Keynes and the Crisis of Capitalism

everybody I marry Caldor and I'm director co-director of the Center for the study of global governance and I'm really happy to be chairing today this Ralph Miliband lecture which is going to be given by Robert Skidelsky Robert Skidelsky is one of my oldest friends he taught me his political politics at Oxford and he's also as all of you know the biographer of Keynes he's written a magnificent three-volume biography of Keynes and it's very exciting that he's just brought out this new book which I meant to hold and wave to you all but I left it on the table haha oh thank you ah which is about the relevance of Keynes for today so that's great so Robert [Applause] it's a great honor to be giving the Miliband lecture I was a great admirer of Ralph and I don't think I'm revealing any secrets when I said when he applied for a professorship at Warwick University at which I then was I was on the selection committee and I made what I thought was an extremely eloquent statement of the case for appointing him I really excel myself and at the end of it he got one vote my own I hoped my advocacy of Cannes this evening will be more kindly received Keynes ended the general theory with these words the ideas of economists and political philosophers both when they are right and when they are wrong are more powerful than is commonly understood indeed the world is ruled by little else practical men who believe themselves to be quite exempt from intellectual influences are usually the slaves of some defunct economist madmen in authority who who hear voices in the air are distilling their frenzy from some academic scribbler of a few years back and he said I'm sure that the power of vested interest is vastly exaggerated compared to the general encroachment of ideas and then to drive home the point soon elated his ideas not vested interests which are dangerous for good or evil and ideas versus vested interests is really the subject of my talk this evening is it to the wrong ideas of The Economist's or to the vested interests of the power holders that we should turn to explain the present deep recession the first focuses attention on the intellectual system of contemporary capitalism the second on its power structure in setting up a debate this way I'm conscious of perpetrating the fallacy of the excluded middle there's a third possibility more correct which relates the dominant ideas in any period to its structures of power in a non contradictory way but for the purposes of this this lecture Miliband lecture shall treat them as alternative explanations of what has gone wrong in shorthand Keynes versus Marx this is apt because Keynes thought he had refuted Marx well the book I've just written Keynes the return of the master concentrates on the ideas which got us into into our present mess and particularly the ideas of the economists as I wrote to understand the crisis we need to get beyond the blame game for at the root of the crisis was not failures of character or competence but a failure of ideas I have behind that the authority of Alan Greenspan famed master of the universe in his days as chairman of the Fed who confessed that the banking collapse of last autumn had left his intellectual edifice those are his words in ruin I call this edifice Chicago economics for shorthand though this is not entirely fair to Greenspan who had a strong dose of Schumpeter in his intellectual makeup but I think Chicago economics is a reasonable short description of the dominant economics of the last three decades taught in universities and business schools and knocked into the heads of bankers and asset managers its main idea is that gut markets don't get things wrong and governments usually do markets are efficient shares are always correctly priced in the name of these doctrines financial and other markets were extensively deregulated governments pushed aside capital left free to roam the world in search of the highest returns the era of boom and bust is over declared no less than Gordon Brown he doesn't use that language today neither does he use the language of prudence which was his code word his his favorite word for all the time he was Chancellor the Exchequer as Paul Krugman says this Chicago economics was a romanticized sanitized version of economic life which led economists and policymakers to know all the things that could go wrong economics went astray because I quote Krugman economists as a group mistook beauty clad in impressive-looking mathematics for truth now it's obvious I think to any historian of ideas that these Chicago doctrines were an updated super mathematician of the ideas Keynes had challenged seventy years earlier politicians regulators bankers money managers financial journalists became slaves not to defunct economists but to a cluster of Nobel prize-winning economists who held chairs in the vicinity of Chicago University the practical man was simply following the latest fashion in economic ideas things were speeded up since Keynes's day nowadays you don't have to be defunct to be fashionable you just need to be regressive provided you can dress up your aggressive outlook in maths Keynes said four things which he thought were obvious he said these were obvious ideas in in the in the general theory first we don't know nearly as much about the future as we think we do and therefore financial markets can crash Alan Greenspan admitted the truth of this when he said that the crisis was caused by the I quote under pricing of risk worldwide that could not have happened at financial markets beneficent second Keynes said that when markets suffer big shocks they don't self-correct quickly but start shrinking like a leaky balloon as people stop spending we have just experienced such a shrinking in the last year the American economy has shrunk by 7% Americans are eight hundred billion dollars poorer than they were a year ago when America sneezes this is still true today the world catches a cold and the world economy has deflated more or less in line with America's Britain's by five point five percent third Keynes said that to make up for the decline of private spending governments should inject extra spending into the economy Keynes is the original inventor of the stimulus this is in striking contrast to what happened between 1929 and 1932 then governments didn't believe that contracting economies might need stimulating they did what they normally did balance their budgets and kept money tight hoping that this would restore confidence as a result the American and the world economy experienced twelve successive quarters of contraction this time governments did the opposite they did stimulate and the contraction has been limited to four months with green shoots of recovery as everyone tells us sprouting out all over the place finally Keynes said the market system needed central management if it was to work for everyone's benefit there's one very important passage in the general theory which opens its last chapter and in it Keynes wrote this the outstanding faults of the economic society in which we live are its failure to provide for full employment and it's arbitrary and inequitable distribution of wealth and income the bearing of the foregoing theory that's the theory of the general theory on the first of these is obvious but there are also in respects in which it is relevant to the second the general theory in other words sets out to explain the fact of persisting mass unemployment it's subject matter was not the arbitrary and inequitable distribution of wealth and income z' which we associate with the marxist and more generally the socialist critique of capitalism in policy terms keynes wanted governments to make sure that there was always enough aggregate demand private and public in the economy to maintain full employment but he also thought it would be much easier to do this if wealth and income swirlie distributed and i come to that later on let me elaborate on these four points emphasizing their relevance to what is happening at the moment the first concerns the volatility of investment markets the whole of our investment machine works on the theory that we can accurately price risk it is if this were so then of course banks and companies would never go bust keynes made a crucial distinction between risk and uncertainty we can accurately can accurately