Leaders Who Generate Diminishing Returns

By Philip Stephens

  • 20 Jan 2012

For a fleeting moment after the collapse of Lehman Brothers it seemed the politicians were masters again. Leaders of rich and rising nations sidestepped their differences to avert a global economic slump. The Group of 20 issued ringing declarations promising a new political architecture for the international financial system. Wall Street and the City of London were unceremoniously toppled from their gilded pedestals.

Three years on, the markets call the shots. Rating agencies humiliate the mighty US government and also strip France of its cherished triple A credit status. The implosion of financial capitalism has become a crisis of political authority in the west. Behind this lies an unequal contest between a globalised economy and politicians struggling to answer the demands of national electorates. “It is not the ratings agencies that dictate the policies of France,” François Baroin, that country’s finance minister, declared after the Standard & Poor’s downgrade. To some it seemed a statement of hope as much as fact.

The financial system is still sickly. So now is politics. Economic stagnation has bred popular disaffection, stirring protests from right and left. The politics of inequality, banished during the boom years, have returned to view. In Britain, the gap between those at the top and bottom of the income scale is as wide as it has been in living memory. The “middle” is feeling badly squeezed. Easy credit masked this unequal share-out. Now, in a time of austerity, the gulf between the 1 per cent and the 99 per cent puts a question mark over the legitimacy of the market system.


Confidence in capitalism has fallen. A recent opinion poll conducted by GlobeScan indicated that support for the free enterprise system had fallen to about 60 per cent in the US. Ten years ago it was at 80 per cent. Mitt Romney, frontrunner for the Republican nomination in this year’s presidential contest, once boasted of his success in building Bain Capital, the private equity business. Now, a career at the sharp end of capitalism’s creative destruction may prove a political liability.

Ironically, the poll found that faith in the market was significantly stronger in China. There were higher scores, too, in Brazil and Germany. Capitalism, leaders of most political colours seem to agree, is still the only show in town – but must it be unfettered?

In Europe, the debts of the banks have been piled on to the deficits of governments, turning a financial crisis into one centring on sovereign debt. The storms engulfing the euro threaten the continent’s most ambitious project. Angela Merkel, German chancellor, warns with only slight hyperbole that the euro’s failure would imperil decades of European integration. On the other side of the Atlantic, an initial fragile consensus in Washington on rescuing Wall Street has given way to political gridlock. Barack Obama faces a constant struggle with Republicans in Congress to secure enough money to keep the federal government running.


All the while, the Tea Party, the Occupy movement and, in parts of Europe, rightwing populists shout from the sidelines. Greece and Italy have lost elected politicians to technocrats. Elsewhere, presidents and prime ministers more closely resemble victims than masters.

In 2009, things looked as if they would be otherwise. Surveying the nationalisation of a slew of US financial institutions and Washington’s takeover of the automotive industry, a senior Chinese official remarked laconically that he detected “socialism with American characteristics”. In Britain, the crash obliged the government to take controlling stakes in two of the biggest banks and to prop up several smaller ones. What had seemed be a life-threatening event has become a chronic illness – not so much a crisis of capitalism but of the capacity of politicians to manage it.

The banks’ losses have been nationalised. Billions of dollars of toxic assets that once sat on the books of financial institutions have piled further pressure on public deficits already swollen by recession.


Governments badly need growth. The US economy shows signs of life, but its recovery has been anaemic. Mr Obama’s hopes of a second presidential term rest critically on a sustained fall in unemployment. In Europe, growth has all but disappeared. The eurozone’s peripheral economies – Greece, Spain, Portugal and Ireland – are on life support and the continent’s banking groups are kept afloat on a sea of liquidity provided by the European Central Bank.

The pervasive sense of political powerlessness is a western rather than a global phenomenon. China, India, Brazil and the rising rest are not immune from the troubles of the rich nations but their economies have continued to grow. For most Asians, today still feels better than yesterday and tomorrow looks better still. American and European politicians have discovered that capitalism no longer belongs to the west. Instead, the troubles faced by the advanced economies have crystallised the wrenching shift in the balance of global economic power. The Chinese, Indians, Turks and Brazilians now have a say in setting the terms of exchange.

Politicians of the left and centre-left saw opportunity in the crash. The Washington consensus, the organising idea behind the global advance of laisser-faire financial capitalism, had been discredited. The demise of market liberalism, the socialists and social democrats assumed, would rehabilitate the role of government as the pivotal actor in economic management. Popular fury with the bankers would translate into renewed faith in the efficacy of the state. As things have turned out, the centre-right has all but swept the electoral board.


Policy Network, the progressive think-tank, has an explanation. The mistake of the centre-left was to misread the anger at the excesses of the market as a return of public confidence in the state. The organisation’s opinion surveys show that the crisis has come to be seen in the minds of voters as one of public borrowing and debt as well as of bankers’ greed. Voters do not think the answer to spiralling deficits is more government borrowing. “It is the question of the state – its size, its role, its efficiency – that has become the central issue, not the inherent instability and free-market ideology,” Policy Network observes. Put another way, if capitalism needs fixing, Europeans have decided to leave the task to the politicians who best understand the marketplace.

The Occupy movement that has sprung up across American and European cities has drawn sympathy from beyond the protesters’ natural constituency. But its many threads – some anti-capitalist, some anti-globalisation and many social democratic – have fallen short of a coherent prospectus. On the populist right the themes are sometimes complementary, as in opposition to immigration, but as often as not contradictory. The Tea Party has harnessed Americans’ scepticism about the role and motives of the federal government: Washington is the big danger. In France, the Netherlands, Finland, Hungary and beyond, parties of the far right have targeted global capitalism as the enemy – with the International Monetary Fund and the European Union at times thrown in as co-conspirators.

