The effects of the financial crisis that blew up with the collapse of Lehman Brothers in September 2008 are still with us. Many Western governments pursue harsh austerity policies in a vain attempt to shift the huge overhang of debt that they took on by propping up economies in freefall. But few have had the courage or political imagination to reshape their economies in ways that will place them on a more sustainable, and equitable footing, in order to ensure a similar crisis does not strike again. Certainly, the world economy has not been reformed sufficiently.
This is a pressing concern, argues Philippe Legrain in his excellent book, Aftershock. A return of the status quo ante will lead to another almighty catastrophe, with effects far worse than what we have experienced already, as governments will be less equipped to step in. Bubbles will grow, laissez-faire economic policies will do nothing about them, and financial crises will recur. Governments need to enact major reforms if we are to prevent this from happening.
Mr Legrain, an adviser to European Commission President, José Manuel Barroso, and formerly of the LSE and The Economist, is a strong proponent of openness – be it of ideas, capital, labour, or trade. He offers a strong, uplifting defence of globalisation, arguing that an open world economy is in our collective self-interest, and that it offers the clearest path for human progress. His argument is far more sophisticated than the standard neo-liberal line, which calls for governments to step aside, however. For Mr Legrain, government has an important role to play in curbing excess power and vested interests, as well as on other fronts, such as correcting incentives through tax reform.
He identifies four big dangers that could derail progressive efforts, however. These are: financial collapse, debt crises, protectionism and climate change. Each could lead to, at the very least, a significant fall in living standards across the globe.
A monstrous racket
Mr Legrain devotes much time to discussing the financial crisis itself. In doing so he makes clear his contempt for the banking sector, describing it at various points as a “racket”. That it was allowed to become so large was in part a political as well as regulatory failing, but it also showed capitalism at its most destructive. Capitalism, when well-regulated (or conducted ‘responsibly’, as Ed Miliband might put it), can be an enormous force for good. But left to its own devices, it can allow powerful vested interests to grow too large, to the detriment of the overall economy. That is what happened in the case of the too-big-to-fail banks. Indeed, Mr Legrain observes that “without the discipline of failure, [capitalism] is a recipe for disaster”. He therefore argues that bank shareholders should have unlimited liability for banks’ losses, which would remove “moral hazard”, and incentivise them to prevent excessive risk-taking, or gambling.
Mr Legrain’s faith that reform will happen on this front is shaky. Clearly, banks cannot be allowed to become too big to fail in future, as this gives them a tacit guarantee that governments will bail them out if their bets go wrong, leading to skewed incentives and irresponsible investing. He mentions that soon after the crisis struck, the former Chancellor, Alastair Darling, had appointed Win Bischoff, former chairman of bailed-out Citigroup, to report on whether British banks were too large. Unsurprisingly, he claimed that they were not. It was, however, according to one expert who Mr Legrain interviewed, “the most ridiculous appointment since Caligula appointed his favourite horse a consul.”
There is more to reshaping the world economy than fixing finance, however. After demolishing the bankers, Mr Legrain moves on to discuss matters of trade, protectionism, as well as free movement of labour and capital. He is a strong advocate of openness, believing fervently in the benefits of free trade. His defence of free trade is not merely based on the standard economists’ argument that it brings down the costs for the consumer (although he does provide that succinctly), but also on the benefits it brings through the exchange of ideas, capital and people, from which innovation is spurred.
His arguments are certainly compelling. But although he is convincing about the benefits for the world if rich countries tore down tariffs and opened up their markets, he does not adequately address the specific needs of poorer nations to develop their industries first. For them, some have argued that protecting infant industries until they can compete is a better strategy. Ha-Joon Chang, a Cambridge economist, (who is once mentioned a bit too dismissively by Mr Legrain) writes about how the rich world became rich by initially protecting their industries. South Korea’s development is a prime example of this approach. Moreover, Robert C Allen, an Oxford economic historian, argues in his short book on Global Economic History, that the strategy adopted by countries to ‘get rich’ after Britain’s industrial revolution involved four key components. These were: the creation of a large national market by stripping away internal tariffs and improving transport infrastructure; the founding of banks to stabilise the national currency and provide capital to businesses; the formation of mass education to speed the adoption and invention of lucrative technology; and finally, the establishment of external tariffs to protect ‘infant industries’ from (British) competition. This last point is crucial: if countries such as the USA and Germany became rich through partly protectionist means, the question of why poor countries today should not adopt some protectionist measures still needs to be answered. On this point, Mr Legrain fails to convince.