price some risk we know we can for example the game of roulette is not subject to uncertainty we know the odds similarly with the chance of drawing a whit willing lottery number we can accurately estimate the prospective returns on many kinds of investments over a specified period of time but over a much larger class of investments we simply don't know what the yield will be nevertheless he writes the necessity for action and decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we would if we had behind us a good Benthamite calculation of a series of prospective advantages and disadvantages each x it's appropriate probability waiting to be summed the fact of our ignorance forces us to fall back on certain conventions of which the most important are that the present will continue into the future that existing share prices correctly sum up future prospects and that if most people believe something they must be right such conventions don't necessarily conform to any fundamentals that economists and business analysts love talking about they're not external objective truth but mental inventions of buyers and sellers and Keynes particularly emphasize the state of confidence a kind of socialized belief about what prices should be which would be irrelevant the state of comfort can't confidence if we had correct probabilities conventional expectations he said a compatible with a considerable stability in our affairs as long as the convention holds but they are liable to sudden overturn when some bit of bad news comes precisely because there is no firm basis of conviction to hold them steady then and I'm quoting now the practice of certainty and security suddenly breaks down new fears and hopes were without warning take charge of human conduct all these pretty polite techniques of the boardroom collapse and this is exactly what happened last autumn It was as if you're going upstairs in the dark and tread on a top step which isn't there now the banking collapse of last autumns and it opened an interesting debate between those economists the vast majority who believe that people's behavior is rational and those who believe that it's irrational those who believe in irrational behavior argue like this if people irrational crashes can't happen as they as crashes do happen they must be irrational at least some of the time this seems to be the chief premise of behavioral economics however this sharp opposition between rational and irrational behavior is only plausible if one accepts a strong version of the rational expectations hypothesis for Chicago econ economists the rational individual is someone who behaves in accordance with a mathematical model of individual decision making the child the chikage economists agreed to call rational and the most efficient application of that chicago model is the efficient market theory believers in efficient markets held that market participants have all the information needed to make sound pricing decisions that they process this information efficiently and they and trade establishes contingent equilibria between the opposing forces of supply and demand at each moment in time market participants do not make mistakes on the average so that current asset prices correctly sum up future prospects in other words what Keynes called a convention to disguise from us the fact that we don't know what the future will hold is treated by these models as true statements concerning the path of share values over time a model of this kind finds it very hard to account for large sudden swings in share prices so rational expectation hypothesis economists say that this must be due either to surprises or confusion or to irrational behavior the assumption that even if the whole world is ignorant of the correct prices these correct prices exist somewhere out there reminds me of nothing so much as the famous parody of Bishop Barclays idealist theory of knowledge you probably some of you at least will have heard of it there was a young man who said God must find it exceedingly odd if he thinks that this tree continues to be when there's no one around in the quad - which God replies dear sir your astonishment Saad I'm always around in the quad and therefore this tree will continue to be since observed by yours faithfully God and jettison the premise of perfect or complete information and the domain of rationality is liberated from its neoclassical chains my dictionary defines rational as reasonable using reasonable logic to think out a problem Keynes asks what expectations is it reasonable for people to hold in face of uncertainty he argues that in most cases it will be conventional expectations even heard behavior that epitome of irrational exuberance is reasonable if there's nothing more solid to hold on to so he didn't abandon the rationality postulate he simply asked how it would work if the future were unknown and I believe that behavioral economics despite its neurological insights it is not the key to any new economics that we need to develop in the light of what's happened in the last two years now consider that favorite of elementary economics textbooks and I'm quoting from one of the most popular ones when economies suffer a shock wages and prices rapidly adjust so there is continuous or almost continuous full employment yes yet we know they don't adjust that quickly an economists have invented all fans a lot of fancy theories to explain what they call sticky prices but it's Keynes's explanation that shines through most clearly prices are sticky he says because following a shock no one knows what the new correct price is things have to settle down a bit before the new pattern of wages and prices discloses itself and that leaves enough time for output to fall and heavy unemployment to develop now I think in this interpretation of the sticky price phenomenon was first put forward by axel lane who food in the 1960s I don't know whether anyone even knows about him today but he was a a towering figure in the in the economics of the you know about in the 1960s and 70s and I think his interpretation is superior to those theories of imperfect information developed by later New Keynesian economists like a cloth and Stiglitz according to learn who food the emergence of unemployed resources is a predictable consequence of a decline in nominal demand when traders don't have perfect information on what the new clearing market-clearing prices will be in line with the Swedish school linhu food emphasizes the fact that economic processes take place in time and therefore following a disturbance the economy is in a temporary state of disequilibrium output and prices both adjust but prices are just slower than output because there's no what he called Val raised in auctioneer available to establish a vector of market clearing prices before the trading starts no other assumption he says is needed to get from classical economics to Keynes to Keynes and I agree with that again even here uncertainty is the key to the successful analysis of sticky prices now what about the Third Point the need for offsetting government action when an economy starts sliding virtually everyone now accepts that shocked economies need some kind of stimulating to come back to life to resume normal life even Robert Lucas the high priest of Chicago economics concedes that we're all Keynesian in the foxhole whether because of uncertainty confusion imperfect information or whatever unemployment develop which may persist for a long time and so there is a case for some government action now Keynes gave an elaborate explanation of what he called underemployment equilibrium and how it gets established and we can apply quite easily to the present situation and this is very elementary to people who are doing economics but I think it's worth just mentioning because it's it's one of his neatest pieces of apparatus we start from full employment but with a large number of people highly indebted and that's really the case today this doesn't matter as long as there's a next step up the staircase but suddenly the next step is no longer there and a lot of people find themselves living beyond their means just as Gordon Brown did the only remedy they have available is to reduce their spending to economize and to save and and and in the last 12 months the British economy has contracted by about five point five percent or about seventy