Today we live in an established societal system consisting out of civil society, state and economy. Whereas this has proven to be a quite successful setup, some historical events made us reconsider these structures. With the global financial crisis we are currently living through such a time. Financial or economic crises are nothing new, but also nothing we completely understand as we have proven to be unable to avoid them. In this short essay, I will investigate the role of the economy within our society, explain the nature of economic cycles causing ups and downs, and how these cycles influence the relationships within our societal system. Equipped with this theoretical knowledge, I will highlight the main features of the current crisis and how it is used to avoid such dramatic downturns in the future.
THE CONTROVERSIAL RELATIONSHIP OF STATE AND ECONOMY
THE DIVISION OF ONE INTO TWO SPHERES
Based upon civil society, the state as well as the economy constitute the two strongholds of our modern societal systems. For most of our civilized times, the economy was strongly bound to the state or other governmental authorities. These institutions controlled resources, both labor and capital, and defined in which way the economy functioned. It was not until the recent century and in particular the last decades, when the economy liberated itself from the state. This was a development not only favored by economic actors but also by the state. Markets, in particular open ones, proved to provide more efficient means to prosperity. This allowed for an increase of the overall welfare and augmentation of a state’s capacity and capabilities. The transition to free market economies sometimes went comparatively smooth, as in the United States, and sometimes only originated from a collapse of the system, as in the former Soviet Union, or through military defeat, as in Germany.
In short, we were able to observe the partition of one sphere into two, namely state and economy. By this, the state gave up a lot of power and control but created an environment which was more conducive to economic growth from which it did not benefit the least.
A POWER OF ITS OWN
In the meantime, this newly established economic sphere developed and continues to develop a life of its own. In addition to vitalizing domestic markets, economic activity seems extraordinarily prone to international markets. Economies of scale, economies of scope[1], interstate tax and regulatory competition[2] encouraged business to enter, to move to or to cooperate with firms from foreign markets. In many cases, economic actors have been at least as successful as states to establish international cooperation and institutions. In particular financial markets have internationalized or globalized to an extent which had been unthinkable before. Even the field of international relations, which is traditionally focused on state actions in the anarchic, international sphere, recognizes the resurrection of private actors. The concept of private authority describes the emergence of powerful private institutions with legitimate claims to authority[3]. One example are rating agencies, which, as recently in the case of Greece, Spain or Portugal, can bring whole nations into serious trouble. Without going deeper into conceptual details, this clearly shows the great power inherent to the economy or economic system.
THE STRUGGLE OF TWO SPHERES
Whereas state and economy are both interested in the autonomy of the economy, the state has an existential interest of staying in control. The state has indeed the legitimate claim to structure and control the societal system as it steers in the interest of the civil society, by which -at least in the majority of market economies- it is also elected. Speaking in Marxist terms, market economies face one critical issue: Whereas a small number of capitalists, those who own capital and invest, collect most of the economic gains, the large number of laborers, those who work and produce, are exploited. This claim holds true at least to some certain extent: Despite overall economic growth that improves the living conditions for basically every individual, open market economies foster the gap between the rich and the poor. In order to avoid civil uproar and preserve its legitimacy, it is in the state’s very own interest to limit the growth of this gap.
A CYCLE OF GROWTH AND CRISIS
The cyclical nature of the economy has been observed long time ago. Even the biblical story tells, seven years of plenty are followed by seven years of famine[4]. Eventually, de Sismondi[5] was the first to explore and explain those periodic downturns within modern economic theories. Today, the bare existence of economic cycles is unchallenged, and we were able to observe those strongly within the last century. Times of unforeseen economic prosperity were interrupted by downturns of equally unknown strength. In addition, the Great Depression’s global extent in the 1930s revealed the interdependence of national economies.
Even if cycles seem to be a natural characteristic of the economy, crisis still originates from some kind of failure. Whereas this failure is difficult to attribute, it is easier to name. Economic crisis are caused by excesses as individuals, enterprises or society take too many risks and live beyond their means. Such excesses create so-called bubbles that artificially inflate the economic system and implode at some point. This implosion constitutes the economic crisis.
UTILIZING THE CRISIS
This cycle of growth and crisis strongly affects the controversial relationship of state and economy, which has been addressed in the previous part. Times of growth are usually satisfactory for economy, state and civil society. All profit to some certain extents. Despite to comparatively huge margins of shareholders and other kinds of capitalists, laborers are happy with their moderate welfare growth. Thus, there is no reason for the state to intervene and to exceed additional control of the distribution of economic gains or the economic system in general. But the tide turns, when the economy slides into a new crisis. The state undertakes expensive interventions to revitalize the economy. Other than the sharing of the gains, the major burden of this revitalization is carried by the broad civil society, the laborers. Dissatisfaction increases subsequently and gives the state the unique opportunity and duty to reshape the conditions of economic activity, which it is barely able to in times of growth[6].
Crisis, times in which the economy is comparatively weak, can be utilized by the state in order to reify its institutional power and authority over the economy and to limit future excesses. As excesses may hardly be avoided completely, a more constant economic development is desirable for the state to ensure stability and limit the unreasonable gains for capitalists due to above average profits during upturns and decreased liabilities during downturns.
