What we've learned–and have still to learn–from the financial crisis*
Financial crises do more than impose huge costs: they have bigger and more insidious effects. We face big challenges in maintaining the supply of global public goods as the world integrates. But these challenges will not be managed successfully if we do not first overcome the legacy of the crisis. Moreover, all this must be done at a time of transition in global power and responsibility from a world dominated by Western powers to one in which new powers have arisen.
Inevitably, such crises also help undermine belief that a globalising economy is of benefit to the vast majority of people. They make people anxious and angry and rightly so. Angry and anxious people are not open to the world. They want to hide in their caves, together with similarly angry people. That is what happened in the 1930s. Financial crises are the events most likely to bring the world back there.
Equally inevitably, crises undermine confidence in the elites. In democratic societies, a tacit bargain exists between elites and the rest of society. The latter say to the former: we will accept your power, prestige and prosperity, but only if we prosper too. A huge crisis dissolves that bargain. The elites come to be seen as incompetent, rapacious, or, in this case, both. The political results may come slowly. But come they will.
Here then are three huge failures of the Western elites.
First, the economic, financial, intellectual and political elites misunderstood the consequences of headlong financial liberalisation. Lulled by fantasies of self-stabilising financial markets, they not only permitted but encouraged a huge and, for the financial sector, profitable bet on debt. The policymaking elite failed to appreciate the risks of a systemic breakdown. The financial elite was discredited by both its behaviour and its need to be rescued. The intellectual elite was discredited by its failure to anticipate a crisis or agree on what to do after it had struck. The political elite was discredited by their willingness to finance the rescue, however essential it was. The decline in confidence in these elites is even worse if the methods used to rescue the economy then make the parts of the elite most associated with the crisis richer than before. This undermines the sense of fairness that underpins the political economy of capitalism: there has to remain a belief that success is earned, not stolen or handed over on a platter.
Second, the past three decades have seen the emergence of a globalised economic and financial elite that has become ever more detached from the countries that produced them. In the process, the glue that binds democracy–the notion of citizenship–has weakened. The narrow distribution of the gains of economic growth risks exacerbating this development.
Third, in creating the euro, the Europeans took their project beyond the mundane into something far more important. The economic troubles of crisis-hit economies are evident: huge recessions, extraordinarily high unemployment, mass emigration and heavy debt overhangs. The constitutional disorder that has resulted remains insufficiently emphasised. Within the Eurozone, power is now concentrated in the hands of the governments of the creditor countries, principally Germany, and a trio of unelected bureaucracies–the European Commission, the European Central Bank and the International Monetary Fund. The peoples of adversely affected countries have no influence upon them. The politicians notionally accountable to them are powerless. This divorce between accountability and power strikes at the heart of democratic governance.
The loss of confidence in the competence and probity of elites inevitably reduces trust in democratic legitimacy. People feel even more than before that the country is not being governed for them, but for a narrow segment of well-connected insiders who reap most of the gains and, when things go wrong, are not just shielded from loss but impose massive costs on everybody else. This creates outraged populism, on both the left and the right. Yet willingness to accept shared sacrifice is likely to be still more important in the years ahead than it was before the crisis. The economies of the Western world are poorer than they imagined ten years ago. They must look forward to a long period of retrenchment. Making that both be and appear fair matters.
Every effort must be made to restore economies to growth, on both the demand and supply sides. Every effort must be made, too, to ensure that a similar crisis will not recur without eliminating those aspects of an open world economy and integrated finance that are of benefit. This will require more radicalism than most recognise. We must not only learn the lessons about how the world economy went awry. We must also act upon them. If we do not, next time a big crisis arrives even our open world economy could end in the fire.
*Extract from Martin Wolf’s 2014 book, The Shifts and the Shocks: What We've Learned–and Have Still to Learn–from the Financial Crisis, published by Allen Lane in the UK and The Penguin Press in the US.