billion pounds that means that people's incomes are shrunk on average by seventy billion and that means seventy billion pounds less is being spent compared to last year now what happens if households and firms all try to increase they're saving at the same time well then total spending in the economy will fall even more since everyone's spending is someone else's income there will be even less demand for goods and services and therefore for labour in other words our attempts to get back into balance by saving more will have made us all poorer and in fact reduce the amount of saving as well since we'll have smaller incomes out of which to save so the economy will go on shrinking till the excess saving is eliminated by the growing poverty of the community the essence of this insight which i think is a very powerful one is captured in the phrase the fallacy of composition the fallacy consists in the belief that what is true of all the parts individually is true of the whole and Keynes's most famous and application of this was the paradox of thrift more saving is good when the economy is overheating because it's a way of removing excess demand but when the economy is sliding down private virtue becomes public vice and the correct response when an economy is going downhill is not to save more but to spend more that in a nutshell is the is the is the theory of the stimulus now conservative economists have had to reconcile their acceptance of the need for stimulus in the foxhole with their dislike of any government activism it's a difficult difficult balancing act their solution is to draw on Milton Friedman's explanation of the Great Depression of 1929 to 1932 following Friedman's lead they explained the current meltdown in terms of the collapse of the money supply they don't quite explain why this but obviously mistakes in policy are always at the root of any conservative explanation of why markets go wrong because by definition markers can't be wrong unless there are mistakes in policy so the collapse of the money supplies due to some mistake in policy and and and then and so they then argue that a sufficient condition for the restoration of the full of full employment is a reversal of the collapse in the money supply hence the only stimulus measure conservative economists approval and dispose for conservative politicians with a capital C is quantitative easing or more familiarly printing money a strange conclusion for conservative economists only explicable because their hatred of governments outweighs their hatred of inflation in December last year Robert Lucas again I think he's an excellent source for many of these arguments says I'm not inventing them wrote a piece in The Wall Street Journal entitled Ben Bernanke is the best stimulus right right now where he argued that the Fed's monetary policy had been the most helpful counter Osetra session action taken to date in my opinion and it will continue to have many advantages it's fast and flexible there's no other way that so much cash could have been put into the system as this six hundred billion dollars was and if necessary can be taken out just as quickly the cash comes in the form of loans and this is the point it entails no new government enterprises no government equity positions in private enterprises no price fixing or other controls on the operation of individual businesses and no government role in the allocation of capital across different virtues these seem to me different activities these seem to me important virtues now there's also a debate going on about this now and you know these are debates that this is why I don't think economics is really a science because these debates are interminable they went on at the beginning of the 19th century they went on during the time of the Great Depression and there reappeared in exactly the same form today now in a natural science this doesn't happen there are no Theory there no believers in theater theory of flood the flood is phlogiston phlogiston theory of energy or in Ptolemaic Ptolemaic astronomy any longer but this debate particularly debate about the quantity of money goes on and on and on and in its present form it's embodied the quantity monitor is monetarists theories embodied by represented by Tim Conda and I and I and I cite him because I've had a big argument with him about this in an in a rebuttal of Krugman's defense of fiscal expansion Condon says that in the real world non fiscal influences that is quantitative easing are much more important powerful than chain is in the budget balance and for all practical purposes fiscal policy is irrelevant in practical terms quantitative easing means that the central government just prints money it purchases government paper and corporate bonds from banks and other financial institutions the creation of this new money is supposed to speed the increase increase the overall money supply through deposit multiplication encouraging lending and reduction in the cost of borrowing and that stimulates new enterprise and so on indeed in an email exchange kangen assured me that if policymakers boosted real money by 10 percent in six months any economy will recover and he challenged me to give a single instance when that hadn't been true well we have an instance right now since March the Bank of England has embarked on us 175 billion asset purchase program it's actually put a hundred and forty two billion pounds into the economy extra extra cash and that has failed to translate to into increased lending or some extent the banks can be blamed for this cheap interest rates have been used to improve bank balance sheets since October last year profit margins measured as the spread between swap rates and the mortgage rates has more than tripled but this isn't the biggest problem on the 4th of September that is six months Condon's test after the launch of the quantitative easing programme stephen major head of global fixed income at HSBC was quoted in the Financial Times as saying the vast majority of the liquidity is stuck in the banks in the form of reserves but this is not about banks holding because they're afraid to lend it is more about a weak economy where households and corporates do not want to borrow this sentimental has been echoed by many others people are in no mood to bother the borough says John Wraith of RBC Capital Markets it's not just banks holding you can't lend if people don't want to borrow and all of this was recognized by Keynes in 1932 when he wrote it may still be the case that the lender with his confidence shattered by his experience will continue to ask for new enterprise rates of interest which the borrower cannot be expected to earn if this proves to be so there will be no means of escape from prolonged and perhaps interminable depression except by direct state intervention to promote and subsidize new new investment and the reason for this is that in a recession monetary policy alone can't get the long-term rate of interest sufficiently low to achieve full employment in the face of liquidity preference and this preference as the evidence shows exists both on the lender and the borrower side in other words quantitative easing provides the fuel but fuel alone cannot get the economic engine going confidence the ignition of any economic activity is being killed by uncertainty and that's why quantitative easing has not actually stopped the slide it may have had a it may have made some contribution and I'm not denying the need for quantitative easing but if you say well why has the slide slot stopped I believe there's a simple Keynes and explanation between February and September this year the monthly budget deficit went from 9 billion to 16 billion this is a month which represents an injection of 35 billion of extra spending in the economy and I think that has been an important part of the stimulus far from being totally insignificant irrelevant useless dangerous as the monetarists say it has been a material fact in stopping our slide down into the Great Depression and conservative Treasury spokesman like George Osborne who demand a cut in government spending now don't explain how this will help the economy to recover the fact is that our economy is on a life-support system and it would be madness to withdraw it until we have substantial evidence of renewed growth and that is whatever the cost of the drip