 13 10 6 6 7 5 2,240

604 – 102 139 81 131 119 69 97 71 74 46 40 25 28 23 21 21 14 11 12 12 14 4 1,756

666 – 103 165 78 148 134 150 88 55 50 74 55 24 31 30 27 23 – 12 23 10 17 – 1,962

578 376 215 129 120 109 103 98 89 67 50 47 36 31 26 25 20 18 16 13 10 9 9 4 1,930

91 6 241 24 39 30 24 45 4 10 14 16 12 10 4 3 4 4 3 3 8 2 6 1 212

0.16 0.02 1.12 0.19 0.33 0.27 0.24 0.46 0.05 0.15 0.27 0.33 0.32 0.31 0.14 0.11 0.21 0.21 0.18 0.27 0.78 0.24 0.70 0.17 0.11

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

58   National comparisons

Education Education and training are key development goals for public policy. Various studies have linked educational development and performance with social stability and economic performance (OECD, 2011a). Public policy seeks to provide an effective education delivery system. Table 3.17 shows the growing percentage of those in OECD countries completing tertiary education (further and higher education), between 2003 and 2007, ranked by the highest national average. Canada, Japan and US have above 35 per cent of the population achieving at this level. However, the data may to some extent be misleading about broad education and training achievement, as some countries like Germany place more emphasis on technical apprenticeship with training based in employment. Table 3.16 Income inequality – Gini coefficient scores for working-age population, ranked by countries with most unequal income distribution mid 2000s Mexico Turkey Poland Portugal US Italy UK New Zealand Canada Ireland Australia Greece Japan Spain Germany Hungary South Korea Iceland France Norway Austria Belgium Czech Republic Finland Netherlands Slovak Republic Switzerland Luxembourg Sweden Denmark

0.47 0.42 0.38 0.38 0.37 0.35 0.34 0.33 0.32 0.32 0.31 0.31 0.31 0.31 0.30 0.30 0.30 0.29 0.28 0.28 0.27 0.27 0.27 0.27 0.27 0.27 0.27 0.26 0.24 0.23

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

National comparisons   59 Table 3.18 shows a more comprehensive assessment of educational skills based on the work of the OECD: including average school maths score, average school science score, percentage experiencing schooling aged 3–5, in addition to the further education and higher education score. Each of the key indicators is then ranked and a sum of ranks and total rank given. Although there is some similarity in the order of countries presented in Table 3.17, countries that move significantly up Table 3.18 with Germany are Belgium and South Korea. Countries that are lower in the rankings compared to the tertiary education completions in Table 3.17 are the US, Sweden, Ireland and Greece. This implies that higher and further education achievement in these countries does not correlate with a broad strength in educational skills overall.

Table 3.17  Higher education attainment rates as percentage of population, 25–64

Canada Japan US New Zealand Finland Denmark Norway Sweden Australia South Korea Belgium Iceland Netherlands UK Ireland Switzerland Spain France Germany Luxembourg Greece Austria Hungary Poland Mexico Slovak Republic Czech Republic Portugal Italy Turkey Averages

2003

2004

2005

2006

Average

SD

CoV

44.0 37.4 38.4 32.3 33.3 31.9 31.0 33.4 31.3 29.5 29.0 28.9 27.5 28.0 26.3 26.9 25.2 23.9 24.0 14.3 19.2 14.5 15.4 14.2 15.4 11.8 12.0 10.8 10.5 9.7 24.3

44.6 38.7 39.1 35.6 34.2 32.9 31.8 34.5 30.8 30.5 30.4 29.1 29.5 29.2 27.8 28.1 26.4 24.5 24.9 23.7 21.2 18.3 16.7 15.7 16.4 12.4 12.3 12.5 11.6 9.1 25.8

46.1 39.9 39.0 39.4 34.6 33.5 32.7 29.6 31.7 31.6 31.0 30.5 30.1 29.6 29.1 28.8 28.2 25.4 24.6 26.5 21.3 17.8 17.1 16.9 14.9 13.7 13.1 12.8 12.2 9.7 26.4

47.0 40.5 39.5 38.3 35.1 34.7 32.9 30.5 33.0 32.9 31.8 29.5 30.2 30.5 30.8 29.9 28.5 26.2 23.9 24.0 22.2 17.6 17.7 17.9 15.4 14.2 13.5 13.5 12.9 10.4 26.8

45.4 39.1 39.0 36.4 34.3 33.3 32.1 32.0 31.7 31.1 30.5 29.5 29.3 29.3 28.5 28.4 27.1 25.0 24.4 22.1 21.0 17.1 16.7 16.2 15.5 13.0 12.7 12.4 11.8 9.7 25.8

1.4 1.4 0.4 3.2 0.8 1.2 0.9 2.3 1.0 1.5 1.2 0.7 1.3 1.0 1.9 1.2 1.6 1.0 0.5 5.4 1.3 1.7 1.0 1.6 0.6 1.1 0.7 1.1 1.0 0.5 1.1

0.03 0.03 0.01 0.09 0.02 0.04 0.03 0.07 0.03 0.05 0.04 0.02 0.04 0.04 0.07 0.04 0.06 0.04 0.02 0.24 0.06 0.10 0.06 0.10 0.04 0.09 0.06 0.09 0.09 0.05 0.04

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

529 519 546 527 541 515 498 513 503 526 507 514 497 492 534 494 487 490 483 487 493 496 495 489 497 483 487 466 445

Japan New Zealand South Korea Canada Finland Belgium Norway Germany Denmark Netherlands Iceland Australia France UK Switzerland Sweden US Hungary Spain Ireland Czech Republic Austria Poland Luxembourg Slovak Republic Italy Portugal Greece Turkey

539 532 538 529 554 507 500 520 499 522 496 527 498 514 517 495 502 503 488 508 500 494 508 484 490 489 493 470 454

2 4 3 5 1 13 17 8 18 7 20 6 19 10 9 21 15 14 26 12 16 22 11 27 24 25 23 28 29

39.1 36.4 31.1 45.4 34.3 30.5 32.1 24.4 33.3 29.3 29.5 31.7 25.0 29.3 28.4 32.0 39.0 16.7 27.1 28.5 12.7 17.1 16.2 22.1 13.0 11.8 12.4 21.0   9.7

2 4 10 1 5 11 7 19 6 13 12 9 18 14 16 8 3 23 17 15 26 22 24 20 25 28 27 21 29

Average Science Percentage FE and school RANK completing FE HE science score and HE RANK 90.0 94.1 79.7 56.8 52.3 99.4 94.5 92.7 91.5 67.1 95.9 54.6 99.9 92.7 47.5 91.1 55.7 87.1 98.5 56.4 79.7 77.6 47.3 85.9 73.5 97.4 79.2 46.6 23.8

Percentage 3–5 in school 12 7 15 21 25 2 6 8 10 20 5 24 1 9 26 11 23 13 3 22 16 18 27 14 19 4 17 28 29

20 22 29 32 33 34 43 45 46 46 48 48 52 53 54 58 64 71 72 73 77 78 79 83 83 84 92 105 116

1 2 3 4 5 6 7 8 9 9 11 11 13 14 15 16 17 18 19 20 21 22 23 24 24 26 27 28 29

Early child SUM of Rank of care RANK ranks ranks

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www.oecd.org/statistics, accessed 23 May 2011.

4 7 1 5 2 8 13 10 12 6 11 9 14 20 3 18 23 21 26 24 19 16 17 22 15 27 25 28 29

Average Maths school maths RANK score

Country

Table 3.18  Combined ranking of educational performance, based on data collections up to 2007

National comparisons   61 Health The provision of health services is another key goal of public policy in a developing or developed state. Table 3.19 shows expenditure on health as a proportion of GDP for 36 countries, including OECD and BRIC nations ranked in order of the highest percentages. This percentage includes private health care, in addition to state funded and NGO provision. The US is at the top of the table with 15 per cent of GDP committed to health care in 2007. The average for all 36 nations is 8.5 per cent. Table 3.20 shows average life expectancy from birth, ranked by improvements in the average from 2000 to 2009 for a larger group of 44 nations. Achievements of 4 per cent or greater are evidenced in Turkey, India, South Korea, Singapore, Cyprus, Estonia and Ireland. Figure 3.4 shows the lack of association between spending on health care as a proportion of GDP and life expectancy (2009). This is because as the proportion of an economy spent on health increases above 5 per cent it does not necessarily achieve increases in life expectancy. Wilkinson and Pickett (2010) have argued that developed countries with more unequal income and wealth distributions have higher levels of health issues such as mental health problems, obesity and drug misuse. Cluster analysis Cluster analysis was undertaken with the economic and employment data to see what evidence emerged for similarities between countries in the five-­year period before the financial crisis of 2008–09. 85 83

R2 � 0.2135

Life expectancy (2009)

81 79 77 75 73 71 69 67 65

0

5

10 Proportion of GDP

15

20

Figure 3.4 Scatter plot to demonstrate lack of association between national health care expenditure as a proportion of GDP and life expectancy, 2009 (32 countries) (source: WHO (2011): http://apps.who.int/ghodata, 31 May 2011).

62   National comparisons Table 3.19 Total expenditure on health as percentage of GDP, 2003–07, ranked by highest average

US Switzerland France Germany Austria Belgium Portugal Canada Netherlands Iceland Denmark Greece Norway Sweden New Zealand Italy Australia Spain Finland Slovenia UK Japan Hungary Brazil Luxembourg Israel Ireland Slovak Republic Czech Republic Chile Cyprus Poland Mexico Turkey Russian Fed China Average

2003

2004

2005

2006

2007

Average

% change

14.6 11.3 10.9 10.8 10.3 10.1 9.7 10.6 9.8 10.6 9.3 8.9 10 9.4 8 8.3 8.3 8.2 8.2 8.6 7.8 8.1 8.3 7 7.7 7.7 7.4 7.5 7.4 7.5 6.8 6.2 5.8 5.3 5.6 4.8 8.52

14.7 11.3 11 10.6 10.4 10.5 10 10 10 10 9.5 8.7 9.6 9.2 8.4 8.7 8.5 8.2 8.2 8.4 8 8 8 7.1 8.2 7.6 7.6 7.2 7.2 7.1 6.4 6.2 6 5.4 5.2 4.7 8.49

14.7 11.2 11.1 10.7 10.4 10.3 10.2 9.4 9.8 9.6 9.5 9.6 9.1 9.2 8.9 8.6 8.4 8.3 8.4 8.4 8.3 8.2 8.3 8.2 7.9 7.6 7.5 7 7.2 6.9 6.3 6.2 5.9 5.4 5.2 4.7 8.52

14.8 10.8 11.1 10.5 10.3 9.9 9.9 9.5 9.7 9.3 9.6 9.7 8.6 9.1 9.3 8.7 8.5 8.4 8.4 8.2 8.5 8.1 8.1 8.5 7.7 7.4 7.5 7.3 7 6.6 6.3 6.2 5.7 5.8 5.3 4.6 8.47

14.9 10.6 11 10.4 10.3 10.8 10.4 9.6 9.7 9.3 9.7 9.7 8.9 9.1 9.1 8.4 8.5 8.4 8.2 7.8 8.4 8.1 7.5 8.4 7.1 7.6 7.5 7.7 6.8 6.9 6 6.4 5.8 6 5.4 4.2 8.46

14.7 11.0 11.0 10.6 10.3 10.3 10.0 9.8 9.8 9.8 9.5 9.3 9.2 9.2 8.7 8.5 8.4 8.3 8.3 8.3 8.2 8.1 8.0 7.8 7.7 7.6 7.5 7.3 7.1 7.0 6.4 6.2 5.8 5.6 5.3 4.6 8.49

0.3 –0.7 0.1 –0.4 0 0.7 0.7 –1 –0.1 –1.3 0.4 0.8 –1.1 –0.3 1.1 0.1 0.2 0.2 0 –0.8 0.6 0 –0.8 1.4 –0.6 –0.1 0.1 0.2 –0.6 –0.6 –0.8 0.2 0 0.7 –0.2 –0.6 –0.06

Source: WHO (2011) http://apps.who.int/ghodata/ (31 May 2011). Note Percentage change 2003–07.

National comparisons   63 Table 3.20 Average life expectance from birth, ranked by improvements in average 2000–09 2009

Turkey India South Korea Singapore Cyprus Estonia Ireland Brazil China Luxembourg Israel Italy Slovenia Spain Netherlands Russian Federation Chile Czech Republic New Zealand Australia Finland Germany Hungary Mexico Poland Portugal Switzerland Austria Belgium Canada Denmark France Iceland Japan Norway Slovak Republic UK US Greece Sweden Malaysia Indonesia Argentina South Africa

75 65 80 82 81 75 80 73 74 81 82 82 79 82 81 68 79 77 81 82 80 80 74 76 76 79 82 80 80 81 79 81 82 83 81 75 80 79 80 81 73 68 75 54

2000

70 61 76 78 77 71 76 70 71 78 79 79 76 79 78 65 77 75 79 80 78 78 72 74 74 77 80 78 78 79 77 79 80 81 79 73 78 77 78 80 72 68 75 56

1990

65 57 72 75 76 70 75 67 68 75 77 77 74 77 77 69 72 71 75 77 75 75 69 71 71 74 77 76 76 77 75 77 78 79 77 71 76 75 77 78 71 65 73 63

Source: WHO (2011) http://apps.who.int/ghodata (31 May 2011).

Improvement 10 y

20 y

5 4 4 4 4 4 4 3 3 3 3 3 3 3 3 3 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 1 1 0 0 –2

10 8 8 7 5 5 5 6 6 6 5 5 5 5 4 –1 7 6 6 5 5 5 5 5 5 5 5 4 4 4 4 4 4 4 4 4 4 4 3 3 2 3 2 –9

64   National comparisons The resulting cluster model for 27 OECD countries used the following variables to form clusters: • • • • • •

Average percentage change in GDP, 2003–07; Average government current account balance as percentage of GDP, 2003–07; Average current account, balance of payments, as percentage of GDP, 2003–07; Average CPI, 2003–07; Average percentage of working-­age population in employment, 2003–07. Average percentage of women of working age in employment, 2003–07.

Method Hierarchical cluster analysis is used as this assumes the starting point is that all the cases are uniquely different and then the computer looks for similarities and patterns. The search for similarities uses the average linking between groups method (see Chapter 2). There are a number of outliers that cannot be joined to others in the analysis. These are Iceland, Norway and Hungary. The two biggest and homogenous groupings (to the right hand side of the dendrogram in Figure 3.5) place the newly developing economies and southern and Eastern European economies at the bottom of the dendrogram, leaving North America and north and Western European and Oceania countries in the top half (see point 10 on the horizontal rescaled distance). Portugal has been connected with the latter group, placed in proximity to UK, US and Canada. This seems to reflect the lower growth and GDP in these countries when compared with the other buoyant economies on the periphery of the eurozone. At points 5–6 on the horizontal rescaled distance, northern and central European countries become separated from North America and the UK (the UK is related closest to the US, before joining Canada and Australia). Within northern and central Europe are two clear subgroups: central countries (Belgium, France, Italy and Germany) and northern countries (Denmark, Sweden, Netherlands and Finland) joined by Austria. Finally it should be noted that Japan and Switzerland are joined, but they sit some distance from the rest of the central and northern European, North American and Oceania groupings.

Qualitative comparative analysis (QCA) A qualitative comparative analysis (QCA) was used to explore the relationship of the clusters with variables, and to attempt to validate aspects of the clusters. Tosmana analysis software (Cronqvist, 2011) was used for this purpose. Table 3.21 shows the variables that have the strongest influence on confirming the clusters. QCA uses the methodological term ‘primary implicants’ to describe variables that share the same threshold for groups of countries. For cluster 1 the primary implicants are lower CPI, lower interest rates (IR), lower percentage of the population in employment and lower GDP. These are the central European

National comparisons   65 countries with tight monetary policy that creates stability but does not result in above threshold growth. Cluster 2 has its primary implicants as higher tax as percentage of GDP. They also demonstrate low CPI and low IR. They have higher percentages in employment, including a higher percentage of women but, similar to the first cluster, average growth is not above threshold. Note that in the truth table (in Table 3.21), Norway has joined the Scandinavian cluster grouping because it has identical threshold results to Sweden, Denmark and Finland. The primary implicants of cluster 3 are higher interest rates, higher percentages in employment, including a higher percentage of women, but, similar to the first cluster, average growth is relatively low. The subcluster of 3.5 (Portugal and New Zealand) is linked to cluster 3 by the higher percentage of women in

Rescaled distance cluster combine CASE Label

0 5 10 15 20 25 Num ���������������������������������������������������

Belgium France Italy Germany Denmark Sweden Austria Netherlands Finland Australia Canada UK US New Zealand Portugal Japan Switzerland Chile Korea Greece Spain Ireland Slovenia Czech Republic Poland Slovak Republic Hungary Norway Iceland

3 9 15 10 7 26 2 18 8 1 4 28 29 19 22 16 27 5 17 11 25 14 24 6 21 23 12 20 13

Figure 3.5  Cluster analysis dendrogram: pre-financial crisis model of OECD countries.

66   National comparisons employment and lower than average growth, but these two countries also share below threshold government current accounts and above threshold CPI. In cluster 3 as a whole (including subcluster 3.5) only Canada has a more favourable current account and balance of payments and CPI data. All the others are below threshold on this indicator. Cluster 4 is the pairing of Japan and Switzerland. Both have favourable government current accounts and below threshold tax as a percentage of GDP and above threshold current account balance of payments. Both CPI and IR are below threshold. The percentage of the population in employment is above threshold and growth below threshold. In cluster 5 Chile and South Korea share the same profile of threshold scores: above on GDP growth, government current account, current account balance of payments, CPI, IR and below threshold on tax take and employment variables. Cluster 6 in effect combines the remaining countries with above threshold growth from southern and Eastern Europe but growth is not an actual primary implicant because Spain (GDP annual growth average in Table 3.1 is 3.2 per cent) has marginally below the growth threshold of 3.6 per cent (GDP is above threshold for all the other countries in cluster 6). The shared primary implicants are: below threshold current account balance of payments and employment levels (with all but Slovenia being below threshold on women’s employment also). The Slovak Republic, while slightly distanced from the other countries in the cluster analysis dendrogram, shares the same primary implicants in Table 3.21.

Conclusions Analysis of the public policy performance of the global economy before the 2008–09 crisis reveals the path that OECD countries most severely affected were taking into the recession: increased growth, rising employment and low but increasing inflation (given the context of rising commodity prices). Employment increasingly underpinned much of the OECD countries’ development of the welfare state, forming the basis of citizenship and benefits such as pension entitlement. The proportion of the population in work and the proportion of women in employment were slowly increasing. These indicators need to be contrasted with rising budget deficits and current account deficits. The narrow economic orthodox of using monetary policy to reduce inflation saw no urgent need to address these other factors. The upward movement of CPI in the largest economies in 2007 only gave a small hint of the coming crisis in 2008. The huge growth of global financial flows from 2003 to 2007 was a megaphone warning to the world of the crisis that was developing, but few heard it. Overall, in the period 2003–07, the global economy is characterized by an apparently solid recovery from the previous recession in the late 1990s. Most countries grow moderately, with sufficient growth to increase the working population and see declines in unemployment. Europe at first grows more slowly, but the launch of the euro sees a loosening of credit in the peripheral national econo-

1 1 1 1 1 1

0 1 0 0 0 1 0 0 0 0 0 1 0 1 1 0

0 0 0 1 0 1

0 0 1 1 0 1 0 0 1 0 0 0 1 1 0 0

1 1 1 1 0 1 1 1 0 0 0 0 0 0 0 0

1 1 1 1 0 1 0 0 1 1 0 0 0 0 1 1

1 1 1 0 1 1 0 0 1 0 1 0 1 1 1 1

0 0 0 0 1 1

0 0 0 0 0 0

0 0 0 0 0 0

v6 % in employment 68.4%

v5 IR 3.2%

v4 CPI 2.4%

Notes Thresholds (1 = threshold or above: 0 = below threshold). Primary implicants are shown in bold.

0 0 0 1 0 0 1 1 1 0 0 0 0 0 0 0

0 1 1 1 1 1

v2 v3 Tax as % of GDP Current account 34.8% balance of payment –1.7%

v1 Government current account –0.4%

Table 3.21  QCA Truth table for validation of pre-crisis clusters

1 1 1 1 1 1 0 1 0 0 0 0 0 0 1 0

0 0 1 0 1 1

v7 % women in employment 59.5%

0 0 0 0 0 0 0 0 1 1 1 1 1 0 1 1

0 0 0 0 0 0

v8 GDP 3.6%

3 3 3 3 3.5 3.5 4 4 5 6 6 6 6 6 6 6.5

1 1 1 1 2 2

Italy France Germany Belgium Austria, Netherlands Denmark, Finland, Norway, Sweden US UK Australia Canada Portugal New Zealand Japan Switzerland Chile, South Korea Poland Greece Czech Republic Ireland Spain Slovenia Slovak Republic

Cluster Country

68   National comparisons mies and this sparks higher than average growth in those countries. There are indications that growth is not sustainable as global commodity prices rise rapidly and ahead of inflation. Commodity prices fail to convert into negative feedback in the economic system via higher CPI and IR because of the continued influx of cheap credit leverage coming into importing countries from the surpluses of those exporting. This global credit line keeps both interest rates and CPI inflation relatively low in importing countries and creates the illusion that monetary policy is maintaining stability in the global and national economies. Although the dollar is declining rapidly in this period because of US loose monetary policy, the psychological effect is the opposite of that caused by a declining currency. The velocity of financial investment traded in dollars rises exponentially as much global financial investment and its derivatives passes through investment banks in New York, London, Paris and Frankfurt. In the short term this produces rich financial trade and a failure of governments to use stabilizing policy feedback like increased taxes, higher IRs, and more regulation and controls. With too much reinforcing market feedback unchecked in the policy system the bubble is soon to burst. This was the great macroeconomic policy failure of modern times.

4 Instability and chaos The financial crisis of 2008–09

Introduction This chapter examines the emergence of the global financial problems in 2007 with its progression to a major crisis in 2008–09. Various sources of material are used to analyse governments’ responses to the crisis including bibliographic accounts, inquiry reports, media and newspaper reports. The chapter examines different arguments about what caused the crisis, and finally reviews the complex systems framework introduced in Chapter 1 as a method for summarizing government intervention in the crisis.

Crisis – what sort of crisis? The financial crisis of 2008–09 started as a credit crisis. This was characterized by a sudden lack of availability of loans (leverage) with a resultant effect on the supply of credit. This led to problems of liquidity – the lack of available cash to pay current creditors. The specific attribute of the credit crunch of the late 2000s was the sudden change from a financial market in the Western developed countries where the availability of credit was extraordinarily good and cheap, to an environment where this was no longer the case. After the initial crisis the key characteristic was the lack of availability of loans, rather than an overall and sustained rise in their cost through increased interest rates. This is an indication of banks’ and financial institutions’ long term need to recapitalize rather than make new loans. Some years after the ‘credit crunch’, as the depth of the crisis and its persistence have become apparent, the Governor of the Bank of England and others have argued that the crisis has been shown to be about insolvency and bankruptcy rather than short term liquidity (Stewart, 2011a: 46). As Stiglitz (2010: 128) says: The main problem . . . was not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds with loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They had lost their capital, and this capital had to be replaced. At first the crisis was experienced within the banking sector, in banks and financial institutions that had become used to borrowing from each other on a short

70   Instability and chaos term basis. They rapidly lost trust in each other and therefore would no longer lend. This left some banks immediately and gravely exposed, as they had got used to depending on this short term interbank market and did not have adequate capital. The short term interbank lending rates rose rapidly. The variety and divergence of the banking sector is important here, as it was not all banks and lending institutions that experienced an immediate crisis, but some of those in crisis were judged so large in their effect on the wider economy that governments felt compelled to intervene. There was a strong political fear of the consequences of letting any major bank fail, even if others could remain insolvent (Paulson, 2010; Brown, 2010).

Events during the crisis Hank Paulson, previously Chief Executive of Goldman Sachs, the US investment bank, became US Treasury Secretary on 10 July 2006. At that time, he recalls in his autobiography, the US economy was superficially strong with pleasing GDP growth and the DOW Jones stock indices were at a near record high. When reflecting he notes that storm clouds were on the horizon (Paulson, 2010: Ch. 3). Soon after he took office, US housing prices slowed rapidly and mortgage defaults increased. The US had two big historical mortgage com­ panies, also known as government sponsored enterprises (GSEs), operating in privileged positions to stabilize the US mortgage market and promote affordable housing, known as ‘Fannie Mae’ and ‘Freddy Mac’. Concerns were growing about their lack of accountability given that the American public and overseas investors wrongly believed them to be underwritten by state guarantees. They made their monies by guaranteeing the mortgage finances of other smaller mortgage providers. Given the erroneous market belief that they were government guaranteed, they were able to borrow at very low interest rates and their levels of reserves and capital had been allowed to deteriorate. By 2006 it was estimated that the two companies guaranteed over half of all mortgage debt in the US, a sum of approximately $4.4 trillion. In retirement, Paulson wrote (2010: 57) that these companies ‘were disasters waiting to happen. They were extreme examples of a broader problem that was soon to become all too evident – very big financial institutions with too much leverage and lax regulation.’ As early as 4 January 2007, an analyst at the US Securities and Exchange Commission (SEC) wrote a memorandum to his Director saying: ‘there is broad recognition that, with the financing and real estate booms over, the business model of many of the smaller subprime originators is no longer viable’ (Financial Crisis Inquiry Commission, 2011: 233). In the summer of 2007 there were the first signs of big global financial institutions getting into difficulty because of the declining value of the US mortgage financial market. The investment bank, Bear Stearns, was forced to close two hedge funds exposed to borrowing on the declining US housing market (Paulson, 2010: 94). In August 2007 the French Bank BNP Paribas experienced difficulties with liquidity for two funds exposed to mortgage securitization and moved to close these funds. This sparked wider

Instability and chaos   71 problems in the European interbank lending market as trust between banks began to erode. Essentially there were no buyers for the BNP funds. It issued a press statement on 9 August stating: The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets. (www.bnpparibas.com/en/news/press-­releases, accessed 28 April 2011) By the 23 August the Bank had estimated redemption values for the effected funds that included losses of 2–5 per cent of their previous value, depending on the specific fund. The later press release blamed ‘trading activity on certain sectors of the US market . . . these three funds are on average over 90 per cent invested in securities rated AAA and AA which have not been subject to downgrading or defaults during recent months, and their valuations are currently depressed due to the illiquidity of the market’ (www.bnpparibas.com/en/news/ press-­releases, accessed 28 April 2011). The Financial Crisis Inquiry Commission (2011: 117) later linked one of these Paris based funds to a notorious US based mortgage securitization fund name CLTI 2006 NC2. In September 2007 there was a run on the UK bank, Northern Rock, following a leak to the British Broadcasting Corporation (BBC) that it was in financial trouble and not able to continue borrowing on interbank markets to finance its needs. Gordon Brown, Prime Minister in 2007, recollects in his autobiography (2010: 23): Northern Rock was the first British lender to fully embrace mortgage securitisation. This meant it no longer held its loans to customers for the fifteen or twenty years it lent, but instead parcelled them up and sold them, and used them as collateral for further funds. This financial strategy of securitization used by Northern Rock made it dependent on short term lending with low interest rates and the bank had been aggressive in pursuing such a radical finance model so as to expand rapidly and overtake its rivals. The Labour government tried to broker a deal with other private banks to rescue Northern Rock and Brown (2010: 23) indicates in his autobiographical account that this was motivated by an anxiety that any nationalization would link his political party to previous UK national industries, such as car and coal production, that were considered to be run inefficiently in the UK in the 1960s and 1970s. World events continued to move rapidly with growing fears about the total global level of mortgage securitization debt, and the only private company seriously interested in Northern Rock wanted a continuation of government funding for liquidity guarantees. In the circumstances, it was eventually decided that full nationalization and public ownership was better value for the UK taxpayer. On 11 March 2008, the Federal Reserve Bank of America announced its Term Securities Lending Facility (TSLF ) that would allow investment banks to

72   Instability and chaos exchange mortgage backed securities (which were impossible to sell in the crisis market) for new US Treasury Securities. Up to $200 billion was permitted for these securities with the aim of injecting much needed confidence into the credit market, but Paulson (2010: 92) notes that the reverse happened and the market saw such an unprecedented intervention by the US government as an indication of how serious the market deterioration was. Later that week it became apparent that the US investment bank Bear Stearns had developed a fatal crisis in liquidity simultaneously with a rapidly declining share price and these combined to threaten it with bankruptcy. Paulson worked to negotiate a merger and by Sunday 16 March 2008, a sale was organized to J.P. Morgan. Bear Stearns was sold for a small fraction of the value recorded at its share price peak. To secure the deal the US government had to open a credit line to the investment bank despite its tradition of only assisting commercial banks. Increasingly world governments had to underwrite the debts of the private market place to prevent economic and social collapse. In April, Alistair Darling, Chancellor of the Exchequer for the UK government, announced a Special Liquidity Scheme for institutions involved in mortgage lending whereby they could swap illiquid financial assets like mortgage securities for UK Treasury bills. The fund was established with £100 billion, but when the global crisis increased further and reached its peak in the autumn of 2008 this fund had to be increased by an additional £100 billion. Despite both the US and UK governments moving to deal with the problem of illiquid securitization the crisis continued to escalate in the summer. There was a realization that a high percentage of the securitization was likely to be toxic and of little real value given increases in the number of families defaulting on their mortgages and the impossibility of selling the properties and recovering the capital in a declining property market. The real human cost was becoming visible on TV screens and in newspaper reports, with stories of families that had been sold mortgages at discount in the US that they would never have the income trajectory to pay back. There were images of empty streets left to decline with no occupants or likelihood of future re-­sales. Some of the images were of ‘new builds’ never to be completed. Confidence in mortgage debt declined further, producing a vicious downward spiral of bad debt and illiquidity that drew in ever more institutions, including some of the best known historical banks. Unchecked reinforcing feedback was destroying the system (Meadows, 2009: 155) Following the collapse of the Indy Mac bank in the US in July 2008, the US government passed the Housing Economic Recovery Act allowing the US government to provide more comprehensive support to failing lenders, including the two large government sponsored enterprises, Fannie Mae and Freddie Mac. By the early autumn the US and UK governments feared a complete breakdown of the global banking system given the increasing number of institutions that were insolvent. Government intervention was to become even more comprehensive to the point of effective ownership and full nationalization of some institutions, although this was not a political term that either government would use publicly. It is notable that politicians went out of their way to present government

Instability and chaos   73 interventions and takeovers as being ‘arms length finance’, with the management and characteristics of the institutions remaining independent. This had first been apparent with the nationalization of Northern Rock in the UK, but was also evident in the US where government intervention was presented as assistance to the market and with the resulting government management of those institutions assisted implicitly kept at a distance from the elected political process. This meant that state officials who had previously held major positions in the insolvent institutions were effectively managing them and connecting with networks of bankers whom they knew as friends and colleagues. This conceptualization of public money being given to private enterprises was consistent with the theories of marketization of the public sector after the 1980s, and the dominant logic of ‘new managerialism’ (Alford and Hughes, 2008; Haynes, 2003) that engulfed the public sector in the same time period. Public assistance is presented with market values and market concepts wherever possible, with a lack of acknowledgement of collective purposes and potential state powers. On 7 September 2008 the US government placed the GSEs, Fannie Mae and Freddie Mac, the two largest financiers of mortgages in the US, in what it called ‘conservatorship’. They were in effect owned by the public, although the method of conservatorship takeover had required their agreement and was not therefore an authoritarian state directive. In reality the chief executive officers and boards had little choice, although they had resisted government regulation and audit for many years. The passing of the Housing Economic Recovery Act had given US government officers the opportunity to audit their operations, and this confirmed the suspicions of bad management, adverse risk, a lack of capital and reserves and a continuing rapid deterioration. Total market failure would have been catastrophic on a global scale given that the Financial Crisis Inquiry Commission later valued their stake in the global economy at $5.5 trillion dollars. The Inquiry noted (2011: 321): Major holders of GSE securities include the Chinese and Russian central banks, which, between them, owned more than half a trillion dollars of these securities, and US financial firms and investment funds owned more than $1 trillion in GSE debt and securities more than 150% of the banks’ Tier 1 capital . . . and 11% of their total assets at the time. September was to be an historic month with previously unimaginable actions necessary to prevent a complete breakdown in the world finance system. The global economic system that required fundamental elements of stability based on trust to operate was on the ‘edge of chaos’, about to tip into a period of instability that would question its paradigm, value base and processes. On 15 September Lehman brothers, one of the most famous of New York based international investment banks, filed for bankruptcy. This was to be remembered as the pin­ nacle of the crisis, with counter-­accusations made about who was really responsible. Paulson’s (2010: Ch. 9) memoirs assert his view that the US legal position prevented the US government taking direct action and his efforts were therefore

74   Instability and chaos to try and negotiate a takeover with other banks. ‘Few understood what we did – that the government had no authority to put in capital, and a Fed loan by itself wouldn’t have prevented bankruptcy’ (2010: 226). He also expressed regret that the UK financial regulator (Financial Services Authority) would not agree to Barclays Bank being involved in a takeover solution. The Financial Crisis Inquiry (2011) supported Paulson’s account and concluded that his judgement of the legal boundaries was correct and that he and the government machine had no time to facilitate a change in legislation given the context of numerous other financial problems and major legislation already in process and subject to political debate. But even if the US government agencies were vindicated in the Inquiry about their lack of opportunity to save Lehman, the market reacted badly at the time and the crisis intensified further. Immediately after Lehman filed for bankruptcy the US Dow Jones Index closed at a two-­year low, having experienced a 4.4 per cent fall, the worse one-­day fall since the 9/11 US terrorist attacks. Shortly after the Lehman collapse another major global institution had to be rescued to prevent bankruptcy. On 16 September, AIG Insurance received an emergency $85 billion loan and the US government had moved to take a direct involvement in the company. They had insured many of the investment bank’s toxic assets. In his autobiography, George W. Bush (2010: 458) made a rare reference to the concept of nationalization when reminiscing on the decision to save AIG and reflects: It was basically a nationalisation of America’s largest insurance company. Less than forty eight hours after Lehman filed for bankruptcy, saving AIG would look like a glaring contradiction. But that was a hell of a lot better than a financial collapse. On 18 September the UK bank Lloyds agreed, following negotiations including the UK government, to take over HBOS, a failing UK bank with unsustainable mortgage exposure. So concerned were the US and UK governments about further escalation of the crisis that they moved to inject substantial state funds into the banking system. On 28 September Paulson announced a planned ­Troubled Asset Relief Programme (TARP), although it was to receive a difficult reception in the American Senate and was subject to fierce political debate and stressed negotiations. Nevertheless, it became legislation later in October and included the remarkable sum of $700 billion available for banks’ asset relief. During the autumn crisis there was increased contact between the richest countries of the world, so as to coordinate their actions and announcements in order to achieve more confidence and stability. The G7 was very aware of the necessity to respond to the collapse in confidence in the global market system with a coordinated international method, and so negotiations and discussions were extended to the G20 group of countries wherever practical and possible. On 13 October the European governments of UK, Germany, France, Holland, Spain and Austria all made public commitments worth hundreds

Instability and chaos   75 of billions of euros to guarantee assets and loans and to recapitalize their banks where necessary. The UK government took a majority stake in the Royal Bank of Scotland (RBS) announcing £37 billion of recapitalization and giving it a 57 per cent ownership. It was also necessary for the UK government to take a part ownership of the failing HBOS to permit the planned Lloyds’ takeover to continue. Brown (2010: 66), who was much involved in arguing for international cooperation with these actions and their announcements, concluded: At no point in history have governments ever injected so much money into buying up assets in the banking system with capital and guarantees running into trillions. . . . The patient was out of the emergency room and into intensive care. Political leaders like Brown and Bush cite the recovery in world stock markets from autumn 2009 onwards as evidence that the government intervention was successful in restoring confidence and preventing an even greater crisis for industry and services beyond the financial sector. Table 4.2 shows the recovery of OECD stock markets through late 2009 and into 2010, during which time the biggest markets had recovered much of their previous 2005 value. However, there were wide differences in how national equity markets were affected. While the fundamentals of the market system had been salvaged in the short term by state intervention, what was not clear was how the crisis would affect nations and their societies in the longer term. Economic policy had suddenly converged much more with public policy, in terms of political and administrative agents of the state taking major economic and financial decisions. Many nations had significantly increased their public government debts in the crisis process while seeking to continue the dualist separation of public and private in policy concepts and language. The long term outcome for the political and policy processes of developed countries was far from clear. Had the old paradigm been saved? Or was a new paradigm being born? A summary of the key events in the financial crisis is contained in table 4.1

What caused the crisis? Financial deregulation The majority of commentators, including those public servants and politicians involved in managing the crisis, have concluded that failures of financial and market regulation were a major contributory factor in the crisis and that more coherent and effective regulatory regime could have played a key part in preventing the crisis and its devastation (Basel Committee on Banking Supervision, 2009; Turner, 2009; Davies, 2010; Kaletsky, 2010; Paulson, 2010; Brown, 2010; Financial Crisis Inquiry Commission, 2011). While political and public servant memories tend to focus on the failings of their own country they also recognize the interconnectedness of the globalized economy and the future part that better global regulation could play.

