Neoliberalism and economic breakdown

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Aus­trali­a’s pre­vi­ous Lib­er­al Par­ty Prime Min­is­ter John Howard “came out swing­ing” last night in sup­port of the pol­i­cy agen­da his gov­ern­ment shared with the pre­ced­ing Labor Par­ty gov­ern­ment of Bob Hawke and Paul Keat­ing:  “neolib­er­al­ism” (for non-Aus­tralian read­ers, the Aus­tralian Lib­er­al Par­ty is clos­er to the US Repub­li­can Par­ty or the UK’s Tories than the US vision of the word “Lib­er­al”, while the Aus­tralian Labor Par­ty is akin to the US Demo­c­ra­t­ic Par­ty or the UK’s Labour Par­ty).

In Five great reforms are an essen­tial lega­cy, Howard defends “neolib­er­al­ism”, and argues that the finan­cial cri­sis was actu­al­ly the result of dis­tor­tions to the finan­cial sys­tem by well-mean­ing but ill-advised gov­ern­ment tam­per­ing with the finan­cial sys­tem:

The world, includ­ing Aus­tralia, will not respond effec­tive­ly to the glob­al finan­cial melt­down unless we prop­er­ly under­stand its ori­gins.

The sub­prime deba­cle orig­i­nat­ed in the Unit­ed States, where the reg­u­la­tions about the mak­ing of loans were far too lax. It was a laud­able social goal to spread home own­er­ship as wide­ly as pos­si­ble, but the method involved the dis­tor­tion of the finan­cial sys­tem. Fail­ures of reg­u­la­tion have con­tributed to the severe eco­nom­ic cir­cum­stances we now face. I do not seek to defend the excess­es on Wall Street and else­where. How­ev­er, these fail­ures and the chal­lenges we face do not rep­re­sent a sys­temic fail­ure of cap­i­tal­ism or indeed of the mar­ket sys­tem…

There is no doubt that gov­ern­ment enthu­si­asm for pro­mot­ing home own­er­ship added to the cur­rent cri­sis, and much of this emanat­ed from gov­ern­ments keen to reap the polit­i­cal ben­e­fits of extend­ing home own­er­ship to its elec­torate. A proud new home own­er is like­ly to vote for the incum­bent gov­ern­ment whose “reforms” enabled him or her to gain the title deeds to a house, rather than mere­ly hand­ing over rent to a landlord–or so politi­cians appear to believe.

In the USA, this took the form of suc­ces­sive Repub­li­can and Demo­c­ra­t­ic admin­is­tra­tions pro­mot­ing home own­er­ship via the (to non-Amer­i­cans!) laugh­ably named insti­tu­tions Fan­nie Mae and Fred­die Mac. In Aus­tralia, we had a panoply of entice­ments into home own­er­ship that went beyond even the Amer­i­can bias, includ­ing encour­age­ments not only to own one’s own home, but to be a land­lord as well (I won­der how many politi­cians tru­ly grasped the irony–and ulti­mate futility–of that com­bi­na­tion?):

• A “First Home Buy­er’s Grant” that gave those who had not pre­vi­ous­ly owned a home a cash grant of, at var­i­ous times, A$7,000, and $A14,000 to help them pur­chase that house. In an attempt to revive the now flag­ging Aus­tralian hous­ing mar­ket, this grant has yet again been increased from $7,000 to $14,000 for the pur­chase of an exist­ing house, and $21,000 for the pur­chase of a new dwelling. This boost is sup­posed to be tem­po­rary…;
• State top-ups of this scheme that increase it to $24,000;
• At var­i­ous times the scheme has been tem­porar­i­ly boost­ed. Howard’s Gov­ern­ment intro­duced the scheme as an alleged­ly tem­po­rary off­set to the impact of intro­duc­ing a Goods and Ser­vices Tax [GST] in 2000. He then dou­bled it in an attempt stim­u­late the econ­o­my dur­ing 2001. Now Rud­d’s Gov­ern­ment has done the same–and topped it by tripling it for the pur­chase of a new dwelling.
• No cap­i­tal gains tax on sales of an own­er-occu­pied house–so that the entire cap­i­tal gain from sell­ing your home on a ris­ing mar­ket is tax-free;
• Tax deductibil­i­ty of inter­est pay­ments on pur­chas­es of addi­tion­al hous­es, with the expec­ta­tion that this will encour­age the con­struc­tion of accom­mo­da­tion for renters. Known as “neg­a­tive gear­ing”, it allows a land­lord to deduct inter­est pay­ments from his/her rental receipts, and get a tax deduc­tion if the rental income is less than the inter­est bill; and
• The rate of cap­i­tal gains tax is half the rate of income tax–which encour­ages peo­ple to spec­u­late on cap­i­tal assets rather than work.