Mr Legrain is not merely interested in the trade of goods however. He believes intertwining the fates of peoples is a strategy to enhance understanding, and promote global harmony – a position that would place him within the Liberal school of International Relations. He is a strong advocate of mobility, and laments barriers to immigration for being both immoral and uneconomical, but he keeps discussion of this topic short, as his previous book, Immigrants: Your Country Needs Them, was devoted entirely to it. He is also fearful of “Panda Panic” – nationalistic sentiments and xenophobic pandering by populist Western politicians in relation to investment from China. Japan suffered a backlash against its global acquisition in the late 1980s, but the world soon discovered that its intentions were benign and mutually beneficial. Mr Legrain hopes that a more positive attitude towards a growing China – and its investments – will breed better relations with that country too, which is in everyone’s interest. The same of course applies with other emerging nations.
His discussion of climate change is intriguing. Mr Legrain believes that attempts by self-interested policy-makers to reach a global agreement on emissions reductions are an almost futile exercise. His approach relies on the power of a well-designed market to curb emissions and promote innovation that will allow for a sustainable future. He advocates a carbon tax, rather than the currently more popular cap-and-trade approach, which would incentivise the reduction of one’s carbon footprint, and would stimulate investment in renewable energy. Designed correctly, a carbon tax could raise revenue for a government, and allow a reduction in ‘bad’ taxes elsewhere, such as on employment or (low) incomes. Moreover, the price of carbon could increase as emissions decreased, maintaining the incentives and the revenue stream. He points out that if the OECD countries emit 13 billion tonnes of carbon dioxide per year, then a carbon tax priced at $30 per tonne could raise $390 billion for rich governments. If the GDP of the OECD countries hovers at around $38 to $40 trillion for the next few years, this revenue would contribute around 1% of their GDP. And that is just one measure of its success: if it could stimulate an innovative boom in various forms of sustainable technology, including energy, and cut carbon emissions simultaneously, it would do wonders for more than just the rich world’s economies. People in the rich world would not have to lower their living standards to cut their carbon emissions to sustainable levels, and people in the developing world could be offered a path to prosperity paved with a plethora of clean technologies.
Mr Legrain believes the changes can be made, and the world economy can be reformed. Whether the political will is there is a different matter. Governments, however, should see that cutting taxes in some areas (such as on jobs or income, in an attempt to eliminate unemployment) and applying them in others (such as on carbon) would be in their self-interest, as well as that of their people.
Adjusting the tax system can also be in tune with social justice. As well as a carbon tax, he argues for a financial transactions tax and a land tax. This last one he seems particularly passionate about, for he identifies land as something that is often initially distributed unfairly, and which earns owners income through little or no effort on their part (citing various Dukes, who earn exorbitant sums from their land, to emphasise his point). His argument here has appeal for both egalitarians and meritocrats (as well as economists).
Overall, Aftershock is a fascinating tour of the world economy and how it must be reshaped to give us a chance of “a fairer, safer, richer and greener” future. In the most part, it is well-argued, drawing sensible, progressive conclusions. It is also eminently readable, and could be used as a decent primer into economics. While the book offers a strong defence of globalisation, it is not a crude neo-liberal tract on the merits of laissez-faire economics. Mr Legrain has confidence in global capitalism, but he does acknowledge and envisage a proper role for governments in shaping a progressive future for all.
Finally, to its great credit, it must be said that Aftershock is an optimistic, inspiring book. Of all the books I have read that were written in the wake of the financial crisis, very few deserve that description.