US House Price Quarterly Appreciation indicator (annualized) slows substantially from quarter 1 (6.14%) to quarter 3 (1.67%) following an average for all quarters in 2005 of 9.07%

French bank BNP Paribas stops payments on three investment funds known to hold mortgage backed securities, due to a sudden problem with liquidity

Summer 2006

9 August 2007

UK government announces nationalization of UK bank Northern Rock, bringing it into public ownership with arm’s length management to protect its commercial identity

US Investment Bank, Bear Stearns, becomes insolvent and is sold to J.P. Morgan

UK Government announces £100 billion Special Liquidity Scheme to allow mortgage lenders to swap illiquid assets for UK Treasury bills

Federal US Bank IndyMac fails and is taken into receivership

The US House of Representatives and Senate pass the Housing and Economic Recovery Act allowing the US government to provide more comprehensive financial support to failing government sponsored enterprises like mortgage lenders, Fannie Mae and Freddie Mac

17 February 2008

16 March 2008

23 April 2008

12 July 2008

23 July 2008

24 September 2007 Media rumours of liquidity problem at UK bank Northern Rock, with large mortgage book. Depositors withdraw £1 billion creating a run on the bank. UK government guarantees creditors

Event

Date

Table 4.1  Key events in financial crisis

US government places Fannie Mae and Freddie Mac into ‘conservatorship’, argued to be a form of government ownership

UK Chancellor Alistair Darling announces availability of public money to recapitalize banks (£50 billion) and an additional £100 billion for the Special Liquidity Scheme

European banks announce comprehensive recapitalization and credit guarantee schemes valuing many hundreds of billions in euros

UK government announces its intention to take a majority stake in Royal Bank of Scotland due to latter’s continuing illiquidity

8 October 2008

13 October 2008

13 October 2008

28 September 2008 US Treasury Secretary Hank Paulson announces that TARP is likely to be legislated to allow a volume of $700 billion in assistance

25 September 2008 US bank Washington Mutual fails and is seized by Federal Deposit Insurance Corporation (later sold to US investment bank J.P. Morgan)

19 September 2008 US government announces it will buy troubled assets in a Troubled Assets Relief Programme (TARP). Legislation needed and planned

18 September 2008 UK bank Lloyds agrees to take over its failing UK rival HBOS

16 September 2008 US based insurance company AIG receives $85 billion loan from US Federal Reserve Bank to prevent bankruptcy

15 September 2008 US investment bank Lehman Brothers files for bankruptcy

7 September 2008

78   Instability and chaos Global deregulation For many commentators, the foundations of the financial crisis of 2007–08 were laid in the deregulation and liberalization of government and state market management in the 1980s. These reforms were typically linked with Ronald Regan as President of the US and Margaret Thatcher as Prime Minister of the UK. This – over time – allowed the banks to become overleveraged and undercapitalized, resulting in major financial instability (Brown, 2010: 21) Table 4.2 Fluctuations in OECD stock markets, 2005–10, ranked by largest increase (2005 = 100)

Mexico Chile Turkey South Korea Israel Poland Norway Sweden Luxembourg Canada Hungary Portugal Denmark Germany UK Australia Switzerland Spain US Finland Estonia Czech Republic France Netherlands Austria Belgium Slovenia New Zealand Japan Italy Greece Slovak Republic Ireland Iceland Totals

2008

2009

2010

Change 2005–10

187.5 138.7 122.9 143.1 117.3 137.7 141.8 107.4 166.8 123.3 104.0 126.5 114.2 121.3 104.1 113.7 110.2 120.5 109.4 118.1 87.4 108.4 103.3 106.0 111.4 102.9 153.7 84.4 93.5 88.1 104.0 98.8 75.0 83.4 169.62

177.2 151.2 128.0 133.1 117.2 108.3 106.7 96.8 96.5 100.7 84.5 105.9 83.7 92.2 88.5 95.4 89.8 98.4 82.9 79.3 55.7 76.7 79.9 74.5 72.4 71.6 91.6 71.2 68.4 63.0 68.8 72.9 41.5 11.4 144.14

233.2 210.1 195.8 164.5 150.4 144.6 135.1 126.3 120.2 119.0 118.4 114.0 111.6 111.1 106.0 105.8 103.0 101.6 98.4 96.4 96.1 93.4 91.5 91.2 85.7 85.6 83.5 73.1 69.8 66.9 52.4 51.7 44.8 13.9 162.15

133.2 110.1 95.8 64.5 50.4 44.6 35.1 26.3 20.2 19.0 18.4 14.0 11.6 11.1 6.0 5.8 3.0 1.6 –1.6 –3.6 –3.9 –6.6 –8.5 –8.8 –14.3 –14.4 –16.5 –26.9 –30.2 –33.1 –47.6 –48.3 –55.2 –86.1 7.8

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

Instability and chaos   79 Deregulation is often juxtaposed with the issue of globalization. It is important to note that many reflections on improving and perfecting global regulation assume that a global economy will continue on the basis of increased free trade and cross border movements of capital and other resources, this when contrasted with more restrictive periods of capital flows in economic history. The failure of global financial regulation to keep up with the spread of global finance and its creative new models of credit was documented before the crisis by a number of key writers, including two influential Nobel prize winners in economics (Krugman, 2008; Stiglitz, 2002). There are arguments for a revision of the regulation of movements of currency and capital that would reverse some of the globalization of finance experienced in the 20 years preceding the current crisis. This articulates regulating and restricting the movements of capital. Krugman’s (2008) work assessing the build up to the financial crisis notes that credit instabilities were not new and had occurred in similar ways in national rather than international manifestations in South America and Asia during the 1980s and 1990s. The fundamental problem he noted was that sudden movements of capital into a country could create too much short term liquidity and the associated problems of cheap loans supporting adverse risks, and all too quickly this liquidity could reverse leaving structural problems of unattainable debt and rapid economic decline. The property boom in Thailand in the late 1990s was one such example (Krugman 2004: 53–56). The massive flows into the US mortgage market can be seen in the same light: as reinforcing economic feedback in the global capital system that is unchecked by stabilizing system interventions from national controls and regulation. This builds to a bubble with a painful systemic correction. Another specific problem with global deregulation was the growing pressure of international competitiveness on banks encouraging them to increase their level of overall risk by leveraging further while reducing their ratio of capital to borrowing. Each bank feared being perceived as ‘conservative’ and not delivering profit results as strong as competitors, although some did maintain a more conservative policy that ultimately left them better equipped after the crisis. In a world of historically low interest rates leveraging was seen as the primary route to profitability. Many businesses and households followed this persuasive model believing that low cost leveraging was a sure way to future prosperity as future asset prices would increase to compensate for the cost of borrowing. High leveraging became seen as a credible and dominant business model. As of 2007, the five major investment banks – Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley – were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses. Less than a 3% drop in asset values could wipe out a firm. To make matters worse, much of their borrowing was short-­term, in the overnight market –meaning the borrowing had to be renewed each and every day. (Financial Crisis Inquiry Commission 2011: xix)

80   Instability and chaos The growth of activity in international markets increased the instability and miscommunications about new financial instruments and presented challenges that national financial regulators were unable to control even within national economic boundaries. The changes in mortgage markets are an example of this failure of regulation at the national level, where national politicians feared being seen as ‘anti-­competitive’ and limiting the capacity of their national economies in a global market place. The lack of independence of national regulatory institutions from these political and market driven pressures is a major concern. Deregulation of mortgage lenders The most specific aspect of the creation of new financial credit products that reduced transparency and accountability and blurred risk by reselling and repackaging was the mortgage market linked to the purchase of family homes. The demand for these products can be traced to social changes in the 1980s, where neo-­liberal politicians made bold claims for the ideological advantages of home ownership as a policy method of giving the public majority a stake in the economy with a prime economic asset. This was thought to strengthen capital accumulation, and commitment and values to such an ideological system, given that more people would have a liquid asset. In the 1980s financial deregulation increased the number of institutions able to provide mortgage loans and loans were permitted on higher salary ratios (more lent against annual earnings), the type of loans available also increased from mortgages based on fluctuating base rates to fixed rate deals. Fixed rate deals appeared to offer more short term security. The percentage of capital deposit required also reduced. These changes set the way for further deregulations in the 1990s and 2000 decade. Buy-­to-let mortgages became popular and an increasing part of the UK market. From 2000 onwards a feature of the US market was selling to poorer social groups without deposit and offering up-­front incentives to promote sales, such as reduced repayments or lower rates of interest for the first few years. This created what became known as the ‘subprime’ mortgage. A growing trend of deregulation was primary lenders moving away from using depositor’s savings to finance new loans to borrowing the money from other banks and institutions and then charging a greater rate of interest on the mortgage products. Or – as in the case of mortgage securitization – the loans were sold onto other institutional investors presented as financial assets that would give a return. Underpinning the growth in the mortgage market was a belief that the financing of residential property was low risk and that the value of property was far more likely to go up than down, especially over the medium and longer term. It can be argued that some fundamentals supported such a view in the countries affected: increased immigration and population growth, smaller households due to family fragmentation and divorce, increased longevity, strong economic growth and employment levels and rising real incomes. But this was never balanced with a more holistic assessment that included inflationary global demand

Instability and chaos   81 for basic commodities like food and energy, an imbalance in the global economy that resulted in the flooding of US and Europe with cheap credit, and the likely counter-­cyclic effects. All this resulted in an adverse assessment of risk on residential loans with, at the worst point before the crisis, mortgages being sold to households who had no realistic chance of sustaining the future payments against property that was overvalued at the peak of the market. One of the most specific and immediate causes of the financial crisis of 2007–08 was the severe lack of properly functioning regulation of lending in the US mortgage market (to some extent these failures can also be argued to have been present in other countries). This was a major finding of the Financial Crisis Inquiry Commission (2011: xvii) who concluded that the crisis was avoidable and that the Federal Reserve should have acted to ‘stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-­lending standards’. Mortgage finance had become erroneously seen as a highly secure long term financial asset that could be fragmented into a variety of new financial products, including mortgage securities (pooling and relending against future mortgage repayments, based on the belief that the repayment of the original loan and its capital home value are both secure) and collateralized debt obligation (a similar process but focused on pooling of the most risky mortgage debt to maximize real returns). Once it became clear these packages of refinancing against mortgage debt were not as secure or ‘prime’ as people thought, they became labelled ‘subprime’. This was shown in evidence of loans made to families without stable incomes and where devices such as interest-­only or other forms of flexible or reduced payments (adjustable rate mortgages (ARMs)) were offered in the early stages to entice poor borrowers into the system. The reality was that many of these people would never be able to pay the full and likely real costs required. These complex and dysfunctional practices enticed front line property companies and loan sellers and linked them with both traditional and non-­traditional financial institutions who wanted to invest in housing debt. Between them these actors negotiated and invested in what they perceived as the pooling of a limited risk, the risk being limited by the rising house prices between 1998 and 2005. Their assessment of risk proved to be a catastrophic failure as it became clear from 2006 onwards that more and more households were unable to make repayments and had no hope of retrieving the money lent on a house that was declining in value, and perhaps impossible to sell. The Financial Crisis Inquiry Commission (2011: 111–117) documents a case study example of one of these pools of mortgage debt and risk, known as ‘CMLTI 2006-NC2’. This package comprised 4,499 loans that were a mix of adjustable rate and fixed rate mortgages. The average loan value was $210,536, very close to the average median US home value in 2006 of $221,900. The average length of loan was 30 years and the majority were issued between May and July 2006 shortly after US house prices peaked. Approximately 80 per cent were ARMs, with over 20 per cent requiring interest-­only payments for the first few years. The security pool had 19 tranches, varying from a triple-­A rated pool worth $282.4 million owned by the Federal Home Bank of Chicago to a number

82   Instability and chaos of smaller tranches rated as higher risk and potentially paying much better returns, but with each tranche being itself broken into several collateralized debt obligations (CDOs). The Financial Crisis Inquiry Commission analysis showed that investors from many countries were included because of the number of international banks and funds who had purchased a stake. They calculated that the most risky tranches only needed losses of above 1 per cent in order for them to lose all their stake. Parvest ABS Euribor purchased $20 million of one of the riskier tranches and became one of the BNP Paribas funds that sparked the full crisis in August 2007. The Inquiry found that the risky tranches in these mortgage securities had offered potential returns of over 15 per cent when based on a continued growth in average US housing prices that never materialized. Structuring and selling mortgage securities like CMLTI 2006-NC2 was described by insiders (former and current financial institution employees) to the Inquiry as based on a ‘bubble psychology’, that is, over-­optimistic and unrealistic expectations. It was reported as easy to find buyers for the risky high-­margin products. The fees, returns and commission for those putting the complex securities together were attractive and related to the success of selling the risky tranches. In September 2011 the US Federal Housing Finance Agency filed to sue a large number of international banks for mis-­selling $200 billion in mortgage securities (Braithwaite et al., 2011) The major failure in the regulation of mortgage lending can be argued to be correlated with the housing bubble in US house prices dating as far back as the late 1990s. The unregulated finance of subprime mortgages that precipitated the banking crisis was not the sole cause of the housing bubble although it added to unrealistic and unsustainable demand among the poorest and most vulnerable. The Financial Crisis Inquiry Commission (2011) also found that the housing bubble was inflated by local and specific population growth and land use restrictions. Inadequate information and failures of communication The miscommunication of information and the failure to analyse information satisfactorily contributed to the failures in mortgage investments. Information failure needs be highlighted as a direct cause of the crisis given the associated failure of transparency and accountability. Since the Enron and Arthur Anderson accounting scandals, new forms of accounting such as ‘mark to market’ had changed the nature of financial information in a way that had reduced the collective understanding of corporate and institutional accounts and the real value of liabilities, balances and assets presented. The failure of credit rating agencies in the 2007–08 is a specific element of this information malfunction. The three credit rating agencies Moody’s, Standard & Poor’s and Fitch were criticized extensively by the Financial Crisis Inquiry Commission (2011: 174) for having an inadequate empirical method for assessing the risk of complex financial products and for being too close to the benefits of the system when giving an upside rating.

Instability and chaos   83 Inability to assess risk The inability of all the players in the market to understand what they were undertaking with new forms of borrowing is illustrated by some of the email communications made available to the Financial Crisis Inquiry Commission. An email released by an employee of a hedge fund showed the vulnerability of the institutions and the commercial bodies purchasing the mortgage backed securities as assets which, they believed, would give a return. The ratings agencies, collateralized loan obligation managers and underwriters have all the incentives to keep the game going, while real money investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based on the news avail­ able everywhere are actually realised. (Evidence to Financial Crisis Inquiry Commission, 2011: 247) The credit rating agencies, still seen as powerful holders of information products in the global market seemed to make inadequate and erroneous assessments of risk, so that lenders in one continent would have little idea about the detailed context of the loan they were taking on in another country. Sometimes these decisions were primarily based on the ratings received from credit rating agencies, without a further assessment of the nature of the financial product and its makeup. Credit ratings agencies have been criticized for being too close to the other market players and being motivated by profiteering rather than any independent regulatory assessment (Davies, 2010). Their sophisticated financial models have been criticized for being too dependent on historical assumptions about stability and without an adequate assessment of instability and complexity and the impossibility of always forecasting the future based on past activity (Taleb, 2005). Arguably the nature of products sold under the umbrella of mortgage securitization meant that it became impossible for purchasers in institutions outside the host country to have enough information to achieve an adequate assessment of risk. This was also in part linked to fundamental erroneous global beliefs, such as a conviction that the US housing market would rise in value for much longer than any previous business cycle, but it was also related to the creative complexity of the financial products and the persuasiveness of the sale. One example of this mismatch leading to dysfunctional global trading and the failure to assess risk was the purchase of mortgage backed securities by the German bank, IKB Deutsche Industriebank AG, a traditional commercial bank which had specialized historically in dealing conservatively with German medium sized businesses. In 2002, however, they created an off-­balance sheet program called ‘Rhineland’ to try and benefit from the new global accounting and shadow banking practices and credit products. By the summer of 2007 it owned €14 billion of such products. The majority were related to mortgage securitization and many at the risky end of that market (CDOs). But the bank continued to purchase risky assets even when the 2007 crisis had taken hold and this

84   Instability and chaos resulted in 100 per cent loses on the later holdings. A witness to the Financial Crisis Inquiry Commission (2011: 247) who worked for a hedge fund implied that the German bank had an inadequate understanding of the dynamics of the new product market and was unable to correctly assess the situation so as to prevent an escalating risk to their investors. Since this revelation, the Securities and Exchanges Commission (SEC) has filed for a securities fraud action against Goldman Sachs for making materially misleading statements and omissions in connection with the selling of this collateralized debt obligation. This example illustrates the systemic problem of the proliferation of new financial instruments that occurred in the global economy from 2000 onwards and the inability of global and national regulators to keep up. It is an example of reinforcing feedback, like the spread of an illness or virus rapidly from one person to another, unchecked by the stabilizing feedback of an intervention like an inoculation that checks the feedback reinforcement. It is a premise of economics that for markets to work optimally they must have perfect information and it is clear in this situation that information, although increasingly sophisticated in its format and application, was far from perfect. Failures of political and policy leadership The immediate build up to the financial crisis of 2007–08 is notable for the failure of political leaders, regulators and senior public officials to see what was coming and, at first, to ignore both the seriousness of what was emerging and the market’s dysfunctions and excesses. At the core of this is the fact that the market place was not politically accountable, but since the 1980s had been increasingly overseen by arms length regulators who were always in danger of having more affinity with their market allegiances than their political masters. In this sense the market was more self regulating than politically regulated and this balance of regulation failed. Political accountability only kicked in when the crisis had started and was already serious in its negative public effect. It was only at this point that regulators called on politicians for decisions and stimulated debate with the political legislators where necessary. Before this, politics was distant from the issues. Politicians in the US and UK had built their reputations from the late 1990s by passively honouring the markets and taking the growing taxation spin-­offs of increased financial services activity. In the mid 1990s, George Bush experienced an influx of capital gains in the US as the stock market rose on high tech and internet expectations, and Gordon Brown saw similar fiscal revenue from the growing profits of international financial services in the City of London. Together these liberal economic approaches also encouraged more inward investment and financing to fuel feel-­good factor credit booms and to allow increased importing of other goods. There was little insight to use the revenues from the good times to keep down government borrowing. The countries diverged in the international recession of the early millennium decade following

Instability and chaos   85 the 9/11 attacks in New York. The UK rode out the brief international recession by growing its public sector while the US embarked on tax cuts (Krugman, 2004). Hank Paulson, US Treasury Secretary at the time of the crisis, initially blamed the crisis on an ‘erosion of standards throughout corporate and consumer credit markets. Years of benign economic conditions and abundant liquidity had led investors to reach for yield; market participants and regulators had become complacent about all types of risks’ (Paulson 2010: 93). Paulson’s analysis is that if the general standards of banking and finance had not been allowed to decline by regulators then the subprime market in mortgages would not have been possible, but Paulson’s analysis lacks an assessment of the political and social dynamics of the regulative system he worked in and he neglects to reflect on his personal and private interests as a previous investment banker and the reality that the regulatory and banking networks had become too closely networked, with the effect that senior regulatory staff were not sufficiently critical of market practices and values. Paulson’s experience was at Goldman Sachs Investment Bank where he had worked since 1974, had risen to become Chief Executive Officer and was a leader in its historic move to become a public company on the New York Stock Exchange in 1999. The trend of investment banks becoming public companies was itself part of financial deregulation, after the 1980s, that contributed to a growth of money raised and recycled for leverage, and an increasing emphasis on the financial services to maintain national GDP growth in countries like the US and UK. Paulson was criticized by the Financial Crisis Inquiry Commission (2011: xxi) in the context of its conclusion that: ‘the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets’. More specifically they said of Paulson’s role: Senior public officials did not recognize that a bursting of the bubble could threaten the entire financial system. Throughout the summer . . . both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson offered public assurances that the turmoil in the subprime mortgage markets would be contained. When Bear Stearns’s hedge funds, which were heavily invested in mortgage-­related securities, imploded in June, the Federal Reserve discussed the implications of the collapse. Despite the fact that so many other funds were exposed to the same risks as those hedge funds, the Bear Stearns funds were thought to be ‘relatively unique.’ (Financial Crisis Inquiry Commission, 2011: 21) Hank Paulson was also interviewed by the Financial Crisis Inquiry Commission over his role as Chief Executive Officer at Goldman Sachs in helping to precipitate the crisis. After Goldman Sachs became a public corporation under his leadership in 1999, he admitted that it had played a key role in the creation and sale of mortgage securities. Goldman Sachs had grown spectacularly in the period

86   Instability and chaos from its flotation on the New York Stock Exchange with assets valued at $1.1 trillion in 2007 (up from $250 billion in 1999). Similarly its business model was changing, with leverage up from $17.1 billion in 2000 to $32.1 billion in 2007. But its methods in the fast evolving mortgage securities market were more sophisticated than some of its competitors, as it covered its position by ‘shorting’ on a down-­turn in the housing market, a bet that made it billions in the crisis. It achieved this while being at the centre of the management and sale of the complicated mortgage securitization market with its diversity of products and inter-­selling as credit swaps. Goldman Sachs took profits on facilitating these transactions (Financial Crisis Inquiry Commission, 2011: 145). Although Goldman Sachs itself fell into some difficulty at the height of the 2008 crisis, it survived better than most and appears to have done better from having a good understanding of how the new market worked and how best to play it and analyse risk. This insight is not surprising, given that it helped create the new market. Many of its competitors emerged at the end of the crisis in a weaker position and some were taken over by stronger performers. Paulson had been at the centre of behaviour that generated the crisis. His reassurances in 2007 that the securities market would stabilize are more based on this recent experience as a wealthy investment banker than his insight as a politically accountable regulator. By 2008, Paulson was working hard from within the government to save the foundations of the economic system that had made him a multi-­millionaire only a few years before. He was a man trying to control a monster of his own making. Some have contrasted the lack of political and regulatory leadership before the crisis with the forthright actions and decisions that emerged in the midst of crisis (Financial Crisis Inquiry Commission, 2011). Paulson and Bush have received some accolades for their course of action in 2008, especially given their willingness to embrace the seriousness of the crisis and commit trillions of dollars of US public money to keep the world markets open (The Independent, London, 13 September 2008). Both have stated this was against their ideological convictions but saw it, paradoxically, as the only way they could keep American capitalism alive. Brown’s memoirs (2010) also describe a reluctance to rescue failing private banks with public money, but there is less ideological distaste for nationalization given his Labour party roots. Brown and Bush were praised for coordinating global action in the autumn of 2008 onwards and for including the full G20 where possible to represent the newly emerging strong growth economies. Brown also worked to include the major European economies in recapitalization and asset protection, given that the EU countries had historically been more sceptical of the Anglo-­Saxon approach to financial deregulation. Many had failed to understand the market liberalization they were promoting. Increased instability was created by massive movements of electric money transactions around the globe (what Brown described as ‘capitalism without the capital’). The cronyism of politicians and regulators with the leaders of financial institutions sustained the dominant culture and pervasive values of marketization, so that it was possible for bankers to promote unethical profiteering by selling financial products that had little transparency

Instability and chaos   87 and regulation (Carr, 2009: 18). The developed world’s leaders should have learnt from the similarities in the US Enron scandal when worthless markets were created and sold on the basis of nothing but creative ideas, but they did not. It was this culture that gave reinforcing feedback to the shadow banking world with its new transactions and products, allowing securitization and hedge funds to sell without accountability. Unchecked reinforcing feedback in a system often leads to a later collapse or destruction. The result was that there were many losers and little of real value was produced. It is therefore unsurprising that both Bush and Brown’s political regimes were rejected by their countries’ electorates in 2009 and 2010. Dysfunctional government policy Similar to the criticism that political leadership failed in the years before the crisis, commentators have blamed an overall failure of policy concepts and policy advisers to see the problems developing. Robert Peston, the BBC business editor who was first attributed with reporting the banking crisis in Britain to the media as the run on the Northern Rock bank took hold, notes the numerous policy failures in the UK that contributed to the resulting crisis: • • • • • •

Unchecked large increases in average household debt, rising to 180 per cent of disposable income; Public expenditure was allowed to grow faster than GDP; Productivity improvements were too dependent on the importing of cheap migrant labour; Lack of regulation of takeovers and mergers, with takeovers often motivated by trying to reduce global competition and competitive accountabilities; Weak regulation of financial services that created economic destabilization such as hedge fund and private equity activity; Low rates of taxation for the highest earners, including a minimum on their capital gains. (Robert Peston’s Blog, Friday, 4 February 2011, ‘Britain: A Land fit for multinationals?’, www.bbc.co.uk/blogs/thereporters/robertpeston/)

Government economic advisors were criticized for being too influenced by classical and monetary models. Similarly, business financial investment models were not properly scrutinized or challenged (Taleb, 2007). Government economic and policy advisors were too in awe of their colleagues and counterparts in the private banks and institutions and seduced by the paradigm of marketization and its supremacy of market values, this over the collective aspirations of government. Policy makers and advisors in developed countries held onto the primacy of a single economic policy vehicle of using interest rates to control inflation and did not realize that low rates were associated with inflows of surplus capital from developing economies. These surpluses were not reinvested effectively. The use of other policy vehicles in developed countries, such as trade and industry, and

88   Instability and chaos fiscal policy, were largely ignored, apart from secondary consideration of labour market supply and flexibility. The inherent dangers of depending on a consumer economy that was based on rising house prices and cheap leverage were ignored by policy makers. Global trade and capital imbalances Wolf (2010) argues that Asia must share responsibility for the crisis because of the unwillingness to increase the value of their currencies against the US dollar and to allow increases in domestic consumption. Fleming (2011: 33) argues that the instability of the late 2000 decade was created by a major imbalance between developed and developing countries, especially the UK and US, which developed big current account deficits dependent on financial services built on overseas investment. Research at the US National Bureau of Economic Research suggests that the asymmetry of global current account deficits and surpluses and the current lower growth in the US will lead to a slow rebalancing between the US and China (Edwards, 2007; Feldstein, 2011). Historical macroeconomic research shows that persistent large deficits are associated with slow growth (Edwards, 2005) and a real depreciation of currency (Freund and Warnock, 2005). Edward’s research (2006) showed that abrupt adjustments were more likely to be avoided in countries with flexible exchange rates and a depreciation in exchange rate would increase the chances of gradual adjustment and correction of a deficit. Excessive profits Turner (2008) criticizes the lack of labour power in the era of increasing global capital flows because large multinationals were permitted to profiteer by moving money and resources at ease and to where labour costs were low. The low-­wage economy in China produced a large imbalance of surplus credit and a resulting flow of high profits and cheap money exported to the West, but this did not result in a rapid rise of wages given the lack of human rights in China. The fundamental solution proposed by Turner (2008: 192) is a more equitable balance between ‘capital and labour’ to prevent such speculative flows. Some isolated strikes and worker protests have begun to occur in China in recent years. Similar commentators have argued that economic globalization resulted in inadequate tax revenues for national governments from the most profitable businesses, especially those that are multinational and able to move their offices and tax liabilities to seek the best geopolitical advantage. Tax avoidance and tax havens were a major concern of European governments in the G20 (2009a, 2009b, 2009c) negotiations in 2009, with these governments wanting to put as much emphasis on the reform of such tax avoidance as continuing to create publicly funded bail outs. Brown (2010: 124) was particularly concerned about the manner in which international companies used small and ineffective political states as tax havens:

Instability and chaos   89 Financial institutions were using them [tax havens] to avoid tax on a huge scale and that tax havens – which are of course – regulatory havens were facilitating a regulatory race to the bottom that continually threatened the legitimate interests of the more fastidiously regulated nations. Exchange rate values Fluctuations in currency markets created unstable and unpredictable exchange rates in a world with very high amounts of international trade. This was seen by observers as symptomatic of a world drifting close to a full scale global economic crisis (Krugman, 2008; Stiglitz, 2002). Exchange rate fluctuations are a key cause of market instability that can result in real costs and loss of value to economic and social systems. Much of the reason for the abundance of the liquid credit in the US immediately before the crisis was the use of the dollar as the default trading and reserve currency of the world, with many countries trying to peg their currency values to it for stability, albeit some successfully and some unsuccessfully. China, in particular, had for a number of years exercised a monetary policy of pegging the yuan to the dollar. This kept its labour costs artificially low and further resulted in jobs migrating from TCs in developed countries to China. The persistence of developing economies in building up their dollar reserves played a part in assisting interest rates in the US to remain low at a time when the dollar was declining against the euro. Wolf (2010), Krugman (2008) and Stiglitz (2007) note that this practice of building up dollar reserves resulted from the trauma experienced by South American and Asian countries in previous crises, when newly industrialized governments had insufficient buffers to protect themselves against sudden capital outflows and the selling of local currencies and the tough rules and negotiations of IMF bailouts. These ‘safe’ dollar based currency investments were therefore rational attempts to stabilize their local systems given the instability of the global market place.

Conclusion: the crisis as instability and chaos An application of the concepts of chaos and complexity theory to the market chaos of 2008–09 illustrates the failure of the methods used by credit ratings agencies and banks, and more fundamentally reveals the instability in the global financial systems and the inability of global market forces to create a short term equilibrium and balance of trade. Mandelbrot and Hudson (2008) put forward a thesis about the failure of international banking and commercial quantitative financial models to predict the numerous periods of instability that free markets experience. Similar to Taleb (2005), they argue that many commodity and asset prices suffer significantly more periods of instability and unusual price change events than conventional statistical financial theory suggests. Taleb (2007) refers to major falls or spikes in prices as ‘black swans’ and notes they are unpredictable and more frequent than market analysts believe.

90   Instability and chaos Historical case studies also reveal this inherent market instability and its possible catastrophic results. The road to the 1929 crash that preceded the Great Depression of the 1930s has some stark similarities with the events leading up to the 2008 crash (see Galbraith, 1992). Krugman (2008) has also argued how the consequences of market instability assisted by global movements of unregulated capital had produced negative economic and social consequences for some individual nations for many years well before the crisis of 2008. Skidelsky (2010) notes that Keynes’ fundamental view of political economy was that markets and market investment are inherently unstable and short term. As a result the market needs government intervention to bring stability and a long term view. He contrasts this with contemporary monetary economic theory that argues markets automatically seek stability via equilibrium in demand and supply. For Skidelsky, the current economic crisis illustrates the failures of classical monetary theory and its applications. Change, that is stable, is likely to take more time to affirm than short term policy that merely leads to increased instability and uncertainty. The investment and training that built China into the world’s manufacturing powerhouse of exports took several decades to mature. Similarly the recent revivals of German manufacturing competitiveness and exports are argued to have taken a decade to achieve from 1999–2010, characterized initially by stubborn unemployment and a lack of consumer spending (Fleming, 2011). Table 4.3 evaluates the crisis intervention policies using the complex systems framework proposed in Chapter 1. The ideological paradigm of most developed governments has been to try and maintain market operations as long as possible and to deal with market failure by negotiating market solutions, such as takeovers by stable institutions or capital injections by the state. There is little regard for the long term effect these actions will have on reducing competitiveness and efficiency. Government finance is used to leverage market deals rather than for the fundamental takeover of market operations with direct government management. Micro government management is seen as ideologically unacceptable. As the crisis worsened governments had to inject more public money into the failing market institutions to maintain the primacy of the market and when public ownership became necessary this was kept at ‘arm’s length’ from politicians and the state. In effect the market and its principles of ‘business’ operations were always seen as preferable and more effective than the establishment of government economic planning, despite the alternative values of public service and the public good. This ignored the fact that the fundamental cause of the crisis was market behaviour of reinforcing feedback (often motivated by greed and short term individual gain) which was not checked by regulation and forms of stabilizing feedback. System rules failed in the crisis. As the FCIC noted, there was an inevitability of financial disaster: ‘What else could one expect on a highway where there were neither speed limits nor neatly painted lines?’ (Financial Crisis Inquiry Commission, 2011: xvii). Although some rules had been in place they failed to be used as appropriate levers and mechanisms in the market system before the crisis. In part this was

Instability and chaos   91 because the actors in the regulator agencies predominantly shared the classical market values of the private sector actors. In some cases staff had studied on the same degrees at the same universities and moved between financial institutions like investment banks and regulatory agencies. The appointment of Hank Paulson as US Treasury Secretary illustrates this clearly. Paulson is documented negotiating with his old bank cronies while in a new role as US Treasury Secretary and therefore helping to decide the fate of his previous competitors. He had previously been at the helm of one of the most aggressive and predatory institutions, Goldman Sachs, in terms of making large profits from new creative investments like mortgage backed securities. This followed lobbying to reduce transparency and accountability. Goldman Sachs continued with these behaviours after Paulson left and the bank is now subject to court proceedings from the US Securities and Exchange Commission (but not Paulson, whose leadership predates the prosecution). The system failed to check the reinforcing feedback that developed first in house purchases and household mortgages leading to escalating house prices. It failed to check the reselling and repacking of mortgage assets in securitization that were used to raise more leverage to encourage more house buyers to take out mortgages despite their lack of income. There was a failure of stabilizing feedback from the system to prevent this reinforcing feedback being amplified: there were insufficient checks on risk at every level from the poor householder buying an inappropriate mortgage through to financial institutions buying a mortgage backed security from an investment bank without investigating what they were buying. There was insufficient use of operating parameters to stabilize the system: interest rates were set too low, too much money was lent against assets and loans were made to those with not enough income to ever pay them back. There was an inability of policy makers to set boundary parameters around the behaviour of the system. This promoted instability. There were fundamental failures of information within the system. Much information was false, for example the advertising of financial products and assets and their likely returns. Risk assessments were erroneous. Prices gave no rational measure of value and cost. Ultimately there was a collapse in confidence in information about the system and no-­one believed the information they were getting. The sharp rise in the interbank lending rate during the crisis illustrates this. The government had to restore confidence in information to help the system to recover and for communications to begin to function again. There was an inability of policy makers to respond with appropriate policy at the correct levels. National policy makers continued to focus on a model of business finance that ignored the fact that instability could move rapidly from one level to another. Policy makers wrongly believed that major imbalances in the global economy would self correct easily via an open market rather than create destructive reinforcing feedback in the exponential flow of goods and money into the US and Europe. This was not only confined to house purchase and mortgage based investments. The reinforcing feedback spread to speculation in the commodities and energy markets. Banks over-­invested in euro denominated

Failure of global and national systems to see dishonesty of new market investment products

Regulators fail to intervene to prevent destructive escalation of reinforcing feedback. Collapse of mortgage backed securities, linked to collapse in house prices

Early indications of chaotic instability are that some Strong negative reinforcement comes via loss of confidence investors becoming more cautious and risk adverse and banks refusing to lend as they seek to avoid further risk. Government has to provide capital and restore confidence to keep system functioning

Limited restrictions and ineffective use of parameters to control system

Decisions based on erroneous and dishonest information

Lack of local controls on household borrowing, lack of local incentives to check credit decisions. Inconsistent global financial controls on exchange and flow

Regulators are ex-bankers with similar background. Regulation is dominated by values of marketization, not enough diversity in values and ideas in the system, so inadequate checks and balances

System rules

Reinforcing feedback is unchecked and promotes major instability. A failure to intervene

Stabilizing feedback

Setting operating parameters

Use of information

Managing ‘levels’

Leading self-organization

Governments and international organizations begin to explore new regulator regimes, but not enough questioning of fundamental purpose of markets and their political and social value base. Inadequate focus on banking ethics and values

Global persuasiveness of market paradigm and values means governments focus on macro solutions to save private institutions, rather than more localized capital and credit controls and regulations

Information failure creates complete loss in confidence in information, so governments intervene

System becomes more and more unstable, resulting in panic use of parameters (very low central bank interest rates)

Unchecked reinforcing feedback results in market ceasing to function, due to lose in confidence in market information

Debate begins on how best to change the rules, with capital to leverage ratios to be increased post crisis

Crisis intervention to save the market system. A focus on capitalization and liquidity of banks through public funding, while banks retain their independence with ‘business as normal’

Market values (marketization) dominate society and pervade political and public policy. Markets create new forms of investment and leverage to raise profits

Ideological paradigm of operation

Crisis intervention

Pre crisis development

Intervention

Table 4.3  Systems interventions in 2008–09 crisis

Instability and chaos   93 bonds. Policy makers failed to see that inflation was artificially low because of the low cost of labour and imports flowing from Asia to the West. Central bank interest rates were often too low, rather than being raised to offer some stabilizing feedback to the overheating system. Finally there was a failure to create a diversity of professionals and front line organizations that could effectively regulate the system. The globalization of the major economies meant that certain socially undesirable behaviours and values dominated and the majority chased the same rewards. Large bonuses were paid that appeared to increase the motivation for professionals on the front line to take very risky decisions. Lewis (2010a: 256) summarized the power of deregulated investment bankers to exploit this system failure: The people on the short side of the subprime market had gambled with the odds in their favour. The people on the other side – the entire financial system, essentially – had gambled with the odds against them. There was insufficient diversity in accountability models and ethical approaches. Greed and dishonesty prevailed. Those that did follow an alternative model based on conservative stability survived better, even though they were ill judged before the crisis for not leveraging more to secure what were perceived to be effortless returns.

5 Intervention The policy response

Introduction Chapter 4 documented and analysed the events of the financial crisis in 2008 and the immediate government responses to save a number of large failing financial institutions by purchasing toxic assets, exercising their role as a lender of last resort and taking a reluctant national ownership of financial institutions. These measures developed very rapidly in response to crisis events and were clear examples of crisis management. This is illustrated by the narrative of the key players in their autobiographies (for example, Bush, 2010; Paulson, 2010; Brown, 2010; Darling, 2011) and in the text of immediate inquiries after the events of the autumn of 2008 (see FCIC, 2011; House of Commons Treasury Committee, 2009a, 2000b; Turner, 2009). This chapter looks at the more systematic and continuing development of policy interventions through 2009 and into 2010, with a particular reference to the immediate consequences on the economies affected and the evolving development of longer term government policy and interventions. This period is characterized by a reduction in the periods of instability in global markets, but still a sense of overall crisis and a lack of foresight about where the global economy is heading, with heightened anxieties about the localized social and political impact. More routine policy analysis and implementation begins to be deployed during this time period, with more opportunities for the normal processes of reflection and debate, but in part this return to routine policy deliberation within nation states limited the opportunities for swift global cooperation and consensus, such as was forged in the fear of the 2008 crisis.

