It’s over – but all is changed, utterly changed

For everyone from the man in the street to politicians, financiers and economists, the world will never be the same again

Anatole Kaletsky

Tuesday’s reappointment of Ben Bernanke as Chairman of the US Federal Reserve Board — accompanied by new highs for global stock markets and news of rising house prices and improving consumer and business confidence on both sides of the Atlantic — was a fitting symbol for the end of the financial crisis.

Whatever happens in the next few months — and some serious risks still lie ahead — it is now clear that a rerun of the 1930s Great Depression has been avoided. The Great Recession, which was predicted by many economists and pundits to be far deeper and more intractable than any previous postwar downturn, may go down in history as the Great Exaggeration.

Having said this, it would be foolish to assume that the world after the crisis will be the same as it was before.

The economic and political lessons to be drawn from the events of the past year will be enough to fill many books — and the world might do well to consider these at leisure, rather than jumping to instant conclusions in the heat of the crisis.

But as the end of recession approaches, it does seem worth highlighting some of the clearest implications for politicians, central bankers, economists, financiers and ordinary voters.

Starting with the man and woman in the street, “end of recession” stories in newspapers and economic statistics will offer little comfort to the jobless or to those struggling to make ends meet. Past experience suggests that unemployment will continue to rise for at least a year after GDP has resumed growing. Wage increases tend to lag even farther behind. Moreover, taxes and interest rates are certain to rise as the recovery gets established, not just in Britain but in all developed countries.

The only consolation is that any rise in interest rates in the years ahead should be much less steep than in previous cycles. The reason for this is that central bankers and politicians will be united in a desire to keep the economy growing as strongly as possible while government borrowing is reduced.

If taxes are to be raised and public spending slashed in the years ahead, interest rates will have to be kept very low to sustain expansion. This is why I believe that Britain, the US and Europe will not see base rates rise above 2 per cent until 2012 at the earliest — and maybe not until the second half of the next decade.

Turning to politics, it is almost certainly too late for Gordon Brown to expect any electoral boost from the improving economy. Unemployment and living standards will continue to deteriorate until the last possible date for the general election, even if growth resumes now. Many voters will, therefore, continue to believe that the economy is terrible even after the statistical recession is over — and government apologists who try to paint a rosier picture will earn only their distrust.

To make matters worse for Labour, the timing of this economic cycle should be very favourable to the Opposition. If the recovery continues on schedule, unemployment should start falling within months of the election. This will create good conditions for the Tories to increase their majority in the following election.

In other countries, by contrast, the timing of the economic cycle is good news for incumbent governments. Barack Obama, Nicolas Sarkozy and Silvio Berlusconi should all be able to present themselves as saviours when they next face the voters. The same will be true of Angel Merkel and the new leadership of Japan’s Democratic Party, assuming that they win their elections, as expected.

The ironic result of all these electoral contests is that the crisis of capitalism is likely to strengthen broadly pro-market parties all over the world and crush anti-capitalist forces. Even the swing to the left in US politics, which ought to be strengthened by the timing of the economic cycle unless President Obama badly misplays his hand, should reinforce the international capitalist consensus.

After all, the US under Obama is merely moving from the extreme right to the mainstream of economic thinking in the rest of the world.

What, finally, might happen to mainstream economic thinking as the crisis fades? One sure prediction is that economists will have to rebuild their subject from the ground up. Almost all the advances of the past 30 years in macroeconomic and financial theory have turned out to be blind alleys.

If economists want their subject to be taken seriously as an academic discipline they will have to acknowledge this empirical refutation and abandon the theories of rational expectations and efficient markets, rather than trying to fix these theories by tinkering at the edges.

If it happens, this seemingly abstruse transformation in the nature of academic economics could have important implications for everyday finance, business and even politics. For the theories of efficient markets and rational expectations have served as the ideological underpinnings for the rigorous, fundamentalist brand of capitalism that has dominated global thinking since Margaret Thatcher and Ronald Reagan swept to power.

Suppose that Thatcher-Reagan’s slogans such as “the market is always right” or “you can’t buck the market” are now replaced with an acknowledgement that markets sometimes make catastrophic mistakes, even when they are as perfect as they possibly can be from the standpoint of theoretical economics. Once this intrinsic fallibility of markets is acknowledged, serious debate can begin about all sorts of issues removed in the past 30 years from the political sphere.

These range from bankers’ bonuses and minimum wage rates to the objectives of monetary policy, the financing of healthcare or the subsidising of uneconomic alternative energy sources.

Exposing to political debate all sorts of issues that were supposedly settled by market judgments need not mean that governments will take over or that capitalism will be replaced by socialism. On that score, the worldwide swing to the right in politics is reassuring.

It does mean, however, that capitalism is likely to evolve in the coming decades into something rather different from market-fundamentalist brand of capitalism that has dominated the world for the past 30 years. (Anatole Kaletsky, The Times)


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