The global financial crisis that is threatening to tip over into a Great Depression as in the 1930s poses awkward questions for neo-liberals who exuded a triumphalist air after the Asian crisis of the late 1990s. When the very survival of the system is at stake, there are no takers for the view of the former chairman of the US Federal Reserve, Alan Greenspan, that one consequence of the Asian turmoil was an increasing awareness that market capitalism, as practiced in the West, especially in the US, is the superior model.
When several Asian economies — then accounting for a quarter of the world’s output — experienced a severe economic slump, this was considered the wages of sin of state-led, crony capitalism. The cozy, collaborative nexus between their ruling elites and big business that fostered private gain and loot at the expense of the economy was believed to underlie their woes. In sharp contrast, the more laissez faire, freewheeling US capitalism held out the promise of continuous growth and rising standards of living.
A decade later, the US has become the epicentre of the global financial meltdown that is spilling over to the real economy. With its growth engine sputtering to a halt, it is already in recession. The best indicator of this is the continuous rise in job losses. Around 760,000 jobs have disappeared in that country since January. Unemployment is at its highest level in five years. Despite boom times till recently, the median American household made slightly less last year than an equivalent household earned in 2000.
When the all-powerful US economy is seizing up, can the rest of the world be far behind? Recessionary winds are blowing through Europe and Japan. Which is why the International Monetary Fund has given its bleakest assessment that the global economy is in the cusp of a recession. The advanced countries are expected to hit near-zero growth next year with the world economy expanding by only 3 per cent. Fears are indeed rife that this downturn will be deep and prolonged as it was during the 1930s.
After being awarded the Nobel Prize in Economics, Professor Paul Krugman of Princeton University, stated, “we are now witnessing a crisis that is as severe as the crisis that hit Asia in the 1990s. This crisis bears some resemblance to the Great Depression.” He also got a similar feeling nine years ago when he penned his book The Return of Depression Economics. The Asian economic slump bore “an eerie resemblance” to what happened six decades earlier. Now, as then, the crisis struck out of a clear blue sky, he wrote.
Krugman got the Nobel for his contributions to international trade theory that could explain puzzles like why most trade is between seemingly similar countries. His work in economic geography answers questions like why did the US automobile industry locate in Detroit and the Mid-West. The role of historical accident in shaping the location of production; the fact that cities and regions might be subject to discontinuous change are also important facets of his work in this highly interesting field.
The return of depression economics was truly heralded when the Asian crisis rapidly spread to Latin America and Japan entered a tailspin. There was even a freeze in US bond markets. According to his book, this return essentially meant that for the “first time in two generations, failures on the demand side of the economy — insufficient private spending to make use of the available productive capacity — have become the clear and present limitation on prosperity for a large part of the world.”
Depression economics means going back to the work of the economist John Maynard Keynes, whose ideas ensured that capitalism survived in the 1930s. Such ideas are now back with a bang as state intervention is now the favoured mode rather than reliance on market forces to fix the generalised distrust within the banking system that does not want to lend anymore. If banks do not lend, the global economy will be brought to a standstill.
The challenge was to sort out this coordination problem to get the banks to lend again.
In keeping with the new zeitgeist, the biggest state intervention in the American banking system since the 1930s, thus, was the $250 billion bailout plan of the US. CEOs of the nine largest US banks were ushered into the Treasury Department and handed a one-page document that said they agreed to sell shares to the government. They all signed that document before leaving the room. By that act, the government took a stake in troubled banks to recapitalise them so that they can lend again.
The Bush administration was only following the lead of Britain in virtually nationalising banks. Although European countries initially expressed a sense of glee at America’s troubles — that it represented an unraveling of the behavioural foundations of its model of capitalism that was based on greed – the fact remains that capitalism is practiced in similar ways across the Atlantic. So, France, Germany, Spain and Iceland among others took ownership stakes in banks and guaranteed debt like the US.
Having addressed the problems of the financial sector, the big priority now is to tackle the problems of the real economy. In his blog, Krugman charts the southward bound rate of growth of US industrial production over the previous year that doesn’t fully reflect the credit crunch yet and predicts that this slump will be “nasty, brutish, and long. These are not good tidings. Are the US and Europe ready to implement the Keynesian remedy of massive spending to pull the economy out of recession and generate full employment?