Economic recovery In the period of reflection, after the crisis was stabilized in the autumn of 2009, world leaders from the countries whose banks had caused the crisis laid claim to the reward that they had saved the world from depression and that the ensuing recession was ‘not as bad’ as the 1930s slump that followed the 1929 Wall Street Crash. But it was soon apparent the recession was the worst since the end of Second World War and more damaging for many countries than the recessions

Intervention   95 of the mid 1970s, the early 1980s and early 1990s. Government policy shifted from crisis management to economic recovery and restoring growth. The examination of policy immediately after the financial crisis, and the ability of policy to move countries out of recession and back to growth are considered in this chapter, with attention to the following aspects: global coordination, neo-­ Keynesian policy, monetary policy, bank regulation and nationalization, and trade. Table 5.1 summarizes the main policy events during 2009–10. Political change was a feature of the policy environment with several changes in government in the countries experiencing national elections after the crisis. Inevitably political parties in office were likely to find it hard to secure popularity and re-­ election if they had been in office during the crisis. For example, George Bush was replaced as US President in January 2010 by Barack Obama, who had been elected the previous autumn. In the UK, Gordon Brown was replaced in May 2010 by David Cameron who headed a coalition government.

The 2009 recession Following the emergency government interventions in 2008 to allow major global financial institutions to survive, the depth of the recession in the global economy became evident in 2009. Unemployment grew in many countries and Table 5.1  Policy responses and developments in 2009–10 January 2009

President Barack Obama becomes 44th President of the US and Tim Geithner, US Treasury Secretary

17 February 2009 President Obama signs the American Recovery and Reinvestment Act, creating a $700 billion stimulus in tax savings and government spending April 2009

G20 summit in London – demand side stimulus agreed primarily via increased lending from the IMF to economies outside the G20

September 2009

G20 summit in Pittsburgh – reform of IMF and World Bank discussed

May 2010

David Cameron becomes Prime Minister of UK, leading a coalition government. Announces that cuts to government debt will be the major priority via an austerity programme for public services

16 June 2010

UK government sets up Independent Banking Commission, chaired by Sir John Vickers

June 2010

G20 summit in Toronto – Leaders unable to agree a bank levy or bank tax to be applied globally on all transactions or on previous balance sheets

21 July 2010

President Obama signs the Dodd-Frank Wall Street Reform Act aiming, via the development of new regulation, to promote financial stability by improved accountability, to end the selling of unfair financial services and to end the need for large government bailouts

November 2010

G20 summit in Seoul – focus on energy and renewables and economic growth in poor nations

96   Intervention economic activity slowed. Brown (2010) described the period at the end of 2008 as having got the global economy ‘out of the emergency room’ so that in the autumn of 2009 the focus moved towards longer term ‘critical care’ to keep it healthy and moving into recovery. Paulson (2010: 432) also noted the easing of the intensity of the crisis: Bankers throughout the country were telling me that the earnings environment had improved significantly in January (2009). It didn’t surprise me that the banks could make good money with the government support programs and low interest rates. What surprised me was that it had taken so long. The major global banks were rescued, but much of the world was in recession during 2009 and so policy had to shift towards preventing the recession from becoming a prolonged depression. Table 5.2 shows the annual percentage falls in the level of GDP in OECD countries in 2008–09. In 2009, the year after the banking crisis, GDP output declined in all OECD countries with the exception of Australia, South Korea and Poland (although even in these countries growth was below 2 per cent). Ten of the OECD countries experienced greater than a 4 per cent loss in output between 2008 and 2009, including the large global economies of Japan, UK and Italy. Ireland experienced the greatest decline in output, above 10 per cent of GDP. Table 5.3 demonstrates the falling value of house values in a selection of OECD countries in 2008–09, ranked by the countries with the largest fall in prices. Ireland is again at the top of the table with a decline in house prices of 21.7 per cent. Six countries experienced declines in house prices greater than ten per cent, including the US and UK. Table 5.4 shows the percentage of the working-­age population unemployed in the 2008 and 2009, and ranked by the largest percentage increase in unemployment between 2008 and 2009. Unemployment increases in all countries in 2009 by an average of 2 per cent, but with a considerable variation. Six countries experience a rise in unemployment above 3 per cent during 2009, including the US and Spain. By 2009, nine countries had unemployment levels at 10 per cent or above. This demonstrates the severity of the recession in output that followed the financial crisis.

Global coordination One of the spectres hanging over the leaders of the world’s strongest economies in 2009 was the fear that many of their countries would fall into the liquidity trap experienced in Japan during its so-­called ‘lost decade’ of the 1990s. A liquidity trap is when changes in the money supply – for example, setting lower central bank interest rates – do not increase aggregate demand. This is because there is perceived to be no psychological or market incentive for consumers and firms to borrow more and to continue to spend. This has also been called a ‘balance sheet recession’, where the priority of the majority is to pay down debt (Koo, 2008). There is a lack of confidence in the market and an anxiety about taking any risky

Intervention   97 or innovative action (Galbraith, 1992). Instead the focus is on paying down previous debts. Krugman (2008: Ch. 3) and Turner (2008) argue that Japan acted too slowly when its bank crisis first became clear in 1990–91. Although capital was injected into the banks this failed to stimulate lending and subsequent reductions in interest rates also failed to stimulate demand. At the point of zero interest rates being set, little more could be done with monetary policy. Instead the Japanese government had to move to fiscal policy and the borrowing of money to undertake public work programmes. So a key policy aim in 2009 for Western developed governments coming out of the immediate crisis was to get banks lending again to consumers and businesses. For this reason politicians and central bankers wanted to continue to keep interest rates low, particularly in the indebted nations. Table 5.2 Percentage changes in annual GDP in 2008–09, ranked by largest drop in output

Ireland Finland Italy Japan Denmark Sweden Hungary Iceland UK Slovenia Germany Spain US Portugal France Netherlands Canada Belgium Austria Czech Republic Greece Norway New Zealand Switzerland Slovak Republic Chile Australia South Korea Poland OECD average

2008

2009

2008–09

–3.5 0.9 –1.3 –1.2 –1.1 –0.6 0.8 1.4 –0.1 3.7 1.0 0.9 0.0 0.0 0.2 1.9 0.5 1.0 2.2 2.5 1.0 0.8 –1.1 1.9 5.8 3.7 1.1 2.3 5.1 0.3

–7.6 –8.2 –5.2 –5.2 –5.2 –5.3 –6.7 –6.9 –4.9 –8.1 –4.7 –3.7 –2.7 –2.5 –2.6 –3.9 –2.5 –2.8 –3.9 –4.1 –2.0 –1.4 0.8 –1.9 –4.8 –1.7 1.2 0.2 1.7 –3.4

–11.1 –7.3 –6.5 –6.4 –6.3 –5.9 –5.9 –5.5 –4.9 –4.4 –3.7 –2.9 –2.7 –2.5 –2.4 –2.0 –1.9 –1.7 –1.7 –1.7 –1.0 –0.7 –0.3 0.0 1.0 2.0 2.3 2.5 6.8 –3.1

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

98   Intervention G7 and G20 Trying to negotiate a medium and longer term global solution to the financial crisis necessitates a move towards a better coordination of global policy with countries collaborating over their policy activities. This should allow the countries carrying the greatest debts to rebalance via policy combinations of increasing capital and savings, a growth in exports, devaluation of their currencies and making cuts in public borrowing. Conversely this would rely on the countries with surpluses, importing and consuming more. They would promote consumption rather than saving, increasing the value of their currencies and investing more in public and social programmes (G20, 2009b; Kaletsky, 2010; Rajan, 2010). The widening of the G7 to include the G20 was an element of trying to achieve this gradual balancing, as it involved incorporating some of the fasting growing economies and those with the biggest surpluses, in particular China, Brazil, India and Russia, into global economic strategy. In reality, such a high degree of coordination was not going to be possible in the short term given the ideological and motivational differences between nations and differences of interpretation from economic analysis about the speed of such rebalancing. A clear indication of the difficulties of such planned coordination was the argument between the US and China over exchange rate policies in 2009–10 when American politicians, joined by some US economists, called Table 5.3  Percentage real house price changes, 2008–09, ranked by largest decrease

Ireland Denmark UK New Zealand Spain US France Norway Italy Japan Finland South Korea Germany Netherlands Sweden Australia Canada Belgium Switzerland

2008

2009

Combined

–11.6 –7.4 –3.9 –7.7 –3.2 –6.2 –1.6 –4.5 –1.4 –2.0 –2.8 –0.5 –0.7 1.5 0.4 0.7 –2.8 1.6 0.0

–10.0 –13.2 –9.0 –4.0 –7.7 –4.1 –6.7 –0.6 –3.5 –1.7 –0.8 –2.3 –1.0 –2.7 –0.3 0.3 4.0 0.1 5.5

–21.7 –20.6 –12.9 –11.7 –10.9 –10.3 –8.3 –5.1 –5.0 –3.7 –3.6 –2.8 –1.8 –1.2 0.1 1.0 1.2 1.7 5.5

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

Intervention   99 for a fall in the value of the Chinese yuan, which was being deliberately pegged against the dollar by China’s policy of purchasing foreign exchange reserves and restricting the international trade of the currency. Global agreements on banking reforms Similarly, global agreement on banking reform did not prove easy to progress in 2009. Europe focused on the idea of a bank levy on profits to achieve some repayment against the cost of the crisis, while the US developed a longer term Table 5.4 Percentage of working-age population unemployed, ranked by largest increase between 2008 and 2009

Estonia Spain Ireland Iceland US Turkey Denmark Slovak Republic UK Czech Republic Sweden Hungary Canada New Zealand Finland Portugal Chile Greece France Mexico Slovenia Australia Japan Poland Italy Austria Belgium Netherlands Switzerland Norway Korea Germany Luxembourg OECD average

2008

2009

% increase

5.6 11.4 5.8 3.0 5.8 11.2 3.4 9.6 5.4 4.4 6.2 7.9 6.2 4.3 6.4 8.1 8.0 7.8 7.4 3.6 4.5 4.3 4.2 7.2 6.8 3.9 7.0 3.0 3.4 2.6 3.3 7.6 5.1 5.9

14.1 18.1 12.2 7.4 9.4 14.3 6.1 12.1 7.8 6.8 8.5 10.1 8.4 6.3 8.4 10.0 10.0 9.6 9.1 5.4 6.0 5.7 5.3 8.3 7.9 4.8 8.0 3.9 4.2 3.2 3.8 7.8 5.2 8.1

8.4 6.7 6.5 4.4 3.5 3.1 2.7 2.5 2.5 2.3 2.3 2.2 2.2 2.0 2.0 2.0 2.0 1.8 1.7 1.7 1.5 1.4 1.1 1.1 1.1 1.0 0.9 0.9 0.8 0.6 0.5 0.2 0.1 2.2

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

100   Intervention approach designed to systematically revisit every level of federal regulation. The IMF (2010: 24) report to the G20 meeting at Toronto in June 2010 (commissioned by the G20 at the previous April summit) concluded: The least distortionary way to recover the fiscal costs of direct support would be by a ‘backward-­looking’ charge, such as one based on past balance sheet variables. This would define a fixed monetary amount that each institution would owe, to be paid over some specified period and subject to rules limiting the impact on net earnings. Nevertheless, an agreement was not reached by G20 leaders and ministers and the European delegation subsequently decided to seek their own separate approach towards the details of reform. The Committee of European Banking Supervisors subsequently issued guidelines intended to limit cash bonuses to bank employees to a maximum of 30 per cent of pay, with any further benefits paid in shares and deferred. In late 2010, the new coalition government in the UK announced a £2.5 billion levy on its banking industry, with the Minister for City of London Finance explaining that the tax was designed to encourage bankers to avoid taking excessive risk. The move was treated with distain by political campaign groups wanting major reforms; they claimed the UK banks could afford to pay ten times as much at £20 billion per year (Treanor, 2010a: 40). Exchange rates Following the immediate crisis of 2008 the G20 became less homogeneous in their views and approaches and less willing to deliver macro policy in a coordinated way (such as moving interest rates in tandem). History will see the coordinated actions of the autumn of 2008 as exceptional and symptomatic of the scale of disaster that the global economy faced. After 2009 the G20 was in increasing danger of becoming a talking shop that avoided the ‘elephant in the room’ – competitive devaluations and the failure of isolated national monetary policies. Figure 5.1 shows the distortions in international exchange rates that stubbornly persisted after the 2008–09 crisis, as analysed by The Economist ‘Big Mac Index’. This model assesses the percentage overvaluation or undervaluation of currencies against the US dollar based on the variable price of a Big Mac in different countries. Without international agreement on realistic currency values and trading boundaries, exchange rates remained prone to instability (Wolf, 2010). Skidelsky (2010: 183) argues the growing currency reserves of rapidly developing countries like China are a hording of liquid cash that is deflationary: ‘any deeper form of reform must address the twin problems of reserves and exchange rates.’ The crisis for the euro and long term uncertainty over the US economy pushed traders towards purchasing the Swiss franc and Japanese yen in the autumn of 2011, events that were cited as more examples of competitive devaluations. The Swiss National Bank moved decisively to intervene and try to  limit the rising value of its currency (Beattie, 2011: 11). Central bank

Intervention   101 interventions in the currency markets, like the purchase of foreign currency reserves, are a form of policy risk management, offering economies a form of insurance and buffer against the instabilities of globalization, but on the downside they can create instabilities and reduce the likelihood of investment in production and trade. The instability and distortions in exchange rates are a core contributor to current global economic problems given the toxic mixture of some

Norway Switzerland Denmark Sweden Euro members Brazil Israel Canada Australia Hungary Turkey Czech Republic UK New Zealand USA Japan Singapore Chile South Korea Poland Peru Saudi Arabia Mexico South Africa Egypt Taiwan Russia Indonesia Philippines Thailand Malaysia Hong Kong Argentina China �60

�40

�20

0

20 Percentage

40

60

80

100

120

Figure 5.1 Percentage undervaluation and overvaluations of currencies against US dollar, based on The Economist’s ‘Big Mac Index’, January 2010 (source: The Economist (2010) Pocket World in Figures, 2011 edition, page 37).

102   Intervention countries with controls and some countries without. Elliot (2011) concluded that the policy solution is either a floating system, or a fixed rate system using a basket of currencies, but for either to work it would need to be agreed by all the major developed and newly developed economies in both East and West. The current mix does not work and allow for trade to balance. Basel Committee on Banking Regulation Reform The Basel Committee on Banking Reform is part of the Bank of International Settlement. They have recommended that from 2012–13 banks should not be permitted to count capital located in their insurance subsidiaries as capital that is available to their mainstream banking operations. This was viewed as too risky an accounting practice and hence should be outlawed (Wachman, 2010a: 37). This is part of the Bank of International Settlement’s continuing work to negotiate and lead on banking reforms that ensures global banks hold higher capital to leverage ratios. Changes in capital to leverage ratios are also being implemented separately within nation states through their own regulatory mechanisms. Restoring good capital ratios to banks has the consequence of making it more difficult for them to lend. So while politicians and policy makers have little sympathy for banker’s dilemmas there is an inevitability that they will find it hard to lend while rebuilding their capital buffers.

Neo-­Keynesian policy Given the difficulties in coordinating a global rebalancing of trade and capital flows, governments also needed to consider the use of fiscal policy to stimulate demand in the recession of 2009 (Krugman, 2009; Skidelsky, 2010). Instead, most governments preferred to remain focused on monetary policy, hoping that maintaining low interest rates and the availability of credit would stimulate demand in new innovations, products and services that would move the world economy onto a fast track to growth. The paradigm of the market providing the primary solution continued to take preference although some politicians clearly aspired to increase innovative renewable energy projects and high-­ speed broadband internet with the associated software and services that this might promote. The insolvency of governments, or at least their perceived insolvency, made them reluctant to embark on large scale investments in public works as advocated by Keynesian economists such as Krugman (2009) and Skidelsky (2010). In America there was a policy approach more recognisable as neo-­Keynesian. President Obama led policy based legislation in the American Recovery and Reinvestment Act to create a $700 billion stimulus in tax savings and government spending, with the capital projects to include road building and green energy projects. Although government capital projects had been increased by the UK government under Prime Minister Brown in 2009, these were cut back by the new coalition government in 2010.

Intervention   103

Banking regulation and nationalization Governments were reluctant to use their direct political power to influence the behaviour of the banks that had become majority or partly owned by the state. In the UK this caused some embarrassment when the nationalized bank RBS leant money to the US TC food manufacturer Kraft for it to take over a national confectionary brand Cadburys. Promises to protect UK factories and jobs did not fully materialize as Kraft sought to use the takeover to consolidate the market share of its strongest brands (Business Innovation and Skills Committee, 2011). Similarly in 2011 the human rights group Amnesty International launched a major campaign to stop the nationalized bank investing in the production of cluster bombs. The ideological priority was seen as returning banks to independent market operations without any broad political interference, or use of the bank to achieve socio-­political objectives. In June 2011, the UK Chancellor George Osborne, announced that the government intended to return the nationalized bank Northern Rock to the private sector as soon as possible, even though commentators were predicting such a quick sale would most likely generate a loss. An earlier independent report by the UK National Audit Office (2010) had predicted that it would take many years for the government to release all its banking assets back into the private sector, in part because of the scale of the operation (given the size of the UK government holdings) but also because of the time it would take for banks to recapitalize and increase in value. Given the limited ability of global cooperation after 2010 to achieve coordinated banking regulation and reforms, national governments pursued their own approaches given that the issue had become highly politicized in the countries that had experienced national elections. Media and pressure groups campaigned for regulation and sanctions on bankers’ bonuses and pay. For example, Brown (2010: 106) concludes on UK banker pay: We can now detail in the most precise terms the cost of excessive remuneration at the expense of adequate capitalisation. We now know that, if British bankers had paid themselves 10 percent less per year between 2000–2007, they would have had more capital, some £50 billion more, to help them withstand the crisis. The extent of the undercapitalisation of our banks was £50 billion, and that was exactly the sum put up by the taxpayers for the emergency stabilisation of our banking system. While there was some ongoing debate about the extent to which high pay and bonuses had caused the crisis, the banks resisted change; they argued that they were determined by a global market that justified high rewards and they threatened that if one country went alone on regulating and limiting the personal gains of investment bankers the result would be that banks would simply move to countries where conditions were more liberal. Many were unconvinced by this argument. A press release in December 2010 in the UK was picked up by several newspapers and it quoted a survey of bank employees. The results claimed that

104   Intervention nearly half expected their bonuses to be higher for the year despite the down-­ turn in bank fortunes and that many would leave and seek employment overseas. It was reported that UK banks had already sought to deal with managing the expectations of lower bonuses by awarding average annual pay rises of up to 17 per cent (Bawden, 2010: 21). In the lead up to the UK general election of May 2010, all political parties sought votes with promises of banking reform and dealing with excessive bankers’ bonuses. The coalition government formed as a result of the election between the Conservative and Liberal Parties announced in their published ­coalition agreement that banking reform would follow, but differences then emerged between the two parties about what the nature of this reform should be. One Liberal Treasury spokesman Lord Oakeshott declared soon afterwards: ‘Breaking up the banks and making them lend is a critical part of why the Liberal Democrats are in the coalition’, implying that nationalized large banking institutions would be fragmented and result in more competition in consumer and business interests (Guardian, 9 August 2010). EU competition authorities had already instructed the nationalized Royal Bank of Scotland to sell off branches and the part nationalized Lloyds to sell up to 600. Numerous rumours circulated in the UK media in the summer of 2009 suggesting a number of businesses were keen to try and finance new small retail banks in competition with the large multinationals. Expensive bank takeovers and mergers had been a key element in the build-­up to the financial crisis in the UK, with the Royal Bank of Scotland first taking over NatWest in 2000, while keeping that brand separate, and then paying billions for its part share of the Dutch bank ABN AMRO in 2007, immediately before the collapse of the banking sector. During the global political negotiations of 2008 at the epicentre of the financial crisis there were widespread concerns about the size of the remaining institutions who in a number of cases had been politically encouraged to take over failing rivals. Therefore a long term goal was to create more competition when economic circumstances allowed and to give consumers and firms who choose which bank to use more direct information and transparency about the risk and leverage of the institutions they were approaching. By the end of 2010 the UK National Audit Office (2010) concluded that the nationalized UK banks had borrowed a total of £124 billion in cash during the preceding year. Barack Obama took office as 44th US president in January 2009 and continued to seek banking reform in much the same way as President George Bush, with advice and lobbying coming directly from the bankers themselves (Hutton, 2011a: 38). Tim Geithner, who had served under Hank Paulson, became US Treasury Secretary. This approach of staying close to banking expertise provided continuity from the Bush administration, but was similar in approach to the appointment of Hank Paulson to US Treasury Secretary by George Bush immediately after he had become a multi-­millionaire as CEO of Goldman Sachs. In the post-­crisis US Financial Crisis Inquiry Report it had emerged that Goldman Sachs had been one of the leading designers of mortgage backed securities and the wide range of dangerous investments developed from them. Eighty years

Intervention   105 previously Goldman Sachs had been at the centre of controversy over the causes of the 1929 crash and its aggressive selling of investments that later crashed spectacularly (Galbraith, 1992). New governments and their politicians continued to struggle to separate themselves from an entanglement with former bankers in the political elite. Since Obama became president, only limited progress has been made in negotiating with US banks to raise their capital to leverage ratios and no formal disclosure of bonuses or remuneration has been accounted for. Banks have a history of being powerful political lobbyists in the US and UK. Similarly, the numerous inquiries and reviews that sought to uncover the micro causes and responsibilities during the banking crisis, so as to make recommendations on reform, made little immediate progress, and what progress they did make was slow. President Obama’s Dodd–Frank Wall Street Reform Act faced a difficult passage through Congress and the Senate during 2009 and 2010. It emerged as a complex piece of legislation requiring years of implementation and regulatory interpretation. It creates an independent Consumer Bureau within the Federal Reserve Bank designed to establish additional protection for households. It will establish powers for government to terminate troubled financial companies before they become too big to do wider damage to the US economy and it commits regulators to closer oversights of derivatives and similar complex financial products. Republicans criticized it for a likely slowing effect on economic growth and innovation, while most Democrats welcomed it as balanced and workable (Dennis, 2010). It commits US regulators such as the Federal Reserve and Securities and Exchange Commission (SEC) to developing long term new working practices. Critics are concerned about sustaining political support to prevent new regulatory practices being tokenistic and without formal powers, and there are question marks over whether real changes in culture will occur to support the regulators and allow them take on the powerful lobby of the US banks and financial institutions with their unprecedented global reach and wealth. There was anger in the British media when the Financial Services Authority (FSA) resisted attempts to make its inquiry into the collapse of the Royal Bank of Scotland public, despite the cost to the taxpayer of the rescue (Clark, 2010: 44). A lack of accountability was seen to be continuing in this institution even though it was now majority owned by the public. In the US, the Securities and Exchange Commission (SEC) did issue a writ against the investment bank, Goldman Sachs, who had aggressively sold mortgage backed securities and their constituents to uninformed customers, but the outcome is still unknown and the case predicted to take many years to conclude. In June 2010, the new coalition government in the UK set up an Independent Commission on Banking under the chair of Sir John Vickers, former Professor of Political Economy at Oxford University, Chief Economist at the Bank of England and Head of the Office of Fair Trading. The terms of reference for the Commission include reform of the UK banking system to promote stability and competition with major consideration to be given to the separation of retail and investment banking. An interim report published in April 2011 met general approval in the UK press, but also some criticism that its recommendations were widely predicted and

106   Intervention conservative in their scope, and unlikely to be radical enough to ensure a prevention of future banking failures. The final report published in September 2011 (Independent Commission on Banking, 2011) recommended the separation of retail and investment banking, with retail banks holding at least 10 per cent of capital in ratio to borrowing. The UK Chancellor supported this separation. Investment banks would have crisis plans that prevented them being rescued by the government and taxpayer and this would include protecting ordinary savers before shareholders and bondholders. John Vickers, Chair of the Commission, criticized the crisis takeover of HBOS by Lloyds claiming that it created more instability in the market and proved to be anti-­competitive. As result, including reference to previous action agreed with the European Union requiring a downsize, he indicated that Lloyds should go further and sell 600 UK branches. This illustrates one of the key tensions between the emergency interventions of governments who experience a crisis and achieving ongoing cultural changes to the dominant policy paradigms. In the height of the crisis the preference of the UK and US governments had been to negotiate private to private takeovers, often stimulated and supported by some government funding. This was seen as much more preferable to complete nationalization and full public ownership. Nevertheless this automatically created problems of limited competition with a few very large banks operating in markets that had already allowed mergers and acquisitions before the crisis. Another aspect of this tension is the need for the UK Financial Investments Ltd (that manages the UK government and taxpayers’ public stake in the UK banks) to realize a return on its £75 billion investment. This would suffer if the banks were reformed and broken up too quickly, especially in comparison with competitor nations (Treanor, 2010b: 42). The public policy task to make banks stable in the long term, competitive and functional for a diverse economy is still a work in progress.

Monetary policy The overall preference of developed economies in 2010 was to use monetary policy levers rather than fiscal adjustments to stimulate demand, but it was clear that interest rates were unlikely to settle quickly into a pattern of rationality and predictability as seen in 2003–07 that would help stimulate a more balanced global economy (Figure 5.2, and see also Figure 3.3). Interest rates In several countries (but not all), national governments continued to find it easy to borrow and finance deficits as investors sought the security of government bonds and fixed rate returns. Low bond yields helped keep interest rates low in the US and UK, despite rising inflation towards the end of the 2009 recession and in 2010. In the short term after the crisis the dollar has largely remained the currency of preference for investors seeking a safe haven for their money. This was one of a number of paradoxes resulting from the financial crisis given that the American economy had continued to acquire inward investment both in the

Intervention   107 run up to the crisis (2003–07) when interest rates were argued to be too low and with the US dollar in decline. The rush for US treasury bonds in 2009 actually caused the US dollar to rise in value despite the recession and its need to pay down debt and create export based jobs. The main exception to this pattern of low interest rates was in smaller countries with weak currencies, or smaller countries with weak economies in the larger euro region (the euro currency crisis is discussed in the next chapter). If low interest rates failed to encourage borrowing in countries like the UK and US that were able to maintain rates at historically low levels, they could at least keep the cost of servicing existing debts low and enable some previous debts to be paid relatively quickly. The G20 Summit in April 2009 in London sought to build the global economic recovery by a demand side stimulus. Additional funding was made available to the IMF to support developing countries and the wider impact of the crisis outside of the G20 and to promote global trade via credits (G20, 2009b). But developed countries could not agree a general fiscal demand side stimulus because of concerns from some countries about the levels of their national debt. Quantitative easing and liquidity Given the failure of low interest rates in late 2008 and early 2009 to stimulate lending and demand, governments turned to other methods for stimulating the money supply and to create liquidity, namely, quantitative easing (QE). The Bank of England (2009) reported that relying on low interest rates alone might 6.0 5.0 4.0

R2 � 0.2918

3.0

CPI

2.0 1.0 0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

�1.0 �2.0 �3.0 �4.0

IR

Figure 5.2 Scatter plot to demonstrate weak association between CPI and IR, national averages, annual percentages, 2009–10 (source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www.oecd.org/statistics, accessed on 23 May 2011).

108   Intervention take two years to have a positive effect on the UK economy and observers of the Japanese economic problems of the 1990s (see Turner, 2008) had concluded that when interest rates had reached close to zero, quantitative easing was the only alternative form of monetary policy to use, given that interest rates could no longer be reduced. Improving liquidity is historically associated with directly increasing the money supply of the national currency. The increased availability of money implies continued low central bank interest rates through cheap borrowing and low competition for such lending. Additional liquidity should increase demand for goods, investment and assets and this in turn stimulate all supply side activity. In modern economies like the G7, additional liquidity at a time of persistent low interest rate is created by the central bank buying financial assets like government bonds and private equity. This has the effect of raising their prices and reducing their yields. This should help keep various commercial interest rates low, separate from the central bank rank. The Federal Reserve Bank of the US started quantitative easing in 2009 and targeted residential mortgage backed securities with the aim of keeping mortgage costs and interest rates low (Ferguson, 2011). There was an expectation that this would prevent further damaging falls in house prices, perhaps permitting a small rise in some circumstances. But rather than boosting the price of property assets, quantitative easing appears to have fed general inflation. QE is argued to have increased investment in shares (De Vita and Abbott, 2011). In addition QE can increase the price of commodities such as oil and food products. As Skidelsky (2010: 96) concludes: Quantitative easing has undoubtedly had a positive effect on bond and stock market prices. But most of the new money has not yet filtered into the real economy. It has bid up prices of existing assets, but not stimulated new investment, because lenders are still asking more from borrowers than borrowers can expect to earn. The launch of QE in the UK in 2009 was argued by the Bank of England (Benford et al., 2009) to be a method for stimulating the economy and meeting its inflationary target of 2 per cent, but as the policy continued inflation overtook the Bank’s rate by an additional 2 per cent. Joyce et al. (2011), presenting an analysis for the Bank of England, conceded that QE had been a contributory factor to increasing inflation in the UK. Any depreciation of financial assets like government bonds by keeping interest rates below inflation is also a method for eliminating debt and has been called ‘financial repression’ (Somerset Webb, 2011a). In an historical study of the liquidation of government debt after the Second World War in the US and UK, Reinhart and Sbrancia (2011) concluded that real interest rates were negative (below the inflation rate) approximately 50 per cent of the time between 1945 and 1980. This allowed for the liquidation of debt at approximately 3 per cent of GDP per annum. Reinhart and Sbrancia further conclude that for Australia and Italy, where inflation was higher, liquidation occurred at approximately 5 per cent of GDP per annum. Nevertheless, a

Intervention   109 theoretical study by the US National Bureau of Economic Research concluded that quantitative easing through the purchase and selling of treasury bonds could be successful in reducing long term interest rates without raising short term yields that had an inflationary effect (Hamilton and Wu, 2011). In March 2009 the UK Monetary Policy Committee of the Bank of England decided to buy UK government bonds and high quality debt as previously issued by private companies. The purchase of government bonds was argued to inject money into the economy fairly rapidly while the careful purchase of private debt was designed to make it easier for companies to raise new credit (Bank of England, 2009). If inflation was to rise above target (which it did in 2011) then the Bank could sell these assets back into the market as an alternative to immediately raise central bank interest rates, as the asset sales would most likely have a similar effect (to raising interest rates) on certain commercial markets and interest rates, thus reducing aggregate demand. In history, the creation of money within a national economy is subsequently associated with rapidly rising inflation as demand picks up too rapidly and prices rise quickly to reflect this. Savings and current balances then decline as customers and firms chase material stocks and goods that will hold value and can theoretically be sold at a high price as money price increases. At worst, national citizens seek to invest in overseas currencies that are more stable, it if is practical and feasible and legal for them to do so. The globalization of national economies, with limited regulation on currency exchanges and movements of financial capital and assets, creates uncertainties about how contemporary attempts to increase the money supply will function, and if they will stimulate the correct sort of investment and demand. It is also less clear how quickly and in what conditions quantitative easing will lead to inflation. One concern is that quantitative easing benefits savings or overseas investments rather than stimulating domestic consumption and this makes it difficult to predict wider consequences like the impact on currency values and inflation in the future. Real concerns about exchange rate instability and the likelihood of higher inflation fuelled the rising price of gold and silver in 2009, as investors sought safer hording, again symptomatic of a recession and a lack of real demand. By keeping interest rates artificially low, one argument is that quantitative easing gives borrowers (like those with long term mortgages that are vari­ able and closely related to central bank rates) a false sense of security and they are then hit hard when rates return to higher and more normal levels. Household budgets then take a shock hit. Similarly quantitative easing might postpone banks from deciding to foreclose on business loans to support failing businesses that are not competitive or efficient. This illustrates the classical economist’s objection to quantitative easing – that it undermines the free market competitive processes and that it supports weaknesses in a market place and therefore prevents needed rebalances and reforms. Without quantitative easing in the US and UK, prices would have probably fallen more – especially property prices – and unemployment would most likely have been higher as public sector cuts fell more quickly and less businesses were able to survive. The social harm of the

110   Intervention recession would have been greater and closer to what was historically associated with the Great Depression of the 1930s. Classical economists argue that the end result is likely to be the same, and that quantitative easing merely spreads the harm over a longer period, or postpones it. If banks and financial institutions hoard the cash generated by selling assets to the central bank in quantitative easing, rather than using it to lend and thereby increase local economic activity, the future is rather unknown. Certain types of assets may be preferred for purchase to others at particular points of time; for example, when quantitative easing was first attempted in Japan in the 1990s this resulted in property asset spikes that were unsustainable and this created more instability and loss of confidence (Turner, 2008). More recently in 2011 there has been a concern that the liquidity resulting from quantitative easing has fuelled spikes in world commodity markets. This can have widespread social consequences when the commodity market in food and fuel is affected and can also be inflationary. As one leading financial journalist concluded in The Times (London): ‘The Fed’s QE scheme, coupled with near-­zero rates is fuelling new imbalances in asset markets today, not least by promoting flows of hot money into quick-­growing emerging markets and driving up commodity prices’ (Fleming, 2011: 33). Bawden (2011) went further in his analysis of the impact of QE on commodity prices and noted that while some banks were returning to profitability through QE facilitated commodities trading, they risked a commodities price bubble that could turn to bust. After the bank rescues, the banks were regularly criticized for not lending and instead hording capital to aid their recovery and minimize risk. In one sense they could defend themselves by reminding campaign groups and politicians that recapitalization and reducing risk had been an implicit requirement of their rescue and survival. Small businesses in particular complained that they were adversely affected and too often rejected on loan applications, and in the UK they could argue with justification this was unfair given that they were the only category of the UK economy not in debt during the financial crisis (Peston, 2008a). In 2009, the major financial institutions focused on the largest corporate businesses where they continued to see potential for exponential quick returns and profits. There was wide spread criticism of the UK bank RBS’s decision to lend to the US company Kraft so that it could take over the UK firm Cadburys. This resulted later in a factory closure and job losses and less competition in the global confectionary market. Coming soon after the global financial crisis, and as an early decision from a national government owned bank, this was perceived as a clear illustration that public owned banks felt no direct obligation to the nation or public they served, but instead saw their primary duty to continue maximizing profit for global shareholders (who now included the UK government). In August 2010 the biggest UK banks met to try and communicate more clearly with politicians and the public on the realities of lending. They claimed that small businesses continued to be good role models to an economy that was supposed to be saving more, and in the main these organizations were paying down credit faster than new loans could be offered to them. So the demand was

Intervention   111 not there for new loans, even with competitive interest rates (Treanor, 2010c: 2). In May 2011, the UK Business Secretary Vince Cable tried to negotiate with banks to ensure that the major UK banks would lend to middle sized companies who were most likely to expand and hire extra employment. £2.5 billion was set aside by banks to focus on the development of these key businesses seen as a neglected area in the UK economy but a sector that had achieved success in Germany. Liquidity is related to the velocity of money. Velocity refers to the speed of circulation of money when it is available for use and ‘liquid’. Price inflation is traditionally argued to increase the velocity of money because customers and firms seek to spend cash before it loses its relative value further and can buy less. In a recession money circulates slowly because customers and firms are risk adverse and paying down previous debts. The large scale changes to the global economy between 2000 and 2007 with the exponential increase in shadow or secondary lending and investment can be argued to have increased velocity and therefore liquidity. The shadow system’s increase in velocity of money also influenced house price inflation. The collapse of this shadow system has had a dampening effect on economic activity with the erosion of confidence that these transactions were adding real value or ‘utility’ from the financial sector into the rest of the economy. A key additional feature of globalization after 2000 was the impact on velocity in the US and UK of inflows from countries generating surpluses like China, Japan, Russia and Saudi Arabia. Financial centres in New York and London made significant profits by recirculating this money and extracting some value – via a management charge – from it. It is unlikely that the level of activity and profits from these financial service activities and the percentage tax revenues generated will ever be recovered in the US and UK economies (Peston, 2008a). This explains the concern in those countries with rebuilding other service sectors and advanced manufacturing. In 2009 the flow of these types of monies declined dramatically in the UK. The UK’s inflows dropped from $91 billion in 2008 to $46 billion in 2009. Outflows dropped more, declining from $161 billion in 2008 to $18 billion in 2009. Much of this decline was analysed as a stagnation of mergers and acquisitions of which the UK had been a world leader in organizing and financing prior to the financial crisis (Allen, 2010). This also reduced tax revenues taken from these financial trades. There was little indication by the summer of 2011 that quantitative easing had made any significant impact on the longer term economic health of the US and UK. While US and UK government debt remained relatively cheap and stable despite the low growth of these economies, manufacturing and service industries failed to invest substantially in domestic production that would rebalance and grow the national economies. A debate in the US about the ceiling of national debt (summarized in The Week, 6 August 2011: 4) made it difficult for the US to embark on a so-­called ‘QEIII’, but commentators argued a commitment from the Federal Reserve to keep interest rates at virtually zero would have a similar effect. One commentator even referred to this commitment as the ‘privatisation of quantitative easing’. Quantitative easing therefore seems to have similar

112   Intervention limitations to other forms of monetary policy and provides further evidence that monetary policy cannot work alone without other forms of government intervention through fiscal policy and regulation. QE like other types of monetary policy has become a medicine that deals with short term symptoms but not the underlying condition. There are also unknown side effects (Oakley, 2011). In conclusion, policies like quantitative easing can increase the velocity of money and the buying and selling of assets like property and commodities (see Bawden, 2011) and financial (bonds, stocks etc), but there are concerns that it has unintended economic effects. For example, it can increase economic inequalities (Stewart, 2011b: 40), create new potential bubbles and instabilities in specific markets, and therefore prevent a focus on major rebalancing and sustainable long term investment. In the longer term there are concerns that it weakens a national currency and is inflationary (Somerset Web, 2011b: 5). It does not provide the investment in societal and industrial structures advocated by neo-­ Keynesians that benefit the economy for future generations (for example, transport, sustainable energy, education and training). Quantitative easing makes a partial impact on short term liquidity rather than dealing with underlying economic problems.