This per­verse com­bi­na­tion of incen­tives encour­ages both home buy­ers and spec­u­la­tors to com­pete against each oth­er with lever­aged funds on the Aus­tralian hous­ing mar­ket.

Howard him­self con­tributed to this farce by intro­duc­ing the First Home Buy­ers Grant in the first place, nev­er remov­ing this “tem­po­rary” scheme after the GST adjust­ment phase was over, dou­bling its rate as an eco­nom­ic incen­tive dur­ing the 2001 down­turn, and by set­ting the cap­i­tal gains tax rate at half the income tax rate. His attri­bu­tion of blame for the finan­cial cri­sis to gov­ern­ment inter­ven­tion would have been some­what more believ­able if his speech had includ­ed a “mea cul­pa” for his own con­tri­bu­tions.

But even so, he pre­sent­ed a half-baked the­o­ry of what caused the cri­sis, and a view of eco­nom­ic reform that, in future years, will be derid­ed as naive. He pro­posed that “five great reforms” were the core of the neolib­er­al agen­da:

In 1980 our nation need­ed five great reforms. We need­ed to dereg­u­late our finan­cial sys­tem, fun­da­men­tal­ly change our tax­a­tion sys­tem, make our labour mar­kets freer, reduce exces­sive­ly high tar­iffs and rid the gov­ern­ment of own­er­ship of com­mer­cial enter­pris­es that would be bet­ter run pri­vate­ly. By 2007 these five great reforms had been achieved.

Those five reforms were an essen­tial Aus­tralian con­tri­bu­tion to what one might prop­er­ly describe as the neo-lib­er­al exper­i­ment of the past 30 years…

The mer­its of Howard’s final four “reforms” are still open to debate, but how any­one could cham­pi­on the first reform–the dereg­u­la­tion of the finan­cial system–as a “great” reform in today’s cli­mate beg­gars belief.

As I argued in the Rov­ing Cav­a­liers of Cred­it, finan­cial dereg­u­la­tion was based on a mis­guid­ed belief that the finan­cial sys­tem oper­at­ed like an ordi­nary mar­ket for goods, where the mar­ket itself would work out a sen­si­ble vol­ume of and price for cred­it. A prop­er analy­sis of how mon­ey is cre­at­ed shows instead that a dereg­u­lat­ed finan­cial sys­tem will pump out as much cred­it as bor­row­ers can be enticed to take on. In a world in which lever­aged spec­u­la­tion on asset prices is pos­si­ble, that will lead to the econ­o­my tak­ing on so much debt that it will ulti­mate­ly fall into a debt-induced crisis–which is where we are now.

Once in this sit­u­a­tion, dereg­u­lat­ed finance then ampli­fies the prob­lem by going from sup­ply­ing too much cred­it to cut­ting off the cred­it tap in a man­ner that reduces over­all eco­nom­ic activ­i­ty.

So the finan­cial dereg­u­la­tion that Howard cham­pi­oned last night, and that suc­ces­sive Labor and Lib­er­al gov­ern­ments intro­duced, led not to a bet­ter func­tion­ing eco­nom­ic sys­tem, but to a finan­cial cat­a­stro­phe that is still in its infan­cy.

To argue that the entire cri­sis was due just to the sub­prime scam, and lax finan­cial reg­u­la­tion, is to ignore the obvi­ous signs in the data that too much cred­it was being gen­er­at­ed rel­a­tive to income. These signs go back to mid-1964 in Aus­tralia, and to Armistice Day in the USA.

USA and Aus­tralian Debt to GDP Ratios

Right from day one of the post-WWII peri­od, the US finan­cial sys­tem grew debt faster than than the USA econ­o­my grew its GDP. As a result, the ratio of debt to GDP rose from a man­age­able 45% of GDP in 1945, to 290% now (with­out fac­tor­ing in the impact of deriv­a­tives, etc., which will sure­ly require dras­tic upward revi­sions of the record­ed lev­el of debt). In Aus­tralia, we prac­ticed 20 years of pru­dent finance–from 1945 till 1964, all under a Lib­er­al Government–before the days of prof­li­gate finance began–also under the same Lib­er­al gov­ern­ment.

