Trudging Down the Third Way

It is this consequentialist stand that has now turned resolutely against freedom, at least in the economic domain. It is blamed for financial mayhem in 2007, a stock market crash and the onset of recession in 2008 and who knows what, perhaps another Great Depression. Since the media all say that the latter is indeed a possibility, business pulls in its horns, which is the surest way to bring it about. In the nature of things, democratic electorates order their governments “Don’t just stand there, do something!” Governments, understandably enough, get busy doing it. We are off, trudging down the Third Way.

Joseph Stiglitz, whose economics nowadays is two parts scholarship, three parts catchy demagogy, tells us that 2008 is nothing less than the 1989 of capitalism. The historical equivalence of the fall of the Berlin Wall and the bankruptcy of Lehman Brothers puts paid to two equally sickly systems. Neither will do, we must have something better.

No one will dispute that it is always better to have something better Liberalism (“classical liberalism” in American English), capitalist free-for-all and deregulation proved bad; re-regulation and dirigisme must be better.

This is a conclusion that majority opinion in most of Europe has always been longing to hear. “Unfettered” capitalism has never been congenial to the German ethos that prefers cozy corporatism, frowns on feverish competition and wants an economy that is both “market” and “social”. France’s two dominant modes of thought, obsessive egalitarianism and awestruck respect for a big and powerful dirigiste state, both generate hostility to free markets and capitalist enterprise (or, as they put it, “financial capitalism”). Throughout, but particularly in Southern Europe, the religious culture affirms that “social” justice has a distinct meaning and that capitalism undermines it.

All in all, the consensus now is that just as socialism had discredited itself in 1989, capitalism lost credibility in 2008. Neither is good enough. One needs a new system that takes what is good in each, a well-regulated free market, vigorous growth and stability, the firm hand of the state on the tiller, fair competition and just rewards for all.

Even before dismissing this conclusion as pathetically naïve, we should question one of the consequentialist premises on which it rests. Are the falls of the Berlin Wall and of Lehman Brothers equivalent evidence of failure? No sensible consequentialist needed the Berlin Wall to fall before noticing that “real existing” socialism and all its works were an appalling failure from beginning to end. On the other hand, sensible consequentialists had realised that the gradual loosening of administrative controls, the dismantling of trade barriers and the shift from (progressive) income to (regressive) consumption taxes since 1945 were accompanied by (or perhaps actually “caused”) six decades of albeit bumpy but historically unprecedented growth of wealth and redeemed the world’s poorest from abject misery. This performance, spectacular by the standards of the past, has earned forgiveness for capitalism in the eyes of many who by instinct and woolly ideas would have felt more at home in a mildly socialist and dirigiste climate. Withdrawing this forgiveness at the sight of what may or may not prove to be the first major bump in the road since 1992 does look rather hasty. Nor need one bow a penitent head at the charge that the 2007 financial mayhem was the fault of insufficient regulation coupled with the irresponsibility of greedy bankers. There was much regulation, all apparently of the wrong sort. But we only know after the event what the right sort would have been. It is a fact that the American over-lending on credit-unworthy no-recourse mortgages was at least in part the result of official urging to help the poor own their homes, and to the facilities offered by Fannie Mae and Freddie Mac. It is also a fact that obliging banks to mark down collaterised securities to the price they would fetch in a panic-stricken market, combined with their desperate need to show respectable Basel II solvency ratios to more and more nervous depositors and call money lenders, was a regulation-made recipe for setting up unmanageable vicious circles. The plain truth is that while there is no denying the blind silliness of many bankers, the real culprit was a hybrid system that was neither really free nor a fully automatic machine and whose component parts have unsurprisingly proved incompatible.

Needled on by strident anger and blame for all that went wrong, and guided by experts determined to fight and win the last war while believing that they are preventing the next one, politicians are getting ready for what is likely to be a protracted campaign of re-regulation. In the first round, the central target will be the financial sphere. Banking supervision will be tightened and banks will have to please their regulators before they please their customers. Securitisation may be restricted, and banks that transform loans into marketable securities may well be required to retain a proportion in their own portfolio or otherwise assume the credit risk. Credit default insurance is likely to be limited by strong margin requirements. All such measures will be aimed at reducing system risk, though what they will in fact do is to reduce the transferability of risk. The cost of credit will have to increase and the efficiency of capital markets must decrease, though it may be that the resulting more sluggish and less efficient system will enjoy easier public acceptance. Bankers will be a little less like wizards and more like post office clerks.

One objective of “putting a stop to the “free-for-all” will be to make stock, bond and commodity markets more stable. The Third Way is actually paved with potential schemes to achieve this. They start at the curbing of speculation and end with state marketing boards and the closure of auction markets. It is ironic that speculation is the pet target of public opinion that takes it to be both immoral and sterile. In addition, there is a belief that “bear” speculation (short selling) makes prices go down. Any economics student whose instructors are worth their salaries knows that all successful speculation reduces price volatility below what it would be if there were no such speculation. The reason is simply that in order to succeed, the “bull” must buy low and sell high and the “bear” must sell high and buy back low, with each of these trades moving the price in the direction opposite to where it would otherwise go, i.e. they smooth out volatility. Never mind the economics, speculation must and probably will be curbed if the
dirigistes have their way.

From finance, the swell of enthusiasm for more dirigisme is almost bound to spill over to commerce and industry. “Incomes policies” and fiscal devices to make income distribution more equal are also a popular means to a “better, more stable and more just” order cleansed of the “extremes” of Left and Right. We are probably committed, and condemned, to trudge down the Third Way for a while. It is a great pity, but there is always the hope that we will come out wiser from the experience.