Trade Governments have been reluctant to use their power of ownership to prioritize the rebuilding of national trade and industry. In part this is limited by international and continental agreements that followed the market liberalization in the 1980s and 1990s which prevent nations protecting their own industries and jobs. Nevertheless contradictions remain. Countries find indirect ways of supporting their own industries, for example how they interpret competition regulation in monopolies, mergers and acquisitions, when external TCs are seeking to buy home industries and the host nation fears job losses and a reduction in its own national industrial capacity. Nations act differently in these circumstances, some protecting home industries from foreign predators more than others. Liberal market economists believe that the host country benefits from such external interventions because of inward investment and increased competition that will raise productivity, but this denies the local social costs and the profiteering of the institutions that organize and facilitate the transactions. It also ignores how the inward benefits are spent. Skidelsky (2010: 182–183) has argued that the money flowing from Asia to the US in the first ten years of the new millennium needed to be invested in more real, tangible and diverse assets that could return an income to service the debt rather than creating asset booms in property and secondary financial investments that were not sustainable. It would have been better if the inward investment into the US had been spent on new high tech industry, such as the next computer revolution, green renewable energy products and the electrical and hydrogen driven vehicles of the future. The UK has benefited from some inward investment that has directly generated specific plant and machinery for overseas TCs, for example, long term production capacity in cars with factories for Honda,

Intervention   113 Nissan and BMW. But it also has a reputation for a lack of regulation of takeovers and mergers as witnessed by the takeover of NatWest by the Royal Bank of Scotland, despite concerns that retail banking was uncompetitive, and of Cadbury’s by Kraft where promises to preserve UK investment and jobs did not materialize. The overall issue here is the model of corporate finance resulting from global flows, with the previous ten years seeing many large banks in the US and Europe favouring investment in the new property assets and mortgage vehicles, mergers and acquisitions of existing sound business ideas, rather than more risky innovative production ventures, like green energy. Similarly these very large banks have been accused of not being interested in investing in moderate risk small and medium sized businesses. This suggests that a large part of the problem of rebalancing the US and UK economies towards export led manufacturing lies with the fundamental dynamics of the financial system that has been saved. This again illustrates the need for reform to change and rebuild the finance sector rather than saving it for ossification and survival of the same failed investment forms. Careful judgement by policy makers about when to protect home industries and their capacity seems more important than a singular market belief that such intervention is always wrong. Good, efficient and productive industries may be vulnerable to market takeovers because of their strengths and competitive threats to other growing monopolies, rather than being vulnerable and inefficient purely because of their smaller size and asset value. Some protection of industries during recession is also justified to protect long term capacity and from the social ills of unemployment. As Skidelsky (2010: 186) says: ‘Protection remained Keynes’ “second best” employment policy for use in emergencies.’ Keynes was also in favour of modern nations having a balance of industries and productive capacity rather than becoming dependent on a few specialist sources of wealth. He noted that this could lead to political tensions and difficulties with the distribution of wealth and power. This is particularly evident today in the oil producing nations of the world where political democracy is often only weakly developed, wealth inequality is high and human rights are abused (Klare, 2004). There is little incentive in such monopoly market conditions for these nations to shift economic investment towards other industries and services. There is little hope of a global rebalance if every major economy tries to simultaneously export itself out of recession. Success in such a strategy will depend on the world’s major exporters, Japan, China and Germany, succeeding in growing their own consumption more and placing less of their earnings in foreign investments (Kaletsky, 2010). Table 5.5 shows the percentage change in annual exports for a selection of OECD and BRIC countries. All countries exports are hit by the recession in 2009, but in the recovery of 2010 it is in the main the BRIC countries that return to the strongest export behaviour ahead of the developed economies that require strong exports to rebalance their economies, like the US and UK. This does not bode well for the rebalancing of the global economy and shows the long time it will take to correct such productive imbalances. A rebalance depends on a strengthening of the currencies of the BRIC nations and their ability to invest in public services and to promote internal consumption.

114   Intervention

Conclusion Table 5.6 uses the complex systems framework to analyse the policy interventions during the recession of 2009–10 immediately after the 2008–09 crisis interventions. The immediate impact is shown in increased unemployment, falling house prices and increasing government debt. There is uncertainty over the continued use of monetary policy as interest rates have little effect on aggregate demand given the very high level of debt. It is difficult to demonstrate that the Table 5.5 Annual percentage changes in trade exports, ranked by largest increase in 2010, OECD and BRICs

Indonesia Estonia Brazil Russian Federation China Mexico South Korea Japan India Slovak Republic Netherlands US Germany Hungary Czech Republic Australia Belgium Austria UK Finland Italy Portugal Sweden Spain South Africa France Iceland Canada Poland Greece Denmark New Zealand Turkey Ireland Norway Luxembourg

2008

2009

2010

20.1 5.4 23.2 33.1 17.4 7.2 13.6 –3.5 36.8 13.3 7.9 12.1 2.0 7.2 –0.2 32.0 2.0 3.2 12.8 –0.2 1.2 1.7 4.8 3.6 33.9 2.5 72.4 7.4 4.9 4.2 6.1 17.4 22.4 –3.6 20.6 5.4

–15.0 –23.4 –22.7 –35.7 –16.0 –21.1 –13.9 –33.1 –5.3 –16.9 –17.7 –18.0 –18.3 –10.1 –13.5 –11.6 –17.3 –20.3 –9.5 –31.3 –20.9 –18.4 –16.6 –14.8 –20.1 –17.0 7.3 –25.6 4.4 –18.2 –15.7 –7.5 –7.1 –2.8 –21.1 –12.1

35.4 34.9 32.0 31.9 31.3 29.8 28.3 24.4 24.0 22.6 21.2 21.0 19.2 18.7 17.6 17.5 17.2 17.0 16.4 16.4 15.8 15.7 14.0 13.7 13.3 13.0 11.3 11.0 10.8 10.0 9.8 9.7 8.2 5.8 5.0 –2.3

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

Low interest rates not stimulating demand because of high debt Government purchases financial assets to ease money and falling incomes supply (QE), because it can no longer reduce very low interest rates

Banks, companies and households want to pay down debt and rebuild capital. Politicians worried that banks not lending enough because they are recapitalizing. Banks claim loans not in demand

System rules

Reinforcing feedback

Quantitative easing launched via US and UK governments purchasing assets to free liquidity, but hoarding of cash likely

Failure of low interest rates to increase aggregate demand

Lack of trust in economic and financial information, uncertainty over future of economy.

Debts in major consuming economies reduce demand in world economy

Failure of banking leadership. Loss of public confidence in investment bankers who self-organize beyond local and national economy to argue international skills demand high premium. Inability of financial profession to provide social ethic and to renegotiate their value with society

Setting operating parameters

Use of information

Managing ‘levels’

Leading selforganization

European countries establish some agreement on banking levy. But negotiations on banking pay and rewards and codes of conduct not well developed. There is a need to sanction negative adaptation, and encourage new diverse and responsible lending models

Coordination of central bank interest rates at historically low levels not necessarily passed to micro customers as banks seek to increase capitalization and raise profit margins

Fiscal Stability Forum tries to prevent further risk of bubbles and instability by providing better information and reporting

Some government investment in demand side of economy to promote demand and spending, but these fail to generate growth in many countries

Stabilizing feedback Lack of demand and spending in economy due to loss of confidence and paying off debts

Government keeps central bank rates low and sets lending targets for nationalized banks to try and encourage borrowing for investment. Quantitative easing used to assist monetary policy

Increasing amounts of government monies invested in the banking and finance system to allow a velocity of continued market operation

Loss of confidence in market place and its values, falling asset prices and incomes. Some commodity prices rising (e.g. food, fuel)

Ideological paradigm of operation

Intervention example

Problem

Intervention

Table 5.6  Policy analysis – policy developments, 2009–10

116   Intervention policy of quantitative easing has had a strong positive national effect on the priority areas of stabilizing house prices, export industries and employment, because of the interlinking of national monetary policy with the behaviour of TCs and their international financial investments and operations. The ideological paradigm (Table 5.6) continued to be monetary policy as the prime intervention, but the use of the central bank interest rates as a system rule and parameter setting failed to stimulate lending and activity. Banks shifted from overleverage to avoiding leverage and trying to recapitalize, and this meant that the reinforcing feedback cycle had reached a tipping point and moved from a belief in the importance of leveraging to acquire assets to a shared belief in paying off debt to build capital. The government in the UK tried to check this new feedback cycle by setting lending targets and exerting pressure on nationalized banks, but in the main they resisted this. There is an attempt to improve the flow of good and reliable risk assessment information in the global economy via the IMF Fiscal Stability Forum and its publications of data and reports. With much of the focus on global and national policy, local policy initiatives are left responding to centralized policy. Cheap central lending available to banks is not available to individual customers who find much higher rates are offered commercially as banks try to improve their profitability and capital ratios. The exception is low mortgage rates that are more directly linked to central bank behaviour. There is an inability of the banking profession to reorganize itself to present alternative social models and options, offering wider competition and diversity of products. In part this is because the crisis has reduced competition through government organized takeovers and mergers. Bankers are involved in ongoing negotiations to improve public accountability given reviews and policy interventions to facilitate such reflection in most counties including the US and UK, but there is little indication of trust being restored between the banking sector and the public.

6 The second crisis From private debt to public debt

Introduction When this book refers to a second crisis it refers to the government debt crisis in Europe from 2010 onwards. In the second crisis the focus has shifted from the private market to the state because the state has taken over aspects of the market’s activity and increased borrowing to stimulate the economy since 2008. In addition, the state and private companies in some of the more peripheral European countries (like Greece, Portugal and Ireland) had borrowed heavily when converting to the euro currency. This was because risk assessments for the euro dominated bonds were often made by referring to the strength of the German economy, rather than properly considering the disadvantages and risks of the peripheral national economies. During 2011 it is argued that the second debt crisis also began to be experienced in the US with the downgrading of American government bonds by some agencies and speculation that US government debt was unsustainable in the long term (Rose, 2011). This implies a rise in US interest rates in the longer term, despite their historic lows in the years immediately after the 2008 crisis, and a predicted deterioration in the relative long term value of the US dollar. One key indication of the arrival of the second crisis was the rising price of gold through 2009 into 2010 and beyond (Wachman and Hawkes, 2011: 35). This indicated a lack of willingness to invest in liquid currencies and a desire to hoard money in the precious metals: the silver price also increased after the 2008–09 crisis (Wachman, 2010b: 38). When the first financial crisis started to take hold in late 2007 the dollar gained rapidly recovering much of the value it had lost in the five years before the crisis. This was because the currency was seen as an emergency safe haven at a time of crisis given that the US was the largest economy in the world and it did not factor in a longer term view that American government bonds represented a less competitive long term investment. (The decline in the dollar from 2003 to 2007 was due to setting artificially low interest rates that reflected the short term political need of the Bush administration to keep the economy buoyant rather than setting rates in the real long term interest of the country and its economy.) Over the longer term the US government has become increasingly indebted and this gives it less flexibility to kick start the US and world economies via increased public expenditure or tax cuts.

118   The second crisis

Rising debt – a comparison of countries Tables 6.1 and 6.2 illustrate the challenge of rising government debt in OECD developed economies during and after the financial crisis. Only a few countries in Table 6.1 have a positive annual government current account balance as a percentage of GDP in 2011: Norway (with its large oil and gas reserves), Hungary, Switzerland, South Korea and Sweden. The other countries all have deficits. The highest annual deficits as a proportion of the economy are in Ireland, US, Japan, UK, New Zealand, Greece and Spain. These countries all have deficits as a percentage of Table 6.1 Government current account, annual percentage of GDP, ranked by predicted 2011 annual outturn (June 2011)

Ireland US Japan UK New Zealand Greece Spain Portugal Poland Slovenia France Slovak Republic Canada Italy Czech Republic Denmark Austria Israel Netherlands Belgium Turkey Australia Iceland Germany Finland Luxembourg Estonia Sweden South Korea Switzerland Hungary Norway Euro area Total OECD

2008

2009

2010

2011

Average

–7.3 –6.3 –2.2 –4.8 0.4 –9.8 –4.2 –3.6 –3.7 –1.8 –3.3 –2.1 0.0 –2.7 –2.7 3.3 –1.0 –3.7 0.5 –1.3 –2.2 –0.2 –13.5 0.1 4.2 3.0 –2.9 2.2 3.0 2.3 –3.6 19.1 –2.1 –3.3

–14.3 –11.3 –8.7 –10.8 –2.6 –15.6 –11.1 –10.1 –7.4 –6.0 –7.5 –8.0 –5.5 –5.3 –5.8 –2.8 –4.2 –6.4 –5.5 –6.0 –6.7 –4.9 –10.0 –3.0 –2.9 –0.9 –1.8 –0.9 –1.1 1.2 –4.4 10.5 –6.3 –8.2

–32.4 –10.6 –8.1 –10.3 –4.6 –10.4 –9.2 –9.2 –7.9 –5.6 –7.0 –7.9 –5.5 –4.5 –4.7 –2.9 –4.6 –5.0 –5.3 –4.2 –4.6 –5.9 –7.8 –3.3 –2.8 –1.7 0.1 –0.3 0.0 0.5 –4.2 10.5 –6.0 –7.7

–10.1 –10.1 –8.9 –8.7 –8.5 –7.5 –6.3 –5.9 –5.8 –5.6 –5.6 –5.1 –4.9 –3.9 –3.8 –3.8 –3.7 –3.7 –3.7 –3.6 –3.3 –2.8 –2.7 –2.1 –1.4 –0.9 –0.5 0.3 0.5 0.6 2.6 12.5 –4.2 –6.7

–16.0 –9.6 –7.0 –8.7 –3.8 –10.8 –7.7 –7.2 –6.2 –4.8 –5.9 –5.8 –4.0 –4.1 –4.2 –1.6 –3.4 –4.7 –3.5 –3.8 –4.2 –3.5 –8.5 –2.1 –0.7 –0.1 –1.2 0.3 0.6 1.2 –2.4 13.1 –4.6 –6.5

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

The second crisis   119 GDP of above 6 per cent. The annual percentage deficit does peak in most countries in 2010, the highest figure being an unsustainable –32.4 per cent of GDP in Ireland.

The government bond market Government bonds are IOUs where a government borrows money from an individual or institution. The bond will normally run for a fixed period of time, typically ten years, and includes an agreement that each year the government will pay the holder of the bond a fixed rate of interest. The holder also has the opportunity Table 6.2 Total government gross financial liabilities as percentage of GDP, ranked by percentage increase between 2008–11

Ireland Greece Japan UK Portugal US Spain Slovenia Finland France Iceland Germany Slovak Republic New Zealand Australia Canada Denmark Italy Czech Republic Austria Poland Netherlands Belgium Estonia Luxembourg Korea Hungary Norway Israel Sweden Switzerland Euro area Total OECD

2008

2009

2010

2011

Increase

49.6 116.1 174.1 57.0 80.6 71.0 47.4 29.7 40.6 77.8 102.0 69.3 31.8 28.9 13.6 71.3 42.6 115.2 36.3 67.3 54.5 64.5 93.3 8.3 16.4 29.6 76.3 54.9 76.7 49.6 43.7 76.5 79.3

71.6 131.6 194.1 72.4 93.1 84.3 62.3 44.2 52.1 89.2 120.0 76.4 39.9 34.5 19.4 83.4 52.4 127.8 42.4 72.6 58.4 67.6 100.5 12.4 14.7 32.5 84.7 48.0 79.2 52.0 41.5 86.9 90.9

102.4 147.3 199.7 82.4 103.1 93.6 66.1 47.5 57.4 94.1 120.2 87.0 44.5 38.7 25.3 84.2 55.5 126.8 46.6 78.6 62.4 71.4 100.7 12.1 19.7 33.9 85.6 49.5 76.1 49.1 40.2 92.7 97.6

120.4 157.1 212.7 88.5 110.8 101.1 73.6 52.9 62.7 97.3 121.0 87.3 48.7 45.8 29.3 85.9 57.1 129.0 49.3 80.0 65.6 74.3 100.7 15.2 20.5 33.3 79.8 56.1 73.5 45.4 38.7 95.6 102.4

70.7 41.0 38.6 31.6 30.3 30.1 26.2 23.2 22.1 19.5 19.0 17.9 16.9 16.9 15.7 14.6 14.5 13.7 13.1 12.7 11.1 9.8 7.4 6.8 4.2 3.7 3.5 1.2 –3.2 –4.2 –5.0 19.0 23.0

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

120   The second crisis to sell the bond on the international markets if they can find a buyer. If a national economy is perceived as performing well and its currency is strong the bond price on the open market is likely to increase allowing the holder to sell and take a profit. Conversely if the national economy is perceived as performing poorly the bond price is likely to fall meaning that if the holder sells they will take a loss. Falling bond prices mean that the annual interest payment as a proportion of the value of the bond is higher in real terms (even though the agreement at the time of issue remains the same). This is likely to exert pressure on the long term interest rates in that country and force up domestic interest rates. Conversely rising bond prices decrease the proportionate value of the annual interest payment made by the holder and will exert downward pressure on long term interest rates in that domestic economy. If a purchaser of a government bond merely holds that bond for ten years in good faith without considering the changing market and currency dynamics between countries they may be disappointed at the end of the ten-­year period. For example, where a national currency is declining through high inflation, say at the rate of 5 per cent per year, the original real value of the purchase will have been reduced by 50 per cent at the end of its life. The only return would be if the annual interest payment had been high enough to compensate. In a deflationary world, however, government bonds – even with low annual interest payments – can appear attractive (Bottle, 1996: 103–104). This is because any falling bond prices keep the fixed income (the yield) of the bond high in real terms. Skidelsky (2010: 96) notes that according to Keynesian economic analysis, if interest rates are low and caused by a deflationary environment, governments are likely to be able to borrow substantial amounts at low rates of interest. The result of the economic dynamics influencing government bonds is that bond markets give a key indication of the global market’s judgement of confidence about the management of an economy in any one nation and its future prosperity. As Niall Ferguson (2009: 69) comments in his book The Ascent of Money: A Financial History of the World: From a politician’s point of view, the bond market is powerful . . . because it passes a daily judgement on the credibility of every government’s fiscal and monetary policies. But its real power lies in its ability to punish a government with higher borrowing costs. . . . In a crisis, however, it can end up dictating government policy. An example of this is the recent crisis in Greece. Greece has been unable to maintain its public expenditure as bond interest payments have escalated and the market has become reluctant to facilitate the government with the borrowing that it needs to afford its current level of public services. Trends in the government bond market One of the overall trends of the financial crisis has been the rising level of government debt in the OECD developed countries (Tables 6.1 and 6.2). Many

The second crisis   121 developed Western economies were relatively highly leveraged going into the crisis and have come out of it worse, due to reduced tax income after the 2008–09 recession, and then there was the additional pressure of needing major funding to support the failing banking systems. Table 6.1 shows the deteriorating annual government current account of OECD nations and Table 6.2 shows government’s total debts. A second stage of the global financial crisis took hold in the middle of 2009 when Greece began to look like it would default on its government debt issued in euros. This caused a sustained major crisis for the European Union and single currency area, as analysts found diverse patterns of debt and accounting amongst the single currency members despite their sharing of a common currency. This created anxiety amongst investors in the global economy because it reminded them of fundamental problems with the euro when it had first been launched. Confidence in the new currency had been questioned at its launch because of doubts about the regulation of its member states that were all political independent and therefore could not be guaranteed to manage their use of the currency in a unified way. On joining euro membership, countries were supposed to agree to maintain strict economic parameters, including a limit to their annual budget deficit and a maximum for total government debt owed, but the unexpected events of the 2008–09 financial crisis had made it impossible for the European Central Bank to continue to enforce these parameters on all members. Indeed the crisis brought to the fore memories of Greece being prevented from joining the currency with the first group of countries because it had not met the strict requirements as argued by the strongest economic nation, Germany. This had delayed Greece joining the euro. Greece The most substantial event in the 2009–11 European debt crisis was the revelation that Greece’s government accounts were in a much more perilous condition than had previously been realized. Table 6.1 shows that Greece is in the top ten OECD countries experiencing a persistent high annual current account deficit for the period 2008–11 with an annual average deficit in that period of –7.5 per cent of GDP. Table 6.2 shows Greece is second in the OECD table for an increase in gross government debt for the same period, with a rapid increase from 2008–11 of 41 per cent of GDP, taking it to a total projected gross debt in 2011 of 157.1 per cent of GDP. This is the highest total government debt ratio for a European country, second in the OECD to Japan. But Japan is a major exporting economy with a strong domestic private savings ratio. In July 2009, the national press in Greece reported an unexpected deterioration of public finances with a downturn in tax revenues set against a 20 per cent increase in public expenditure (Yannopoulos, 2009a: 8). An election was called in Greece in September 2009. It followed a number of political scandals including allegations that politicians had received bribes to promote shipping contracts and that state owned land was traded for less valuable land as a favour to private owners. There was growing

122   The second crisis public concerns about the future of the Greek economy following the world economic crisis that had affected its tourist and shipping businesses. Public distrust of the government had grown following the shooting of a teenager by police officers. Forest and mountain heath fires had threatened the outskirts of Athens in the summer before the election. Confidence in government and public services was at a low point. The result of the election was the formation of a new government led by the majority party, the Panhellenica Socialist Movement. Georgios A. Papandreou became the new Prime Minister on 6 October. Yiorgios Papakonstantinou became Finance Minister and initially estimated the government’s annual budget deficit at below 6 per cent of GDP, however his new regime quickly discovered major accounting errors in public finance with substantial debts left from the previous public accounts. Post-­election press reports revealed discussions between the outgoing central banker Nicholas Garganas with his replacement Yiorgos Provopoulos, with the former predicting the budget deficit was likely to be much nearer 10 per cent (Yannopoulos, 2009b: 24). The debt discovery and revised public auditing process continued and it was soon clear the reported budget deficit of €7 billion was closer to €30 billion. Table 6.1 shows that the eventual figure recorded by the OECD for Greece’s government current account deficit in 2009 was –15.6 per cent of GDP. It was emerging that Greece, despite having been permitted to enter the euro currency in 2001, had no adequate government budget office or independent statistical service for auditing its economic and social data. As the Greek financial crisis unfolded major allegations appeared in the world’s media about tax fraud, with reports of tax inspectors taking bribes to sign off fraudulent tax returns and companies failing to record and receipt smaller cash purchases, thus depriving the state of its legitimate purchase taxes (Lewis, 2010b). By December the crisis had inevitably led to a downgrading of Greek government debt by credit rating agencies. On 8 December 2009 the ratings agency Fitch downgraded government bonds to BBB+ from A–. Negative speculation followed with markets betting on falling bond prices and higher interest rates for new debts (Yannopoulos, 2009c: 4). In January 2010 the government revealed plans to cut its expenditure so that the annual deficit would be less than 3 per cent by 2014. The plans included a public sector pay freeze with some pay cuts, redundancies, scrapping of bonuses, an increased retirement age, and changes in public sector pensions from final pay to average salary (BBC News, www.bbc.co.uk, 5 May 2010). On 2 May 2010 the eurozone member states, working with the IMF, agreed a €110 billion loan to Greece to prevent default on its debts, but this followed tough negotiations that required additions to the majority austerity programme of public expenditure cuts, including increasing tax receipts and the privatization of government services. Major political unrest followed, with riots and strikes in Athens and an attack on a branch of a bank resulting in the death of a pregnant bank employee. The Greek media criticized the German Chancellor for giving ambivalent messages to the world’s media over the commitment of eurozone countries towards continuing to support Greece and her questioning of the

The second crisis   123 wisdom of the historical decision to let Greece join the euro in 2001. By June 2010 Greece’s annual government budget deficit was reported as 12.2 per cent and its total national debt as 124.9 per cent of GDP (European Commission). Tables 6.1 and 6.2 show some recent 2011 estimates as validated by the OECD. In order to finance the support for Greece, and other European countries at risk of default, the European Union created the European Financial Stability Facility (EFSF ) on 9 May 2010. This facility is a company owned by the euro area Member States; it is registered in Luxembourg and led by Klaus Regling. He was previously the Director-­General for economic and financial affairs at the European Commission. Up to €750 billion was made available to the company, who can issue high quality euro bonds to assist euro member governments in difficulty. In November 2010, Eurostat further revised the Greek economic statistics for 2009, putting the annual budget deficit at greater than –15 per cent of GDP and total government debt at 127 per cent of GDP. This again illustrated the insecurity of Greece’s public accounts after the country joined the euro in 2001 and in the years running up to the world economic crisis in 2008. A debate in a national newspaper, Athens News, in April 2010 illustrated serious divisions about how the country and its allies should deal with the national crisis. Greek banks argued for the liberalization of trade and easier access for foreign investors to ensure rapid growth, academics blamed corruption in the political system for undermining the proper organization of state finance, and business leaders welcomed privatization of state enterprises and increased competition. The emphasis on the importance of promoting growth reflected an escalating debate in 2010 in global economics about the correct economic policies for dealing with the aftermath of the financial debt crisis, between those who saw debt reduction as the priority and those who saw growth as the immediate priority before major debt reduction could successfully begin. In May 2011, new concerns emerged indicating the IMF and euro bail out of Greece to prevent government default would not be sufficient, given a continued lack of growth and therefore further deteriorating fiscal position. Greek bond prices dropped further than had been anticipated. New negotiations started and included discussing an extension of the terms of the bailout to spread repayments or to lower interest rates on repayments. Some external commentators were beginning to predict that a Greek default was inevitable and could be followed by similar problems for Spain and Portugal. In May, the credit rating agency Standard and Poor’s further downgraded Greece’s credit rating from BB– to B leading to increasing costs to insure investments in Greek bonds. The government made plans for a rapid privatization of assets, reported as a ‘fire sale’ in the world’s media. In June 2011 there was an additional crisis for the government with the Prime Minister forming a new cabinet and seeking a vote of confidence; more riots in Athens followed. Angela Merkel, the German Chancellor, publicly stated her support for the euro and preventing Greece from having to leave. Negotiations continued about debt restructuring with reports of disagreements about who should pay the price of restructuring the government debt: European governments or the banks and financial investors who held Greek bonds.

124   The second crisis Events reached a crisis again in September 2011 with banks fearful of major losses if Greece defaulted on its loans. Interbank lending dropped prompting the IMF and European Central Bank to offer finance as some institutions dependent on short term lending looked vulnerable (Milne and Oakley, 2011a: 20). Extensive discussions between Europe’s politicians led to further stringent conditions for Greece in order for it to continue to receive financial support. But given the continued lack of growth in Greece commentators argued that a managed default for either the Greek government or some banks heavily invested in Greek bonds was inevitable (Spiegel, 2011). Some confidence was restored in global markets when the German parliament voted to increase financial support to Greece. But the global economy was becoming used to a repeating crisis presented in the world media every few months and symptomatic of the fundamental reality that Greece was unable to reverse its descent into an austerity cycle of nil growth and rising debt (Hope, 2011). Authers (2011b: 24) argued for a need to manage default in both Greece and those banks most exposed to Greek bonds, arguing that such intervention had worked in the US banking crisis in the autumn of 2008 when the US government and treasury had applied selective assistance and intervention. By October 2011 future losses for Greek bond investors looked inevitable. Ireland Ireland is a comparatively small economy with a population of approximately three million, but its relatively small economy has been very badly affected by the financial crisis. Table 6.1 indicates that Ireland had the highest government current account deficit in 2011 when compared with other OECD countries, a fate shared with the US, at –10.1 per cent of GDP. While the US deficit has risen incrementally, the Irish government’s percentage of current account deficit has been highly unstable between 2008 and 2011, reflecting the government’s attempt to use rapid public expenditure cuts while experiencing the highest decline in GDP between 2008 and 2009 of any OECD country (see Table 5.2). Table 6.2 shows that its gross government debts rose by 70.7 per cent of GDP between 2008 and 2011 to a projected 120.4 per cent in 2011. The growth from 2008 to 2011, as a proportion relative to the size of the economy, was larger than any OECD country. Following historical difficulties and conflicts about its independence from the UK and desire for economic dependence from its larger neighbour, it entered the euro currency in 1999 and at first the economy benefited greatly. Due to mass emigration to America during its historical hardships under British rule it developed deep cultural, extended family, community and political links with the US. After entry to the euro, several major American TCs were keen to invest and develop European operations in Ireland. The migration pattern in Ireland switched to net immigration in the immediate post-­euro period as the country was able to support a rise in employment. Similar to Greece, entry to the euro currency permitted low interest rates and ease of borrowing given the international scope and strength of the new currency, but unlike Greece the

The second crisis   125 inward investment primarily found its way into a ballooning banking sector rather than into large and inefficient public expenditure. The Irish financial crisis was characterized by the government inheriting its banks’ debts to protect them from bankruptcy and then finding that its own public finances were in crisis as the recession deepened and growth failed. Banks lent in particular to the domestic housing market and commercial property developments, where cheap debt and easy mortgages fuelled a rapid rise in property values. Many new properties were built. The new property market, based primarily in the capital Dublin, saw its values decline rapidly in the global financial crisis. Like the US, speculation and leverage on property played a large part in the overheating of the Irish economy. As Lynn (2011: 65) says in his analysis of the quarter of a million empty Irish homes identified by a 2006 census: ‘Many people were simply buying up houses, leaving them empty for a year or two, and then planning to sell them when prices had risen by another 50%.’ In June 2010, the European Commission estimated the Irish government’s annual deficit to be 14.7 per cent of GDP and total national debt at 77.3 per cent of GDP. In September 2008 the Irish government had began to offer guarantees to its national banks following the collapse of Lehmann brothers in the US. By January 2009 the government was planning to part nationalize the Anglo Irish Bank because of its deepening problems and during the year it had to increasingly provide capital for other failing banks, including the Bank of Ireland and Allied Irish. In 2010, Ireland established a National Asset Management Agency (NAMA), similar to the US concept of purchasing bad debt from banks to release liquidity into the banks, but the government required substantial discounts on the loans purchased in order to try and protect it from future bad debts. By September 2010, the Irish Central Bank estimated that its ongoing intervention to save the Anglo Irish Bank would cost over €30 billion. Given that Ireland was in increasing difficulty supporting its banks with public funds, and with its austerity measures creating political instability and hardship for its population, it turned to its euro partners for assistance. The EU’s Finance Ministers agreed on 28 November 2010 to make a financial package available up to €85 billion, including a substantial element from EFSF. Ireland had suffered from a similar problem to Iceland in that its banking sector had grown rapidly to a disproportionate size in relation to its own small population and GDP. Its economy had returned to the similar historical difficulties it has faced in the decades before it joined the euro and its migration pattern had returned to net emigration (Lynn, 2011: 191). Portugal The economy in Portugal was one of the weakest in the five years before the financial crisis and there is little evidence of it benefiting from joining the euro apart from it becoming cheaper to finance public debt. Table 6.1 shows Portugal’s expanding government current account deficit as a percentage of GDP in the period of the financial crisis, this rose to a peak of –10.1 per cent in 2009.

126   The second crisis Table 6.2 shows a 30.3 per cent rise in its gross government debts as a proportion of GDP between 2008 and 2011, this rose to 110.8 per cent of GDP in 2011. Portugal, like Greece and Ireland, had experienced a surge of cheaper and easier lending after joining the single currency, even though the fundamentals of its agricultural and tourist based economy did not change (Lynn, 2011). On 7 April 2011 the Portuguese government approached the euro member countries for assistance having faced severe pressure to raise borrowing to finance its public expenditure commitments. Following negotiations a financial assistance package was agreed by EU Finance Ministers on 17 May. This guaranteed support for Portugal up to €78 billion via the EFSF, the EU and the IMF. Spain Spain benefited greatly from joining the euro. As with other countries, the cost of borrowing was considerably reduced by the perceived international strength of the European currency, and Spanish households and business acquired an unprecedented level of debt. This fuelled property prices and resulted in some of the highest house price increases in Europe. As Lynn (2011: 59) notes: Spanish property prices rose by a massive 80 percent. To afford these houses, 50-year mortgages were becoming commonplace, offered with reckless abandon by mainstream Spanish banks. Spanish banks were very successful in expanding by facilitating all this leverage. Santander became one of the largest banks in the world, taking over the UK bank Abbey National. Lynn concludes rising prices in Spain were associated with rising debt and little else was supporting economic growth. Carr (2009: 4) estimated that between 2000 and 2008 Spain imported foreign capital worth 50 per cent of its 2007 GDP. This resulted in low interest rates and increased lending. Lynn (2011: 61) notes the exponential effect of leverage: Between 2000–2008, the first years after the Euro was formally launched the rate of growth of public and private debt rose by 7.4% a year. It was the fastest acceleration of indebtedness among any of the major developed world economies. Behind the boost to the economy caused by high leverage many of the fundamental problems with the Spanish economy remained: unemployment was stubbornly high, Spain having had one of the highest unemployment rates in Europe even before the crisis. Industries like the mass exports of salad crops from southern Spain relied on cheap labour and periodic immigration. In April 2011 mass political protests occurred in Spanish cities before local and regional elections, predominantly involving young unemployed people who felt their country had no future and no credible economic plan. In June 2011 the government announced an increase in its austerity cuts to reduce gross external debt. The

The second crisis   127 government announced a plan to achieve a total 3.8 per cent cut in government expenditure in 2012. Johnson (2011: 7) concluded: While Spain has succeeded in trimming its deficit from 11.2 per cent of gross domestic product in 2009 to 9.2 percent last year, its €1,744 bn gross external debt burden and dependence on foreign financing has placed it in the crosshairs of international debt investors. UK The national general election campaign in the UK in April 2010 was influenced by the growing international debt crisis and the spectacle that Greece was close to realizing external support from the EU and IMF. Indeed negotiations were underway at the time of UK voting. When the UK election result was inconclusive, the growing European debt crisis and the vulnerability of countries to default was very much in the mind of politicians and the issue was at the top of the agenda as political parties negotiated to try and form a new government. When the Conservative and Liberal parties agreed a policy programme and formed a new coalition government, debt reduction and austerity were at the top of their joint agenda with an ambitious commitment to balance the annual government budget in one term of the UK parliament (five years). There was also a commitment to do this primarily by cuts in expenditure (75 per cent) rather than by raising taxes (25 per cent) and the first details were published in an austerity budget. The approach proved popular with the markets and no immediate difficulty was experienced in raising the required bonds and finance. After the election, the policy was less popular with the UK public, especially public sector workers and unions. The first casualty were young people and higher education students with plans to increase tuition fees to market rates with a rapid end in government subsidy, and some support was also withdrawn from pre-­tertiary education. Similar to Greece, protests and disorder followed in the autumn of 2010. Although the UK economy slowed in the winter of 2010–11 both the Office of Budgetary Responsibility (OBR) and IMF reported in 2011 that the slowing was not sufficient to push the economy back into a so-­called ‘double dip’ recession. But very low levels of growth in 2011 continued to prompt an intense political debate about whether austerity measures would push the economy back into recession if growth in the private sector failed to materialize. US The US intervention was in contrast to the UK and European austerity measures with the Obama administration choosing to follow a more neo-­Keynesian policy of fiscal stimulus. This was presented to the US and global economy very early in the Obama administration through the passing of the American Recovery and Reinvestment Act that includes both tax cuts and public expenditure investment in transport and renewable energy. But some economists argued that this could only

128   The second crisis be a short term measure as the US is one of the major nations that suffer a serious imbalance, both in its level of government debt and weak current account balance of payments. In the longer term the US needs to reduce its government debt and dependence on imports. Macroeconomic commentators like Kaletsky (2010) argue that this type of rebalancing cannot occur in isolation from the other major economies in the world, especially given that the US is still the world’s biggest single economy and arguably the largest source of imbalance. One of the most contradictory features of the economic crisis was the strength of the US dollar, given that it was paradoxically seen as a safe haven in 2007–08 for investors, despite the fact much of the crisis of capitalism had originated from American institutions who no longer trusted each other with their financial trades. This currency strength declined to a limited extent in 2009–10, but the eurozone’s own crisis of economic divergence assured people that it would not replace the US dollar as the currency of global preference any time soon. This persistency of the value of US dollar, when US government borrowing is at record highs and still with relatively low yields, also needs to be put in the context of the currency’s relative weakness in the years immediately before the global financial crisis took hold. As investors increasingly took the long term view that neither the US dollar nor the euro could be the world’s future currency of trading preference, there were unpredictable and rapid rises in other smaller currencies, fluctuations and increases in the prices of precious metals, and general short term instabilities in exchange rates. Several commentators predicted exponential rises in the price of gold, similar to its spectacular rise in the 1970s. In the longer term, there are several commentators who see the demise of the US dollar as inevitable, and some correction looks necessary if the US is to move forward with its economic strategic priority to innovate and revive its industrial base to increase exports. An example of this tension is the political rhetoric in the US about the Chinese government’s intervention to prevent the appreciation of the value of the Chinese yuan and the argument in defence by the Chinese government that they cannot simply let the yuan float on the exchange market without causing catastrophe in the short term for their own economy. Rajan (2010: 219) has argued about the difficulty in rebalancing the global economy while Asian economies like China buy dollars to keep their own currencies weak and also subsidize their own export economies: Poor households across Asia are effectively taxed to transfer benefits to exporters and are thus subsidising the consumption of rich households in industrial countries. This situation is neither efficient nor fair. There is growing concern about the lack of rebalancing in the global economy since the crisis, with little change in the trend balance between the major exporters of goods and importers of finance. China has failed to shift its economy towards internal state investment and increased consumerism (Barboza, 2011: 1). Table 6.3 shows the balance of payment current accounts for major OECD countries in 2010, with little change in the ranking of countries when compared with the data in Chapter 3 before the crisis.