THE LATEST ECONOMIC CRISIS
2007 FINANCIAL CRISIS AND GOVERNMENT RESPONSE
In 2007 the housing bubble in the U.S. burst, triggering an economic crisis with effects that can still be felt all over the globe. The current crisis is often referred to as financial crisis, as the causes are seen within the financial system, or more precise financial institution holding too many bad assets. The overvaluation of assets, in particular in housing, created artificial values and gains[7]. As these values were not covered in the real world, they created a bubble which had to burst at some point. This burst was so severe that it endangered the liquidity of even the largest financial institutions.
States all over the globe saw their financial system collapsing with the whole economy following as a likely consequence. Governments reacted by bailing out the threatened institutions, buying bad assets worth billions and pumping money into the system on several other ways. So far, these measures were successful in keeping the system alive and some countries already experience a slow recovery. Despite the revitalization it is obvious that these measures will not change the way of doing business but just get it back on track. In addition, the liquidity supporting government initiatives are financed through taxes thus paid for by all citizens. As not all tax payers are capitalists, meaning those who directly benefit from stock markets, the legitimacy of government bailing out financial institutions remains questionable. More importantly, there is a common understanding that future excesses of this kind are to be avoided, or realistically speaking, are at least to be restricted. In spite of this broad agreement little has happened so far.
TAMING THE FINANCIAL MARKETS
Apart from the case of war, a state’s jurisdiction is limited to its territory. Within its jurisdictions the state defines the regulatory framework of financial markets. With the proceeding globalization, these frameworks have been aligned all over the world and opened to each other. Today, basically any stock can be traded anywhere in the world. This gives capital the advantage that it can move and work for their owners anyplace. In consequence, regulation needs to be enacted on a global level. States that enforce too strict regulations by themselves run danger to experience an extensive flight of capital. Despite this obvious need of a joint initiative, the international system faces the seemingly insurmountable challenge to find a consensus on how to tame the financial markets. Whereas there are ideological debates on how extensive state restrictions should be, there is also no agreement regarding to feasibility of different approaches of regulation.
Some countries that are facing stronger public pressure push for such global solutions and in some cases also start to implement them domestically. Whereas the effectiveness of such domestic initiatives is likely to be very limited, they may motivate others to follow. As one of these countries, Germany recently enforced a law to prohibit so-called bear raids[8], a special kind of derivatives. Bear raids are responsible for the extent of excesses but are by far not the sole cause and their prohibition can only constitute the beginning of measures. It remains interesting whether Europe and eventually the global market will follow this example.
SHAREHOLDERS DO NOT WANT TO SHARE
Shareholders, or capitalists, as I called them before, gain from economic growth and excesses but fail to equally cover for financial shortcomings in times of crisis. The global setup of financial markets already gives them a systemic advantage to governmental regulation efforts. Indeed, capitalists can only hope to live through the crisis with as little additional regulation as possible. For this reason, banks and other financial institutions as well as their lobbyists fight vehemently against such regulation. This could be observed for example during the last weeks in the United States. The government in Washington D.C. was working on the legislation of the financial market reform. Initial discussions included considerations about the re-enforcement of the Glass-Steagall-Act. The law was introduced in the aftermath of the Great Depression prohibiting the combination of investment banks and depository banks in order to limit speculation and avoid transfer of risks to regular clients of depository bank just until 1999. The bill, signed into law by U.S. President Obama on July 21, 2010, lacks any regulation of comparable impact[9]. Thus, the pressure and lobbying efforts from the financial sector have proven to be broadly successful. Neither does the new law restrict the trading of derivatives, as introduced in Germany, nor does it enforce any kind of bank levy, a development which takes shape in many European countries as well as on the level of the European Union.
In spite of praising the steps undertaken within many European countries, we have to be aware that even these, in comparison to the U.S. quite progressive measures, are not able to unfold their whole power unless enacted upon the global financial system in a whole. And, if even they were, these regulations barely constitute a framework which is able to fix the drawbacks of the financial system. As pointed out before, the financial sector has an intrinsic interest to preserve the regulatory status quo. And, the sector and its lobbying groups are doing a good job on this, likely to oppose any radical, structural change successfully if politicians are not to realize the dramatic need and the unique chance to initiate such changes.
To learn more about Marxist explanations of the current crisis I recommend watching this video by David Harvey.
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[1] Schmid, S. (2009): Management der Internationalisierung, Wiesbaden, p. 59.
[2] Picciotto, S. (1996): The Regulatory Criss-Cross: Interaction between Jurisdictions and the Construction of Global Regulatory Networks, p. 107ff, in: Bratton, W. W. et al., International Regulatory Competition and Coordination, Oxford, pp. 89-125.
[3] Hall, R. B.; Biersteker, T. J. (2002): The emergence of private authority in the international system, p. 4ff, in: ibid., The Emergence of Private Authority in Global Governance, Cambridge, pp. 3-22.
[4] Genesis 41:29-30. “Behold, there come seven years of great plenty throughout all the land of Egypt. and the plenty shall not be known in the land by reason of that famine which followeth; for it shall be very grievous.”
[5] De Sismondi, J.C.L. (1819) : Nouveaux Principes d’économie politique, Paris.
[6] Gourevitch, P. (1986): Politics in Hard Times, New York, p. 21ff.
[7] Taylor, J. B. (2008): The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. Bank of Canada. November 2008.
[8] Schröder, M. (2010): Bundestag verbietet ungedeckte Leerverkäufe, published on Tagesspiegel.de, July 2, 2010.
[9] Currie, D. (2010): Punting on Financial Reform, published on NationalReview.com, July 22, 2010.
