Nowhere to Hide (Part 1 of 2)

Mr. Lim is a professor of economics the Ateneo de Manila University and a member of the management collective of Action for Economic Reforms. This piece was published in the November 29, 2010 edition of the BusinessWorld, pages S1/4 to S1/5.

The book Nowhere to Hide: The Great Financial Crisis and Challenges for Asia (Singapore: Institute of Southeast Asian Studies, 2010) by Michael Lim Mah-Hui and Lim Chin is a must- read not only for policymakers and practitioners and students of economics and finance but also for ordinary people who want to understand the worst global financial and economic crisis since the Great Depression.

Few of us were left unscathed by this global earthquake that shook the world from 2007 to 2009. But most people did not know what hit them, or at best had a confused or distorted view of what happened. How else can Americans – the biggest victims of this disaster – vote back to power the party that harbored most strongly the ideology of unregulated financial markets, protected the financial monsters from regulation and punishment and allowed them to wreak havoc at the height of the Bush administration? The biggest winners in the latest U.S. elections were the most rightwing members of the Republican Party comprising the Tea Party Movement. The Tea Party Movement espouses the exact opposite of what is needed to bring the American economy back to life and to prevent another similar financial disaster. It calls for small government that does not regulate, does minimal taxing (especially of the rich) and does not try to use fiscal pump-priming to ensure that the U.S. economy does not slide back to another recession. It espouses a government that does not provide safety nets and social protection to the most vulnerable and hard-hit families of the crisis.

But perhaps the most frustrating for an economist like me is that the economics profession, which should have known and understood most what had happened, continues to teach the wonders of the efficient market school. This school is identified by the authors as the ideology that justified unfettered mortgage lending and securitization of financial assets that made the whole world suffer. Many economists cannot distinguish between the fact that markets do play a major and positive role in the allocation of economic resources and the fact that markets – the product markets, the labor markets, and most especially the capital and financial markets – also require strong regulation and intervention. They view the two as incompatible.

Economic textbooks preach that price control and minimum wages distort markets and aggravate the situation. Students are thus given the impression that markets should be left alone. Yet every time a typhoon hits the country, most people agree or clamor that among the weapons against hoarding of food products should be temporary price controls and the close monitoring and inspection of the outlets of food products. Drugs and restaurants require safety standards and regulatory agencies to protect consumers. Labor markets of even the most advanced economies still have some form of minimum wage to protect the workers and most developing countries have labor standards, even if very poor.

Market efficiency in allocating resources is taught but market failures – of equal if not more important impact than market efficiency – are relegated to negative externalities (pollution), public goods (infrastructure) and some hazy picture of positive externalities (some government help for education for example). So our youths continue to be indoctrinated in the efficient market school. Liberalization and deregulation of everything in the economy are associated with good governance, especially because corruption and cronyism are prevalent. Trade liberalization is not distinguished from capital account liberalization. Deregulation of the telecommunications industry is not distinguished from financial deregulation.

But important breakthroughs in modern economic thought in both micro and macro analyses of economics have been mainly theories about market breakdowns and market failures. Keynes, in his response to the Great Depression, posited clearly that the labor market does not bring about full employment. In periods of weak confidence, low demand for labor (as is currently the case in the US) does not yield enough wage cuts to clear the labor market at “full employment.” This, he argues very wisely, is because the money wage is not a price that clears the labor market. It is a political and social exogenous variable: it is a result of a social contract, achieved through bargaining and negotiations between workers and employers.

Modern New Keynesians such as Joseph Stiglitz would argue, through the “efficiency wage” hypothesis, that essentially, in periods of low confidence, firms lay off the less productive workers and keep the more efficient ones, instead of cutting everybody’s wages. The arguments of both Keynes and the New Keynesians explain involuntary unemployment and why the market capitalist system is volatile and unstable. Keynes further poses that in the product markets, firms operate at much less than full capacity during recessions – a not very efficient market outcome. Even if prices fell and there were deflation (such as what happened during the global crisis), as long as people remained unemployed and uncertain of the future (as they are now in the US), products would not be bought and firms would continue to have excess capacity, and hiring would be dismal. The vicious cycle of pessimism, weak consumption spending and high unemployment can only be broken by a big exogenous push to spur domestic demand.

(To be continued)

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