Finan­cial dereg­u­la­tion sim­ply assist­ed the finance sec­tor’s own innate ten­den­cy to pump out as much debt as it would man­age, and each “res­cue” of the finan­cial sys­tem by reg­u­la­tors like the Fed in the USA and the RBA in Aus­tralia sim­ply encour­aged the cen­tre of finan­cial spec­u­la­tion to move from one asset class to anoth­er. The Sub­prime Scam was sim­ply the last gasp of the sys­tem, which was pushed so far by the naive belief that con­ven­tion­al (“neo­clas­si­cal”) econ­o­mists have in free mar­kets for every­thing that they stood by while the finance sec­tor pre­tend­ed to make mon­ey by lend­ing mon­ey to peo­ple with a his­to­ry of not hon­our­ing their debts.

Even though the Sub­prime Scam was extreme, it was sim­ply the cur­rent sys­tem pushed to its extremes: it was not an aber­ra­tion due to lax reg­u­la­tion, but the final gasp of a sys­tem that was always pump­ing out too much debt, and had already many times overex­tend­ed itself into what should have caused a cor­rec­tive cri­sis.

Now we are being held in a per­ma­nent finan­cial cri­sis by gov­ern­ments attempt­ing to revive the sys­tem while con­tin­u­ing to hon­our debts that should nev­er have been issued in the first place.

The one aspect of Howard’s defence of his eco­nom­ic agen­da that is plau­si­ble is his argu­ment that Rudd “cher­ry-picked” his­to­ry to describe every­thing the Lib­er­al Par­ty did as neolib­er­al, while por­tray­ing the Labor Par­ty (ALP) as non-neolib­er­al. In real­i­ty, both par­ties sup­port­ed a neolib­er­al agenda–the Lib­er­als mere­ly went fur­ther in fol­low­ing that “log­ic” to its inevitable denoue­ment.:

How­ev­er, it is not plau­si­ble for the Rudd Gov­ern­ment to argue on the one hand that Aus­tralia has entered the finan­cial cri­sis in bet­ter shape than just about any oth­er nation, and yet declare my gov­ern­ment guilty of the extreme neo-lib­er­al­ism which has alleged­ly brought about the cri­sis. The strength of the Aus­tralian bank­ing sys­tem is a direct result of a sen­si­ble bal­ance between mar­ket forces and pru­den­tial reg­u­la­tion adopt­ed by my gov­ern­ment not long after it came to office…

The con­struct of Rud­d’s essay in The Month­ly is clear. The wicked neo-lib­er­al gov­ern­ments of Mar­garet Thatch­er, Ronald Rea­gan and John Howard pur­sued poli­cies of total dereg­u­la­tion that let the mar­ket rip, yet the more benign social demo­c­ra­t­ic admin­is­tra­tions such as the Hawke gov­ern­ment, the British Labour gov­ern­ments of Tony Blair and Gor­don Brown and the Amer­i­can Democ­rats under Bill Clin­ton fol­lowed a dif­fer­ent path and got the bal­ance right. It now falls, accord­ing to Rudd, to the social democ­rats to unite to save cap­i­tal­ism.

I expect that the belief that the Aus­tralian bank­ing sys­tem is immune from the prob­lems that have beset the rest of the world will be sore­ly test­ed in the next year or two, as the macro­eco­nom­ic cri­sis caused by finan­cial dereg­u­la­tion strikes at the heart of Aus­tralian home­own­er­ship. The lev­el of house­hold debt in Aus­tralia is as high as in Amer­i­ca (when mea­sured in terms of each coun­try’s GDP), and though all the focus has been on the USA’s irre­spon­si­ble lend­ing to the Sub­primes, in fact house­hold debt in Aus­tralia grew three times as fast as it did in Amer­i­ca in the last twen­ty years.

The Aus­tralian finan­cial sys­tem is thus depen­dent on all Aus­tralian mort­gage hold­ers being able to ser­vice their debts, when the only source most of them now have to do that is their jobs. As jobs go as the cri­sis deep­ens, the sol­ven­cy of the Aus­tralian finan­cial sys­tem will be sore­ly test­ed.

No-one will then claim that finan­cial dereg­u­la­tion was a “great reform”.