to summarize this part of the argument you can see how uncertainty comes into Keynes in economics at various points first in explaining the instability of investment secondly the the uncertainty attaching and to the failure of wages and prices to adjust instantaneously and thirdly uncertainty about the future course of interest rates today these sources of uncertainty have been concealed by a veil of risk management strategies and an exaggerated belief in the markets ability to self-correct credit default swaps allow investors and money traders to insure against losses incurred as a result of bad decisions and rational expectations are assumed to lead to near-instantaneous adjustments of nominal variables however as our present predicament shows the greatest challenge to our economic system is not risk AIG and other insurers wouldn't would have kept afloat if risk had been the only problem its uncertainty the big question therefore is not how best to repackage uncertainty in the form of risk but how to design an economic system which takes uncertainty seriously well what are the future I would pick up two main elements in the Keynes in political economy looking at our permanent system the first basic Keynesianism maintain aggregate spend at a continuously high level hence you need to reestablish in some form or other a full employment commitment and secondly well as part of that full employment is to be maintained by fiscal and not monetary policy the Keynesian recipe was to raise taxes in a boom and lower them in a downturn he didn't believe in using interest rates for cycle control precisely because he thought it would be difficult to get long-term rates down once they'd become too high for change conditions am I simply an unqualified admirer of gains the answer is not entirely there's no doubt that Keynes and policy as applied in Great Britain in the 1950s and 1960s relied excessively on fine-tuning and I don't think we should follow that route today secondly I think it was missing an absolutely crucial piece of you might say economic theory and that is the theory of the natural rate of unemployment that was the essential contribution of Milton Friedman who always described himself actually as a Keynesian though it's often forgotten but that if that had been there I don't think governments in the 1960s would have tried to maintain an over full rate of employment by using trying to use prices and incomes policies which couldn't work and discredited Keynesian demand management in the 1970s in a way I'll explain later now the second element I think in the Keynes in political economy Keynes thought that full employment would be much easier to maintain if wealth and income were more equally distributed both domestically and internationally too much wealth piled up in too few hands makes economies unstable and for that reason Keynes would have favored more equal distribution of purchasing power than we now have and for much the same reason he would have favored a more equal distribution of international reserves something he tried but failed to achieve in his clearing clearing Union plan of 1941 and I'll be happy to answer questions on that but it's too big a subject to go into at the moment now let me having talked about the ideas ideas wrong ideas as the explanation for the current mess let me now turn to vested interests in an essay I wrote on Carl Marx in 2000 I said that Marxist labor theory of value was dead that his theory of the class struggle may have had some validity in the past but was dead also but that did but that in the event of large-scale economic crises the discourse will change again and that time has come keynes believed at the power of ideas his own ideas would kill marks permanently but he never considered the possibility that his own ideas might be at the mercy of changes in the power structures of Western society if one word if one were to attempt however briefly a structural analysis of the present crisis of capitalism one might start with the balance of forces that existed to make possible Keynes his own revolution as described by John Kenneth Galbraith the post-war economies of the West and he had chiefly the American economy in mind but but but Tony Crossland applied it to the British economy as society as well the the post-war economies of the West had three countervailing powers capital labor and government now today just one of them capital remains the single prevailing power and this brings one close to the conditions of the Industrial Revolution which were which were brilliantly analyzed by Marx Marx failed to see the unavoidable consequences of economic and technological revolution which were going on before his eyes these consequences as summarized by one economic historian were the change of social stratification with the shift of political part of the middle classes and the rise of strong labor unions capable of making their growing aspirations felt under a system of widening franchise this not only democratized the spirit of modern government but created the new administrative key position for a progressive control of economic by political forces in other words Marx missed the growth of a social balance between business labor and government and this balance dominated the political economy of the 1950s through to the mid 1970s but then it all changed in a penetrating analysis a Washington economist argues before 1980 economic policy was designed to achieve full employment and the economy was characterized by a system in which wages grew with productivity this configuration created a virtuous circle of growth rising wages meant robust aggregate demand which contributed to full employment full employment in turn provided an incentive to invest which increased productivity thereby supporting higher wages but after 1980 or thereabout a new economic paradigm established itself based on I quote asset price inflation equities and housing widening income inequality detachment of worker wages from productivity growth rising household and corporate leverage ratios measured respectively in debt income and debt equity ratios a strong dollar he's talking about the United States but this applies pari passu to Britain as well trade deficit disinflation or low inflation and manufacturing job losses workers were pressured on four sides by globalization by reduction in the size of government by the increase of labor market flexibility and the retreat from the full employment commitment well labor laws were weakened and membership of trade unions was sharply reduced now what accounts for this shift adding this is a very very difficult question to answer and there are there are a number of causes and I think the factors we should consider they're not exclusive and they're not to be considered in isolation from each other are as follows first the consolidation of big business and banking the degree of concentration has increased for example five banks control over 80 percent of UK lending we were told that we were creating competitive markets in all our deregulating policies in fact we created a global network of interlinked oligopolies second there's been a major political shift there was a major political shift towards the right and in the UK at any rate this was largely influenced by by hostility to over powerful trade unions the there was there was a person what undoubtedly happened in the 1970s was an increase in the monopoly power of organized labor which turned people against the unions even their own members in other words in the 1970s the trade unions threatened to become the prevailing power labour government programs in the early 1970s and I lived through that period envisaged a trade union state or trade union state a sort of a system of government to run the economy with only a minor role left for private business and Thatcherism was the political reaction to that so I think that was a political shift just because the Keynesian consensus which has sustained the batterer that the balance of the post-war economy had started to break down when the balance started to break down third factor globalization globalization was based on the export of manufacturing jobs where unions were strong and rebuilding the economy on the basis of service industry where they were weak globalization was the business response to the declining rate of profit which Marx