The second crisis   129

The policy response to government debt: austerity In Greece the austerity programme proved very unpopular with public sector workers and young adults, and students. Unemployment rose to 16 per cent of the working population in 2011 and was much higher for the 18–25 age groups. Homelessness grew in Athens, which had experienced a much higher cost of living than the rest of the country for some years. Young people increasingly moved to the less sparsely populated coastal and rural areas, returning to extended families, and in search of a cheaper lifestyle of self sufficiency and living off the land, at least supported by Greece’s favourable climate. A ‘brain drain’ was said to be occurring, with the brightest professionals leaving by their thousands for employment overseas (Smith, 2011: 27). Crime and disorder rose, with some of it explicitly political, given major rioting in the capital. Business foreclosures increased, although there were signs that the tourist industry began to make some recovery in 2011. Greece’s large current account balance of payment deficit remains largely unaltered (see Table 6.1). Many commentators predict a debt default with the likely consequence that public pressure will force Greece out of the euro to implement a much devalued currency (Giles, 2011: 10). But the French and German governments are determined to resist this in the immediate future with additional European bank support being given. This makes the timing of any further crisis difficult to forecast. The worst case scenario is that a Greek default would precipitate a major sovereign debt crisis in several others countries like Spain, Portugal, Ireland and Italy, with global banks who hold euro bonds in these countries becoming insolvent. There is, however, some hope that because of a long build up to such a final crisis, there are chances that the eventual impact will be mitigated by markets planning in a default and preparing adequate diversity of investment portfolios and counter-­investment insurances, including a recapitalized banking sector. Similar problems were experienced in Ireland. Unemployment has hit young people especially hard and the country fears a return to its pre-­euro existence when the most talented and qualified young adults emigrated to take professional jobs overseas. The collapse of the construction industry and housing market has been problematic, with some building sites abandoned with unfinished properties, completed developments finding sales impossible and many borrowers left with rising costs on their loans while the value of the asset prices on which those loans were based have fallen sharply like the career prospects and incomes of their owners. A debate developed in 2011 with some indications of the first signs of Ireland’s recovery. On the one hand, classical economists note its highly educated workforce, low wages and low tax rates, but neo-­Keynesians fear its better relative position in Europe is due to a dramatic fall in localized wages and prices that would have been considered deflationary if applied elsewhere in wider Europe. There are also doubts about whether Ireland’s export drive is sustainable in the current unstable global economy. In the UK, the coalition government elected in May 2010 made reduction of the national deficit its top priority, in a large part because of the crisis with debt

130   The second crisis in Greece and a fear of contagion spreading to the UK given its high annual deficit. The main economic policy became loose monetary policy combined with tight fiscal policy. This was based on the principle that this combination would inspire confidence in the private markets and encourage investment, leading to recovery in the private sector with job growth when compared to austerity and increasing unemployment in the public sector. The high profile political target of the government was to completely remove the budget deficit (as a percentage of GDP) over the period of the UK parliament (five years). This was acknowledged to lead to a reduction in the total size of the public sector as a proportion of annual GDP. The main opposition coming from the Labour Party has argued that the deficit must be reduced, but at half the speed, therefore only eliminating part of the budget deficit as a proportion of GDP by 2015 (in total volume expenditure this is a political difference of between £40–£50 billion over five years). As in Ireland and Greece, there has been considerable political and economic debate in the UK about the appropriate tipping point for achieving growth while reducing the budget deficit. If public sector cuts are made too readily and too early in the economic circle they will contribute a slowing factor on the economy and increase government expenditure on unemployment benefit. The UK coalition government established the Office of Budget Responsibility (OBR) to provide independent information and audit of public finances, a move in part to build confidence in the national economy and its political management after the crisis. During 2011 the OBR (2011) revised its growth forecasts downwards predicting that the economy would not be capable of reaching above 2 per cent growth in 2011 as aspired to in 2010. The diagnosis from the OBR, however, was that this declining growth prediction was not a direct result of public sector contraction and tax increases but rather caused by higher than expected inflation linked to rising oil and food prices. The OBR concluded these inflationary pressures were short term. Perhaps the bleakest conclusion for the UK was that average earnings would rise less than CPI inflation until 2013, resulting in declines in real incomes and standards of living. This implies future growth and prosperity are dependent on exports. General government consumption was still growing in 2011 before its planned decline from 2012–15. The OBR noted that a further deterioration in the euro area would reduce UK growth potential and create additional pressures on achieving economic objectives. There is little sign yet of the UK achieving its aim of export led growth (see Table 6.3). The chances of the UK experiencing slow growth for a long period of time, similar to the Japanese lost decade of the 1990s, look high with the result that some periods of Keynesian public investment may be required (Milmo, 2011: 51). Public investment would provide the UK with an opportunity to take a long term perspective on improving public transport, broadband supply and renewable energy generation, projects that would provide long term economic advantage and protect against instabilities in future world energy markets. The US experienced a mild recovery in 2010 with a growth rate of 3.1 per cent (OECD estimate) and some indication that employment levels and housing prices at least stabilized. However, the dollar declined in value during 2011

The second crisis   131 Table 6.3 Balance of payments, current account, as annual percentage of GDP during 2010, ranked by highest positive balance, 2010

Switzerland Norway Netherlands Luxembourg Sweden Germany Denmark Japan Estonia Israel Finland South Korea Austria Chile Hungary Belgium Mexico Ireland Slovenia France New Zealand UK Australia Canada US Poland Italy Czech Republic Slovak Republic Spain Turkey Iceland Portugal Greece

Q1

Q2

Q3

Q4

2010

14.9 14.7 7.0 5.0 6.5 5.5 5.5 3.8 9.3 3.5 1.0 1.3 2.3 4.0 1.6 2.5 0.2 –1.6 –1.6 –1.9 –2.7 –2.6 –5.0 –2.1 –3.0 –2.0 –3.5 –4.1 –5.3 –4.8 –5.7 –2.8 –10.0 –14.4

12.5 12.2 5.7 8.3 6.8 4.8 4.0 3.3 –7.5 3.5 2.7 2.7 2.7 –0.8 1.9 3.0 –1.0 –3.3 –2.5 –1.8 –4.0 –2.1 –1.3 –3.3 –3.4 –2.0 –3.5 –2.5 –0.9 –5.7 –5.1 –8.4 –12.4 –7.5

17.3 12.1 8.5 8.5 6.1 6.0 5.8 3.6 1.2 3.2 1.4 3.8 2.5 2.6 1.9 –0.4 –0.3 –0.4 –0.2 –2.3 3.6 –2.4 –1.9 –4.2 –3.4 –4.7 –3.1 –8.9 –7.3 –4.3 –7.0 4.0 –6.6 –10.7

13.9 12.5 9.3 8.4 5.9 6.1 6.6 3.5 11.0 2.3 6.5 3.3 – 3.7 3.1 0.3 –1.3 2.6 –0.6 –2.4 –5.6 –2.9 –2.1 –2.7 –3.0 –4.8 – 0.4 –2.5 –3.3 –8.2 –24.8 –9.8 –9.3

14.7 12.9 7.6 7.5 6.3 5.6 5.5 3.6 3.5 3.1 2.9 2.8 2.5 2.4 2.1 1.4 –0.6 –0.7 –1.2 –2.1 –2.2 –2.5 –2.6 –3.1 –3.2 –3.4 –3.4 –3.8 –4.0 –4.5 –6.5 –8.0 –9.7 –10.5

Source: OECD (2011). Based on data from title of the indicator, OECD Statistics from A to Z, www. oecd.org/statistics, accessed 23 May 2011.

after quantitative easing and some of the growth was taking place in overseas activity from TCs based in the US. As a result unemployment has remained high with limited domestic and consumer based demand. Similar to the UK, there are no immediate signs of a move towards addressing the underlying current account balance of payments challenge. Like the UK, the US experienced rising inflation in mid 2011 with the annual rate rising above 3 per cent, and this was linked to rises in commodities. US domestic investment was disappointing (Bond, 2011). Rising commodity and share prices were linked to quantitative easing (see

132   The second crisis Chapter 5) and predicted to fall in 2011–12 if the US stopped this monetary policy. The dilemma was that quantitative easing monetary policy seemed to be doing more for Wall Street than ‘Main Street’, with little improvement in US job creation (Milne, 2011: 18). The risk of a prolonged period of low growth and short recessions looks similar to the UK, suggesting that public investment programmes that can help rebuild the strategic direction and balance of the economy remain important considerations. The long term value of the US dollar is also questioned, given the fundamental weakness of the economy and the contradiction that the US Treasury is the world’s reserve currency banker. During 2011 there was increasing political argument about the level to which US government debt could continue to be extended with fears that the country would pass its legal federal debt ceiling without the political parties in government being able to agree an extension, therefore providing a further shock to the global economy as the government hit a buffer (Wilson, 2011). This was a budget crisis of the government’s own making, rather than one enforced by the market being unwilling to invest. When a new debt ceiling was finally agreed amidst much acrimony, President Obama launched a further fiscal loosening to stimulate jobs. Neo-­Keynesian economist Krugman (2011) nevertheless argued that the effect was merely to neutralize already agreed fiscal budget cuts in public expenditure, as evident in America’s own austerity plan already implemented by the US government. This casts doubt on the analysis that US policy has been stimulatory and interventionist. 2011 ended with a growing global concern of a ‘double dip’ recession caused by austerity measures applied too early before growth had been established (Stewart and Boffey, 2011: 24–25). In addition there has not been a substantial rebalancing of the global economy to allow debtor countries to export their way out of the crisis. Exporting creditor countries have not shifted towards a model of increased internal consumption.

Austerity policies – where next? In a large number of European countries attempts to reduce government annual borrowing are now connected with immediate policies to reduce the size and expenditure of the state. In Greece and Portugal this appears to have made matters worse as declines in public output have depressed the general economy further. This is counterproductive and increases government borrowing. In Greece there is the potential in the future of the government to default and leave the euro, thereby allowing the central bank to float a new weaker currency that will make its economy much more competitive. Such a situation is predicted to create another major banking crisis given the number of world banks who have invested in euro based government bonds in Greece and the other vulnerable European economies (Lynn, 2011). In Spain and the UK economic recovery is dependent on the private sector growing faster than the public sector declines. The jury is still out on whether this can happen or not, but in large part this may depend on external events in the global economy given that the national

The second crisis   133 ­economic strategy is dependent upon exports. The social and political implications of such a major shift from the public to the private may also be costly given the level of distrust left after the deregulation of the financial services sector. It is hard to imagine there is much political will from the public majority for an assertive privatization and marketization of public services and a belief that these can really bring more efficiency and effectiveness. Indeed in recent months, the UK government has shown some signs of drawing back from seeing further privatization as a major solution (House of Commons Treasury Committee, 2011). Privatizations in Greece have failed to produce the target incomes set for the state (Spiegel, 2011). The fear is that a return to the ideology of the 1980s will bring more instability to public services with scandals of profiteering against declining quality. Market reorganization transaction costs are also known to be high when moving from state services to private provision. The alternative of building neighbourhood and locally based services that add value through community involvement, volunteering and cooperative action, rather than needing an expensive market based system of transactions, will require a bold political project (Blond, 2010). This will need to rewind decades of individualization and an ethic that paid employment is the only useful form of social obligation. Such a new political project must be accompanied by regulatory limits to the global market of TCs, and the ability of TCs and central government to override the slow build of local and micro social and economic capital. It is hard to see the public trusting in any new political project of localism. Such a project would need a serious commitment to reducing social inequality and to promote the labour opportunities and social housing needs of local people. The use of labour would be recognized as much a part of local social enterprise as it is an international commodity. At present the project of austerity has no political vision or purpose other than to save an open global market place, and there is no articulation of how it might be an opportunity for a new social contract and locally based citizenship that offers both collective obligations and strengthened rights of citizenship. There is no public vision of an austerity based on a collective spirit and real sustainability that might lead to less waste and a better quality of life. Richard Koo, an expert analyst of the Japanese ‘lost decade’ (that followed the debt inspired ‘balance sheet recession’ of the 1990s in Japan), has warned Europe and the US against reducing government spending at moments when the private sector is not investing or growing. The Japanese experience was that such ill-­timed actions led to further economic contraction and inevitable rises in government expenditure (Johnstone, 2011a). National government default is not a new policy problem and there have been numerous examples and case studies in the post-­Second World War period. The IMF and World Bank have strategic funds contributed to by many nations. These funds can be used for the purpose of preventing political collapse and civil strife in countries that suddenly find they are bankrupt and cannot pay government expenses and wages to meet essential service requirements. Writers such as Krugman (2008), Sachs (2002) and Stiglitz (2002) have reflected on IMF .

134   The second crisis interventions in south and east Asia, South America and Russia. They have criticized the IMF for being over punitive and too prescriptive when rescuing countries in default, for example, by requiring unrealistic payment plans for rapid reductions of budget deficits, by requiring specific structural reforms such as the closure of certain banks and practices, and the rapid privatizations of state assets in a time of crisis (so-­called ‘fire sales’: Shleifer and Vishny, 2010) that can result in considerable discounts to private companies and individuals. Krugman (2008: 187) concludes on the necessity of maintaining IMF intervention in the post-­crisis period but with ‘less of the moralizing and demands for austerity that it engaged in during the Asian crisis of the 1990s’. At worst, the suspicion has been that the IMF is too influenced by US market ethos and financing and is therefore imposing ‘US financial fads’ on other countries, rather than sound economic policy management that is contextualized to specific countries. Post-­crisis talks involving the major economies, with an emphasis in 2009 on including the G20 rather than the previously exclusiveness of the G7 and G9, suggests that US domination may change, with the IMF becoming less US driven and more genuinely global, but such a major cultural change is likely to take time. In the summer of 2011 there was considerable debate about how the IMF should be run and whether a European leader should remain at the helm rather than an economist from a rapidly developing new economy. This ended with the appointment of Christine Lagarde. This signalled a growing focus on Europe and its sovereign debt crisis with escalating euro bond debts in the autumn of 2011 (Emmott, 2011: 19). A number of euro member nations saw bond yields rise in November 2011. Investors increasingly priced in the likelihood of the euro failing given that Germany would not agree to the full independence and intervention of the European Central Bank to buy up bonds in the struggling economies so as to force down their yields (a proposed European quantitative easing). Bottle (2011) warned that bonds are not always a safe investment in times of economic uncertainty when economies flip from inflation to deflation. Milne and Oakley (2011b: 20) proposed that the contagion of rising bond yields in euro denominated economies in the autumn of 2011 were an indication of the demise of the euro and a growing sense of crisis for banks heavily invested in euro bonds. This looked likely to further restrict borrowing by increasing its cost.

Conclusion Table 6.4 summarizes the current systemic problems with global economic policy. The primary problem is a continuing dependence on monetary policy and austerity without adequate consideration of fiscal alternatives. The pre-­2008 crisis orthodoxy of lowering interest rates to loosen monetary policy no longer works as there is insufficient demand for money. In part, the high level of total debt owed means that there is no longer an appetite for new debt, and large sections of the economy have no confidence in acquiring further debt. Banks are nervous to lend from the cheap credit facilities offered to them by governments as they seek to raise their capital ratio reserves after the disastrous lack of

The second crisis   135 liquidity in the 2008–09 crisis. They fear further losses if government bond markets collapse. There is a weaker link than previously between central government monetary policy and the interactions of the wider economy of businesses and households given increased job insecurities, and fears of asset deflation set against rising food and fuel prices. For example, many consumers find that debt is too expensive or simply not available from commercial lenders, due to banks being risk adverse, profiteering and not willing or able to pass relative cheap central rates onto the consumer markets. The environment for monetary policy has therefore been destabilized through the financial crisis. Central bank monetary policy always had some limit in its direct association with the wider economy and it has been argued previously that interest rate changes can take up to two years to change price indices, but in the current environment any stable relationship that did exist between monetary policy and prices and consumer demands seems to be broken. Governments have taken on the debts of banks and financial institutions and have also experienced reduced tax receipts as a result of the recession. Government borrowing has escalated as a result, and governments are nervous about borrowing to create fiscal stimuli that might lead them to default or to raise taxes that might slow the economy further. The rescue of countries within the euro currency group has confirmed this policy paralysis. Lynn (2011: 254) has argued that the second financial crisis in Europe is quite different to the first global banking crisis, in that the focus has moved from ‘consumer debt recycled through the banking system’ to ‘government debt recycled through the bond markets’. But there is a strong overall theme. This is the failure of monetary policy. Lending decisions before the crisis were based on current consumer behaviour and rising asset prices, but not on a synthesis of economic fundamentals that considered historical patterns and future scenarios. The ‘here and now’ assessments were distorted by the low cost of imports from Asia while ignoring the unsustainable rise in property prices. Governments chose to ignore their weak balance of payments in trade and capital flows believing they would self correct through inward investment in an increasingly open global market place. Government policy and central banks failed to evaluate the whole systems environment. As a result banks lent too much to governments, businesses and consumers. This was a joint error of judgement. Both lenders and borrowers were responsible for false economic optimism. There has been no new tipping point reached in the ideological paradigm of the relationship between the state and market, no such paradigm shift has occurred. The long term dominant view is that the government is subservient to market forces. What Kaletsky (2010) describes as the emergence of a new paradigm of capitalism is not happening; instead, the major states wait for the old capitalism (Kaletsky’s model 3.0) to revive itself and repay the state its huge investments in the financial sector. The great hope of governments is not that they can radically improve society and its relationship with the market, but that they can sell their investments and shares in rescued banks at a profit and return the national accounts to something that resembles the low inflation world of

National government insolvencies: cannot borrow Money lent with austerity conditions attached: cut public expenditures, from markets, need IMF and EU assistance. New privatize national assets. Some ‘haircut’ penalties applied to banks who rules for IMF and inter-governmental lending issued irresponsible loans

Households, businesses and public sector reduce spending. This fuels economic stagnation and lack of growth

System rules

Reinforcing feedback

Stabilizing feedback Debt-ridden countries need to devalue currencies, Insolvent countries seek export or inward investment solutions to growth, reduce borrowing and imports via rapid i.e. export drives in UK, US and Ireland, but their success depends on stabilizing trade growth in exports previous creditor BRIC nations creating internal demand

Previous growth of public sector services, jobs and pensions strongly checked by government cuts in funding and pushed into reverse. This may further reinforce economic stagnation, lack of spending and growth

Reluctant intervention of European Union and IMF in Greece, Ireland and Portugal. Narrow vision based on classical IMF approach. Short term austerity and growth seen as possible and achievable, despite historical evidence showing it is contradictory. Evidence of these countries drifting into hopelessness and political crisis with nil growth

Contradictions in values. Intervention to save banks, with unrealistic targets placed on countries in default (where protecting bank bond investments is seen as primacy). No clear articulation of new principles for global economy that provides for national–local political and social needs

Ideological paradigm of operation

Interventions attempted 2010–11

Problem

Intervention

Table 6.4  Policy analysis – system interventions, 2010–11

Breakdown in classical control method of using interest rates to control inflation and demand. Very low interest rates not stimulating adequate internal investment and demand

Governments trying to persuade populations of the necessity of national austerity to reduce debt, by arguing worse long term consequences if public cuts avoided

The major exporting economies need to promote more internal consumption and let their currencies rise in value

Austerity further threatens demise of public services. Little sign of willingness to embrace new systems of micro organization due to growing unemployment and loss of confidence in marketization

Setting operating parameters

Use of Information

Managing ‘levels’

Leading selforganization

Governments unable to tap self-organization potential of public professionals who have largely become defensive and distrusting of government, resulting in poor industrial relations. Lack of innovative models evident

Impossible to rapidly rebalance global supply and demand, and exchange rates. China fears instabilities and inflation from rapid adjustments towards internal consumption

Political election results in Greece, UK and Ireland. Many vote for austerity, fearing further escalations in total debt, but debts may increase more under austerity programmes if growth not achieved

Fiscal targets to reduce government borrowing set to encourage private sector confidence and activity. Debate over European monetary policy and whether to use central quantitative easing. This reflects the diversity of the European economy and the difficulty of using single parameters

138   The second crisis 2003–07. Politicians talk of global rebalancing but have no credible plans to achieve it (Coman, 2011). The state has intervened to save the deregulated global market place, promising changes in regulation to aid the market’s function, but the majority of states are now sitting back and waiting for the market to grow and lead societies out of the crisis. Too many countries are seeking economic growth via exports. These governments have no confidence in their ability to use the power of the state and its major contribution to the wider economy; instead they see themselves primarily as guardians of the market place. This lack of political and policy leadership is at present leaving nation states drifting without direction in a choppy sea of instability. Economic forecasting, always a difficult art, is even more impossible than previously in an economic world that has no strategy or policy direction, where speculators try and spot the continuing fluctuations of currencies, commodities and bonds. No obvious trend is emerging because the world and its major states have no sense of direction. Investor analysts talk of the need to spot the buying opportunities in the short term dips in the rollercoaster ride of unstable currencies, bonds and stocks, as they fluctuate in short cycles. The only predictable factor is that TCs continue to have a strategy: to maximize their profits by moving capital and labour where this is most advantageous. The world in 2011 is a world largely devoid of a coherent public policy strategy, and waiting to evolve its micro strategies to the demands of the market place. The market, not government, is believed to be the saviour. In the next two chapters the book examines some alternatives.

7 From austerity to opportunity The next ten years

Introduction This chapter looks at the major challenge for public policy in the next decade given the high level of debt in Western economies and the economic imbalance with BRICs and developing economies. Using the data analysis and policy ana­ lysis from the earlier chapters, this chapter seeks to draw out overall conclusions for public policy and government intervention, and the most likely consequences of continuing crisis and change. The challenge for policy makers is to take a holistic view of social and economic systems and not to limit their vision and intervention to previous dogma and ideological limitations. The interventions should be designed to bring long term stability to systems, moving them away from the edge of chaos and repeated patterns of instability. Historical events will always generate some instability and uncertainty, but policy should seek to inter­ vene to build an underlying stability despite this. Monetary policy was designed to bring stability to the monetary system through central bank influences on the price of money, but this policy has been shown to be very limited and not holis­ tic in effect. A bolder intervention in market processes is needed that is holistic and driven by a paradigm of public value and collective achievement.

Possible trends Although the crisis interventions of 2007–08 have reduced the extent of the social, economic and political damage caused by market excesses and failure, they have not successfully dealt in the medium term with the major causes of the recession: that is, excessive market instability caused by speculators and inves­ tors chasing short term profit, and imbalances in the global economy and the high levels of debt in most Western developed countries. This can be likened to a doctor giving medicine that relieves some of the pain of the disease, but that does not deal with the underlying causes. Therefore the risks remain of the pain returning and the longer term condition of the patient is not improved. The best guide that politicians, policy makers and economists have to finding a way out of the ongoing crisis is the 1929 crash and subsequent depression, and the post-­war banking and credit failures of individual nations, or clusters of countries

140   From austerity to opportunity (Krugman, 2008). These illustrate the severe difficulties in reducing the impact of large debts acquired in a relatively short space of time, and that corrective policies – if they are to be successful – take time to achieve. Such policies are also dependent on external contingencies, like the behaviour of other countries and external markets. There is still too much focus on market processes with not enough consideration of the end game, in terms of the kind of societies and economies that governments are trying to create. What then is the most likely medium term (3–5 year) economic outcome of the crisis? For the most indebted nations the terrain looks highly challenging. Their currencies look vulnerable, inflation is likely to run above target in the short term and, while commodity prices are high, growth is unlikely to increase above 2 per cent per annum (the rate of growth that is historically attributed with being critical for increasing full time employment). Government bond market conditions look likely to become more testing for the most highly indebted nations, in time pushing up interest rates. For the major banking nations at the heart of the crisis, like the US and UK, some short spurts of growth and activity seem likely, but these will be quickly checked by quarters of decline with low growth over the cycle, so as to keep any long term trend growth restrained. Job growth is therefore most likely to come in part time and low paid employment. Employment policy coupled with a policy of creating greater income equality looks to be important to build social cohesion and to prevent rising unrest, social disorder and welfare distress. Employment had become the main vehicle to cit­ izenship in developed economies in the decade before the 2008 crisis, with a growing level of employment and levels of women moving into employment alongside caring roles. Maintaining high employment should be a major policy objective for governments, using specific tax reductions for employers (reducing the direct cost of employment) or using taxation to maintain public employment. Short term direct job subsidies should also be considered, especially for the young. This promotes training and work experience. Investment in education and training is vital for future economic growth and these areas should be prior­ ity areas for public expenditure and subsidy. Long term unemployment reduces the long term capacity of a nation, reducing value and contributing to social problems. Long term unemployment provides a reinforcing feedback into the system that is highly negative in social consequences and further undermines other policies. The majority of developed Western countries of the OECD as a collective look dependent on being able to sustain, or rapidly build, export markets if they are to achieve growth while paying down their household, company and public debts. Realistically the debt repayment process will take at least five years, more likely a decade, before it has less drag on economic performance. But the devel­ opment of exporting growth requires additional importing by the world’s devel­ oping nations, in particular China, India, Russia and Brazil, but also the numerous developing economies of South America, Africa and Asia (Kaletsky, 2010). For this to happen the focus of global financial services will have to shift to financing the development of these countries, but needs to do so in a

From austerity to opportunity   141 coordinated and sustainable way that does not create local asset bubbles. The decision of the G20 in London in April 2009 to focus more of the IMF and World Bank activity and resources on this new globalization project offered some hope. But the history of IMF intervention in South America and Asia in the last 20 years does not offer much hope for success if the IMF pursues free market goals in a manner that are in the fundamental interests of the developed West, rather than the developing nations themselves (Stiglitz, 2002, 2010). Some new system of reserve or capital buffers for developing economies may be needed that prevents them from over protecting themselves with large foreign exchange reserves (Wolf, 2010). Otherwise, given the large risks from sudden movements of capital these countries feel exposed to, it is inevitable that they will behave in a risk adverse way. Countries affected by the banking crisis that have a positive balance of pay­ ments and trade surpluses look as if they might fair slightly better in the next few years (Blanchard and Milesi-­Ferretti, 2011). Examples are Germany, Denmark, Sweden, Finland and Norway. These countries are characterized by more balanced fiscal, monetary and trade policies. Germany, for example, emerged in the middle of 2011 as having above trend growth based on increased exports with Asia, but also has increased domestic consumption. But a banking crisis still hangs over Germany, with its banking sector having lent heavily to the governments of southern and Eastern Europe. Japan runs a trade and current account surplus, and these are part of the picture that has made it possible for it to have amassed the world’s largest government total debt profile as a proportion of GDP without immediate fear of default. Japan has a high percentage of its government debt owned by its internal businesses and households, the so-­called ‘Japanese exceptionalism’. If the indebted nations like the UK and USA need to borrow to find investment routes out of the crisis they need to borrow wisely and from their own people. This will be from secure local sources, like sections of their own population saving for retirement, or through long term investment bonds that are locked in for maximum stability. The currencies of the indebted nations will have to fall alongside their comparative standard of living until they have balanced their government and trade current accounts. This will reduce imports and see a return to local and national production. The shift must be from cheap prices, quantity and much waste to more careful purchases, of quality and with reduced waste. Privileging local and regional economies via changes in tax­ ation should promote this. Increased overall taxation is needed to assist rebalanc­ ing the government current account. The primary goal of economic policy needs to be to reduce instability and to rebalance the economy so that any periods of excess are swiftly moderated. To try and run an economy and sustain activity on a single area of excess, whether it be leverage, public borrowing or an asset bubble, has been shown to be errone­ ous and inflicts longer term damage. Economic management needs to focus on broad economic and social stability, not just stability of the money supply. A more holistic economic policy therefore must consider the interrelation and dynamic of inflation-­deflation, leverage-­investment, imports-­exports, inward

142   From austerity to opportunity investment-­outward investment. This is a complex systems approach as advo­ cated in this book. Economic policy must be equipped with what Beautement and Broenner (2011) call complexity worthiness: the openness, pragmatism and ability to analyse and understand the operation of complex systems. This holistic approach to policy clearly needs to work at numerous levels: international, con­ tinental, national and local, but with a renewed level of confident intervention at the local and national level. While the globe has seen some limited success in continental cooperation, global cooperation has not been able to develop fast enough to manage the development of a global market flow and relatively free flow of capital. There needs to be more control on monetary flows and more stocks and buffers in the system to prevent sudden instability. Monetary policy alone will not stabilize the global and national economies. Strong local and national interventions and cooperation on tighter regulations have a major part to play in a new systems policy approach. Public policy should oversee the economy and not the reverse. The primary goal of a national society is not the just the functioning of markets but a stable and collective place for people to live and trade. The economy and market place should be subservient to public and social goals. This is not communism or socialism, but a society that includes markets as a form of organization, but where the form of organization operated is to achieve agreed social and public priorities rather than only creating opportunities for individual gain. Individuals may derive benefit from market activity and motivations, but in accordance with public principles and priorities.

Will austerity measures work? When some European countries implemented austerity measures because of rapidly rising annual government budget deficits in 2009–10, a considerable debate began about whether the cuts in public expenditure and tax rises imple­ mented were too rapid and whether they would prove counterproductive. Greece provided a key test of this policy approach and by the end of 2011 ‘haircuts’ had had to be negotiated on its debts to banks because of a lack of growth and con­ tinued major declines in its economy. The question of whether austerity measures will work depends on what politi­ cians and policy makers want them to do. Is the ideological purpose of austerity to revive marketization and privatization and to reduce the size of the state, or is it part of a rebalancing towards a vision of a society that is less wasteful, has a more resilient and diverse economy and is more equal? The focus in 2010 and 2011 on public sector levels of debt and the need for austerity to reduce debt had different drivers in different nations. In Greece and Portugal governments were unable to sustain their public sector expenditure levels once they were in reces­ sion, meaning that public services might have to suddenly close because the gov­ ernment might not have enough liquidity to pay the salaries and running costs. This could happen in a given month if tax revenues were insufficient to make all the required expenses payments, and borrowing was refused by a market that

From austerity to opportunity   143 will not purchase new government bond issues. At this point national govern­ ments can approach continental partners (for example, Greece approached Euro­ pean governments in the single currency area) and the IMF. International assistance in the form of loans is contingent on agreeing national policy reforms and expenditure reductions to guarantee the loan can be repaid. Public austerity in Greece and Portugal was conditional on the governments remaining solvent in the euro single currency area and not defaulting back to pre-­euro currencies that would allow them to competitively devalue. In Greece, the government’s liquid­ ity crisis was caused by a proliferation of government borrowing at cheap rates after 2001 when it joined the euro. There is some history of Keynesian econo­ mists criticizing the IMF for enforcing too many austerity measures and mone­ tary controls in these kinds of rescues, as these can prove counterproductive and reduce any chance of achieving levels of growth that allow the loans to be repaid (Stiglitz, 2010). Greece has followed that trend. In Ireland, UK, Spain and Italy, governments made planned decisions to reduce public sector borrowing because they feared a crisis of public solvency similar to that experienced by Greece. These decisions were preceded by increased borrowing set up in 2009 to rescue banks through state ownership and falling tax revenues to support already planned public expenditures in the policy systems. There was a widespread perception that annual deficits were not sus­ tainable, but disagreement about the sustainability of the total level of national debt and therefore about the time scale for moving back to a balanced budget and gradually reducing total national debt. These countries increased tax reve­ nues and reduced current and planned expenditures. There were substantial aca­ demic and media debates about the mix. All countries faced a common challenge: if new growth did not occur quickly they would be ‘running to stand still’, as increasing taxes and reduced public expenditure would reduce economic activity and in the short term actually worsen the public accounts. For example, rising unemployment results in the state paying more unemployment and welfare benefits and this creates more not less public expenditure. Similarly reductions in public sector employee earnings decrease tax receipts from income tax and consumption taxes. In short, the success of the austerity measures depended upon the private sector increasing its employment and income levels faster than the rate of public sector decline. Private sector growth was a prerequisite to success. It was clear by late 2010 that Ireland got the initial judgement wrong. The timing of public sector cuts only added to the economic decline and in Novem­ ber Ireland had to approach the EU and IMF for assistance to remain solvent. In part, the general election in the UK of May 2010 was a debate about over what periodic rate of austerity was appropriate. The previous Labour government had already embarked on some reductions in public expenditure and also planned tax rises on employers if they won the election. The Conservative opposition argued that the rate of expenditure reduction needed to speed up and to be more urgent, and they were more reticent about tax increases. The Liberal Democrat Party favoured a slower pace of cuts, and a shift towards an emphasis on tax increases

144   From austerity to opportunity as a preference to rapid expenditure reduction. When the final government coali­ tion was formed, the agreement (Conservative Party, 2010: 1) between the Con­ servatives and Liberal Democrats stated that they: agree that deficit reduction and continuing to ensure economic recovery is the most urgent issue facing Britain. We have therefore agreed that there will need to be – a significantly accelerated reduction in the structural deficit over the course of a Parliament, with the main burden of deficit reduction borne by reduced spending rather than increased taxes. An emergency budget later that summer established immediate £6 billion reduc­ tions in public expenditure and set up a formal process for reviewing all govern­ ment department expenditure priorities. Growth in the UK economy has remained sluggish since the election and has not achieved target levels. Borrow­ ing has proven stubborn to reduce with the largest element of the target reduc­ tion still to be achieved between 2012 and 2015. At the UK Chancellor’s autumn statement in late November 2011 the coalition government had to acknowledge that a lack of economic growth meant it was missing its targets for the reduction of borrowing and that balancing the government current account by the end of the parliamentary term of government looked impossible. New policies for the government to bring forward public investment and to underwrite bank credit to businesses were also announced. Risks from austerity? There is a high risk of further financial crises. Some crisis at lower levels of the global system, for example, for specific countries seems inevitable. For example, there is a high risk of Greece defaulting on its debts because the European Union and IMF will continue to impose tough austerity measures. If the economy does not grow then the country can no longer sustain the increased payments and cuts are required, but the decision to leave the euro would be as much a political judgement as an economic one. Cuts without growth look likely to increase internal political resistance to the government’s austerity plan to stay within the euro. Even in the short term, over the next two years, Greece’s targeted reduc­ tions in annual and net borrowing as a percentage of GDP look unattainable given the perilous state of the global economy and the severe difficulties Greece has of achieving growth in this environment. This has led to debt restructuring negotiations, with some so-­called ‘haircuts’ where creditors have to accept a loss on their investments, such as reductions in interest or even some reductions in the capital value. While this creates difficulties for European banks and further adds to their debts, it is likely to be more manageable than a major unplanned political and economic crisis that results in Greece leaving the euro and seeking to re-­establish its own currency. This would lead to much greater losses for external banks and could result in making some banks insolvent, and also lead to other countries with high public debts, such as Spain and Italy, facing new public

From austerity to opportunity   145 accounts crises if they need to support their own banks further. In short, the greatest risk for the next outbreak of instability is that it will spread from one country or a TC (like a multinational bank based in Europe) to have global level consequences. Commentators have compared the possible global impact of Greece defaulting on its debt as similar to the bankruptcy of Lehmann Brothers investment bank. The Greek crisis could result in another major banking crisis. For example, in October 2011, the Franco-­Belgium bank, Dexia, was rumoured to be in major difficulties because of its exposure to Greek bonds; the combined governments of Belgium and France, already major shareholders in the bank after the 2008 crisis, had to move to reassure the markets that they would guar­ antee all deposits. In the medium and longer term the debt levels in the US and UK still look problematic (Elliot and Inman, 2011: 35). Any problem in the US is likely to have global implications because of its economy being the biggest in the global system. Both governments have large annual deficits and total national debt, and households are burdened with debt. Repaying these debts will reduce consump­ tion and makes the countries dependent on exports to achieve good growth, but doubts remain about how the global economy will adjust to assist them with making this balance of payment change. Manufacturing and energy are strategic areas for rebalancing identified by both nations. Such fundamental change is likely to take at least a decade to achieve. There are growing concerns about the sustainability of the US government debt given that it is maintained by the posi­ tion of the US as the strongest global power and its tradition of being a safe haven for investors. The rising price of gold between 2008 and 2011 implied that this fundamental view was being challenged. The dollar looks likely to weaken against developing world currencies but given neither the euro nor yuan is well placed to replace it as a global reserve currency in the short term; major fluctua­ tions in global exchange rates look likely to be a further source of instability in the coming period. Economic policy in the US and UK is struggling to articulate a clear national strategy. The primary value of ‘global free market values’ appears to leave national political leaders struggling to articulate how to transform their econo­ mies. It is as if their hands are tied to the requirements of global financial institu­ tions and TCs dictating that they should not intervene to undermine global profits. This is similar to the contradiction in the crisis of using the machinery of the state to save global market institutions from bankruptcy while at the same time seeking to deny the political implications, responsibility and opportunities of state ownership of major financial institutions. This should have created an opportunity for direct investment into major projects of national value, including some innovative state run financial services and new forms of investment.

