[p2p-research] Why are neoliberal myths still dominating EU policymaking?

[Michel Bauwens]

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*Why are neoliberal myths still dominating EU
policymaking?<http://feedproxy.google.com/~r/P2pFoundation/~3/z1SuWSvcorw/12>
*

A number of French economists has started a signup campaign to the *“Manifesto
of the appalled economists”*. It’s one of the best deconstructionos of the
destructive neoliberal myth-making that I have seen published. It contains
an explanation of *“10 pseudo “obvious facts”, 22 measures to drive the
debate out of the dead end.”*

The full pdf version is
here<http://www.paecon.net/PAEReview/issue54/Manifesto54.pdf>
.

*Excerpts* (specific material related to Europe has not been excerpted):

“The crisis has laid bare the dogmatic and unfounded nature of the alleged
“obvious facts” repeated ad nauseam by policy makers and their advisers.
Whether it is the efficiency and rationality of financial markets, or the
need to cut spending to reduce debt or to strengthen the “stability pact”,
these “obvious facts” have to be examined, and the plurality of choices of
economic policies must be shown. Other choices are possible and desirable,
provided that the financial industry’s noose on public policies is loosened.
We offer below a critical presentation of ten premises that still inspire
decisions of public authorities all over Europe every day, despite the
fierce denial brought by the financial crisis and its aftermath. These are
pseudo “obvious facts” which are in fact unfair and ineffective measures,
against which we propose twenty-two counterproposals that we would like to
bring into the debate. Each of the proposals is not necessarily unanimously
supported by all the people who have signed this manifesto, but they have to
be considered seriously if we want to drive Europe out of the current dead
end.

*Pseudo “obvious fact” # 1: financial markets are efficient*

Today, one fact is obvious to all observers: the crucial role played by
financial markets in the functioning of the economy. This is the result of a
long evolution that began in the late seventies. However it is measured,
this evolution constitutes a clear break, both quantitatively and
qualitatively, with previous decades. Under the pressure of financial
markets, the overall regulation of capitalism has deeply changed, giving
rise to a novel form of capitalism that some have called “patrimonial
capitalism”, “financial capitalism” or “neoliberal capitalism”.

The theoretical justification for these mutations is the hypothesis of the
informational efficiency of financial markets (or Efficient Markets
Hypothesis). According to this hypothesis, it is important to develop
financial markets, in order to ensure they operate as freely as possible,
because they are the only mechanism allowing an efficient allocation of
capital. The policies persistently pursued over the last thirty years are
consistent with this recommendation. Their purpose was to create a globally
integrated financial market, in which all actors (firms, households, states,
financial institutions) can exchange all types of securities (stocks, bonds,
debts, derivatives, currencies) for all maturities (long term, medium term,
short term). Financial markets have come to resemble the “friction free”
market of textbooks: the economic discourse has succeeded in creating
reality. The markets being more and more “perfect”, in the mainstream’s
meaning of the term, the analysts have believed that the financial system
had become much more stable than in the past. The “great moderation” – this
period of economic growth without wage growth experienced by the U.S. from
1990 to 2007 – seemed to confirm this view.

Even now, the G20 still thinks that financial markets are the best mechanism
for allocating capital. The primacy and integrity of financial markets
remain the ultimate goals pursued by the new financial regulations. The
crisis is interpreted not as an inevitable result of the logic of
deregulated markets, but as the effect of the dishonesty and
irresponsibility of some financial actors poorly supervised by governments.

Yet the crisis has demonstrated that markets are not efficient, and they are
unable to allow an efficient allocation of capital. The consequences of this
fact in terms of regulation and economic policy are tremendous. The theory
of efficiency is based on the idea that investors seek and find the most
reliable information on the value of projects that are competing for
funding. According to this theory, the price that forms on the market
reflects investors’ appraisals and synthesizes all available information: it
is therefore a good estimate of the true value of the securities. This value
is supposed to summarize all the information needed to guide economic
activity and social life as well. Thus, the capital is invested in the most
profitable projects, and leaves the least efficient ones. This is the
central idea of this theory: financial competition generates fair prices,
which are reliable signals to investors, and an effective guide for economic
development.