predicted it was seen as the master key to overall improvement in the position of the business class globalization increased corporate profits reduce the prices of consumer goods and made possible a huge influx of outside money into the Western banking system but most important it was used as a bludgeon to frighten workers and to emasculate their economic and political power interestingly Marx supported free trade because he wrote free the free trade system is destructive it breaks up nationalities and pushes the antagonism of the proletariat and the bourgeoisie to the extreme point in a word free trade hastens the social revolution these warnings were ignored by the creators of the Washington Consensus then a fourth factor on the intellectual side the rehabilitation of the market and the denigration of the state the counter-revolution in economics starting with Friedman and adaptive expectations and ending with the new classical's and rational expectations all that rehabilitation of the market was a very important factor in the dismantling of the Keynesian system now the rehabilitation of the market didn't entirely depend on new classical bubbles also there was a revival of Schumpeterian models the idea that capitalism depended on creative destruction on heroic entrepreneurs too much stability destroyed capitalism's dynamic so we must in the words of Magna Desai who's been a professor of economics here and one of my oldest friends so we must ride the surf and learn to enjoy it because unless we do capitalism will stagnate and coupled with this was the justification of super profits as the reward for super enterprise then I think a fifth factor more institutional was the hegemony of right-wing think tanks and journalists who simplified and popularized the academic celebration of markets and revulsion against big government one consequence of all this it was that the welfare state as the basis of the social contract was dismantled and replaced by access to credit to quote one American analyst maintaining growth of spending on consumption requires continued excessive borrowing and continued reduction in the savings rate continued excessive borrowing requires ever-increasing asset prices and debt income ratios hence the systematic need for bubbles which eventually burst which eventually burst meanwhile when the savings rate hits zero little further reduction is possible consequently both drivers of demand eventually exhaust themselves so both at the top and at the bottom of this system in which a median income had become increasingly sort of spread you had you had speculation and over leveraging and the policy and the triumph of corporate globalisation accelerated the process and transformed it into financial crash so where do we go at this point it's probably impossible as well as desirable undesirable to restore trade unions as a countervailing power in the anglo-american type of economies dominated by a service sector and high-tech manufacturer though I think they do there's much more of a balance type of economy a much more of a balance type of economy of this kind survives on the continent of Europe especially in Germany but it's gone from the anglo-american model and I don't know I didn't see how you can restore it in our type of economy the liberal solution of breaking up concentrations of big business trust-busting as the Americans used to call it is probably unavailable in the increasingly integrated global market though I would go if it were at all possible for a restoration of the glass-steagall approach to banking I believe that would be one way of trying to break up the corporate banking system and and separate out different functions of banking but no one is prepared to do that at the moment and and so what they're really talking about is something milder which is some forms of financial regulation which aim to secure financial stability via either increasing capital and reserve ratios or using them counter-cyclical II so that in bad time and good times banks would be required to hold higher ratios and in bad times they would be allowed to hold reuleaux ratios I mean I think that's so helpful but I think it doesn't quite get to the heart of the matter because I think banks will actually be able to cheat on those and I think that they're cleverer than the regulators what is capital can anyone define capital here say if we talk about them that the banks must increase their capital capital ratios capital our ratios to that to the deposits they can always somehow say well this is capital you know so I think I think the regulator's will lose on that one in the end now another another argument is national states can't control global capital and therefore there's nothing we can do because the world state is unavailable and probably undesirable as well but a single world model of globalization is not the only one it's far more plausible to think of global integration developing via regional integration and that offers a more feasible route to reinserting democratic oversight of the economy and I think the European Union is a very positive development it hasn't got there's no strong state there but this is a this seems to me to be one way in which through the development of powerful regional bodies that we can try to control global capital but I'm not saying that we're we're we're there and and to get a system that doesn't crash every few years with increasingly serious social consequences does require enormous effort of thought keynes repeatedly said that he had not come to destroy the market system his aim was to make the world safe for markets and mark it's safe for the world well thank you Robert that was a really brilliant tour Dora's on and I hope we all know what cane stood for now we have half an hour I think for questions so who would like to ask a question okay down here at the front I'll do not shy go up to the which do you prefer I'll do it here yeah it works okay um you were talking about the models that they use in the efficient law you must switch it on and by the way everybody just say who you are because it's quite interesting I'm David and I'm a student currently but I just like to know you were talking about the efficient market hypothesis how do you think we can change that so that we can predict how people act and put that into a model because we need something to go buy a dog breed okay no not necessarily we can predict a lot of easy economic behavior but I think in certain in certain do I have to switch this up or is it already on in certain crucial areas particularly affecting long term investment we don't have we don't have a prediction these were these predictive tools available because there's genuine uncertainty and I don't think we can develop models which which deal with with with them which translate or uncertainty into risk and therefore we have to do without it now what what are the consequences of having an economics in which uncertainty is taken seriously that I think is is one was is one very important question one thing that'll I think comfort all or encourage all people who feel slightly challenged in maths is that as I do is that it will it will really encourage an economics which places less reliance on maths and places more reliance on other other ways of standing human behavior and and and I have at the end of my book I've got a rather brief sketch for how one could reform the teaching of economics and I think people are into have become rather interested in this just because they think economics is useless for a most most many many crucial problems in the real world it's fine for pricing a transport system or something like that but I mean in in the fallacy of composition is is is a very important insight that Keynes had that the parts don't add up to the whole you can't get the whole just from analyzing the part and so you've got to think about the distinction between microeconomics and macroeconomics very seriously and not assume that you can get your macroeconomic outcomes just through the the study of the assumptions that govern microeconomics rational rational individual maximization now I think but it's not I'm not saying I've got an answer to your question all I'm saying is that the quest for an entirely predictable economic predictable economics is is a false one economics is not a natural science it's not physics using