Alternative policies If public policy is to move more centre stage over economic policy and free market dogma, government politicians need to articulate something more of the

146   From austerity to opportunity key goals and plans they have for their economies. At present there continues to be too much focus on restoring global financial market processes rather than policy intervention in the market that achieve good public and social outcomes at national and local levels. It is a continuation of the assumption that market values will ‘trickle down’ social benefits. This reflects a ‘paradigm level’ failure in public policy as indicated by Meadows’ (1997, 1999, 2009) framework of system interventions discussed in Chapter 1. The time has come to turn the market paradigm on its head and organize policy and interventions so that the market delivers public and social benefit. The concept of the development of a green economy and taxation system is one illustration of the possibility for achieving this new paradigm, where the primary goal of the government inter­ vention in the market place is to prevent pollution, the over exploitation of depleting resources and unsustainable development. The local economy takes preference over global competition and exploitation. Such a new system would therefore explicitly or implicitly assess the costs of impacts on the wider envi­ ronment and be much more proactive in promoting renewable and sustainable development. Several commentators noted that the need for economic recovery after the crisis of 2008–09 presented a major opportunity for a ‘Green New Deal’, a major fiscal stimulus package that was a long term investment for the future (Jackson, 2009: Ch. 7). This would be similar to the Roosevelt New Deal of the 1930s, when roads and public buildings were built across America to help move the country out of the Great Depression. A Green New Deal would provide a major fiscal stimulus in the form of government investment for public benefit. Investment would be committed to projects with a substantial long term benefit, such as building hydroelectric power, wind turbines, solar PV generation, rail projects, carbon neutral housing developments, home and workplace energy effi­ ciency, and electric transportation and the related infrastructure. Krugman (2008: 187) has said that such a stimulus needs to be at least 4 per cent of GDP to have a major positive impact. The US has begun to make some investment in this manner but the UK government has failed to deliver on its promised green investment bank. There is an urgent need for governments to consider how best to create financial investment vehicles that can deliver on public works pro­ grammes either through the nationalized banks or national savings schemes. This will prevent them being over exposed to international markets and allow a national investment programme built primarily from the host population who can use such government organized specific investments not only to assist their country but to build pensions and long term savings. Similar direct incentives need to be developed for local investments of public and social value. Long term fixed tariff payments for micro generated electricity is one positive example. Energy Energy policy is at the forefront of contemporary public policy debate about the future of the world economy and how to build in local stability and resilience. Industrial development has moved societies into a dependence on a large

From austerity to opportunity   147 wholesale system of energy production where a small number of service provid­ ers (the suppliers) deliver to a very large number of users (the demand) in the form of firms and households. Energy production is dependent on a global com­ modities market in primary fuels that is geographical, transnational and often subject to difficult periods of instability. These instabilities are in part created by political unrest and war in the countries that own vast reserves. Political instabil­ ity can both be caused and sustained by a national dependence on a single com­ modity. This is a global system that at present is too easily disrupted by shocks. Another source of instability in the supply of these commodities is the time lapse between their discovery and extraction. Uncertainties over what resources are left, where they are, and how much it will cost to extract them, tends to increase the level of market speculation with instability in the basic commodity prices, but also in the shares of the companies involved. At the heart of the debate is environmental impact and the carbon based pollution of much energy produc­ tion, with coal being the worst polluter, followed by oil. Natural gas in compari­ son is seen as relatively clean, but not without environmental considerations. Nuclear energy prevents carbon emissions but has other environmental ­challenges with fears on the large scale consequences of any accident and many doubts about how nuclear waste can be managed. These issues became starker after the 2011 Japanese earthquake and resulting destruction of its nuclear energy plant at Fukushima Daiichi. The developed OECD countries have become increasingly dependent on importing energy commodities, with a few exceptions (Canada and Norway), so that a cluster of less developed countries and regions supply a large proportion of the world’s energy commodities (Russia, Central America, Middle East and northern and west Africa.) But many commentators see nuclear as an essential part of the generating capacity of large economies (Hastings, 2011: 11). Energy policy is directly linked to concerns about carbon dioxide increases in the global environment leading to global warming and climate change. Interna­ tional agreements on carbon reduction have proved very difficult to negotiate, largely because the majority of carbon pollution currently comes from developed countries and developing countries omit much less per capita, but increases in their omissions seem inevitable as these countries develop and industrialize. International negotiations seek national targets in carbon reduction and several developed countries including the UK are trying to implement these targets into both national and local energy policy (Bebbington et al., 2009). Reports in the summer of 2011 suggested that despite the global recession, climate change caused by industrial carbon dioxide waste was almost irreversible in its perma­ nent damage to the world’s ecosystems (Harvey, 2011). The main economic driver of how the transnational energy market has evolved, including the large scale production and delivery of energy to users, has been the basic primary commodity price. It is the price of the primary fuel com­ modities that has driven the cost of the energy derived and delivered to users. A key feature of the 2008–09 crisis was speculation on the oil price immediately before the depth of the crisis, with a considerable and rapid drop in price after

148   From austerity to opportunity 2009. The world saw another rapid spike in oil prices as the global economy came out of recession in 2010–11. The lack of stability in primary commodity prices has resulted in governments attempting to establish efficient internal market systems for the distribution of energy where there is a surplus available in storage for supply to the customer, and the distributors therefore compete to give the best price to consumers. This creates a method for managing system instability via a held stock or buffer (Meadows, 2009). Given the strong influ­ ence of primary commodity price and the relative inflexibility (inelasticity) in its price at any one time, competition in the middle ground of supply, to micro users, is confusing for firms and households, and involves judging how long to accept contracts with periods of fixed and guaranteed prices. The increased storage of oil and gas closer to the national delivery networks was supposed to make price competition at point of delivery more elastic, but it has taken some time to develop infrastructure and storage capacity. In addition, electricity cannot be stored, so the issue is finding efficient ways for pricing by bringing on addi­ tional generation facilities at peak times and the financial system of reward to use. All this illustrates the workings of market that is far from perfect competi­ tion and subject to inevitable government regulation and intervention. Neverthe­ less, governments were clear in the 1980s that they wanted to move away from any remaining state monopolies to attempt privatization and marketization. A key element of the debate about how best to build an efficient and effective market system for energy distribution is whether to extend intercontinental grids for the rapid transportation of oil, gas and electricity across continents, or to put more focus on micro local generation, or to do both. Large scale networks have economies of scale, but these are still subject to short term instabilities. Local networks require expensive capital investment and thereby raise long term payback costs, but these balance over the long term because local networks tend to be driven by renewable sources like solar, wind and tides. If the right mix of renewables is developed, these can provide a more stable supply than primary commodities, with less risk of short term shocks and long term depletion (Jacob­ son and Delucchi, 2009). In practice it would appear that the most likely future is for a combination of both intercontinental and local delivery, as this diversity reduces risk while increasing efficiency. Scientists made a presentation at the UK House of Commons in June 2009 arguing that an electricity supergrid across Europe and North Africa could solve the problem of the intermittency of wind turbines and solar power (Cornago, 2011). An example is negotiations with the Irish government in 2011 to build wind farms on the west coast of Ireland, known to be some of the most turbulent air in Europe, so as to generate excess capacity from the small nation to the UK and the rest of Europe (McKie, 2011). The challenge is the immediate need for investment into these innovative long term projects. Such investment will make energy more expensive to the con­ sumer and so need to be accompanied by good micro energy efficiency and man­ agement at the point of use. The attempt to create national and continental markets in energy supply is only one part of the vision to realize efficient power supply that does not create

From austerity to opportunity   149 large scale pollution and environmental degradation. Large scale systems of electricity generation lose a percentage in the transmission process and create difficulties of scale when bringing an additional major power generator onto the grid. Similarly the building of gas and oil networks makes national suppliers focus in the early stages on the largest and cheapest short term supplier and this can leave the system vulnerable to shocks in the market. An alternative small scale localized and renewable system could be based on a real acknowledgement of the long term cost of producing energy and give local incentives to reducing waste at the point of use (McKibben, 2007: 145) There are major signs of innovation in the world energy market, but only small percentages of supply generated by renewables at the present time. The Pelamis wave machine can generate 750 kW and is about to be tested off the west coast of Scotland, with the potential for a field of machines in their hundreds generating 180 MW. There are hopes that its construction and trial will make it a world leader with export potential (Carrell, 2011: 44–45). Denmark is a world leader in wind turbine construction and use and has developed a £6 billion export market through manufacturing the products, although it is important to acknowledge the fact that domestic energy is relatively expensive in Denmark. In 2010–11 the International Energy Agency reported that Denmark had produced 27 per cent of its domestic electricity by renewable means, the majority from wind turbines. Various experi­ ences are underway to improve household micro wind generation, including the UK awarding winning invention, the ‘Secret Turbine’ (SET). This claims chimney pot generation of 25–100 watts, or larger ‘clock tower’ structures that can generate up to 350 watts (see www.secretenergy turbine.com); the initial investment needed is a few thousand pounds. The UK coalition government followed the German government’s example in creating an incentive for micro household feed-­in tariffs with renewables, offering a good long term tariff return for each unit of electricity generated in the future, although the German scheme was criticized in a research evaluation for incentivizing small projects with very low efficiency (Frondel et al., 2009). In May 2010 the UK press (Observer, 15 May) reported that the coalition government in the UK had reached an historic agreement on establishing a carbon budget designed to maximize the reduction in carbon pollution by the UK economy. It was reported that this was the first major carbon reduction policy strategy in the world, with a target expressed to reduce 80 per cent of carbon emissions by 2050 and 60 per cent reduction by 2030. It was also sug­ gested that 40 per cent of the UK’s electrical power generation should come from wind, tide and wave sources by 2030 given its island position in north-­west Europe and the North Atlantic. The government’s radical policy approach had been facilitated by advice from the Civil Services’ Committee on Climate Change (CCC). Although doubts over the policy were expressed by the Business Secretary and Chancellor from within the government’s cabinet, the medium and longer benefits of trying to intervene to get the UK ahead of the competition with the development of new technology and green power generation equipment was seen as more important, and a signal to the private sector to invest.

150   From austerity to opportunity Developed countries that are dependent on importing energy are increasingly looking at ways of making their energy needs more secure and protecting against being dependent on a few sources of supply from unstable countries and markets. One obvious way to improve this is diversification, so that a nation is not too dependent on one commodity or type of energy. While Europe has moved sig­ nificantly from the use of oil to gas to generate electricity because it was seen as cleaner and cheaper, as regional stocks have been consumed, the countries of the European Union have had to look further away to Russia and the Middle East where the political implications are that supply is seen as less stable and the price more volatile. Gas has become more expensive on the global market and no longer seen as relatively cheap. Attempts to move personal transportation to public shared systems or alterna­ tives such as cycling, electric or hydrogen fuelled cars and motorbikes have proved of limited success in terms of any change in the overall dependence on oil. So far consumers seem to have demonstrated little sensitivity to rising petrol price even when incomes are falling, with only moderate reductions in the private consumption of fuel resulting. Governments need to create many more incentives to encourage market movements away from the petrol driven car system so that a tipping point in the balance of the system working is achieved. Oil In part the fact that spikes in the oil price in 2008 and 2010 did not cause the US, Europe and Japan more immediate economic problems is an indication that they have adapted to be less dependent on this single source of energy. The previous price spike of 1976 caused stagflation because of the effect of the rising oil prices on a whole range of goods, with a rapid effect on production costs and wages. Improved energy efficiency was one good consequence of that crisis. Nevertheless, rising inflation in the US and UK in 2011 is connected to rising oil prices, coupled with a dependence on energy imports and a trade deficit. There remains fierce debate about whether the upward trend for both oil and gas com­ modity prices is inevitable given rising demand in new rapidly developing econ­ omies like India and China or whether prices will soon fall or stabilize. On balance the literature seems to conclude that the real price of oil, relative to other goods, is on an upward trajectory and in part this is related to the concept of ‘peak oil’. This is the theory that the globe is currently passing through an era that will be viewed in history as its maximum period of capacity of oil produc­ tion, as new oil fields become more expensive and difficult to extract from. One sign of this theory being realized was the major disaster in the Mexican Gulf in 2010 when one of the first ‘deep water’ drilling rigs, Deepwater Horizon, suf­ fered a major technical fault and a subsequent spill that caused much environ­ mental damage to the US gulf coast. Questions remain about whether the companies involved can survive the impact of the cost of litigation and compen­ sation payouts. Other new sources of oil such as the tar sands of Canada are also argued to be more costly on the environment with increased carbon pollution,

From austerity to opportunity   151 deforestation and excessive use of water. In October 2011, the European Com­ mission looked likely to advise European Union governments to ban tar sand imports because of the high global environmental cost. The difficulty of securing supply and the upward price trend is not the only reason why Western govern­ ments need to urgently take a more proactive interventionist stance in stabilizing long term energy policy by investing in national and local renewables. Commen­ tators like Klare (2004) see the political instability associated with an over reli­ ance on global supply, and the possibility of oil related wars, as a major threat. Diverse and localized energy production policies are seen as essential for world peace after the costly military interventions in Iraq and Libya by the US and UK. Gas In the 1980s there was a so-­called ‘dash to gas’ for electricity generation, as natural gas supplies appeared abundant and available from a relatively diverse range of countries, and at a competitive price when compared to oil and nuclear. In addition, natural gas was considered to be a relatively clean method for gener­ ating electricity. For example, in the UK, several coal and oil-­fuelled electricity generation plants were closed and replaced by new, efficient gas-­fired genera­ tors. Natural gas production rose steadily in the UK from the 1980s until 2000, but then declined and by 2010 had almost fallen back to half the 2000 level, this making the UK much more dependent on imported gas. After 2000 the global supply of natural gas became more problematic, particularly in Europe, as the European market became increasingly reliant on Russia and Norway, and long distance shipping and pipelines from Eastern Europe and near Asia and the Middle East. Wholesale prices began to rise steeply and concerns were expressed about the security of supply. After a long period of relative stability in imported natural gas prices between 1984 and 2004, prices rose rapidly until the recession of 2008. For example, the International Energy Agency (2010) reported that import prices in the major importing countries of US, Germany, Japan, Belgium and Spain had more than doubled between 2004 and 2008. The rising cost of gas is one cause of the consideration of further nuclear and renewable energy sources and is promoting consideration of investment in these alternatives. Shale gas The increased importance of shale gas in the US since 2000 and the increasing proportion of US gas production and supply coming from shale extraction raised excitement in Western developing OECD countries that are dependent on energy imports, especially in Europe, where shale gas offers a new indigenous low cost energy supply in abundance. However, some attempts at abstraction in the US in more populated areas such as the eastern seaboard have been fraught with envi­ ronmental problems, including ground water contamination (Osborn et al., 2011). Environmental campaign group evidence submitted to a UK House of Commons Energy and Climate Change Select Committee (2010) urged much

152   From austerity to opportunity caution. While acknowledging that shale gas could prove more carbon efficient than coal it was argued to be worse than natural gas due to escaping methane during the production process. A large scale shift in the energy market towards shale gas would undermine the much needed investment in longer term research and development of renewables. France has prevented commercial exploration for shale gas until environmental scientists can satisfactorily advise the govern­ ment on the level of environmental risk. Eastern European countries like Poland are very interested in the commercial exploitation of shale gas for domestic supply because of the hope that it will release them from dependence on Russian supply lines and continued increases in price that are largely out of their national control. Further new investment is starting in countries with large coal reserves to experiment with the capture of carbon omissions during the burning of the coal. While this will increase the expense of generating heat and electricity from coal, it may still be economically viable compared to nuclear and renewable genera­ tion. This is important research and development given the substantial coal reserves that still remain in a number of developed and rapidly developing nations. In summary, the approach of public policy to energy production must be at the core of any future public policy paradigm. It is a fundamental element for the new millennium, in the same way that democratic enfranchisement and the development of an ethical public administration was core 100 years ago. The state must intervene to organize energy production and its use as a public good that reduces externalized public costs in the form of carbon emissions. As Stiglitz (2010: 188–189) says, the fundamental problem is that ‘scarce resources are treated as if they are free’. Rising energy costs are inevitable in the global economy, but by investing in a more complex and diverse range of energy pro­ duction and distribution national and local economies can be revived alongside the rising costs. The rising costs can bring quality benefits to local economies. Internet and communications Information technology and the internet drove the US and other developed econ­ omies from the late 1980s through the 1990s and into the new millennium. Although Asia quickly competed with the US and Europe for hardware and inte­ grated micro chip production, new innovations in software design and the use of the internet and portable IT hardware also became lead industries in the 1990s, often led by American entrepreneurs. This growth led to an investment bubble (the so-­called ‘dot.com bubble’) in the late 1990s as investors rushed to buy shares in newly set up internet communications companies, with money chasing company ideas, sometimes before they made any revenue or profit. At the height of the bubble, websites that were little more than ideas were attracting high valu­ ations. Although the share market bubble deflated, a small number of these new service industries emerged as major billion dollar global brands and TCs. These service ideas continued to evolve rapidly, providing success to the strongest

From austerity to opportunity   153 contenders in each new concept: Google has come to dominate search engines, Facebook powers social networking, and Amazon and eBay remain major elec­ tronic market places. Prior to this, mobile phone hardware, software and infra­ structure had similarly provided important technological based economic growth with major taxation gains for governments as they sold off licenses for micro­ wave communications technology to mobile phone operators. In the new millen­ nium mobile and computer technologies increasingly converged. The dot.com bubble has left governments and investors nervous of the economic future of technological and related services. Some of those lobbying for public investment after the financial crisis have argued that upgrading broadband cables and wire­ less distribution of information is one way to ensure continued innovation and economic growth in the future, as new products and services can spin off from an improved infrastructure. Information technology is another key area for gov­ ernments to encourage investment for the building of social and economic capacity.

Reducing inequality In addition to a failure of long term investment, a second key area of market failure is the increasing levels of inequality that market activities have delivered when they were not adequately managed by public policy interventions (OECD, 2011b; Hutton, 2011b). Discussion and debate about poverty and inequality became unpopular with some governments during the rise of Capitalism 3.0 (Kaletsky, 2010) given its optimistic and dominant logic that the market would ultimately solve and correct all problems and government interventions would merely make things worse. But recent concerns with rising levels of inequality and their distorting effects on global labour markets and flights of capital has seen a return of inequality issues to key aspects of policy debates. Initially this focus was on absolute poverty and how to ensure that the continent of Africa was not left behind as some progress was made in South America and Asia (see Commission for Africa, 2005; Africa Commission, 2009). Then, in the years preceding the financial crisis of 2008, academics, policy analysts and some serious journalists revisited the issue of growing inequality and wealth within nation states, in particular asking to what extent this was undermining the sus­ tainability of the national economy in those countries (Peston, 2008b) and more widely whether growing inequality within a nation could undermine health and wellbeing (Wilkinson and Pickett, 2010). Various studies have shown the uneven effect of the post-­2009 recession, with poorer households and individuals being relatively more disadvantaged by the resulting changes in incomes and prices (Levell and Oldfield, 2011). In developed countries, state intervention had largely remained in place to prevent absolute poverty and destitution in the 1990s, but had started to retreat on the idea of relative poverty (where poverty was defined by how close earn­ ings and wealth were to average earnings). From the 1980s onwards some gov­ ernments in developed nations dispensed with targeting relative poverty as a

154   From austerity to opportunity policy priority. This was connected to concerns about increasing the motivation for work, and a perceived need for lower wages and a flexible supply to the labour market when the economy was changing. Conversely, absolute poverty had become a major international issue with a national charitable and develop­ mental focus in many of the OECD’s wealthy countries. Numerous charities campaigned in wealthy OECD countries for funds and assistance to prevent star­ vation and destitution in the poorest countries of the developing world, including lobbying to increase the percentage of GDP committed to overseas aid. Against the backdrop of these campaigns relative poverty within a wealthy nation looked less important to politicians. This decline of policy initiatives on relative poverty effected the redistribution of monies from the wealthiest to the poorest, with growing inequalities in many countries (see Table 3.16). It also meant that the most powerful and wealthy had more opportunity to increase their earnings exponentially while their avoidance of progressive taxation largely went unno­ ticed (Peston, 2008b). But by the time the global financial crisis hit in 2008, the public in developed countries were becoming increasingly aware that excessive earnings had been driven by a competitive greed fed by unethical behaviour like the mis-­selling of financial products to others, but that also those driving these excessive rewards through dubious means were also paying less tax than the poor. For example, Peston’s (2008b) book in the UK revealed how the owners of a large hotel chain could pay less tax than its cleaners. If voters had hoped that the international community and rich governments were focusing on absolute poverty (while they ignored relative poverty and unequal incomes and wealth) they would be disappointed by the slow progress to reduce world poverty since market liberalization in the 1980s (Fardoust et al., 2011). As Stiglitz (2010:191) says: ‘The growing inequality contributes to the lack of global aggregate demand – money is going from those who would spend it to those who had more than they needed.’ Policies to prevent excessive differences in the distribution of income and wealth are another major public policy priority in the age of austerity.

Building resilience at national and regional levels If public policy is to intervene more successfully in markets and limit the destruc­ tive instabilities of global capitalism, the initial focus has to be from the bottom up. It is clear that global public policy cooperation will take many decades to achieve at a holistic top-­down level and the only possible way forward in the short and medium term is from the bottom up. This fits with market economics in that the fundamentals of optimal market processes demand an adequate number of purchas­ ers and sellers with a good flow of information between them. It is much easier to deliver this at a local level than a transnational, global level. Government should focus on giving preferential treatment to businesses and operations that are rela­ tively small and local because they are disadvantaged in global capitalism. In the UK, small and medium sized companies have been shown to generate more employment than large national and multi-­national companies after a recession,

From austerity to opportunity   155 and they also stimulate more innovation. Nevertheless, a large number of small businesses do fail after start up and in the first few years, so this route is not an easy or unproblematic road to a dynamic and sustainable local economy. Banks see lending to small businesses as relatively high risk when compared to large compa­ nies who already own large assets. This is one reason why small businesses in the UK were the main component of society still in credit in 2009 when the govern­ ment, large companies and households were all in substantial debt. Business educa­ tion is an important aspect, making sure that those starting out get good ongoing advice, support and mentoring. Finance The financial crisis of 2007–09 has clearly demonstrated the harmful instability of unregulated global markets. One consequence of this has been a commitment to better global, continental and national regulation of finance. But while most agree that global regulation and intervention are needed, many are also concerned about the ability and sophistication of global institutions to deliver. Fundamentally this depends on a level of persistent cooperation between the leaders of the world’s strongest economies not yet seen. Reflections on the Asian crisis of the late 1990s showed that unusual and short term national government interventions in the global market were sometimes necessary to create stability and contain the spread of instability, even if in the short term these were labelled as protectionist and anti-­ global. The reality was the government’s need to be pragmatic and interventionist in the short term to prevent their exposure to harmful global forces they had little control over. For example, in the Asian crisis, Malaysia used capital controls to reduce the flight of capital and further depreciation of its currency against the US dollar. Hong Kong used its substantial currency reserves to purchase shares to prevent a further stock and currency decline that would have enabled greater hedge fund gains (Krugman, 2008: 127–131; Brown, 2010: 73–74). During 2010 US pol­ iticians repeatedly criticized China for keeping its currency the yuan artificially high in value against the US dollar, thus preventing a reversal in the trading imbal­ ance between the two countries, but China feared other consequences from not intervening to keep its currency lower in value and has been cautious in letting the yuan float on foreign exchange markets. Greater financial regulation and interven­ tion in financial and global markets is part of the national public policy requirement after the 2008–09 crisis. National and local economies have a right to act in the short term to prevent excessive speculation that damages the public interest. This is an important part of active systems management. Future of banking and finance reform Banking reform is a long term project given the fear that individual governments have of going it alone and losing out in the internationalized TC world of global finance. This fear means that governments have not been quick in finding crea­ tive and alternative ways of managing the financial system. Nevertheless a

156   From austerity to opportunity number of trends are emerging. Capital to leverage ratios are increasing (reduc­ ing the lending by commercial banks). It looks as if governments and the regula­ tory bodies they support will slowly become successful in improving the financial stability of banks. The greatest short and medium term risks are in gov­ ernment debt and this looks likely to place some further crisis on some over exposed banks. If more banks do fail this is also counterproductive as the remaining banks become ever more large and monopolistic. If national governments fail to implement long term reforms of the major inter­ national financial institutions it might be that ordinary citizens, neighbours, com­ munities and trades unions decide to take more direct action. The history of friendly societies in the UK is one of micro credit facilities organized by collec­ tives of similar people to attempt to meet their combined needs for savings, bor­ rowing and social insurance. Credit Unions represent a local and micro alternative to national and global banking (where banks have little interest in the individual and are more focused on borrowing and lending to international business). McKil­ lop et al. (2011) show that membership of Credit Unions grew in Great Britain between 2003 and 2009 from 500,000 to 800,000 members, with a growth in shares valued at £364 million in 2003 to £556 million in 2009. Nevertheless the average member’s share value fell in this period from £723 to £691. While the authors of the study welcome the growth in number of members they note that the expansion of micro credit in Great Britain was not without its problems, with some local credit unions failing. Credit Unions can continue to lend when whole­ sale money markets stop lending and their rates of interest are more realistic to local need, supply and demand rather than being distorted by the bubbles of glo­ balization and sudden movements of billions of dollars of capital and liquid assets. Stiglitz (2010: 181–183) has noted the need for governments to create stable long term investments that protect both savers and lenders. Index linked savings accounts or GDP linked bonds that help build people’s long term savings are such ideas. It has been argued that Japanese government national debt when compared to the US national debt is more stable because of its tendency to be built around domestic long term savers rather than international money markets. Such long term investors remove the transaction profits of TC financial institu­ tions that constantly buy and sell short term investments trying to outwit each other in ‘casino’ capitalism. Such a short term international financial system merely creates more instability and less long term stability and real value. A better-­regulated financial system would actually be more innovative in ways that mattered – with the creative energy of financial markets directed at com­ peting to produce products that enhance the well being of most citizens. (Stiglitz, 2010: 182) Local currencies The use of local currencies and similar local trading schemes can create opportu­ nities for local people to increase the velocity of the local economy and to guard

From austerity to opportunity   157 against aggressive outside competition that has no interest in the local environ­ ment and social needs of its people. In the Argentinean crisis of 2002 when the government ended dollar convertibility, towns and cities issued local ‘comple­ mentary’ currencies (Lietaer, 2001). A number of cities and towns in the UK and North America have started local currencies to encourage local trade. There is a long history of using local currencies in difficult economic times (Monbiot, 2009). Traders who use these local currency schemes may offer discounts to cus­ tomers and local traders who pay in the local currency, therefore reinforcing keeping trade local. If local government became more involved it might be pos­ sible to give local taxation reductions to traders who support a local currency on the basis that this is reducing the cost to the environment and supporting the local community. Financial policy needs to change its focus from international deals that encourage the merges of large TCs (where banks benefit from the large size of the transaction) to a focus on locally based small and medium sized businesses where there is the most potential for growing real innovation and productive benefit for local and regional economies (Stiglitz, 2010: 192). Health Health costs are rising as a percentage of GDP in most developed countries. Health care is advancing and with it the costs associated with developing new treatments. Table 3.19 showed that for OECD countries the average percentage of GDP spent on health care between 2003 and 2007 was 9 per cent, but there was quite a significant variation between Poland with 6 per cent and the US with 15 per cent. Private health care differences and inequality of health outcome within nations account for some of this variation, as does the administrative and organizational cost associated with the different types of market, insurance and state based schemes. However, national comparisons show that only marginally aggregate benefit is made to average life expectancy once 6 per cent of national GDP is committed. Internal cultural, dietary and socio-­economic factors proba­ bly account for the fact that the nine countries with between 9 and 11 per cent of GDP spent on health could have a life expectancy rate that varied by as much as 73–82 years. This is similar to Wilkinson and Pickett’s (2010) argument that, once countries had achieved the average income levels of the newly developing economies in South America and Asia, there was little evidence that further rises in average income automatically increased a citizen’s quality of life and health. The high technological gains that are benefiting survival with non-­communicable diseases such as cancer and heart disease need to be balanced with investment in social care for those survivors with disabling conditions. The commodification and marketization of social care and efforts to separate it from professional nursing have reduced the dignity of those in need and the quality of the caring relationship. The removal of care from family and personal relationships has created a number of ethical and human rights issues in developed countries. This illustrates the need for a care partnership between the state, professionals and the

158   From austerity to opportunity family, so that the family and personal relationships are supported in their role. The overly technological approach to health care treatment is also problematic if it results in a dualist separation of chronic health treatment from long term care for recovery and rehabilitation. Related to this is the need for health care expend­ iture to maximize the efficiency of local primary care rather than hospital based treatments. Similarly public health and health promotion investments that encourage healthy behaviours are important when the state is looking to make investments that have real gains and savings in the future (Bunt et al., 2010). Food Prosperity in developed countries has reduced the quality of food while provid­ ing choice and convenience at a high cost, bringing new public health issues such as increasing obesity. The mass production of food within global and conti­ nental markets has increased food waste with approximately 30 per cent of food argued to be wasted between production and consumption. While primary com­ modities have been kept low in price by the monopoly of large TC supermarkets, this trend is starting to change more with increased global competition from newly industrialized countries, increased global population and increased diffi­ culties with primary production linked in part to global warming. It appears likely that in the next decade consumers in developed countries will have to become used to spending a higher proportion of their household income on food and that this will also act to reduce waste. Local food production in gardens and allotments is also likely to increase in popularity, in part supported and encour­ aged by local councils and green organizations. There are also likely to be public health benefits, with the population being more careful about its diet and choos­ ing to consume more primary foods and less processed meals. Public policy can do more to promote a diversity of food production that is more localized and healthy. Transport A number of countries are investing in high tech solutions to personal transport by subsidizing electric, hydrogen and LPG fuelled cars and the network of refu­ elling services that they require. The Committee on Climate Change that advises the UK government on carbon reduction has recommended that the government should continue to act with subsidy and tax incentives to make sure that electric cars can increasingly replace petrol vehicles, as they are suitable for the majority of commuter journeys. A number of other countries are also investing in such projects, with Israel working on a scheme where stations can change the car’s battery over so the national system will not require individual consumers to depend on recharging their battery overnight. Paris is launching a system of pooling electric car use via a city membership scheme that allows hiring at com­ petitive rates. Investment in this multi million euro project has come both from the public and private sectors. Personal green transport is an area that looks

From austerity to opportunity   159 likely to see exponential economic investment and growth in the coming decades. The spare industrial capacity caused by the recession also gives govern­ ments opportunities to further improve their rail and bus services with invest­ ment and modernization possible at low interest rates. Waste management Local waste recycling is another local industry that is growing due to changes in tax regimes. Increased tax on waste and landfills is encouraging new trades in recycling and reprocessing materials. Again much of this industry can promote local economic activity while preventing costly damage to the environment.

Conclusion Public policy needs a new paradigm that allows governments to manage the global and transnational markets in a way that reduces both environmental damage and inequality. This is not an end to market capitalism, but a major reo­ rientation to check its less desirable outcomes and to restore some protection to the local community. Related to this is the idea that macroeconomics needs to move its focus from the output key indicator of gross domestic product (GDP) to a macro indicator that better reflects the public goals and social wellbeing associated with economic activity (Stiglitz et al., 2010). The real opportunity of the financial crisis is to reflect on the relationship between state and market and between locality, nation and global communities, and to reconsider the public value of what economic development is advisable. The debate about alternatives is emerging in some unusual places and the debate is not yet wide enough or creative enough (Coman, 2011: 31). How can indebted governments, unsure if they will ever recover their invest­ ments in nationalized banks, be encouraged to further borrow to stimulate the economy? Indeed, would this precipitate further bond market problems that in turn lead to additional banking crises for the institutions that hold any failing government bonds? For this reason the IMF has recently preferred tax cuts as a stimulus, as an alternative to increased fiscal investment, but these may not lead to an increase in aggregate demand (for example, if they are used to pay down debt). Also there are political difficulties with tax cuts at a time when govern­ ments need to deal with inequalities to protect the poorest from falling real incomes, and public welfare services are in steep decline. If tax cuts were suc­ cessful in driving consumption, this would most likely be a short term spike, linked to imports from existing export markets, rather than industrial investment and rebalancing. Such consumption is only a temporary sticking plaster over the injury and does nothing to establish a long term cure. The great opportunity is to design innovative investment products that actually drive a strategy in the devel­ oped countries towards creating the sort of future societies they want to be. This is where political leadership in the West is lacking. Politicians make remarks about the need for rebalancing, and green and technological revolutions, but do

160   From austerity to opportunity not know how to deliver such change and prefer to assume the market will inno­ vate. The reality is that political leadership and fiscal policy must shape the market in this direction. The political moral imperatives of a new paradigm are clear: saving the environment, reducing inequality to acceptable levels, allowing young people a stake in their community through education, training and employment – these are the moral imperatives of the twenty-­first century. Politi­ cians exist not just to make the market function, but to make the market function in a way that is morally and socially acceptable. If governments are unable to borrow directly to invest in the major projects needed – public transportation, renewable energy generation, energy conserva­ tion, local agriculture, education and training, etc – they must incentivize the market or similar to make these investments. This can include fiscal incentives, tax breaks, public and private partnerships etc. The Carbon Budget in the UK is one fiscal method for achieving this change of direction, but in the short term it needs to be strengthened by investment initiatives such as the proposed Green Bank and directing nationalized banks to invest in these public priorities. The depletion of limited resources and inadequate waste management is one major limitation of market competition where public policy has failed to inter­ vene. Developed economies have already started to implement some aspects of the green economy, but these are still in their infancy and have not got to the point where they balance against the economic damage done by global markets. Examples of such policies are: placing additional purchase tax duties on goods that pollute and cause environmental damage, like the sale of petrol for motor vehicles; specific taxation on the amount of waste produced and not recycled; and tax subsidies for waste recycling and subsidies for green power generation and use. The Current Account, Balance of Payments, indicator took much less promi­ nence in macroeconomic policy in the last 20 years as economists argued – in the context of globalization – that the current account would naturally clear to equilibrium and therefore not require much national political management. Given the deregulation of capital and financial flows, and the tendency towards floating exchange rates, economists believed a natural equilibrium would occur if nations resisted the desire to regulate and intervene. Developed countries’ policy therefore focused on making their supply side competitive and attracting as much inward investment as possible to match host TC outward flows for over­ seas production and rising imports. In reality any balance was far from equilib­ rium and subject to lengthy time delays. These time delays created their own dysfunctions and instabilities (what Skidelsky (2010) refers to as the difference between the ‘long run and the short run’). After the South American and Asian economic instabilities in the 1980s and 1990s, newly emerging and developing countries felt very vulnerable to current account, balance of payment moves, because these worked interchangeably with very unstable exchange rate fluctuations. Krugman (2008) and Stiglitz (2007) have described how the pressures of globalization on small economies of emerg­ ing and developing countries created trends in the interaction and path of these

From austerity to opportunity   161 variables that could result in dramatic extremes. Such sudden movements in capital flows and current exchange conditions are difficult, if not impossible, for national governments to predict and manage (Viñals and Moghadam, 2011). As a result there were times when governments of newly emerging economies needed to use strong interventionist methods, such as exchange controls, to bring stability and calm to the market. Indeed the tendency of countries to develop large foreign reserve buffers after 2000 was to protect themselves from these very powerful global market system forces. Economists have learned from the major problems with globalization in South America and Asia in the last two decades. Countries like Mexico, Argentina, Indonesia and Malaysia were caught out as much by the financial instability created by unregulated global markets as they were by their own poor economic management, while the US led global institutions like the IMF would have us believe these problems were all of those governments’ own making. In the deregulated period after 1980 (what Kaletsky (2010) calls Capitalism 3.0), economists focused on monetary indicators first, fiscal indicators second and then trade indicators. The primacy of money and markets was the driving focus of the paradigm. The future management of capitalism by nation states requires something more complex: an integrated approach to fiscal and regulated interventions in the monetary system, with the aim of achieving sustainable development of trade that can also protect the public good. This is holistic public policy rather than minimal government regulation of the economy via interest rates and quantitative easing. It involves the belief that the state can be used for the public good and that the government can provide a strong steer on invest­ ment and trade and industry policy. The age of austerity and reducing debt creates some opportunities for rethink­ ing the role of the state and civil society in protecting the public good. It is an opportunity to reduce waste and dependency on cheap energy commodities that cannot remain relatively cheap forever. Local production that focuses on sustain­ ability and quality is one way to reduce overproduction and expensive transpor­ tation costs. Not all energy and food can be produced locally but the local community should be encouraged to take pride in what it can achieve and be incentivized for local production. Society needs to build incentives to encourage localism, in terms of employment and use of public services, so as to enhance the sense of public ownership and cooperation in the local community. This includes an increase in local participation in the governance and the means of production. For example, neighbourhoods could be rewarded for investing in local power and food projects by sharing the benefits such as lower tariffs on electricity, and given incentives for pooling of resources like electronic transport being exempt from local car parking charges and vehicle recharging. These local benefits are at the core of the concept of investment in the Paris electric car membership scheme. The continued updating of IT projects should be used to encourage home working in more jobs, again to minimize travel and to maxi­ mize the building of stronger local communities. For example, firms could be given tax incentives for allowing workers to spend some of their time working at

162   From austerity to opportunity home and for the number of employers who also take on several hours a week of voluntary care work on the days they are working at home. Falling real incomes may be inevitable in many highly developed countries in the current decade, but if this can set against reductions in travel and waste with more efficient use of commodities like energy and food, the returns to social wellbeing and health could be greater than the loss in monetary income. A summary of the opportuni­ ties offered by austerity is given in Table 7.1 Table 7.1  The opportunity of austerity 1

Reduce energy and food waste to increase efficiency of resources

2

Incentivize localism to reduce transport and energy costs

3

Strengthen local resilience through communal and neighbourhood renewal and production

4

Reduce income inequality to maximize wellbeing and local social cohesion

5

Create diverse and local energy supply with an efficient energy transportation grid

6

Facilitate increased public participation and involvement via localism, with more direct public involvement in the management and organization of all local services

7

Promote investment with transparent long term returns, e.g. carbon free transport, renewable energy production, IT infrastructure

8 Resilient policies Protection against chaos and shocks

Introduction This chapter repeats the cluster analysis method used in Chapter 3 to assess if there are any changes in the patterns of similarities and differences between OECD countries post-­crisis compared to pre-­crisis. This leads to some conclusions about the type of public policy model that is most likely to be successful in developed countries. This model is then explored and defined.

Resilient countries In Chapter 3 a cluster analysis was used to summarize national differences in political economy and policy before the crisis. A repeat cluster analysis for data in 2011 reveals some movements in OECD nations. The data used is from OECD estimates made available in the summer of 2011. This data represents OECD figures for quarter one in 2011 based on the previous 12 month period. In the first cluster of Figure 8.1 are a group of countries that can be argued to have fared better than others in the financial crisis: Austria, Germany, Finland and Sweden; closely linked to Denmark and the Netherlands. In the second cluster are countries struggling to find a coherent path out of the crisis: France, Slovenia and the Czech Republic, closely linked with the pairing of Italy and Spain and also attached is Belgium. The third cluster is a small group of relatively high growth countries: Poland, Slovak Republic and South Korea. The fourth cluster is the old ‘Anglo-­Saxon’ economies and consists of the pairings of New Zealand and the UK; Australia and Canada, also linked with the US and more loosely attached is Portugal. Cluster five is the pairing of Japan and Switzerland. Cluster six is the pairing of Greece and Ireland. Hungary, Iceland, Chile and Norway are outliers that do not attach to a cluster. Similar to the method used in Chapter 3, a qualitative comparative analysis (QCA) highlights the relationship between the variables and the clusters (see Table 8.1). Cluster one is a European group of nations with relatively strong economies founded on a positive current account balance of payments. While many countries aspire to export their way out of the financial crisis, these countries look like they can achieve it. These counties also take an above average

164   Resilient polices percentage of GDP from the economy in taxation. They prioritize public intervention and welfare and have a strong national and local state sector. In addition they share low interest rates and high employment, especially of working-­age women. While these countries still exercise caution with public spending and borrowing and do not tend to have a high government current account deficit, they are not following severe austerity programmes designed to reduce the size of the state. It is argued by some commentators (Leach, 2011) that they have reduced the size of their state involvement from a relatively large percentage of GDP to a more moderate size, but the point is they still have a relatively high tax take from the national GDP compared with other OECD nations. Cluster two is an economically weaker group of central and southern European counties. This is a diverse group of counties, but they are united primarily by their higher than average government current account deficits and below Rescaled distance cluster combine CASE Label

0 5 10 15 20 25 Num ���������������������������������������������������

Austria Germany Finland Sweden Denmark Netherlands Italy Spain Czech Republic Slovenia France Belgium Poland Slovak Republic South Korea New Zealand UK Australia Canada US Portugal Hungary Iceland Japan Switzerland Greece Ireland Chile Norway

2 10 8 26 7 18 15 25 6 24 9 3 21 23 17 19 28 1 4 29 22 12 13 16 27 11 14 5 20

Figure 8.1  Cluster analysis dendrogram: post-financial crisis model of OECD countries.