Waning public confidence is in part simply a reflection of the brutal economic facts. The financial crash inflicted huge losses on the innocent. Unemployment has risen sharply and living standards have stagnated or fallen. Yet even as they have been swept along in treacherous currents, politicians have not helped themselves. The west is not blessed by decisive leadership. Mr Obama lacks the temperament of a Franklin Roosevelt. Ms Merkel’s almost pathological caution has significantly raised the cost of rescuing the euro – if such a rescue remains possible. Nicolas Sarkozy, the French president, has energy and rhetorical ambition but lacks clarity and concentration.


Missing, too, has been a convincing prospectus. The regulation of financial institutions has been tightened. The US has its Dodd-Frank Act and Volcker rule; Britain has its Vickers commission on banking. Germany and France are plotting a financial services tax. Mr Obama promises less Wall Street and more Main Street, Britain’s David Cameron less financial engineering and more of the real sort. The talk of “responsible” capitalism, of rebalancing economies and constraining the rewards of the super-rich, falls short of anything resembling a grand plan. The ambition is to make do and mend.

Behind all this, however, lies the structural problem – the mismatch between global economics and local politics. States have been shedding power to globalisation. The big lesson has been about the extent to which globalised capitalism has outstripped the capacity of national governments to manage it.

Governments have ceded power to mobile capital, to cross-border supply chains, to instant global communications and to rapid shifts in comparative advantage. Citizens expect their politicians to protect them against the insecurities of the age – whether economic or physical. Yet governments no longer have the tools to provide such a shield. “Inequality is being driven by globalisation,” one senior minister in Mr Cameron’s government says of the wage stagnation faced by the middle classes. “And there is not a lot we can do about it.”

The same might be said of the rise in structural unemployment in most rich economies as comparative advantage has moved rapidly eastwards.

It is this gap between the supply and demand for governance that fuels popular discontent, and gives impetus to the temptation for states to look in on themselves. It explains the rise both of rightwing populism and the anti-capitalist movements of the left, and risks fuelling a dangerous revival of the politics of identity on both sides of the Atlantic. The response of many governments has been to turn inwards and seek to defy the realities of interdependence by elevating narrow definitions of national interest. Old concepts of mutual interest and solidarity have cracked even in the eurozone, the most closely integrated group of rich nations.

Ms Merkel says German voters cannot be held responsible for the feckless behaviour of their spendthrift European cousins. Politicians on the continent’s troubled periphery rail against German selfishness. The effect has been to recast the euro crisis as a zero-sum game. What Greece, Portugal, Spain and Italy stand to gain, creditor nations such as Germany, the Netherlands and Finland must lose.

The signal this sends to rising states is equally counterproductive. The sense of collective interest visible at the post-crash meetings of the G20 has dissipated. If states so politically integrated as those in the eurozone are so reluctant to act in concert, why should China, India or Brazil invest their faith in co-operative global governance? It is a question to which western leaders have yet to find an answer.

Charles Kupchan, a professor of international relations at Georgetown University, says the political breakdown – political stasis in the US, a fracturing of solidarity in Europe and a merry-go-round of prime ministers in Japan – adds up to a crisis of governability. The diffusion of power in the international economic system has diluted the efficacy of traditional policy tools. There are answers to the malaise, he says, including more government activism in the provision of infrastructure and training, and drives to improve competitiveness and weaken the special-interest groups that have captured some of capitalism’s commanding heights.

These, though, are not quick fixes. The danger is that what started out as a crisis of financial capitalism will give way to a new age of nationalisms – a backlash against globalisation and a return to zero-sum politics. The better route would be an effort to extend and refurbish the multilateral order to match economic integration with great global governance. But, for the moment, we are as far from that as from a serious attempt to remake the rules of capitalism.

How A Vicious Credit Cycle Has Left States Saddled With Debt

Debt crises rarely occur in isolation – which is why many investors and academics looking at the sovereign debt inferno raging in the eurozone prefer to cast it as the latest in a series of rolling crises stretching back at least a decade, writes Richard Milne.

Today it is government debt that is under the microscope. The net debt of advanced economies has risen from 45 per cent of gross domestic product in 2007 to an expected 73 per cent this year – and will rise to 78 per cent by 2016, according to forecasts from the International Monetary Fund.

However, the debt cycle began with companies at the start of the century, as businesses launched expansion programmes funded by cheap credit, which were followed by a wave of bankruptcies. By 2007-08, consumers and banks caught up in the escalating global financial turmoil were facing their own debt crises. This forced states to intervene, both to save lenders and to try to keep their economies growing, leading to a rise in public debt.

Taking the UK as an example, a new report from the McKinsey Global Institute on debt and deleveraging shows government debt was reasonably stable between 1987 and 2008 at 40-50 per cent of GDP. But between the end of 2008 and the end of 2011, it shot up from 53 to 81 per cent of GDP.

The ballooning in household and financial institutions’ borrowing came earlier. Both experienced big rises from 2000 to 2008. Household debt jumped from 69 to 103 per cent of GDP, while financial institutions’ debt nearly doubled from 122 to 209 per cent of GDP.

The McKinsey report looks to the experiences of Sweden and Finland in the 1990s for an idea of how deleveraging will play out in the west. The authors find that the US has followed the Nordic path most successfully, with aggressive debt reduction by consumers, companies and financial institutions. Household borrowing could be cut to sustainable levels in just two years, whereas in the UK it could take as long as a decade.

The question of how developed countries can reduce their debt piles is knottier. Many investors and academics have turned to the work of Carmen Reinhart, a US academic who has shown how states have opted for “financial repression”. A combination of caps on interest rates – such as the quantitative easing policies used by the US and UK central banks – and captive domestic investors helps to keep state borrowing costs low. It is a phrase likely to be heard more and more.

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