But the crisis confirmed various critical works which had cast doubts on
this proposition. Financial competition does not necessarily generate fair
prices. Worse, financial competition is often destabilizing and leads to
excessive price and irrational fluctuations, the financial bubbles.

The major flaw in the theory of efficient capital markets is that it
transposes the theory used for ordinary goods and services to financial
markets. On markets for goods and services, competition is partly
self-regulating under what is called the “law” of supply and demand: when
the price of a commodity rises, producers increase their supply, and buyers
reduce their demand. As a consequence, the price decreases and goes back
towards its equilibrium level. In other words, when the price of a commodity
rises, restoring forces tend to impede and reverse this increase.
Competition produces what is called “negative feedbacks”, i.e. restoring
forces that go in the opposite direction from the initial shock. The idea of
efficiency arises from a direct transposition of this mechanism to financial
markets. However, for the latter, the situation is very different. When the
price increases, it is common to observe, not a decrease but an increase in
demand! Indeed, the rising price means a higher return for those who own the
security, because of the capital gain. The price increase thus attracts new
buyers, which further reinforces the initial increase. The promise of
bonuses pushes traders to further strengthen the movement. This is the case
until the incident, that is unpredictable but inevitable, takes place. This
causes the reversal of expectations and the crash. This herding phenomenon
is a process of “positive feedbacks” which worsens the initial imbalances.
This is what a speculative bubble consists of: a cumulative increase in
prices that feeds itself. Such a process does not produce fair prices, but
rather inadequate prices.

As a consequence, the predominant place occupied by financial markets can
not lead to any kind of efficiency. Even worse, it is a permanent source of
instability, as is evident from the uninterrupted series of bubbles that we
have known in the past 20 years: Japan, South-East Asia, the Internet,
emerging markets, real estate and securitization. Financial instability is
reflected by the huge fluctuations of exchange rates and of the stock
market, which are clearly unrelated to the fundamentals of the economy. This
instability, arising from the financial sector, spreads to the real economy
through many mechanisms.

To reduce the inefficiency and instability of financial markets, we suggest
the following four measures:

* Measure 1: To separate strictly financial markets and the activities of
financial actors, prohibiting banks from speculating on their own account,
in order to prevent the spread of bubbles and crashes.
* Measure 2: To reduce liquidity and destabilizing speculation by controls
on capital movements and taxation on financial transactions.
* Measure 3: To restrict financial transactions to those meeting the needs
of the real economy (e.g., CDS only to holders of insured securities, etc.).

* Measure 4: Capping the earnings of traders.

*Pseudo “obvious fact” # 2: financial markets contribute to economic growth*

Financial integration has hugely increased the power of finance because it
unifies and centralizes capitalist property globally. It determines
profitability standards which are required of all capital. The idea was that
financial markets would replace the financing of investments by banks. But
this project has failed, since today, on the whole it is firms that fund
shareholders instead of the contrary. Corporate governance was nevertheless
profoundly transformed to meet the standards of market profitability. With
the rise of shareholder value, a new conception of the firm and its
management has emerged, where the firm is being conceived as an entity at
the service of the shareholder. The idea of a common interest of the
different stakeholders of the firm has disappeared. The operators of
publicly traded companies now have the primary and exclusive mission to
satisfy the shareholders’ desire to enrich themselves. Consequently, they no
longer behave as wage earners, as they witness the excessive surge in their
incomes. As argued by “agency” theory the aim it is to ensure that the
interests of managers now converge with those of shareholders.

An ROE (Return on Equity) of 15% to 25% has now become the standard imposed
by the power of finance on companies and employees. Liquidity is the
instrument of that power, as it allows unsatisfied investors to go elsewhere
in no time. Faced with this power, the interests of wage earners as well as
political sovereignty were marginalized. This imbalance leads to
unreasonable demands for profit, which then hamper economic growth and lead
to a continuous increase in income inequality. Firstly, the profitability
requirements greatly inhibit investment: the higher the required return, the
more difficult it is to find projects that are competitive enough in order
to meet these requirements. Investment rates remain historically low in
Europe and the United States. Secondly, these requirements cause a constant
downward pressure on wages and purchasing power, which is not favourable to
demand. The simultaneous curbing of investment and consumption leads to low
growth and endemic unemployment. This trend has been thwarted in the
Anglo-Saxon countries by the development of household debt, and by asset
bubbles that create fictional wealth, allowing for a growth of consumption
without wages, but ending up with crashes.