different words I'm looking at the back I've seen you where I sound better at the back so you're next thank you my name is John Young now my question is just how do we try to cut the current deficit without running the risk that is of deepening the deepening of recession I remember your story of Roosevelt why didn't it which was that you told I don't ride I have no memory left the story is that canes that Roosevelt and Roosevelt said I'm very impressed by everything I've read all your work but I just can't cut this damn deficit yeah how do I cut the deficit yeah yeah no the answer is you don't cut the deficit now you you allow it to expand to whatever to whatever level is necessary to make sure that we don't slide any further at you see I think a lot of people don't understand this point that obviously and when you're when you're at full employment one set of one set of rules applies but when you're very well below full employment you've got to overturn some of these as the economy recovers and as though by magic a lot of the deficit will disappear because red the revenues will rise faster than GDP in the recovery phase and so a lot of the deficit will disappear and then then I mean if you then you have a also a medium term plan for five years of restoring the budget to balance but it's the task would be much much greater if in fact our economy was ten or fifteen percent below full employment level then it than five percent where we seem to have managed to cut off the slide and I think the conservatives I mean I know I don't think they're wrong about everything if I were a conservative I I would have if I were a conservative Treasury spokesman I would have concentrated my attack on I'm afraid on on Gordon's fiscal record before he became prime minister as Chancellor of Exchequer I think it was quite contract Keynes to enter a recession with a budget deficit as as big as as as we had and I think that has created confidence issues about the deficit which would otherwise not have been there it was Keynes who said that ass terror that the boom is a time for austerity at the Treasury he wanted budget surpluses to be run during a boom which would then be available for spending in a recession and we didn't do that and as a result our fiscal position would be worse than it would have been but the basic point is true if you start cutting spending now you're going to deepen the recession and therefore you shouldn't do it you should allow spending to increase I think we probably need a further stimulus but I don't know what what all the figures are yeah well I think at least the Labour government says it's not going to cut now which the Conservatives have wanted to do and I think if the Conservatives were in power and they wouldn't cut either and they couldn't afford to take the political risk of cutting but they're not and therefore their policies thankfully won't be implemented or they're Avadh policies for several months at least now I'm going to next take a person right up on my theory of being equitable between above and below and then I come to the below Neil subber well the Labour Party shouldn't have said that what do you see as the next bubble um I don't I don't um I don't have any any basis for accurate prediction you know having having said that no one does it would be rather rather arrogant for me to claim that I do we don't know what we can be sure about is unless they fix the system in quite a radical way we will just go from one crisis to another I think I think what will what's likely to happen is the recovery is going to be quite weak and the term there'll be another dip or two and it'll it'll it'll be in the financial system itself but I don't know exactly which bits of it and I can't say you know when it when it when it would happen I think I think one of the one of the misconceptions there was a faded there's been quite a lot of discussion apparently the Queen to asked an economist at some reception why didn't you see it was it Elysee she when was she here she was hearing in now what was the date because I broke my arm and couldn't yeah are you missed you missed her question yeah she said why didn't any economists predict this and and and it was it was a good Reve Airy reasonable question in in for someone who had studied new classical economics which presumably she hadn't but it was a reasonably but but the real answer is it was unpredictable in terms of timing it was one of those it was one of those you could call it a Talib Black Swan it was a sort of it wasn't in the models that were being used at the time and and even Keynes couldn't have predicted it exactly what he could have said this system is sufficiently unsound for something like this to be always possible and then when it happened it wouldn't have surprised him so the answer is I can't predict what the next water when the next crash will come but I think unless we unless we really take take this one seriously and take the reform the system seriously it will happen again okay now I'm now getting lots of glue so I think this time I'm going to bunch them in three and on my principle also not only of equitable distribution but gender distribution I'm going to take the lady up there because we haven't had any and then you and then you and then I'll come on to the next round mmm hi I'm Anna and its banking socially useless so we're like sorry what we didn't hear it um is banking socially useless wait a minute I'm gonna have the other questions so write that one down yeah if as you just said and the nie SR has predicted that we'll have a can protracted recovery isn't it's the reason that both parties obviously the Conservatives principally are very worried about the deficit because the growth is not going to deal with it and basically this could result in a crisis of confidence particularly in terms of those actually lending to government and the government's difficulty the government's different government's difficulty in borrowing and therefore obviously an increase in interest rates isn't that the reason why there's so much concern in Whitehall and in the Treasury about about the deficit my name is Bernard Casey and I'm actually from the University of Warwick as well if it is a case that uncertainty exists alongside risk and we cannot repackage uncertainty into risk somebody has to manage that uncertainty who is going to manage that uncertainty and whose ideas are going to drive them it's in a three is in cluster three is cranking socially useless no it isn't it's very important because it's the conduit by which savings are transferred into investment and investment is what drives the economy what a dare Turner said was that a lot of the financial services or the the extent of the financial services has ceased to be socially useful useful it should be they should be smaller and I think also I think I was I think I agree completely with Gordon Brown when he said that finance should be the servant and not the master of industry a phrase you can find in page 142 of my book but anyway it's always nice to to to have one's thoughts picked up in that way and that's it anyone might have really said that but I think that's that's the important point finance has to serve the economy it mustn't be master of it and that means it shouldn't be as as as large point one in relation to the whole and also rewards shouldn't be as large I mean these I mean these huge rewards which which people in the financial services have been getting our premise time on the fact that they're adding that amount of value to the economy now if that's not the case and I don't think it is the case then I think they should be controlled and there were many ways of doing it which aren't excessively penal or particularly penal at all so the answer is yes I think I think I think City of London plays too large a part in the British economy it also it also has this other effect that it concentrates a huge amount of political power in one place and that parr should be dispersed over the whole economy you know it smooth it it's the it's the idea of trying to get a balanced economy you just have one set of people who tell the government what to do essentially or what if they don't do they'll all leave the country and destroy and destroy Britain's only engine real engine of growth and I think that's very unhealthy because it does mean that the government is