Don't turn the world over to
Development financing, which
had been influenced by the generous philosophies of John Maynard Keynes after
the second world war, has been mistakenly returned to
the commercial bankers in the past 20 years.
By JAMES K GALBRAITH
Woods Conference, in 1944 towards the end of the second world
war, put in place the International Monetary Fund and the World Bank.
The fame of John Maynard Keynes, after his far-reaching critique of the
Versailles Treaty in 1919 (1), his theoretical revolution in the 1930s and his
recommendations for policies against the great depression, had won him the
leadership of the British delegation. As Robert Skidelsky
(2) writes in his biography, Keynes there confronted a United States Treasury
determined to impose on Great
Britain (which was nearly bankrupt) a strict
financial dependence. During the war President ranklin
D Roosevelt had kept that wolf from the door by the Lend-Lease policy. But for
the postwar period, larger and more enduring questions loomed. Keynes's effort
to build a multilateral world financial order may yet be a source of
inspiration for us.
Keynes sought a system for
the postwar world in which great nations would not be obliged to place the
meeting of commercial financial terms ahead of every goal of human social
progress, including full employment. He sought a system of free trade that
might co-exist with a generous and protective system of international financial
institutions. A key feature of those would be creditor adjustment. Sanctions
could be imposed on countries that ran trade surpluses, not on those that ran
deficits. This would force the former to choose between accepting
discrimination against their trade or expanding their domestic demand and
absorption of imports. Meanwhile debtors would have access to an overdraft
facility in an international clearing union, backed by the capacity to issue an
international reserve currency (the bancor).
The Americans would not accept any
such order. Their ideal was laissez-faire and the gold standard, in a world
dominated as it then was by the crushing superiority of US manufacturing
industry. An international financial facility representing debtor interests was
as foreign to Wall Street thinking as a prison run by inmates. Debts contracted
today are to be paid tomorrow. Postwar inances were
to be run by the rich. And so the Americans agreed to a dollar-based
International Monetary Fund and World Bank on much more traditional lines than
Keynes had hoped for, with some specific concessions
to British interests. To this was added, in 1945, a US
loan for Britain
on terms Keynes found intolerably harsh.
In the course of time, two things
happened to ease the situation for Britain. First, the cold war
brought with it the Marshall Plan and a large, comparatively unstinting measure
of material and financial relief. The Soviet military threat to Western Europe may have been (and indeed, was)
overstated, but the Soviet economic and political models were far from
discredited at this time. The Soviet challenge made rapid postwar
reconstruction and the implementation of social democratic reforms
In the US longer term
transformation, based partly on the military but much more on the flowering
over a generation of such New Deal and (later) Great Society (4) programmes as social security, Medicare, and support for
housing, education and the credit markets, transformed household consumption
and converted the US into a Keynesian locomotive for the rest of the world.
During this time, international
convergence was a reality. The poor countries grew more rapidly than the rich.
But in the 1970s this system ended.
The job of development finance was returned to the commercial banks. It took
only a few years for them to prove Keynes had been right. By the 1980s, what
the late Walt Rostow called the "barbaric counter-revolution"
was well under way. The entire
system of development finance broke down, engulfing the developing world in
waves of speculative instability and debt crisis. Twenty years on, that system
Brazil is an interesting case study. It is a country with some
$250bn in debts, mostly owed in dollars to entities in the US, alongside
an economy in deep recession and a trade surplus. The Keynes remedy, focusing
on the recession and the surplus, would have been clear. For Brazil to expand,
it should move toward full employment, and reduce its trade surplus, all
financed by an issue of international reserves. Instead, today's IMF offers a
$30bn loan, on the strict condition that domestic demand in Brazil
continues to be repressed. This is not a loan for Brazil; it contributes nothing to
its long-term prospects. It is simply a way to hold open the exits for existing
creditors as their obligations mature and other opportunities permit them to
Moreover Brazil gets that much only because
it is a large country with a grave debt load and a potentially threatening
political left in the ascend ant. Argentina,
where political currents remain undefined, gets much less, although during much
of the 1990s it was widely celebrated as a model liberalising
country, which Brazil
was not (5). Substitute the name of Turkey,
and the story is similar: a model liberaliser,
overwhelmed by debts, and yet assisted only to the extent of its strategic
importance and cooperation in the war with Iraq. The tragedy of financial liberalisation in Russia is too well known to require
further comment (6).
Sad to say, the successful
countries of the developing world are those like China
(and there are few, if any, others even remotely like China) that
have pursued mercantilist policies and detailed planning strategies throughout
the era of globalisation. Whether China's
prosperity will survive its recent commitments to liberalise
under the WTO (if those commitments are met, which is always uncertain) remains
to be seen. One may also mention India, an intermediate case which
has at least maintained exchange and capital controls, and for this reason has
enjoyed fairly steady if slow growth since the early 1980s.
And Europe? Here we see rising a curious project of monetary union,
free trade and capital flow: an economic superstate.
But it is married to a pre-Keynesian vision of its capacities and
responsibilities. European countries are enjoined, under the stability and
growth pact, to maintain small unified budget deficits almost at all costs,
irrespective of either their rates of unemployment (except in an actual, and very steep, recession) or their investment
needs. They and their private-sector companies and households are further
enjoined by the European Central Bank to pay interest at whatever rates that
central authority demands, for whatever purposes the bank may wish to pursue
(under the charter, price stability above all other goals).