1 1 1 1 1 1 0 0 1

1 1 1 1 1 1 1 0 1

1 1 1 0 1

0 0 1 0 0 0 1 0 0 0 0

0 1 1 1 0 0 0 0 0

0 0 0 0 0

1 0 0 1 0 0 0 0 1 0 0

0 0 0 1 1 1 1 0 1 0 0 1 0 0 1 1

1 1 1 1 1 0 1 0 0 1 0

0 0 0 0 0 0 1 1 0

v5 IR 3.2%

0 0 1 1 1

1 0 1 1 0 0 0 1 0

v4 CPI 2.4%

0 1 1 1 1 0 0 1 1 0 0

0 0 0 0 1

1 1 0 1 1 1 0 0 0

v6 % in employment 68.4%

Notes Thresholds (1 = threshold or above: 0 = below threshold). Primary implicants are shown in bold.

1 0 0 0 0 0 0 1 1 0 1

0 0 1 0 0

v3 Current account balance of payment –1.7%

v2 Tax as % of GDP 34.8%

v1 Government Current account –0.4%

Table 8.1  QCA truth table for validation of post-crisis clusters

0 1 1 1 1 1 1 0 1 0 0

1 0 0 0 1

1 1 1 1 1 1 0 0 0

v7 % women in employment 59.5%

1 0 0 0 1 1 0 0 1 0 0

0 1 1 1 1

1 1 1 1 0 1 0 0 1

v8 GDP 3.6%

3 4 4 4 4 4 4.5 5 5 6 6

2 2 2 3 3

1 1 1 1 1 1 2 2 2

Cluster

Austria Germany Finland Sweden Denmark Netherlands Italy Spain Czech    Republic Slovenia France Belgium Poland Slovak    Republic South Korea New Zealand UK Australia Canada US Portugal Japan Switzerland Greece Ireland

Country

166   Resilient polices average proportions of the population in employment. Apart from Spain, they all have an above average tax take as a percentage of GDP. These are countries at the centre of the euro currency crisis with banking sectors heavily committed to euro denominated bonds. Only Belgium and the Czech Republic have positive current accounts, balance of payments data. Cluster three is a small group of fast growing economies with relatively high growth accompanied by above trend inflation and interest rates. Cluster four contains countries often referred to as the more market liberal ‘Anglo-­Saxon’ economies. They are united by a negative current account balance of payments despite being countries that want to export their way out of the financial crisis. Employment is still above average, especially amongst women. Only Australia has a positive government current account, the rest are in deficit. Inflation is above average in all these countries, apart from the US. Given the negative balance of payments situation in these countries, inflation would seem likely to be related to import prices, with the US slightly protected by the strength of the dollar in the financial crisis. Finally there are two pairings. Greece and Ireland are two countries that have suffered much in the crisis and who required assistance from the European Stability Fund, yet they remain below the OECD average for taxation as a percentage of GDP. They have above average interest rates associated with their borrowing and below average employment and GDP growth. Switzerland and Japan are countries whose currencies have increased significantly in value on world exchange markets in 2011. This means they have below average inflation and interest rates and still retain above average proportions of their working population in employment. Outliers that do not share strong similarity patterns with other countries are Hungary, Iceland, Chile and Norway.

Preventing instability As this book has shown, the financial crisis has brought much instability to public services across the globe. In the countries where recent short term austerity measures are being applied budgets have been cut in real terms, sometimes with the result that some public policy institutions and services are disappearing. There have been pay and pension cuts and pay freezes in some countries. When one considers that inflation has run higher than expected in many countries, pay freezes translate to pay cuts. This has led to a worsening of the industrial relations between public sector professionals and the political governments that employ them, with increased strikes and industrial action resulting. The motivation of workers has been affected and public sector work has become more explicitly politicized around the size of the state and the welfare scope of public policy. There has a been a return in some countries to the more polarized public sector politics of the 1980s, with the government ideology of a minimal state and an increase in policies of self-­help and a withdrawal of the state that potentially leaves welfare in the hands of community groups and non-­government organizations, with a necessary increase in volunteering and

Resilient polices   167 family support to provide welfare support. But the cluster analysis in this chapter in Figure 8.1 and the QCA in Table 8.1 suggest that the road to stability is not easily correlated with reducing the public sector and the size of the state. The key in part would appear to be supporting the public sector with adequate taxation and a proportion of taxation from GDP that can meet the demands of people for high quality government and services and also provide stable employment when the private market is unstable. This is the necessity over the medium term, to support public expenditure from taxation rather than long term borrowing and annual deficits. This has been part of the Scandinavian historical success story. Some of the euro countries with acute public financial problems have problems caused as much by their inadequate and ineffective taxation systems as by a too easily available line of credit in the world’s financial bond markets. The public sector can have a positive effect in this mix and dynamic of an economy, as long as its financial basis is sound and its citizens understand the need to pay for high quality public services. This also requires a transparent democratic system that is not over centralized, as evident in the Scandinavian system. The austerity policy responses that target the size of the public sector, rather than its financial base, and seek to prioritize reducing taxation, is a libertarian defence of old market values, a form of conservatism that believes the only way to manage public policy in the future is more of the market based revolution from the 1980s. This is an old paradigm. This involves fragmenting the public sector into competitive quasi markets and placing public agencies at arm’s length from politicians wherever possible so as to avoid both political interference and macro organized labour resistance. Public service performance is reduced to a simple causation of how activities link to immediate outputs, and these processes are managed with regard to an economy of input to achieve an efficiency of outputs per unit of input (Haynes, 2003: Ch. 4). These management approaches ignore the ‘added value’ of complex professional processes and fail to assess the broader longer term outcome of public service intervention. Such classical market management comes from a business and sales world where factories and services focus on volume simplicity, volumes and margins of output and profit increases. These public management methods are largely inappropriate for complex public services, even more so in a world that is going through a major period of transformation where the primacy and individualization of market values no longer makes any sense as a method for building social cohesion and sustainability. Instead of retreating to classical business models of managing public policy, the practice of public administration needs to move more urgently forward on the new routes cast in the days of disillusionment with new public management (NPM) from the 1990s onwards. The implementation of NPM reforms was not uniform in OECD countries. The characteristics of political and policy administration limited reforms in some nation states. Tepe et al. (2010) argue that the Scandinavian cluster were able to embrace some managerial reforms in the global evolution of NPM practice, but that they were highly selective in how these were applied. It was a disillusionment in the US and UK with the politicalization of NPM and its implementation as a market based panacea

168   Resilient polices for efficiency that established less dominant but alternative models, such as an orientation towards public value (Benington and Moore, 2011; Talbot, 2011) and systems and complex systems process approaches (Beautement and Broenner, 2011; Teisman et al., 2009; Seddon, 2008; Haynes, 2003). What is immediately obvious with these types of approaches is that they take a holistic view of public policy that is wider than market values and the scope of the market to provide for ‘individual’ consumers. Instead they locate citizens and service users into public policy processes, noting the importance of factors like social capital, social networks, and neighbour and community ties. The requirement that public policy collaborates with these phenomena when designing and delivering public services has never been more urgent. Marketization and privatization do not provide fundamental answers to making public services more efficient and more accountable. Neither does the market provide humane and civic values for social cohesion (Purdue, 2011). The answer is in more direct public and professional engagement and dialogue, and breaking the monopoly of state services and professional groups into smaller forms of civic organization that are much more sensitive to the needs of the local public (Robinson, 2011; Blond, 2010; Bunt and Harris, 2010; Wyatt, 2011; Barnes and Cotterell, 2012) Such organizational change cannot happen quickly but will take decades to achieve. There are dangers with public service unions and professional bodies reacting to any revival of marketization with a retreat to a defensive position of preserving working practices that are not holistic and inclusive and further damage the quality of life of the poor and vulnerable. Resistance needs to very much take the form of empowering the poorest and most disenfranchised and not collaborating with practices that threaten these groups. New and more locally devolved systems of organization for future services may be inevitable and in the public interest. The current discussion on workers’ cooperatives needs serious consideration and the associated discussions about moving power and responsibility in smaller forms of public service organization nearer to the front line, where professionals can have close working dialogue with service users and local communities. Public workers need to consider how they will organize and cooperate in ways that avoid domination by the very market practices that undermine the whole process of social cohesion and democratic transparency. This may mean establishing their own micro credit movement of banking and financial institutions for their members, as a method for shifting political power away from discredited institutions and banking practices to move economic power to the most vulnerable in society. The pace of public service reform needs to be realistic and long term and not based on short political objectives that favour immediate restructuring and cosmetic change. The argument made here is that marketization will not bring stability to public services, but conversely will deliver more instability. While marketization may improve some outputs and processes for some periods of time, it does so too often at the expense of other areas of public value that are marginalized with their quality reduced. This is because of the tendency of marketization to simplify and to select the easiest quantifiable and managerial challenges while ignoring other

Resilient polices   169 complexities. Marketization also raises costs over the longer term, when analysis looks beyond the immediate observable gains and considers a more holistic analysis of costs and benefits and real long term outcomes. Instead the road to stability for public services is forms of organization that provide a small and coherent focus as close to the point of delivery as possible. Such forms of process will be open and transparent and have a strong commitment to joint management with local people, involving the service user also where appropriate. Such forms need also to link into the rest of the public service system so that they do not become isolated and only focus on their direct part, but are able to consider and reflect on their interaction with other services and social issues. Work from consultants like Seddon (2008), Snowdon and Boone (2007) and Beautement and Broenner (2011) shows that this type of reflective self management in the locality is possible and achievable, but it is culturally different to the managerial world built into public services in the late 1980s and 1990s. It will take some difficult negotiations, reorganization and changes in culture to achieve this and will require some developmental input. But this is the kind of organizational approach that will build a stable culture in public services. There is a clear role for the not-­for-profit, voluntary sector, in working with the state to ensure diversity of provision. The voluntary sector provides the ethical alternative for dealing with concerns of state monopoly given the problems caused by the profit motive when it is applied to welfare services. Voluntary and not-­for-profit organizations can take on a variety of forms depending on the country and context of operation (Steele et al., 2003). A study of privatization in four European countries (Kramer et al., 1993) noted the advantages of building collaborative models of public service delivery based on partnerships between the state and voluntary organizations, even though this necessitates some transactional bureaucracy for arranging contracts and funding mechanisms. Relational and collaborative contracting is more bureaucratically efficient in public services than short term adversarial contracting. This is because short term business contracting is primarily driven by reductionist methods to keep costs down rather than considering adding value to the externalities of the public policy process. Deficit reduction plans are needed in many countries, but they need to be sensitive to their effects on the whole system rather than driven by unrealistic ideological dogma. If countries try to reduce their government deficits too rapidly (Talbot and Talbot, 2011) and assume they can quickly replace the public sector with private sector activity, they are at high risk of failure with the consequences likely to be higher unemployment, increased social problems and little improvement in the overall deficit. The correct dynamic of choosing which taxes to increase balanced with targeted efficiencies in expenditure are important details in government fiscal policy.

Public policy and macroeconomic policy After the financial crisis there is a need to look further than a defence against the decline of the traditional services affected by austerity cuts to consider the wider definition of public policy and its sphere of operation. If we revisit definitions of

170   Resilient polices public policy in the historical literature of public policy and administration there are two core aspects. The first concerns the macro, the second the micro (Hill, 2005). The macro is public policy expressed as the politics of intervention in the state in social life with the intention of using interventions to achieve collective benefits and public value. The second, at the micro or specific policy level, is the study of policy development in the institutions of the political process and state legislature, and its implementation and specific operations in the agencies that organize, manage and provide policy processes and outputs. The post-­Second World War period of public policy, with its focus on national level state intervention and stability (named ‘Capitalism 2.0’ by Kaletsky, 2010), positioned the emphasis of macro public policy to oversee economic management and planning, so that the market was restricted and subject to national public objectives. This was the era of large scale social housing development in the UK and when politicians believed in using Keynesian demand management to achieve full employment. The Regan-­Thatcher revolution of the 1980s shifted that paradigm and made public policy subservient to the dominant aims of the globalization of markets and market values. Governments were no longer central to economic management and planning, and became only the regulator and referee of last resort. This is the paradigm Kaletsky (2010) describes as ‘Capitalism 3.0’. The academic study of and debate about the broad scope of macro public policy was reduced, and shifted to university economic departments, or the treasury offices of national and local governments, where a classical and orthodox market approach dominated. Since 1980 the study of public policy increasingly focused on the micro element with much energy spent defining and responding to the new public management (NPM) approach. This was very much about supply side management and organizational ideas from business and the private sector being increasingly imported into the public sector. The limited macro debate moved to economics, to concerns of managing the money supply and adjusting the central bank interest rate as the best methods to keep inflation stable. This economic fixation with inflation followed the oil price crisis of the mid 1970s and a fear of escalating prices related to the demand for oil. Fiscal policy at the macro level received less attention. Fiscal policy was no longer a tool of economic and social planning (Walker, 1984), but rather seen as a potential negative drag on dynamic and innovative growth of the private market place. The possible benefits to the market of a positive and dynamic public policy sector were downplayed. Kaletsky (2010) has argued that we are now, as a result of the 2008–09 global financial crisis, entering a new relationship between the state and market that he describes as ‘Capitalism 4.0’. This is characterized by the large scale economic investment in markets by governments using fiscal resources, illustrated by their intervention to save global TC financial institutions. Government macro policy has gone beyond the economic focus of attempting to reduce inflation by raising central bank interest rates. As Kaletsky says (2010: 258): ‘During the 2007–09 crisis, finance ministers and central bankers realized that their jobs went beyond controlling inflation and allowing market forces to do everything else.’

Resilient polices   171 Public policy is reasserting itself at the macro level. This involves public policy reasserting its interest in interventions for the wider social good, policy interventions that can achieve sustainability, carbon reduction and reduce social inequality. But public policy needs a more assertive transnational agenda to assist the development of international and continental institutions that can enable national governments to build on these shared objectives, despite the instabilities of global markets. Dealing with climate change and developing an international economy that reduces carbon emissions is an imperative. Some countries are beginning to approach this as a national issue, risking a go-­it-alone strategy in the belief that there will be economic benefits through being ahead of the game with renewable electricity generation, electric and hydrogen powered vehicles (CCC, 2010). Denmark has already achieved impressively high percentages of its national energy needs generated by wind with a national industry to support its production that is a world leader and exporter. The German government, for example, has recently gone as far as stating that it will decommission its nuclear electricity generation following the reactor disaster in Japan (Evans, 2011). Israel is organizing a national network for the use of electric cars. But despite these national initiatives, international cooperation will also still remain a prerequisite to achieve a coordinated and collaborative approach to the considerable challenges of global warming and better natural resource management. Public policy needs a new internationalism that strengthens the global institutions of government and finance and makes them more acceptable to the non-­ developed world, over developed Western interests. This is part of the paradigm shift that is needed with associated changes in rules and parameters for all countries. As argued in Chapter 7, the crisis has moved the operating environment of public policy towards large scale economic intervention, in a manner that was unthinkable for several generations, but that intervention has not explicitly permeated the values of public service or the operational models that it is currently using. There is a mismatch between the central model of public policy in many countries where a small and elite group of civil servants manage extraordinary sums of money to intervene in the market place, so as to protect and preserve traditional financial institutions, while public services at the meso and micro levels appear to be resubjected to versions of the old post-­Reagan–Thatcher model of ‘new public managerialism’ where public services are re-­organized to market values and quasi market models. This is ironic given that these models had increasingly been shown to fail public policy in the new millennium, and new approaches were developing that moved the meso and mirco organization of public services away from micro economic analysis and simplistic classical management of complex public services to more systems based explanations and practices (Seddon, 2008). The correct way to achieve savings is not reorganization by market methods, but to reorganize in a manner that is commensurate with the availability of social capital and community resources, so that effective savings are made by preventing social problems occurring. This is clearly much more preferable in economic and social terms than creating a competitive market to find efficient methods for dealing with problems

172   Resilient polices that are always assumed to continue. Policy must become focused on longer term social outcomes rather than immediate policy outputs. Prevention entails driving policy with positive social goals that reduce unemployment, reduce preventable diseases and build sustainable and shared neighbourhoods and spaces where people have incentives and skills to learn and cooperate together rather than competing for limited resources. Such neighbourhoods and communities will have collaborative spaces and services built into them, so that investment leads to less intervention being needed in the future national state. Such a system will reduce public sector costs in the longer term as citizens become more self supporting and collaborative. Local food production, volunteer care schemes for the vulnerable, and shared and pooled local transport systems (like the new developing schemes of electrical bike and car rental in major cities) will be a strong feature of public policy in the future. What does this mean for the size of the state and the issue of what proportion of GDP a national government should take from the economy? Surprisingly, Kaletsky (2010) has proposed that a growth in public expenditure to increase the size and employment of government is the biggest long term threat to establishing a more interventionist form of capitalism that is both economic and socially optimal. He associated this with a likely repeat run of the ‘crisis of capitalism’ in the late 1970s that resulted in new market liberalization and supply side competition. He argues that, paradoxically, if the government is to be more interventionist in the market it must not crowd the market out and promote large monopoly public organizations, driven by trade unions and professional bodies, over private and other non-­governmental forms of organizations. His fear is expressed: The supreme irony of Capitialism 4.0 – and the greatest risk to its future – is that in the process of reorganising the importance of government, the new political philosophy will try to expand the size of government. (Kaletsky 2010: 266) This argument, however, ignores the success of countries with relatively high fiscal intervention, such as Denmark, Sweden, Finland and Germany. These countries have retained fairly successful market economies, including specialist export into the global market without experiencing the overleverage symptoms of collapsed demand, negative balance of payments and import driven inflation. Sweden and Finland did experience their own banking crises in the 1990s, but recovered well from these localized incidents with considerable economic strength. In addition their government policies and services are argued to be well organized and efficient when compared to other countries (Joyce, 2011). Public policy boundaries cannot be assessed simply as the balance of state and market, but rather analysed as part of a more complex system of interactions. Public intervention needs to be better understood with regard to its interconnections with the economic system: the degree and type of borrowing available to the state and its relationship to the domestic and global economy,

Resilient polices   173 the stability of monetary policy and transactions, and the balance of industries and services in the national economy. In relatively balanced economies like the Scandinavian countries the contract between the state and market place includes an ideological commitment to preventing increased inequality and insuring a reasonable degree of social protection, as these attributes contribute also to the overall stability of the economy and help prevent excessive and unsustainable debt. A strong state and civic system, with a high degree of political trust between government and the public, can therefore contribute to both social equity and market efficiency. One does not have to be pursued at the expense of the other (Lombard, 2010).

The public good and consumerism It is important to revisit the major failings of the new managerial and quasi market model of public services developed in the late 1980s and implemented in the 1990s. The repeated problems were: (1) consumerism and individual choice at the point of ‘purchase’ not being appropriate for many public services, (2) the dilemma of social control over consumerism, (3) market fragmentation, (4) market brand over public ethos (loss of public ethos), (5) the undermining of professionalism, and (6) the undermining of democratic localism. (1) The failure to develop competitive consumer markets in public services is illustrated by the difficulties in creating economic efficiencies in the privatization of the UK rail network (Jupe, 2010). While passenger numbers increased substantially after privatization large scale inefficiencies continued due to the structural limitations of competition and relative ease of profitability for the private operators (McCartney and Stittle, 2011). Public subsidies remained high, despite fares increasing above inflation. A major review (McNulty, 2011) of UK rail transport costs found them to be up to 40 per cent greater than the systems in France, Netherlands, Sweden and Switzerland, both accounted for by Network Rail (the track provider) and the train operating companies. The main problem with train operators was identified as a relatively low level of train utilization per train journey. For the majority of journeys, travelling the same journey to work every day at peak time, there was not a meaningful way of making the service structure provide competition for the consumer. For the train operators there was no sense in which they could choose to operate their trains on a different track system, they were wholly dependent on the Network Rail monopoly provision. In 2011, a UK company Southern Cross providing residential care to over 30,000 vulnerable adults announced that it was in major financial difficulty having expanded rapidly by ‘lease back’, a system whereby it acquired capital for investment through selling its properties and then renting them back (Johnstone, 2011b). Its crisis in 2011 was created after deterioration in market conditions and the service of leverage that left it no longer able to afford the rents on the leased back properties. There was much speculation that the government would have to organize a rescue package for the company because of the social needs and vulnerability of its residents, while the executives would receive

174   Resilient polices generous severance pay (Power and Hipwell, 2011: 31) Residential social care was one of the first welfare services to be privatized by the Thatcher government in the UK in the 1980s, this resulted in much instability and cost escalation in the sector through the decade. From 1991 onwards a new system of local government intervention was implemented to plan services and keep costs down (Haynes, 2007). A UK experiment in free market social care ended in local economic planning and a control of subsidy of the form the government ten years previously had despised. Privatization and marketization of public services in the UK in the 1980s and 1990s was supposed to deliver dramatic savings in costs through increased efficiency, but there is little evidence that these large gains materialized. In UK social care there followed concerns about the monopsony power of local authorities to force prices down in the market at the expense of quality of care, and this made financial operations difficult for small care home providers. The subsequent growth of large providers, with near monopoly powers, was an increasing feature after 2000, as smaller providers found it difficult to survive and were bought out by larger businesses. But in some cases, expansion was too rapid because of the easy leverage and ‘creative’ financial products available in the middle of the 2000s. Southern Cross in the UK was one of the major providers to tens of thousands of vulnerable people and looks close to bankruptcy in 2011. A UK Financial Times investigation (FT Weekend, 4 June 2011) showed that a number of company directors had made a substantial profit at the height of the company’s takeover of other services, followed by its public stock sale between 2006 and 2008. This appeared to be ‘profiteering’ at the expense of the public interest with a resulting loss of public value and investment in care. Why had the local government and health care contractors purchasing care on behalf of individuals not preferred contracts with non-­government organizations with charitable status who were not looking to make such short term profits? The core of public services do not respond well to market competition, but require a strong sense of stability, locality and predictability – because they need to be reliable within a local and periodic routine and of high quality – not un­stable, unpredictable and of low quality. (2) Many public services have a strong element of coercion and social control, even if this is implicit rather than explicit. Children need to go to school even if they do not want to. Those with mental health difficulties or addictions are strongly persuaded, in some cases compelled, to embark on treatment. Older family members agree to packages of care at the persuasion of family members as they reluctantly accept they are losing their interdependence. These situations are not cultural examples of strong individual consumer choice but complex social negotiations where the parties concerned are vulnerable to abuse. In these circumstances, an underpinning legal context and social contract is a vital component of the conceptualization of good and optimal practice. This makes applying simplistic market notions of supply and demand difficult to implement. One answer from classical economists has been to appoint professionals as purchasers on the demand side of a public service market place, so that a medical

Resilient polices   175 practitioner, social worker or similar makes a purchasing decision about what is best for the service user on their behalf. But the professional also needs to take into account the legal precedent as they articulate the view of the state. Extremely complex case law and ethical judgements apply. The situation is not organized simply as an individual’s contract with private providers for the purchase of a product. (3) The attempt to create individual contracts with service providers has fragmented public services in some situations where they should be logically resistant to fragmentation. For example, travelling on a long rail journey with numerous geographical train operators who only sometimes cross each other’s jurisdiction makes planning long journeys to get the fairest ticket price complex and problematic. In structurally resistant markets, competition can end up being focused on marginal areas of resourcing, on the periphery of the main activity: for example, the delivery of energy where actual real local cost deferential is small, and provider-­to-consumer contracts focus on maximizing longer term discounts and incentives that may mask other cost uncertainties to the consumer. The market information presented to the consumer is highly complex and daunting, and designed to create brand difference in a market place where the real local cost differences of providing energy are negligible and subject to national changes in a wholesale energy market that is unpredictable due to global commodity price spikes. For the average citizen the market appears overly complicated and presents complex information. What the citizen requires is a stable supply of energy at a predictable and fair price. In the US, the famous Enron scandal concerned the creation of a shadow energy market with no real value, but the company managed to convince shareholders and the US nation, via false accounting, that the development of a retail market for energy was possible and profitable (Fox, 2004). The collapse of the company showed that much of the market concept was an illusion. Market provision of health care can fragment provision so that insurance providers, or primary professional purchasers on behalf of the patient, behave differently in neighbouring localities, at worse meaning that people with rare and unusual conditions have to move locality, or try and change insurance com­ panies, to get the best health treatment they need and deserve. These are the bureaucratic transactional costs of a market system that can cancel out the benefits of the mass provision of core services. (4) The market based branding of public services compels them to seek a distinctive market brand over public service ethos. Ideally the two concepts can be combined, but similar organizations, not in direct competition, may end up undergoing detailed cultural and mission development programmes to differentiate themselves in an unnecessary manner. For example, neighbouring UK Primary Care Trusts seeking to commission and fund hospital care for local and regional populations have no real need to be branded as distinctive competitors. Even in situations where there is a limited level of competition, providers may be pushed by market values to create a brand distinction. For example, community colleges in the US and academy schools in the UK may still have a strong

176   Resilient polices necessity to provide an underpinning service for a locality across a generic range of education skills but will be pushed towards overemphasizing difference and speciality in a way that is not realistic for the majority of their generic pupil catchment. Similarly, new universities in the UK (previously polytechnics) and community colleges in the USA are being pushed by more competition over public funding to overstate their segmentation and difference when their tradition is to provide a broad range of technical and professional education in a locality and region. Specialization in these situations may push providers to crowd out the cheapest and least risky specialism, at the expense of more costly and risky specialisms that then no longer get given local priority. (5) Another disadvantage of marketization is the undermining of professionalism and professional judgement (sometimes referred to as ‘professional discretion’). This is when professionals are obliged to work to standardized managerial targets rather than being able to offer flexible responses to individual service users. An example of this is where managerial market approaches contract professionals to supply fixed block contracts that must be used up as a priority in given time frames. For example, the National Institute of Clinical Excellence (NICE) recommends to Primary Care Trusts (health care commissioners and block purchases) the most efficient drug and surgery treatments that doctors should use. While this may be underpinned by good clinical trials and scientific research programmes based on aggregate outcomes it may limit professional judgement with exceptional cases, and therefore steer professional doctors to purchase inefficient outputs for some patients, a behaviour known as ‘adverse selection’. This type of limitation on professional flexibility is not solely linked to the marketization of services but is also strongly associated with the managerialism of professional services and use of classical management methods to deliver output efficiency via increased standardization for complex professional services. The alternative is to focus on the process of demand and to ensure requests for public service are first screened and processed effectively. These staff need adequate training and a high standard of professional information (Seddon, 2008). (6) The undermining of democratic localism is another criticism of the marketization of public services. This is where operational services are subject to managerial contracts driven by specific managerial efficiency targets based on input to output efficiency ratios. These contracts are set by arms length management commissioning units. Local politics and national politics are likely to be a distance from these contracting methods given their strong managerial and contractual ethos. The emphasis on competition tends to result in operational units competing across geographies rather than the focus being on stable local neighbourhood based services. This means that local beneficiaries feel removed from service provision and less able to affect the evolving of service provision (because the managerial contract is not necessarily written in a local context). For example, the timing and method of waste collection and disposal services may perplex localities which find it difficult to negotiate any specific neighbourhood based changes and experience a lack of meaningful local control.

Resilient polices   177 The failures of public market managerialism The abundance of literature on new public managerialism and the new management models in the public sector from the early 1980s onwards established a method of managing public services that borrowed much from business services in the private sector. This used relatively simple methods to identify cost processes based on the definition of input costs, activity costs and outputs achieved. This was the dominant method of resource allocation and planning. Financial accountants increasingly influenced these definitions as budgets were devolved and an increasing quantity of micro activities were costed in the process. Targets were all too readily associated with the definition of tangible outputs that did not necessarily include measurement of externalized public value outcomes. At worst services could shunt costs onto each other by ignoring externalities in their own models. An example of this in the UK was the interface between health and social care, with allegations that by discharging older people too early from hospital treatments, medical services were shunting costs onto social care services. Transaction costs were not always easily articulated in activity costing and complex products such as crisis services for those with very diverse needs were not well measured and documented. Marketization was in part a reaction to the monopoly bureaucracy of public administration in the 1960s and 1970s, with incremental growth defined by provider interests expressed in a professionalization and unionization that were not always in the public’s interest. These provider interests were built on increased specialization to acquire resources and higher pay and better conditions. Police forces became increasingly specialized and dependent on technology, ignoring closeness to the neighbourhood and community. The medical profession sought new scientific discoveries and the application of technologies to treat a minority of severe conditions rather than improving public health and developing preventative approaches. The costs of secondary hospital care escalated. Business managerialism was also an ideological reaction to a crisis of public expenditure after the public financial crisis that followed the oil price crisis hike of the mid 1970s. Limits on public expenditure at a time of rising social stress and growing unemployment meant that politicians increasingly, if erroneously, looked to market based business methods to manage the public services efficiently. There is much overlap between the failures of marketization discussed above and the dysfunction of market managerialism. An over-­assertive classical management of highly skilled professionals to limit capacity for unique and flexible judgements, and the distancing of services from their local populations by the use of relatively closed and strong managerial practices, are two prime examples of the resulting problems caused.

Self-­organization and public policy, building from the locality The complex systems and systems approaches to public management described in Chapter 1 are not overtly anti-­market, but they start with a different premise

178   Resilient polices about their understanding of how services could be made more efficient and effective. The various systems approaches emerging in the last decade have a strong belief in the importance of human relations and culturally driven values based practice, this given the focus on local reflective understanding and dialogue. This is different to the classical managerial approach that seeks perfected structures and processes and standardized operations that can easily be generalized to similar practices. While writers like Seddon (2008), Stacey (2007), Snowden and Boone (2007) and Beautement and Broenner (2011) share an underpinning desire to increase the reflectivity of practitioners in their local context, they put different emphasis on the degree of challenge needed to improve communication and judgement in complex public service operations. Further they tend to focus on specific micro organizations and do not concern themselves with the higher layer – that is, the organization and context of policy. It is in the policy process that local democracy and neighbourhood participation occur, where the local public and political representatives are concerned with the interlinking and interconnectivity of numerous organizations to meet the overlapping and complex needs of their populations. This is where micro managerial insights need to metamorphose to ‘policy insights’ given the consequences of marketization being a focus on the experience of an individual consuming one service, rather than a localized shared experience of interconnected services. New debates on local politics and participation have tried to assess this democratic deficit in public policy. Again the current crisis provides opportunities to move this debate forward, given the danger that governments will retreat into market driven consumerism where the local state is a contract state rather than a participatory state. Seddon’s (2008) work illustrates the importance of involving workers in analysing and improving complex workflow processes to make them more efficient. In this situation specialization is not overly separated but relies on good communication with other parts of the system to be optimal. There is also a preference for skilling up those with less status and recognizing their contribution to the work processes, as they are often the most involved in initiating contact between different parts of the organization, or being present when a person first enters the labyrinth of the public service system. For this reason, Seddon (2008) often focuses on entry to the system in terms of ‘demand failure’, where people are wrongly advised, assisted or processed when they first contact a public service with a problem that needs solving, and this leads to wasted efforts for them and the organization they approach before any solution is found. Seddon found the cause of these problems was often that front line staff were not empowered to take decisions and action, and had to record and pass on information that could then be misunderstood or wrongly interpreted later. This type of approach to the micro organization of public services shows awareness that public policy systems are complex, periodically unstable and always evolving and changing. Table 8.2 summarizes the key characteristics of the self-­organized, adaptive approach to public administration proposed in this book. It contrasts with the other recent and contemporary models of public administration. The organization form moves to heterarchy, with the emphasis on forms that reflect and facilitate the

Resilient polices   179 ­realities of front line practice. It is not just a devolved form, but must retain creative forms of linkage with the rest of the policy system through liaison and partnerships. This type of matrix communication is time consuming, but vital for cooperation and coordination of public services (Teisman et al., 2009). Operational management is as close to the professional form as possible and facilitative of professional expertise and judgement. This reflects a high degree of trust in professional training and judgement where management seeks to build good critical self reflection and adaption to change, based on outside observations. These reflections must include service users and local representatives. Accountability is therefore with one’s peers, the relevant professional body and local people, while facilitated by a manager who can offer some element of impartiality and distance, with a commitment to resolving complaints and mistreatment. The organizational culture is more collaborative than competitive while recognizing the diversity and difference that each professional brings to their team and workplace. This approach builds a culture that recognizes the personal contribution of staff and the responsibility of the self to reflect and adapt in the employment role for the good of the organization and policy process. This shared reflection with colleagues and service users on how to improve services is holistic and wide in scope, and not only restricted to essential elements of the work process that deliver tangible outputs. Consideration of how users enter and leave the policy process is of essential consideration, with a view to how value can be added to services at these critical points. Table 8.2  Self-organized, adaptive public services Self-organized adaptive

Administrative

Market

Managerial

Organizational form

Heterarchy, matrix SMT core

Strong hierarchy Several management levels and functions

Devolved operations Separate purchasing SMT core

Devolved functions

Management of professionals

Facilitative, devolved, peer based

Rule and Cost units of Standardize process, action measure tasks for procedure bound and quality accountability

Accountability

Peers, local political, and managerial

Peers and administrative rules

Culture

Collaborative, Collaborative, individual as part standardized of the team

Service user model

Holistic (process Client with rights Consumer and outcome) choice

Process orientation

Whole process Prioritization of (eliminate need via demand failures) assessment

Managerial

Managerial

Competitive

Individual performance Outputs experienced

Economic Efficiency of supply outputs input to output

180   Resilient polices

Nested systems and nested policies Complexity theory demonstrates the connectivity of levels of government and other forms of social organization. It illustrates how imbalances between levels can reach tipping points that then affect much larger parts of the system. There is an interconnection of global-­continental-national-­regional-local policies as a complex structure. This has major implications for government policy; its implementation and management. A public policy process that creates and encourages more connection with the neighbourhood and local community therefore needs to be mindful of the potential fragmentation that this will cause at regional and national levels. One of the key counter-­developments to globalization was the premise that the rise of globalism and global markets would make localism much more important rather than less important, as populations struggled to protect themselves from the loss of power and identity associated with globalization. John Ralson Saul (2009) has written of how a paradigm solution to the failure of globalization must begin from the bottom-­up rather than the top-­down and the need for a dominant ideology of action that promotes the whole society rather than the individual. He links this to what he calls ‘positive nationalism’ where nations will not be subservient to global markets and multinational corporations but to the needs of their immediate citizens. To make this paradigm a reality the connections between local people are all important, within neighbourhoods, communities, towns and cities. These are the places where people can begin to be reconnected with taking responsibility for their society with a sense of shared ownership and a belief that they will be given the power to prevent the dictates of central government and TCs. This is why politicians are struggling all over the world to redefine community and neighbour as an engine of change and spark of public policy, but cannot find a way to do it in ever competitive global markets. The increasing emphasis on paid employment in many countries (with a growing proportion of women and older people in work) has meant that people have less time for social activism and caring.

A new systemic public policy If a new model of public administration is to be more adaptive and locally holistic, and less organizationally tied to a classical productive managerial process, a key issue remains with regard to the best method of funding for such a system. At one level it implies a locally based funding system where a local system raises the revenue it needs, uses a political process to allocate resources and then allows the micro elements to decide on the operational expenditure. If a market form of organization is used to distribute the resources in the micro system, it can mean less consistency between geographical areas, and less medium and long term security for employee conditions of service and rights of employment. Poor conditions and job insecurity will create stress and anxiety and undermine the efficiency of the work force. An alternative to the market discipline as the only method for dealing with the enforcement of economic change might be a

Resilient polices   181 new form of employment contract that guarantees ongoing work, but with more flexibility to the employer for redeployment and adaptivity. Marketization has tended to create a two-­track world of employment conditions in the public sector: those who remain at the core due to their managerial oversight of contracts or a high degree of professional skills and those who are on the contracted margins with reduced rights. Those who remain at the core have professional and union power to protect their interests and they retain a strong degree of organizational influence. But in a world that moves towards smaller forms of public organization with less direct managerial and hierarchical control on the detail of work, stability of employment might become more difficult for even the professional and highly skilled worker. A move to a more federated and participatory service structure will face some difficult issues about employment rights and conditions, but these aspects are important to achieve a more small scale and adaptive ‘micro’ public policy world. Locally based funding systems also have the potential to create inequalities across regions and national areas. So, for example, if one local area raises local tax and over time this has a very different social profile to its neighbours, this can create instabilities in terms of population movements, property prices, etc. Moving to smaller locus of the organization of public services is not, therefore, without its challenges. But allowing public policy to evolve towards more locally based and smaller structures looks vital to deliver effective and socially relevant services. The new policy model Public policy needs to reassert the social values of the public process adding public value rather than attempting to reinforce outdated and failed market dogma and ethics. Stiglitz has concluded that neither the private nor public sectors have demonstrated supremacy in delivering optimal communal social benefits: ‘this is the fundamental dilemma of the management of the commons: historically, neither the private nor the public solution has consistently promoted both efficiency and equity’ (2007: 164). Here Stiglitz is referring to those spaces and activities in life that are by their nature ‘common’ and shared rather than individual and private, and he cites fishing in the oceans as an example. He notes the dilemma of reaching formed agreement of how to preserve use of common resources and to allocate them fairly without resorting to privatization and individual, or company, ownership. While a new model of public policy should not be built on market dogma and forcing the public world to be subservient to the economic and market world, it will not return to the pre-­1980s model of centralized administrative monopoly (Hughes, 2003). The features of the new models will be based on professionalism, small scale accountability, adaptable specialization, new forms of state investment linked to individual and business savings, and mutual management and ownership. This will be a form of organization that can result in pragmatism, public value and social outcome focus aspired to by recent commentators­

Core values that inspire action. Make clear the political and professional ‘vision’

Use of legalization and other policy rules

Rapidly growing behaviour patterns that self reinforce (i.e. bubbles) and are not checked by symmetrical interactions [Government or managing organization often has to design a symmetrical intervention.]