a servant of the bankers and that they simply exist in order to guarantee banking profits now III think we're we're uncomfortably enough close to that to make marks or rather rather rather perceptive analyst at the way the way capitalism works and I don't want to be there I didn't think it's necessary second week recovery well if the recovery is weak does that increase lacquer or reduce confidence in the financing of the government deficit I don't think there is any real evidence at the moment that the government is is is finding it difficult to place its paper I think this crisis of confidence in in the finances of the government is a long way along along the road I don't think it's there now and I think it's almost alarmist to believe that it is there I think people have quite you know have a considerable confidence in the in the stability of government finance now look I mean look at it in a comparative point of view a lot of people are worried about the debt but you know we the worst projections of the national debt suggest that we'll get up to 80 80 percent of GDP now we ended the second world war with a national debt of two hundred and fifty percent of GDP in 1953 when it was down to 150 and those were the start of you've never had it so good years and no I I honestly think I honestly think that's that's an Julie and Julie alarmist I we're not a Latin American as it used to be said Republic sorry I won can't say that today but because that America has much better finances than it did in the 19th century but the thing is we're not we're not heading in that direction and and I I don't I don't think I don't think we will who's going to manage uncertainty it's very good question at least we start by recognizing its existence and don't think that our only task is to manage risk because if you if you if you read what they're writing about they do never use the word uncertainty it's all risk systemic risk how can we manage systemic risk the trouble was our system of control wasn't sufficient to manage systemic risk systemic risk it's all risk and if you go on using the word risk you do you do attend to the belief that there is some super mathematical model that you can devise which can be applied macro economically and that will eliminate systemic risk well it's not the right approach let's I would prefer to say I don't mind about I don't want to eliminate risk i I think risky and you know people should should should take bets they should gamble and if their Gamble's fail they should go bankrupt but what you can't allow what you can't allow is is is is major banks to fail and especially banks that are whose whose deposits are guaranteed by the Treasury and therefore ultimately by the taxpayer they you got to limit them and once you recognize that a lot of what they were doing wasn't just risky but it was actually it was actually playing with uncertainty they didn't actually know what what the value of their loans was what the value of what the value of their insurance policies was they didn't know what was on their balance sheet now that shouldn't be allowed and you just got to stop it and so you can approach you can approach the management of uncertainty by simply stopping certain activities being done which would endanger the economy and which of their nature are uncertain and the rest you can you can sort of allow to happen I mean I don't I don't want to eliminate risk-taking I didn't want to eliminate people making fortunes and going bust but they mustn't be in institutions which can actually whose activities can bring the economy down they there be fringe activity okay I have here Chris Brown I'm a socially responsible property developer and what what do you think of option pricing models and if you think they're dead what do you think financial markets will do without them socially responsible property developers at I resign from the London School of Economics it may be a crisis of capitalism but since there is no longer any alternative to capitalism we still have capitalism after the crisis the question I'd like to ask is this seems to be the crisis of the US dollar as international currency what do you think is the future of the US dollar I think I know I've got to pick more people and I've got gosh I've got one two three four I think we can get everybody in I want to ask a question and so we'll do these three and then we'll take the remainder and my question is does it matter what the stimulus is on and who makes the stimulus in other words that actually relates to the previous question does it matter whether it's British spending or IMF spending or Chinese spending that's three do you say there was one more no we've had three and then that will have one last round when this three is over okay well um you mean doesn't matter what the stimulus is spent on yeah okay yeah I think it does I mean Keynes said well in in purely macroeconomic terms it doesn't you know he said if you think of nothing better to do just very very banknotes in and dig them up again or you spend it on useless things because still the point is that it that it gets expenditure going and therefore it lifts the economy even though even though the initial money is spent on useless things provided I mean you could have you could have I I think had you had you last Christmas had the Treasury had the brilliant idea of giving every every single person in in in Britain a 500 pound Christmas present which which would consist of a voucher with it with an expiry date on it which could only be spent on buying British goods that had answers one part of your question we wouldn't have been a recession today still that depends on one or two assumptions which a bit dicey but I mean you know it's it's it's it's it's a good thought experiment to think actually what what would have happened had hadn't had they done that so I think it matters enormous ly what you spend it on and and and and I think that I would say that it would be much better to spend one stimulus now on on a medium to long term investment program it provided it could be started reasonably quickly for example there's a there's a great big high speed trade link that is is is now approved they're running between London Edinburgh and I know Android owners has pressed that through the cabinet and it's a very very expensive program the trouble is you know it's it may not get going quickly enough to have any impact and that's always been the trouble with with investment programs which you have to devise when the recession's hit because they start start operating you know after the recession is over so it's quite a good idea to have a portfolio these investment programs which you can sort of actually for which all the approvals are already there which you can implement fairly quickly but we don't have that so but in principle of course you should you should to spend it on things that will add will add value social value to the economy and bring them and bring about a rate of return that's what the Chinese are doing now so that's a partial answer to your question the crisis of the US dollar and taking them in reverse order well this is this is very important it's very important indeed and I think that the global imbalances have been a major contributor efactor to the crisis because what what what some what what they did was was what what the in a way if you if you think of it in terms of a savings in that saving investment analysis there are a lot of savings being done in China and they somehow didn't actually produce American you know they American investment didn't grow to absorb those savings there was another kind of mechanism by which the Chinese government central bank bought US Treasury bills and those had the effect of an enabling Greenspan to run a very very low rate of interest in the United States because the US government could borrow from from the Chinese and therefore there wasn't a crowding out effect which otherwise would have led to a rise in interest rates so it was a mechanism for avoiding deflation in the United States but at the cost of unbalancing the American economy even further and it created asset bubbles in America rather than a steady growth of demand the Chinese have been pressing for some internationalization of the reserve function which would imply an end to the hegemonic role of the dollar as a reserve currency Japanese have