In order to eliminate the negative effects of financial markets on economic
activity, we propose the following three measures:

* Measure 5: To strengthen significantly counter-powers within firms, in
order to force the management to take into account the interests of all the
stakeholders.
* Measure 6: To increase significantly the taxation of very high incomes to
discourage the race towards unsustainable returns.
* Measure 7: To reduce the dependency of firm’s vis-à-vis financial markets,
and to develop a public policy of credit (preferential rates for priority
activities on the social and environmental levels).

*Pseudo “obvious fact” # 3: markets assess correctly the solvency of states*

According to the proponents of efficient capital markets, market operators
take into account the objective situation of public finances in order to
assess the risk of taking out state bonds. Take the case of Greek debt:
financial operators and policy makers rely exclusively on financial
assessments in order to assess the situation. Thus, when the required
interest rate for Greece rose to more than 10%, everyone concluded that the
risk of default was high: if investors demanded such a risk premium, this
meant that the danger was extreme.

This is a profound mistake if one understands the true nature of the
assessment by the financial market. As this market is not efficient, it very
often produces prices disconnected from the fundamentals. In these
circumstances, it is unreasonable to rely exclusively on the financial
market assessments in order to assess a situation. Assessing the value of a
financial security is not comparable to measuring an objective magnitude,
like, for example, estimating the weight of an object. A financial security
is a claim on future revenue: in order to evaluate it, one must anticipate
what this future will be. It is a matter of appraisal, not of objective
measure, because at the instant t, the future is by no means predetermined.
In trading rooms, it is what operators imagine it will be. A financial price
is the result of an assessment, a belief, a bet on the future: there is no
guarantee that the assessment of markets is in any way superior to other
forms of assessment.

Above all, financial evaluation is not neutral: it affects the object it is
meant to measure, it initiates and builds the future it imagines. So, rating
agencies play an important role in determining interest rates on bond
markets by awarding grades that are highly subjective, if they are not
driven by a desire to fuel instability, a source for speculative profits.
When agencies degrade the rating of a state, they increase the rate of
interest demanded by financial actors in order to acquire securities of the
public debt of this state, and thereby increase the risk of bankruptcy they
have announced.

To reduce the influence of market’s psychology on the funding of the state,
we propose the following two measures:

* Measure 8: Rating agencies should not be allowed to influence arbitrarily
interest rates on bond markets by downgrading the rating of a State. The
activities of agencies should be regulated in a way that requires that their
ratings result from a transparent economic calculation.
* Measure 8a: States should be freed from the threat of financial markets by
guaranteeing the purchase of public securities by the European Central Band
(ECB).

*Pseudo “obvious fact” # 4: the soar in public debts results from excessive
spending*

Michel Pebereau, one of the “godfathers” of the French banking system,
described in 2005, in one of those official ad hoc reports, France as a
country stifled by debt and which is sacrificing its future generations by
engaging in reckless social spending. The state running into debt as a
father who drinks alcohol beyond its means: this is the vision usually
propagated by most editorialists. And yet, the recent explosion of public
debt in Europe and the world is due to something which is very different:
the bailout plans of the financial sector, and, mainly, to the recession
caused by the banking and financial crisis that began in 2008: the average
public deficit in the euro area was only 0.6% of GDP in 2007, but the crisis
has increased to 7% in 2010. In the same time, public debt increased from 66
% to 84% of GDP.