The governments of the poorer
regions within Europe cannot isolate and industrialise,
has done. Nor can they borrow to finance their own specialized contributions to
European development, as every US
state and city can and does do under a capital budget. Nor can they implement
Keynesian mechanisms for macro-economic stabilisation
and run a counter-cyclical budget policy except under extreme conditions. Nor
can they devalue to protect the competitiveness of their industries. They are
dependent on transfers from the community budget. These are large enough to
make a material difference in the poorest regions, but too small to effect the
macroeconomic stabilisation of large low-income
regions, such as Spain and Greece in their
entirety, let alone the vast new candidate- member regions of the East.
It is not an accident that
convergence of Europe's less wealthy regions
towards the incomes of its wealthiest regions has stopped. In the emerging
European recession, these disparities are only likely to get worse. In today's Europe, as in the Atlantic Alliance of 1945, the creditors
rule absolutely. And as Keynes feared in 1944-45, their rule is proving an
The US has been
able to overlook these issues and to remain relatively unaffected by them so
far only for three reasons. First, the status of the dollar as the world's
reserve currency has permitted the US to continue to live well despite
having to run very high current account deficits at full employment and despite
the vast decline in its industrial base since the new system got under way in
the early 1970s. Second, the US
has long enjoyed the status of a safe haven for financial investors fleeing
crony capitalism, corruption and instability in other parts of the world, for
some of which US
financial and foreign policy have to be blamed.
Third, there has been the de facto
continuing core Keynesianism of US domestic policy. This has three dimensions:
the practical behaviour of the administration and
Congress in slowdowns (they cut taxes), the practical behaviour
of the Federal Reserve under similar conditions (it cuts interest rates without
worrying too much about effect on prices), and a vast system of state support,
mainly through unobtrusive credit guarantees and tax subsidies, for private
consumption (notably in housing, medical care, education and pensions). This
last is the US
version of the "soft budget constraints" familiar to students of East
European state socialism two decades ago.
But these US advantages
may now be coming into question to some degree. The dollar's privileged status
is unlikely to disappear soon. But neither is it an eternal gift, particularly
given the emergence of the euro, the deepening crisis in Japan, and the disrepute into which US foreign
policy has fallen. US asset markets no longer have a clean reputation, as the
criminal penetration of US
corporate life, the failures of the accounting profession, the decline in
effective regulation and the collapse of the info-tech bubble all attest. The
native Keynesianism of the US
is also under threat, since too much devolution has left a large body of total
social spending in the hands of states and localities, which face hard budget
constraints and must cut sharply as their revenues
fall in the recession.
Should international wealth even
begin to depart US shores, the deteriorated ability of the US to provide
for its own needs will be exposed. There could be a
big effect on US
demand. This would soon be transmitted to the exports of countries that rely on
market, and that will affect their ability to pay their debts. That in turn
would affect the credit and reputation of US financial institutions, the
bulwarks of international finance and the dollar system. The risk of a crisis
arising from such a sequence is perhaps not imminent. But it is not negligible
The Iraq war opened with surging stock
markets in psychological reaction to the release of tensions. But even if
attention now turns to Syria
(and to Lebanon), to North Korea, and to Iran, tensions will rise once
again. Moreover the tensions may, soon enough, take on a nuclear dimension.
This, given the reckless abandonment of collective security on nuclear issues
now under way, could also begin to make the US look like less of a safe haven.
All of this raises a question. Is
the position of the US today
so very far removed from that of Britain in 1944-45? Do we not share
a pattern of military over-commitment, weakened export capacity, a long but now
threatened period of monetary hegemony, and illusions of indispensability on
the world stage?
To be sure, those who sit in
the war councils of Washington
today do not conceive the possibility that their empire is built on financial
quicksand. Still, political change is possible even in the US. If the Bush
war policy goes on from Iraq
to the next places, a general disillusion with US
war policy could set in, not only around the world but also within the US. We are not
an especially martial population; our patience with military obligations is
tightly related to their cost.
A wave of political change could,
eventually, return the US
military to the primarily defensive role that it would almost certainly prefer.
It would make it possible for Americans to begin the reconstruction of our
domestic economy along more peaceful lines, within a renewed framework of
collective security arrangements. But this would also require that our capacity
to mobilise resources not be constrained too much by
considerations of international finance.
Thinking now about such a remote
contingency may seem idle. But should such a thing happen, Americans, alongside
the representatives of the rest of the world, will need the enlightened
understanding of the citizens of the new centre of financial privilege. This
will almost surely be on the continent of Europe.
The Europeans of that moment, if
and when it comes, must not make the mistake that the Ameri
cans made in 1945. They must not, as we did at that time, turn over the key
decisions and the key institutions to people with the mentality of bankers.
* James K Galbraith is chair of
Economists Allied for Arms Reduction, director of the University of Texas
Inequality Project, chair in government/business relations at the Lyndon B
Johnson School of Public Affairs at the University of Texas, Austin, and senior
scholar at the Levy Economics Institute
(1) He was the representative of
the British Exchequer at the Paris peace conference but resigned three days
before the treaty was signed; he disagreed with the amounts of the reparations
demanded of Germany, which he thought exorbitant, in his famous work The
Economic Consequences of the Peace.
(2) Robert Skidelsky,
John Maynard Keynes, Macmillan, London (3 volumes: 1983, 1992,
(3) See Eric Hobsbawm,
Age of Extremes: the Short 20th Century, Michael Joseph, London
(4) The domestic policy programme initiated by President Lyndon Johnson in 1964.
(5) See Carlos Gabetta,
IMF's show state revolts," Le Monde diplomatique, English language edition, January 2002.
(6) See Carine
the default option," Le Monde diplomatique,
English language edition, February 2003.