been supporting them but we're not nearly there yet because I don't think you could have that rebalancing without some agreement on exchange rates and we're simply not not not there because what is the value of the what what is the relationship of the currencies that would prevent global imbalances from piling up either either great deficits or surpluses and we haven't begun to discuss that though I think there is a working party on it but the other thing is that the the imbalances have suited both sides and the Chinese have got export-led growth for an undervalued currency as well as in fact some protection against another financial crisis such as 1997 to nineteen a and the United States have had the immense privilege of being the policemen of the world and and and and it suits lots of countries that America should actually be losing lives defending freedom or whatever and rather than them and the Russians for example are delighted the Americans are in Afghanistan so you can see there's a corrupt bargain here say it has a geopolitical element as well as a straightforward economic element now the last point of a from from from question from a socially responsible property developer I'm sure you are well you see I mean option pricing could you just explain what you what you had in mind a bit well it seems to me that all of these these sort of option pricing models really depend on on the assumption that you can accurately price them I don't believe you can and in many many options you can't accurately price and and and and in fact in fact I mean when when I when I became director of an American mutual fund I got lots of options and I thought they were accurately priced in fact they're all underwater sorry maybe I maybe my mom is hurt okay so option prices option who did sit well they work some of the time because you see I think I think I think Keynes's point was for a lot of the time I mean these these constructions of pricing um he he called the mental mental constructions and as long as the convention supporting them hold then they were I don't think they tell you very much about what fundamental whether shares are their securities are at their fundamental value but if people believe that to be the case then I think that's that's compatible with a lot of stability in the financial markets they're not always all over the place what he's saying is that because they don't actually the pricing doesn't reflect fundamentals in fact we don't really know what the fundamentals are over over a over any length of time and perhaps not even ever they're liable to sudden overturn because there's no steady conviction to hold them and they have all kinds of techniques for pricing securities accurately but they all tend to break down and you suddenly Eliza's Alan Greenspan said that risk was underpriced worldwide how can that be if there were accurate option pricing models see I mean that's really what what what I'm now we've actually only got two minutes left and I have I forgotten how - oh there's okay yeah I know there's this one up there so let's could you be really quick I cannot can't take all of them because it's just impossible and the gentleman down there and the gentleman there but well I have three questions related to China can you make it one because we're running out short all of them so well the first one is can China help the Western financial system by using its a surplus and help to recover and what are the political implications of at a global level and can China become the rule of the system and dictate new role rules for a new game and is this deep I make I make it three questions already know this is the last one this rubbish press my heart as I this is the last one and is this the end of neoliberalism and can America and can America and what the last one promise and can the Federal Reserve finish - should stop printing money and well not create all these bubbles around the world thank you now we won't bubble but I think we've got enough loss Ladell see I've read your book and all except the last chapter many questions occurred to me but one occurred to me this evening as you were talking do you think that the inequality of incomes which is become so tremendous could in fact be alleviated if more power given to shareholders in corporations it does strike me that too much power is in the hands of pension fund operators who are part of the city and part of remuneration committees and therefore the heads of our corporations tend to determinate I think their own remuneration Annamalai which back would be a boy and a final question next to what degree do you think the repeal of the glass-steagall Act contributed to the severity of this crisis who asked that question sorry he did um what do I think it contributed to the severity of the Christ yes what the grid of severity did okay um I can be very short in answer to the China questions no no no they're not good enough Thomas come see me up doot-doot-doot but actually yeah well sorry the last one but I didn't hear the very last one is this the end of neoliberal era yeah I think it probably is in the form we've experienced it in the last 25 years could it inequality be alleviated by giving more part shareholders and not really I don't think I wouldn't I think the only way you can actually mitigate or reverse the the rise inequalities through the tax system very straightforward and I don't believe in really the race to the bottom that if we have a we have higher rates I think we can we can we can adjust the tax system in such a way as to help the poorest sections of the population without driving everyone who earns more than 50,000 pounds abroad you know I mean I think you can do it and I think that yeah I think there's too much alarmism about it anyway we've got to and we can't we can't go on with white continually widening widening inequality and with the stagnation of me of average incomes because that of course does put people on to over borrowing I mean it encourages indebtedness you see now the the what did what did the repeal of glass-steagall contribute it's one of it was one of the factors I mean I think what it did was it it it abolished the distinction between a retail and and an investment banking and made banks gamblers with their depositors money in a way that they haven't been before and and and and in fact the investment departments of banks and and and and the Andy and the rest of the banks we're now just integrated to each other and and and the point is that the the risky the risky I'm using the word risk because I can't think of a another adjective the uncertain all right be uncertain investments that the investment side of the banks were making were were really with money that was was actually guaranteed by the Treasury both in the UK and and in and in and the United States and and that shouldn't have been possible I don't mind investment banks making risky investor investments uncertain investments with with with investors who expect that to be the case but I do do mine when when when when rita when when when retail banks become you know casino like in there in there in there in the way they dispose of their depositors money and i didn't think and you know it one example of it is though is the way the housing marble developed and and banks were simply giving mortgages out on the ground that they they they they could securitize them and sell them or sell them on and and and and and that they were safe and they weren't safe so that wouldn't have been i think possible to nearly the same extent before the glass-steagall Act was repealed of course there was securitization going on before that but it was on a much smaller scale if you look at the data a once glass-steagall went securitization credit default swaps they just skyrocketed okay well I think we finally come to an end what I should tell you before you cap is that the books are on sale outside and if you bring them if you want one and if you want Robert to sign one you go and get it and you come back here and he'll sign it very favorable price [Applause]

Channel: LSE

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Keywords: LSE, London School of Economics, Public, Lecture, Event, Seminar, Professor, Lord Skidelsky, Robert Skidelsky

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Length: 88min 8sec (5288 seconds)

Published: Fri Dec 17 2010