But the rise in public debt, in France as in many European countries, was
initially moderate, and prior to that recession: it mainly comes not from an
upward trend in public spending – since, on the contrary, as a proportion of
GDP, public spending is stable or declining in the EU since the early 1990s
– but from the erosion of public revenue, due to weak economic growth over
the period, and the fiscal counter-revolution led by most governments in the
pas twenty-five years. In the longer run, the fiscal counter-revolution has
continuously fuelled the swelling of the debt from one recession to another.
Thus, in France, a recent parliamentary report estimated 100 billion Euros
in 2010 as the cost of tax cuts granted between 2000 and 2010, even without
including exemptions from social contributions (30 billions) and other “tax
expenditures”. As tax harmonization has not taken place, European states
have engaged in tax competition, lowering corporate taxes, as well as taxes
on high income and assets. Even if the relative weight of its determinants
varies from one country to another, the rise of government deficits and debt
ratios that has taken place almost everywhere in Europe over the last thirty
years does not primarily result from an increase in public spending. This
diagnosis obviously opens up avenues other than the reduction of public
spending mantra, repeated ad nauseam, in order to reduce public deficits.

To restore an informed public debate on the origin of the debt and therefore
on the means to cure it, we propose the following measure:

* Measure 9: To conduct a public audit of public debts, in order to
determine their origin and to identify the main holders of debt securities,
as well as the amounts held.

*Pseudo “obvious fact” # 5: public spending must be cut in order to reduce
the public debt.*

Even if the increase in debt was partly due to an increase in public
spending, cutting public spending would not necessarily be part of the
solution. This is because the dynamics of public debt have little in common
with that of a household’s: macroeconomics is not reducible to the economy
of the household. The dynamics of debt depends, in all generality, on
several factors: the level of primary deficits, but also the spread between
the interest rate and the nominal growth rate of the economy.

For, if the latter is lower than the interest rate, debt will increase
mechanically because of the “snowball effect”: the amount of interests
explodes, and the total deficit (including the interests of debt) as well.
Thus, in the early 1990s, the “franc fort” policy conducted by Beregovoy,
and maintained despite the 1993-94 recession, resulted in an interest rate
higher than the growth rate, explaining the surge in France’s public debt
during this period. The same mechanism caused the increase in debt in the
first half of the 1980’s, as a consequence of the neoliberal revolution and
the high interest rates policy led by Ronald Reagan and Margaret Thatcher.

But the rate of economic growth itself is not independent from public
spending: in the short run, the existence of stable public expenditures
restrain the size of recessions (through “automatic stabilizers”); in the
long run, public investment and expenditures (education, health, research,
infrastructures…) stimulate growth. It is wrong to say that any public
deficit further increases public debt, or that any reduction of the public
deficit reduces debt. If reducing the deficit weighs down economic activity,
this will make debt even larger. Neoliberal news analysts point out that
some countries (Canada, Sweden, and Israel) have achieved very abrupt
adjustments of their public accounts in the 1990s, followed by an immediate
upturn in growth. But this is possible only if the adjustment regards an
isolated country, which quickly regains competitiveness over its
competitors. Obviously, the proponents of European structural adjustment
forget that European countries are the main customers and competitors for
the other European countries, the European Union being, on the whole, a
rather closed economy. The only effect of a simultaneous and massive
reduction of government spending in all EU countries will be a worsened
recession, and thus a further increase in public debt.

To avoid public finance policies that will cause social and political
disaster, we submit the following two measures for discussion:

* Measure 10: The level of social protections (unemployment benefits,
housing…) must be maintained, or even improved;

* Measure 11: Public spending on education, research, investment in
environmental conversion, etc., must be increased, in order to set up the
conditions for sustainable growth and to bring about a sharp fall in
unemployment.

*Pseudo “obvious fact” # 6: public debt shifts the burden of our excesses on
our grandchildren*

There is another fallacious statement that confuses household economics with
macroeconomics: that the public debt would be a transfer of wealth to the
detriment of future generations. Public debt is a mechanism for transferring
wealth, but mainly from ordinary taxpayers to shareholders.

Indeed, on the basis of the belief (rarely documented) that lower taxes
stimulate growth and increase government revenue in fine, European states
have, since 1980, imitated U.S.fiscal policy. Tax and social contributions
cuts have proliferated (on corporate profits, on the income of the
wealthiest individuals, on property, on employer contributions…), but their
influence on economic growth has been very uncertain. As a consequence,
these anti-redistributive tax policies have worsened cumulatively both
social inequalities and public deficits.