Ideological paradigm of operation

System rules

Checking reinforcing feedback

Stabilizing feedback Behaviours and actions that check other behaviours, i.e. symmetrical interactions

Conceptual examples

Intervention

Table 8.3  The systemic public policy model

Accountability and transparency used to check negative behaviour that might advantage some at cost of others

Organizational forms that mirror business models and expand via competition and monetary incentives

Market rules: Emphasis on contracts and efficiency and performance targets to drive behaviour, reward competition

Public servants as managers and business leaders needing market and competitive values (output focused)

Old model

Multiple forms of localized accountability, including direct public involvement. Emphasis on local participation and transparency of information

Shift towards more closed systems with checks on market extremes and monopolies

Rules encourage action to promote public value, supported by participation, rewards for collaboration and positive social outcomes

Public servants as adding public value and protecting welfare of public (social outcome focused)

New model

Use of information can change agent and system Primarily the use of quantitative behaviour performance information

Setting integrated and commensurate policies at Central, national models continental, national, subnational or local levels dominate and management practices dominated by central and national ethos

The inevitable discretionary behaviour and Focus on developing strong local/contextual judgements of policy actors, leadership and management of like professionals. professions Can be used as positive intervention in the local policy and practice environment

Use of information

Managing ‘levels’

Leading selforganization

Output targets Performance targets Fixed budgets

Set control parameters on system and its operation

Setting operating parameters

Enable professionals to be more directly involved in micro management, but in partnership with other local public representatives

More local control and local democratic accountability. Some national funding to priorities. Case studies of best local practice

Sharing of extensive local information to get maximum involvement in local services and to increase accountability

Mixed dashboard informs synthesis of ‘public value’ and qualitative judgements

184   Resilient polices (Alford and Hughes, 2008; Benington and Moore, 2011). Paradoxically this restoration of the local also needs to be linked with global changes in regulation. Public policy needs a new internationalism that takes it well beyond comparing the national implementation of market mechanisms. At the macro level this demands greater cooperation and academic interaction with the discipline of economics to promote a renewed interest in macro theories and models. Public policy needs to take centre stage in exploring the best methods for intervening in the market place to achieve public benefit. Table 8.3 revisits the complex systems analysis proposed in Chapter 1 and developed throughout the book. Here the framework is used to compare the new model of systemic public policy with the old market model that dominated the last 30 years of practice.

9 Conclusion New methods and new policies

So many people in the West now take it for granted that oil fired consumer capitalism in its exact present form will continue as it is, it seems inconceivable we might gather together to discuss the means by which the present system will be either superseded or overthrown. (Hare, 2009: 111)

The literature, documents and data reviewed in this book indicate the instabilities of the globalized economy and the ongoing search for finding an intervention method to bring stability for the public good. The ease of movement of capital is the main reason for these instabilities. Closely related is the movement of production methods to where labour is cheaper. There are some chances for correcting these balances where developed countries shift to more advanced production and services, and where they develop more balanced and locally based economies. Where BRICs have tightly managed capital investment strategies, in the form of the state management of capitalism, these have over time contributed to the build up a persistent imbalance of trade and capital flows (Barboza, 2011). The instabilities of globalization therefore need to be checked by better international cooperation and regulation and stronger buffer defences and regulation within all individual countries that suit their specific needs. The build up of foreign exchange reserves has been shown to be one of the natural buffer defences that BRICs use to protect themselves against the instability of the global system. Many developed countries need to shift from a dependence on finance driven importing and consumption to a model based on national investment for a sustainable and locally efficient economy. This is proving to be a highly problematic adjustment. National economies often contain serious imbalances around the distribution of wealth, opportunity and income. Given the added effect of the growing instabilities of the global economy many nations have become less internally resilient and have seen inequalities grow. This book has explored the possibilities for building a new more locally based economy that allows nations to become more stable and resilient through planned investment to deal with the major social challenges of the twenty-­first century.

186   Conclusion Public value driven policy making needs to achieve a greater influence than classical economic theory with its faith in markets and competition. The idea that market values will universally deliver optimal public policy solutions has failed. This book has argued for a more holistic public policy approach where long term public values and objectives are clearly stated, and intervention in the economy is used to achieve these long term goals. Carbon reduction, public and productive investment, job creation and reducing inequality should be at the top of this agenda. Purposeful public policy intervention is an imperative if global instability is to be reduced. The key theoretical conclusions from applying the concepts of complex systems to public policy and state intervention in the market place is that four aspects of complex systems theory can improve our understanding about how to use interventions: levels, self-­organization (small organization), stability and paradigm shift.

Levels Complexity theory demonstrates a scaling effect whereby communication and action clusters around specific levels and critical time points in social systems. In the policy system we can recognize these as in part related to scales of institutional processes: global, continental, national, regional and local. Theories and conceptual models of agent behaviour and organizational economic transactions and effects can be modelled at these levels, but understanding the interaction of all levels at the same time is formidable. Nevertheless, modelling at the macro, meso (middle) or micro level can still be useful in the study of public policy as long as there is a better appreciation and understanding of how modelling at one level is subject to periodic major disruption at other levels. An example of this is modelling the interaction of interest rates and inflation that at first suggests some element of policy success in Europe between 2003 and 2007, but that ignored the extraneous build up of external factors at the global level outside of national countries. The factors building outside of Europe but increasingly affecting the European system were the flows of investment entering from outside (via trade surpluses in BRICs). There was the relatively low cost of many imports, influenced by exchange rates and reduced labour costs in the exporting countries. In time these external reinforcing factors tipped the European system over into crisis, the relationship between interest rates and inflation broke down with bankruptcy and deflationary pressures taking hold. These failures could not be checked by lower interest rates alone. A more dramatic restructuring and planned return to economic balance is needed. The policy shift needs to move to the nation state and locality. Policy should build resilient, balanced and dynamic economies and welfare systems at this level while managing the flow of resources in and out of these systems. The research in this book argued that the Scandinavian countries had begun to achieve this balance better than other countries. The balance of trade in these countries was argued to be important, alongside relatively high taxation that in part supported a secure and quality labour force operating in a dynamic market place.

Conclusion   187

Self-­organization – small organization Another conclusion from this book is the dynamic of small forms of organization compared with large forms. This is linked to self-­organization and the inevitable attempt of local actors to try and make sense of their part of the system and to control it and give it a local purpose. Self-­organization can include competitive behaviour, especially in a profit driven system that is primarily about local survival and development. Self-­organization is not universally good, but it is a dynamic bottom-­up feature of human systems and it presents an opportunity for optimal and good social interventions. Large private organizations magnified the risk in the financial crisis. Examples of this are the failures of Freddie Mac, Fannie Mae and AIG in the US, and the Royal Bank of Scotland following its takeover of other banks. The term ‘too big to fail’ developed as a political response to the crisis of these organizations, ensuring anger at their privileged position and creating major concerns that inappropriate behaviour would be rewarded rather than punished, leading to repeats of high risk taking and unaccountable actions. Large organizations tend to amplify the reinforcement process and can become unstable if not adequately checked by other counterweight systems processes. This is one of the difficulties of classical command and control management with its deterministic and hierarchical approaches, as criticized by complexity management writers and researchers like Stacey (2007), Snowden and Boone (2007) and Seddon (2008). Although large organizations can function well if they apply appropriate principals of disaggregation and devolution, they have to work hard to change and evolve alongside the external environment, and need excellent internal communication systems to do so. Small and medium sized organizations are often better at adapting and evolving (Hilton, 2011: 42), even though some will fail. The danger is that large banks and financial institutions avoid investing in these smaller forms of organization because they see them as not offering high enough returns for the element of risk, and instead prefer the safety of large mergers and acquisitions where large assets minimize risk but increase the opportunities for big returns. Paradoxically mergers and acquisitions focus on increasing the profitability of an existing market by limiting competition and reducing costs, while the support of small scale innovation is more likely to increase the total economy and its value. This is a negative version of ‘scaling up’ where policy would do well to promote innovative new forms of smaller organization. Governments are interested in promoting smaller scale forms of public organization but have faced dilemmas of the extent to which this should be linked to market values. The challenge is to find new ways of organizing public services that both maximize local flexibility, participation and decision making at the micro level while still creating a stable operating environment that demonstrates good practice and shared values of success that all can benefit from. The underlying values need to be optimal, so ‘not-­for-profit’ should be preferred to ‘for-­ profit’. Unstable, rapid marketization of public services has been shown to raise transaction costs. It evolves quickly towards monopoly provision that maximizes

188   Conclusion profitability through large economies of scale and forcing up prices to the government. If this is the outcome, choice and quality of experience becomes an expensive illusion created by brand identity and advertising, rather than the realities on the ground for service users. Smaller scale organization that focuses on not-­for-profit is the way forward, but challenges persist with what pace of change is realistic and how to prevent too much national fragmentation.

Instability Complex systems illustrate the flow of instability and stability across time and the dynamic of the interaction between different levels. A build up of instability in one part of the complex system may take time to spill over into other levels. At the same time other parts of the system, previously unstable, move back to periods of stability. This ebb and flow of instability and stability is very much a feature of the global economy and the interaction of public and private forms of organization. It is difficult for policy makers to estimate and forecast where instability will move and how it can best be contained. The great difficulty is that because a complex system is dynamic and in a large part determined by its own interactions and communications, there is no single deterministic theorem or set of rules and methods that can be learnt and repeated to create the optimum balance between stability and instability. Having some limited instability in some places, for some periods of time, also appears to be optimum to any holistic system, enabling it to evolve and survive ‘on the edge of chaos’. But human systems and their leaders and managers do not automatically find the right dynamic between stability and instability and need to learn and understand how best to achieve this. As Stiglitz (2010: 191) says: The final challenge is stability. Growing financial instability has become an increasing problem. In spite of the alleged improvements in global financial institutions and increased knowledge about economic management, economic crises have been more frequent and worse. Policy stabilizers should be based on social goals that express public value rather than market performance: for example, seeking full employment, carbon reduction and reduced inequality. Regulating markets and their functions and pricing to create equity and quality rather fell into disrepute after the late 1970s and new classical economics, linked closely to public choice theory and new public managerialism in public policy, created a dominant public policy narrative and political culture that reinforced market values and classical market concepts as the best method to achieving any optimal public outputs. This was a passive approach to public policy that took its values from classical economics rather than any political idealism about the moral nature of human systems and interaction and it moved societies away from assertive political goals of equality and harmony between human actors and their environment. Such philosophical and political collaborative

Conclusion   189 concepts were still present and influential in public policy but they became more dormant and subject to an overwhelming logic of protecting the market first. This is the irony in the narrative accounts of how the world’s leaders dealt with the great financial crisis of 2008–09. While undertaking emergency large scale interventions they were working as much to protect the market as they were to protect the social cost to the actors caught up in the crisis. The world they have left behind is a strange new entanglement of market and public state where there is still, in part, denial of the public ownership of much that was previously private. Public policy, as a form of market intervention, is not a fundamental problem; it is a form of intervention and solution to achieve stability. The market on its own and without sufficient regulation will evolve towards instability. A key lesson of the system based reflections of this book is the importance of building medium and long term system resilience after short term crisis reactions. Good medium and longer term policy resilience will prevent the need to focus all resources on short term crisis management. One of the best illustrations of this is energy policy and climate change. Long term investment in diverse and ‘carbon sensitive’ energy supply will not be the cheapest policy in the short run, but will present the better public alternative in the longer term. It can also have positive consequences for local investment and job creation.

Paradigm shift It has been beyond the scope of this book to explore political philosophy and its relationship with public policy intervention in detail, but the most important conclusion is to note that complex systems approaches – while excellent in providing a systematic and analytical framework for assisting the challenging job of leading and managing public policy – have to include a recognition of normative value based consideration about what is judged an ethical and moral priority. The danger of transporting complex systems concepts from the natural sciences into the social sciences is that these philosophical aspects get forgotten. Meadow’s (2009) seminal work around ‘paradigm shifts’ and ‘goals in systems change’ allow us to make the normative connection more easily. If a political project can shift a policy system and its public actors to more collaborative and humanitarian goals and principals, much of the detailed work of getting the system to function correctly can then follow on from this purpose and direction. The research for this book has shown that the financial crisis of 2008–09 had a strong moral element that related to interactions in the system where power and knowledge was misused. Fundamentally this was the unfair selling of mortgage products, upwards from front line mortgages sold to the low paid and poorest members of society. They would never have a chance to live a stable existence in their new home, but would be condemned to repossession, and an increase in their indebtedness and poverty. This immorality was of course connected higher up the chain to the investment bankers who aggressively sold mortgage backed securities to other financial institutions, perhaps in other countries, knowing that there was a very high financial risk given the likelihood

190   Conclusion of a collapse in the US property market. And unknown to the buyer these sellers were sometimes betting (hedging/shorting) that the sell would lead to near immediate disaster for their client. As Meadows (2009) identified, the easiest way to try and do better with leading and managing our complex policy systems is to get a satisfactory system of values in place first. Meadows (2009) noted that the clearest way to change a complex social system is to implement a paradigm shift and to change the fundamental and dominant values that underpin it. The global economy has been on the edge of such a shift since the height of the crisis in 2009. If its values do not change it looks likely to drift further into chaos, instability and disorder. The global financial market failed spectacularly and had to be saved by the governments of the most powerful economies in the world. To do this they had to put aside their values of the dominance and importance of the self determination of the market place and suspend these for a time. This can be observed in the personal accounts of Hank Paulson, former US Treasury Secretary, former US President George Bush and former UK Prime Minister, Gordon Brown. Each account talks of their preference for negotiating and facilitating market based takeovers, even if this involved some supportive investment of public money. This was seen as a strong ideological preference instead of nationalization and state ownership. Later in the crisis, however, the facilitation of takeovers was not enough if the institutions were to be saved and state ownership became a reality. Both the US and UK governments were keen to avoid any representation of direct ownership. Public relations exercises were used to indicate government involvement was kept at a distance and that management would follow a market model with the aim of at some point returning value to the taxpayer and the selling of the nationalized institutions back to private shareholders. The paradigm of the globalization, individualism and materialism of market capitalism remained dominant and this evident contradiction has placed many countries into something of a political vacuum. This implies the crisis will continue as the failures of the global paradigm have not been resolved. In the second major period of the crisis the focus on debt has moved to government borrowing and its lack of sustainability. This crisis was directly, but not exclusively, linked to the first crisis. One country may be the tipping point in a third act of the drama. If Greece, Ireland, Portugal, Italy or Spain cannot raise borrowing on the bond markets or from European or IMF loans, one of two things are likely to happen: either one of these countries could leave the euro to resume its previous currency, or a major bank or banks could face insolvency because of their high level of investment in sovereign bond debt. How deep and how far ranging such a crisis would be is difficult to tell. It certainly would not assist the attempts to stabilize the global economy. The world in late 2011 is waiting to see whether European countries can agree a new political settlement that puts the management of the European central bank and its control of the European money supply and lending at the core of a new continental public policy intervention. If such a confident move was agreed and implemented it might be the tipping point and monetary buffer in a new age of public policy that is more assertive over markets and global flows. But the crisis is not over.

Conclusion   191 The alternative is that new public policy models come from within an increasing number of bankrupt nation states who choose to resist the dominance of market globalization because the stakes feel like lose-­lose rather than win-­win. Planning economic security from the bottom up will have elements of protectionism. One way or another, public policy will increasingly have to work with stronger interventions that buffer against global forces and innovate in local and regional markets, and governments will emerge with a clearer sense of their local and national public welfare purpose. Consumption patterns will shift from global quantity to local quality. Taxation and public expenditure should underpin a regulated market that has a bias towards local and regional trade and activity. This will provide a foundation of stability for all citizens who have to live and work in a more sustainable environment.

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Index

Abbott, A. 108 Adams, C. 28 Africa Commission 153 Aldenderfer, M. 28, 29 Alford, J.A. 184 Allen, K. 111 Allen, P. 15 austerity 55, 95, 122, 124–5, 127, 129–35, 136–7, 139–45, 154, 161, 162, 164, 166, 167, 169 Australia 36, 64, 96, 108, 163, 166 Austria 49, 64, 74–5, 163 Authers, J. 36, 124 Argentina 161 Asian crisis 36, 41, 134, 155 attractors 10–12, 30 autopoiesis 13 Azadegan, A. 18 balance of payments 22, 39, 42, 64–8, 67, 128, 131, 131, 135, 141, 160, 163, 166, 172 balance sheet recession 96, 133; see also recession Bank of England 11, 69, 105, 107, 108, 109 banking reform 99–100, 102, 104 Bar-Yam, Y. 21 Baranger, M. 22 Barboza D. 128, 185 Barnes, M. 168 Basel Committee on Banking Supervision 75 Bawden, T. 104, 110, 112 Bear Stearns 70, 72, 76, 79, 85 Beattie, A. 100 Beautement, P. 141 Bebbington, J. 147 Belgium 59, 64

Benford, J. 108 Benington, J. 168, 184 Blanchard, O. 39 Blashfield, R. 28, 29 Blond, P. 168 bifurcation 6 Boffey, D. 132 Boisot, M. 18, 20 Bond, S. 131 bonds 93, 106, 107–9, 112, 117, 119–20, 122–4, 127, 129, 132, 134, 138, 141, 145, 156, 159, 166 bonuses 44, 93, 100, 103–4, 105, 122 boolean algebra 25 Boone, M. 17, 20 Boons, F. 15 Bottle, R. 120, 134 Bourdieu, P. 11 Braithwaite, T. 82 BRICs 61, 113, 139, 185 Broenner, C. 141 Brown, Gordon 31, 70, 71, 75, 78, 84, 86, 87, 88, 94, 95, 96, 102, 103, 155 bubble 9, 12, 34, 36, 68, 69, 79, 82, 85, 110, 112, 141, 152, 153, 156, 182 buffer 19, 89, 101, 102, 132, 141, 142, 148, 161 Bunt, L. 168 Bush, George 74, 75, 84, 86, 87, 94, 95, 104, 117 Business Innovation and Skills Committee 103 Byrne, D. 25, 26, 30 Cadburys 103, 110 Cameron, David 95, 95 Canada 34, 36, 37, 58, 64, 163 capital flows 40, 41, 41, 79, 88, 135, 161, 185

Index   203 Capitalism 2, 170; see also Kaletsky, A. Capitalism 3, 12, 135, 153, 161, 170; see also Kaletsky, A. Capitalism 4, 170, 172; see also Kaletsky, A. case based methods 25–6 Carr, E. 87 Carrell, S. 149 chaos 3–8, 14, 18, 24, 73, 89, 139, 188, 190; see also edge of chaos Chile 39, 55, 66, 139, 163, 166 China 22, 36, 40, 42, 88, 89, 90, 98, 99, 100, 111, 113, 128, 137, 140, 150, 155; yuan 89, 99, 128, 145, 155 Chretién, J. 37 cluster analysis 1, 26, 28–30, 61–6, 65, 163–6, 164 Clark, A. 105 Cilliers, P. 22 coalition government UK 2, 95, 100, 102, 104, 105, 129, 130, 144, 149 collateralized debt obligations (CDOs) 82, 83, 84 Coman, J. 159 Commission for Africa 153 Committee on Climate Change (CCC) 149, 158, 171 comparative research 26–8 complex adaptive systems (CAS) 20 complex systems theory 1, 186 complexity theory 1, 5, 3–24, 186–91 Conservative Party (in UK) 104, 127 consumer price index (CPI) 42, 43, 44, 45, 48, 64–8, 67 cooperatives 168 Cornago, A.A. 148 Cotterell, P. 168 Cox, R. 37 credit ratings agencies 82, 83, 89, 122, 123 Credit Unions 156 Cronqvist, L. 64; see also Tosmana currency speculation 36; see also exchange rate Cyprus 42, 61 Darling, A. 31, 72, 77, 94 Davies, H. 75, 83 De Vita, G. 108 Deacon, B. 32 Delucchi, M. 148 demand failure 20–1, 178, 179; see also Seddon, J. dendrogram 30, 64, 65, 66, 164; see also cluster analysis

Denmark 45, 65, 141, 149, 163, 171, 172 Dennis, B. 105 Dexia 145 Dicken, P. 32, 41 dissipative structures 6, 13 distributed control 18 documentary analysis 30–1 Dodd-Frank Wall Street Reform Act 95, 105 Dooley, K.J. 5, 18 dot.com bubble 36, 43, 152, 153 economy of logic 12 edge of chaos 6–8, 10, 139 Edmark, K. 49 education 58–60, 59, 60 Edwards, S. 88 Elliott, E. 6 Elliot, L. 101, 145 emergence 8 Emmott, B. 134 employment 48–57, 64–8, 80, 111, 124, 129, 133, 140, 143, 154, 160, 161; part time 51, 52; women 49, 51, 51, 67 energy 2, 19, 36, 40, 81, 91, 95, 102, 112, 113, 130, 135, 145–52, 156, 160, 161–2, 162, 170, 171, 175, 189 Enron scandal 82, 87, 175 Estonia 48, 49, 61; Euclidean distance 30 euro 33, 34, 36, 40, 43, 45, 48, 66, 75, 77, 89, 91, 100, 107, 117, 121–6, 128–30, 132, 134, 135, 143, 144, 145, 148, 166–7, 190 European Central Bank 48, 121, 124, 134 European Stability Fund 166 European Union (EU) 33, 36, 40, 41, 86, 104, 106, 121, 123, 126, 127, 136, 143, 144, 150, 151 Evans, S. 171 exchange rates 41, 88, 89, 100–1, 101, 128, 136, 145, 160 Fagan, C. 51 Fardoust, S. 154 far from equilibrium 12 feedback loops 12 Feldstein, M.S. 88 Ferguson, J. 108 Ferguson, N. 120 Fleming, S. 110 Financial Crisis Inquiry Commission (FCIC) 71, 81, 82, 85, 90, 94 Financial Services Authority (FSA) 74, 105

204   Index Finland 34, 35, 40, 45, 64, 65, 141, 163, 172 fiscal policy 36, 48, 88, 97, 102, 112, 130, 160, 169; see also taxation fitness peaks 8 Fitoussi, J. 200 Foden, G. 4 food 2, 39, 81, 103, 108, 110, 115, 130, 135, 158, 161, 162, 172 foreign reserves 41, 89, 99, 100, 141, 155 Forgues, B. 15 Fox, L. 175 fractal 8–9 France 36, 55, 64, 74–5, 145, 152, 163, 173 Freund, C. 88 Frondel, M. 149 G7 37, 42, 74, 98–102, 108, 134 G20 39, 74, 76, 88, 95, 98–102, 107, 134, 141 Galbraith, J.K. 95, 97, 105 gas 36, 147–50, 151–2 Germany 33, 36, 40, 45, 49, 58, 59, 74–5, 111, 113, 121, 134, 141, 149, 151, 163, 71, 172 German Bundersbank 48 global capital flows 41, 88 globalization 32–3, 39, 79, 88, 93, 101, 109, 111, 140, 156, 160–1, 170, 180, 185, 190–1 Giddens, A. 49 Giles, C. 129 Gini coefficient 57, 58 Goldman Sachs 70, 79, 84, 85–6, 91, 104–5 government bonds 106–8, 109, 117, 119, 120–4, 127, 129, 132, 134, 145, 159 government current account 35, 36, 64–8, 67, 118, 118, 124, 125 government investment 36, 115, 146 government net total debt 37 Governor of the Bank of England 69 Great Depression 21, 90, 110 Greece 2, 33, 37, 40, 41, 45, 48, 59, 117, 118, 120–4, 129, 131–3, 136–7, 142–5, 166, 190 Griffin, D. 14 gross domestic product (GDP) 33, 34, 35, 37, 64–8, 67, 70, 85, 87, 96, 97, 108, 118, 119, 121, 22, 123, 124, 125, 126, 130, 131, 141, 144, 146, 154, 156, 157, 159, 164, 167, 172 Gullberg, J. 25

Hamilton, J.D. 109 Hare, D. 185 Harmon, D. 21 Harris, M. 168 Harvey, D.L . 6 Harvey, F. 147 Hastings, M. 147 Hawkes, A. 117 Haynes, P. 5, 7, 8, 11, 14, 15, 18, 27, 31, 73, 167, 168, 174; health 61, 61, 62, 63, 153, 157–8, 162, 174, 175, 176, 177 Helco, H. 28 Heidenheimer, A. 28 Hill, M. 14 Hilton, A. 187 Hipwell, D. 174 Hong Kong 33, 36, 45, 155 Hope, K. 124 House of Commons Energy and Climate Change Select Committee 151 House of Commons Treasury Committee 30, 94, 133 house prices 12, 23, 81–2, 88, 92, 96, 114 Hudson, R. 9–10 Hughes, O. 184 Hungary 54, 64, 74–5, 163, 166 Hutchinson, M. 37 Hutton, W. 104, 153 Iceland 33, 34, 36, 41, 42, 48, 64, 125, 163, 166 Iceland Krona 42, 48 immigration 55, 57, 80, 124, 126 Independent Commission on Banking 105 India 61, 98, 140, 150 Indonesia 39, 161 inequality 16, 50, 56–7, 58, 112, 113, 133, 153–4, 157, 159, 160, 162, 171, 173, 181, 185, 186, 188 inflation 10–11, 42, 43, 44, 45, 48, 49, 66, 68, 80, 87, 93, 106, 107, 108, 109–12, 120, 130, 131, 134, 135, 140, 141, 150, 166, 170, 172, 173, 185; see also Consumer Price Index Information Space (I-Space) 18 Inman, P. 145 Instability 5–8, 10, 24, 69–93, 185–91 interest rate (IR) 10, 36, 43, 45, 45, 46, 64–8, 67, 96–7, 100, 102, 106–12, 107, 114, 115, 164, 166, 170, 185 International Energy Agency (IEA) 149, 151 International Monetary Fund (IMF) 11, 29, 32, 33, 89, 95, 100, 107, 116, 122, 123,

Index   205 124, 126, 127, 133–4, 136, 141, 143, 159, 161, 190; Fiscal Stability Forum 116 International Social Survey Programme (ISSP) 27 internet 84, 102, 152 inward investment 23, 34, 36, 42, 84, 106, 112, 125, 135, 136, 160 Ireland 2, 33, 36, 41, 45, 49, 59, 61, 96, 117, 118–19, 124–5, 126, 129, 130, 136, 143, 148, 163, 166, 190 Italy 2, 36, 55, 64, 163, 190

Lietaer, B. 157 life expectance 61, 63 Linn, M.W. 49 Lipsky, M. 14 liquidity 1, 45, 69–72, 76–7, 79, 85, 92, 96, 107–8, 110–12, 115, 125, 135, 142–5 Lombard. M. 173 Lorenz, E. 4 Luhmann, N. 9, 13 Luxembourg 49, 54, 123 Lynn, M. 34, 36

Jackson, T. 146 Jacobson, M. 148 Japan 36, 37, 41, 45, 55, 58, 64, 66, 96–7, 100, 108, 110, 111, 113, 118, 121, 130, 133, 134, 141, 147, 150, 151, 156, 163, 166, 171; Japanese exceptionalism 141; lost decade 36, 96, 130, 133 Johnson, M. 127 Johnson, S. 8 Johnstone, R. 133, 173 Joyce, P. 172 Joyce, M. 108 Jupe, R. 173

McCartney, S. 173 McKelvey, B . 10 McKibben, B. 149 McKie, R. 148 McKillop, D. 156 Mackintosh, J. 43 Maclean, D. 7 MacIntosh, R. 7 McNulty, R. 173 Mahoney, J. 27 Mandelbrot, B. 3–4, 8–9, 89 manufacturing exports 36, 90, 113, 149 Marion, R. 18 marketization 1, 5, 7, 11, 23, 73, 86, 87, 92, 133, 137, 142, 148, 157, 168–9, 174, 176–8, 181, 187 Maturana, H. 13 Meadows, D. 12, 18, 19, 22, 23, 24, 72, 146, 148, 190; mergers 32, 87, 104, 106, 111, 112, 113, 116, 187 Mexico 54, 161 Middle East 6, 147, 150, 151 Milesi-Ferretti, G.M. 39 Milmo, D. 130 Milne, R. 124, 132, 134 Moghadam, R. 161 Monbiot, G. 157 monetary policy 45, 48, 65, 66, 68, 89, 95, 102, 106–12, 114, 115, 116, 130, 132, 134–5, 136–7, 139, 142, 173 Moore, M.H. 168, 184 mortgage backed securities 13, 41, 72, 83, 104, 105, 108, 189

Kaletsky, A. 12, 75, 98, 113, 128, 135, 140, 153, 161, 170, 172 Kalleberg, A. 51 Kauffman, S. 8 Kennett, P. 27 Keynesian policy 22, 90, 95, 102, 112, 113, 120, 127, 129, 130, 132, 143, 170 Klare, M. 113, 151 Kiel, L.D. 6 King, M. 49 knowledge management 18 Kontopoulos, K.M. 11 Koo, R. 96, 133 Koskela, E. 53 Kraft 103, 110, 113 Kramer, R.M. 169 Krugman, P. 22, 40, 42, 79, 85, 89, 90, 97, 102, 132, 133, 134, 140, 145, 155, 160 Larkin Terrie, P. 27 Leach, G. 164 lean systems 20 Lehman Brothers 6, 73–4, 77, 79, 125, 145 Levell, P. 153 Lewis, M. 21, 93 Lloyds Bank 74–5, 77, 104, 106 Liberal Party 104, 127, 143–4

National Audit Office (NAO) 103, 104 national debt 34, 37, 111, 123, 125, 143, 156 negative feedback 5, 12, 18, 22, 68; see also stabilizing feedback negative interest rates 36; see also quantitative easing

206   Index nested systems 8–10, 180 Netherlands 51, 55, 64, 163, 173 New England Complex Systems Institute (NECSI) 21 new public management (NPM) 7, 167, 170 Newtonian reductionism 16 New Zealand 37, 163 North American Free Trade Agreement (NAFTA) 40 Northern Rock Bank 71, 73, 76, 87, 103 Norušis, M.J. 26, 28, 29, 30 Norway 36, 39, 45, 64, 65, 118, 141, 147, 151, 163, 166

profits 19, 38, 84, 86, 88–9, 91, 92, 99, 110, 111, 138, 145, 156, 174 public investment 36, 48, 130, 132, 144, 153 Purdue, A. 168 qualitative comparative analysis (QCA) 25–6, 30, 64, 67, 163, 165 quantitative easing (QE) 107–12, 115, 116, 131–2

Oakley, D. 124, 134 Obama, Barack 95, 95, 102, 104, 105, 127, 132 Office for Budget Responsibility (OBR) 127, 130 Oldfield, Z. 153 oil 36, 44, 108, 113, 130, 147, 148, 149, 150–1, 170, 177, 185 O’Reilly, J. 51 Organisation of Economic Cooperation and Development (OECD) 27, 28, 29, 33, 45, 48 Ormerod, P. 21 Osborn, S.G. 151 Osborne, George 103

Ragin, C.C. 25 Rajan, R. 98, 128 Reagan, Ronald 171 recession 2, 33, 36, 37, 38, 41, 66, 84, 85, 94–6, 102, 106, 107, 109, 110, 111, 113, 114, 121, 125, 127, 132, 133, 135, 139, 142, 147, 148, 151, 153, 154, 159 Reed, M. 6 reinforcing feedback 12, 19, 23, 72, 87, 90, 91, 92, 115, 116, 136, 140, 182; see also positive feedback Reinhart, M. 108 Rhodes, M. 6, 7, 20 Robinson, D. 168 Rose, A. 117 Royal Bank of Scotland (RBS) 75, 77, 103, 104, 110, 113, 187 Russia 36, 39, 42, 73, 98, 111, 134, 140, 147, 150, 151, 152

paradigm shift 3, 135, 171, 186, 189–91 Pareto, V. 10, 16 Pastor, D.A. 28, 29 Paulson, Hank 30, 70, 71, 72, 73–5, 77, 85–6, 91, 94, 96, 104, 190 Peston, R. 87, 110, 111, 153, 154 Peterson, I. 5 Pickett, K. 56, 61, 153, 157 Pierpaolo, A. 10 Poland 49, 53, 55, 96, 152, 157, 163 policy systems 1, 3, 5–6, 7, 14, 24, 178, 190 Pollit, C. 17 Poincaré, J.H. 3–4 Portugal 2, 37, 40, 41, 49, 54, 55, 64, 65, 117, 123, 125–6, 129, 132, 135, 142–3, 163, 190 positive feedback 5, 12, 18, 19; see also reinforcing feedback Power, H. 174 power laws 9–10, 16 Prigogine, I. 13 privatization 5, 11, 122, 123, 133, 134, 142, 148, 168–9, 173–4, 181

Sachs, J. 133 Saul, J.R. 180 savings 39, 48, 80, 95, 98, 102, 109, 121, 146, 156, 158, 171, 174, 181 Sbrancia, M.B. 108 scaling 5, 8–9, 186–7 Securities and Exchanges Commission (SEC) 21, 70, 84, 105 Seddon, J. 14, 20–1, 168, 169, 171, 176, 178, 187 self organization 5, 13–16, 19, 23, 24, 115, 137, 179, 187–8 shale gas 151–2 Shleifer, A. 134 Skidelsky, R. 12, 22, 90, 100, 102, 108, 112, 113, 120, 160 Slovak Republic 53, 55, 163 Slovenia 48, 49, 66 Singapore 33, 36, 61 Smith, H. 129 Snowden, D. 17–18, 20, 178, 187 solar power 146, 148 Somerset Webb, M. 108, 112

Index   207 South Korea 33, 36, 55, 59, 61, 66, 96, 118, 163 Spain 2, 41, 42, 49, 55, 66, 74–5, 123, 126–7, 132, 143, 144, 151, 163, 190 Spiegel, P. 124, 133 Stacey, R. 14, 17, 178, 187 stabilizing feedback 12, 19, 23, 84, 91, 93; see also negative feedback Steele, J. 169 Stewart, H. 132 Stiglitz, J. 33, 36, 48, 69, 79, 89, 133, 141, 143, 152, 154, 156, 157, 159, 160, 181, 188 Stittle, J. 173 structural coupling 13; see also Luhmann Sweden 34, 35, 39, 45, 59, 65, 118, 141, 163, 172, 173 Switzerland 37, 55, 64, 66, 118, 163, 166, 173 system goals 19 system paradigm 19; see also paradigm shift system rules 19 Talbot, Colin 169 Talbot, Carole 169 Taleb, N. 9, 83, 87, 89 Taiwan 33, 36 taxation 38, 38, 48, 64–8, 67, 84, 87, 140, 141, 146, 153, 154, 157, 160, 164, 166, 167, 186 Teisman, G. 14 Tepe, M. 167 Thatcher, Margaret 10, 78, 170, 171, 174 Thietart, R. 15 third way 49 tipping point 6, 12 Tosmana 64 Toyota 20 trade deficit 22 transnational corporations (TCs) 22, 32, 33, 41, 42, 89, 103, 112, 116, 131, 132, 124, 138, 144, 145, 152, 155, 157, 158, 160, 170, 180 transport 112, 127, 130, 145, 148, 150, 158–9, 160–1, 162, 172, 173, 189 Treanor, J. 100, 106, 111 Turkey 48, 61 Turner, A. 94, 97, 108, 110 Turner, G. 36, 45 Uhl-Bien, M. 18 unemployment 48–9, 52–5, 53, 54, 66, 90, 96, 99, 109, 113, 114, 126, 130, 131, 137, 140, 143, 172, 177

United Kingdom (UK) 2, 8, 10, 11, 20, 23, 30, 36, 42, 43–4, 54, 64, 88, 95, 95–6, 100, 103–4, 160, 163, 190; austerity 140–5; education 58–9; energy 146–52; financial crisis of 2007–8, 70–87, 76; government debt 127, 130; imports 42, 141, 150; monetary policy 106–12; pound sterling 43, 149; privatization and marketization 5, 23, 173–7; quantitative easing 107–12; TCs 42, 103, 112–3; unemployment 53, 54–5, 96, 99 United Nations (UN) 27 United States (US) 64, 95, 95–6, 102, 105, 106–7, 166; austerity 140–5; dollar 2, 42, 43; energy 146–52; education 58–9; Federal Reserve Bank of America 77, 85, 108; financial crisis of 2007–8, 70–87; government debt 2, 127–8, 132; government sponsored enterprises (GSEs) 70, 73, 76–7; housing market 6, 43, 70, 83, 86, 98; imports 42, 128, 141, 150; inward investment 22, 41, 42; quantitative easing 108–12; TCs 41, 42; unemployment 53, 54–5, 96, 99 Uprichard, E. 28 uptick rule 21 Uusitalo, R. 53 van de Ven, A.H. 5 Varela, F. 13 Vickers, J. chair of UK Commission on Banking 95, 105–6 Viñals, J. 161 Vishney, R.W. 134 Wachman, R. 117 Walker, A. 170 Wall Street Crash 94 Warnock, F. 88 Warsaw Pact 36 waste management 159 Wilkinson, R. 55, 61, 153, 157 Wilson, S. 132 wind power 146, 148–9, 171 Wolf, M. 88, 89, 100, 141 World Bank 95, 133, 141 World Commodity Price Index 40 World Health Organization (WHO) 27, 61, 62, 63 Wu, J.C. 109 Wyatt, C. 168 Yannopoulos, D. 121, 122