These tax policies have forced governments to borrow from well-off
households and financial markets, in order to finance the deficits created
in this way. This might be called the “jackpot effect”: with the money saved
on their taxes, the rich were able to acquire (interest bearing) securities
of the debt issued to finance public deficits caused by tax cuts… The public
debt service in France represents 40 billion Euros each year, almost as much
as the revenue generated by the income tax. This tour de force is all the
more amazing given that political leaders then succeeded in persuading the
public that the employees, pensioners and the sick were responsible for the
public debt.

Thus, the increase in public debt in Europe or in the USA is not the result
of expansionary Keynesian policies, or expensive social policies, but, much
more, of a policy in favour of the lucky few: “tax expenditures” (lowered
taxes and contributions) increase the disposable income of those who need it
least, who, as a result, can further increase their investments in treasury
bills, which are reimbursed, with interests, by the state with the tax
revenues paid by all taxpayers. On the whole, a mechanism of upwards
redistribution has been set up, from the lower to the upper classes, via
public debt, the counterpart of which is always private rent.

To bring an upturn in public finances in Europe and in France, we propose
the following two measures:

* Measure 12: To restore the strongly redistributive nature of direct
taxation on income (suppressing tax breaks, creating new steps, and
increasing the rates of income tax…)
* Measure 13: To suppress tax exemptions granted to companies, which have
insufficient effects on employment.

*Pseudo “obvious fact” # 7: we must reassure financial markets in order to
fund the public debt*

At the global level, rising public debt must be analyzed in parallel with
the process of financialization. During the last thirty years, due to the
full liberalization of capital flows, finance has increased significantly
its grip on the economy. Large firms rely less on credits and increasingly
on financial markets. Households also see an increasing share of their
savings drained to finance for their retirement, through various investment
products or in certain countries through the financing of housing
(mortgage). Portfolio managers seek to diversify risk invest in government
securities in addition to private equity. These public bonds were easy to
find as governments were conducting similar policies leading to a surge in
deficits: high interest rates, tax cuts targeted on high incomes, massive
incentives to the financial savings of households for pensions funds, etc.

At EU level, the financialization of the public debt has been included in
the treaties: since the Maastricht treaty, central banks are prohibited from
directly funding states, which must find lenders on financial markets. This
“monetary punishment” is accompanied by a process of “financial
liberalization”, and is the exact opposite of the policies adopted after the
Great Depression of the 1930s, which consisted of “financial repression”
(i.e. severe restrictions on the freedom of action of finance) and “monetary
liberation” (with the end of the gold standard). The purpose of the European
treaties is to submit states, supposedly too extravagant by nature, to the
discipline of financial markets, which are supposed to be by nature
efficient and omniscient.

The result of this doctrinal choice is that the European Central Bank is no
longer entitled to subscribe directly to the public bonds issued by European
states. Deprived from the security of always being financed by the Central
Bank, Southern European states have suffered from speculative attacks.
Admittedly, in recent months, the ECB has bought government bonds at market
interest rates to ease tensions on the European bond market, something that
previously it had always refused to do, in the name of unwavering orthodoxy.
But nothing says that this will suffice, if the debt crisis worsens and if
market interest rates soar. That monetary orthodoxy devoid of scientific
foundations may then be difficult to maintain.

To address the problem of the debt we propose the following two measures:

* Measure 14: To authorize the European Central Bank to directly fund
European states at low interest rates, thus loosening the straitjacket of
financial markets (or to require commercial banks to subscribe to the issue
of government bonds).

* Measure 15: If necessary, to restructure the public debt, for example by
capping the service of public debt to a certain percentage of GDP, and by
discriminating between creditors according to the volume of shares they
hold. In fact, very large stockholders (individuals or institutions) must
accept a substantial lengthening of the debt profile, and even partial or
total cancellation. We must also renegotiate the exorbitant interest rates
paid on bonds issued by countries in trouble since the crisis.
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