In his infamous Monthly essay “The Global Financial Crisis“, Andrew Charlton Kevin Rudd uses the word “crisis” 14 times within three paragraphs. Scary stuff.
But my complaint about the essay is not the fear-mongering. That’s fairly standard in politics. My complaint is that Rudd simply gets the economics wrong, time and time again, starting with the second paragraph reference to “fundamentalism”.
Free-market fundamentalism?
To describe the last 30 years as a period of “extreme capitalism” or “free-market fundamentalism” is to believe the warped spin of the far-left. Free-market politics means having low government spending. Even Rudd later describes it as “government activity should be constrained”. If Rudd’s dramatic hyperbole is accurate then we would expect government spending to have reduced considerably since 1980. The truth is the opposite.
During the 1970s federal government spending grew significantly from 19% to 24% of GDP (mostly due to Whitlam). During the 80s this rose to 25%, during the 90s spending rose further to 26%, and during the last decade government spending rose to 27%. If this is “free-market fundamentalism” then what would the left chatterati call it if spending was actually reduced?
The last three decades did see some liberal reforms, as the Australian economy opened up to the world and became marginally more flexible under the leadership of Hawke, Keating and Howard. These liberal reforms turned around a struggling economy and helped Australia maintain strong growth for most of the last two decades. However, these reforms were by no means “extreme” or “fundamentalist”, and have been partially offset by the growth in government spending and creeping regulation.
The cause of the crisis
Rudd doesn’t get everything wrong. He correctly notes that falling house prices were “at the core of the crisis”. But then for some reason he cites George Soros as an expert and insists that the crisis was actually caused by capitalism. He provides no evidence for this.
Instead, he paints a childish & silly picture of “neo-liberal” thought, getting hopelessly confused in the process. Rudd complains that “neo-liberals” don’t believe in asset bubbles, but then he names these evil neo-liberals as Mises and Hayek… who both subscribed to the Austrian Business Cycle Theory (which explicitly includes the existence of asset bubbles). It seems clear that Rudd doesn’t understand what liberals think.
To understand the cause of the crisis Rudd over-looks the government policies that encourage over-investment in housing, he overlooks the expansionary monetary policy, he overlooks the failure of the (government supported) ratings agencies, he overlooks the impact of “jingle-mail”, and he overlooks the consequences of ever-growing moral hazard.
Instead, Rudd finds one piece of financial deregulation that he doesn’t like. In the late 1990s the American government allowed commercial banks to invest in capital markets (including mortgage-backed securities).
There is a link between this policy and the crisis, but it is not a strong link. The change in regulation did nothing to change the housing market, and so had no impact on the cause of the crisis. All it did was re-arrange who owned the the “toxic” financial assets. And given that most “toxic” assets were still held by investment banks and government-backed agencies anyway (not commercial banks) the regulatory change was not a significant element of the crisis.
Rudd’s second complaint is that the government didn’t do enough to ban the creation of new financial assets — such as mortgage-backed securities. Without admitting the benefits flowing from financial innovation or the difficulty in regulating new innovations, the essay smugly asserts that governments “should have done something”. But more to the point, derivatives are only as valuable as the underlying asset. While trading property derivatives will change who has the risk, it does not change the problem of the underlying property asset. Once again, Rudd is looking straight past the real problem and concentrating on less important issues.
It seems as though Rudd has skirted around all the main culprits because they were related to government failure, and then eagerly jumped at marginal issues because they are market failures. Such eagerness to warp the discussion shows that Rudd’s essay is an excercise in populist politics and not economic analysis.
But eventually, the essay has to admit to some of the main causes of the crisis. Rudd briefly notes the failures of the ratings agencies, but fails to mention that the government has endorsed two ratings agencies, exaggerating their credibility and reducing the competitive pressure for accurate risk analysis. He alludes to the problem of moral hazard, but for some reasons he simply takes it for granted and doesn’t mention that it’s created by government policy. He goes on to mention the “easy monetary policy” in passing, but absurdly calls this “the defining characteristic of Greenspan’s neo-liberal financial order”, once again showing that he has no understanding of liberal thought. Of course, Mises and Hayek would have been vocal critics of the easy monetary policy.
With all of these mistakes and distortions, it is tempting to accuse Rudd of being dishonest. But the scarier possibility is that Rudd honestly doesn’t understand what he’s talking about.
The evils of capitalism
The essay has many complaints about capitalism. Rudd is upset that in 2007 (before the financial crisis) American CEOs were paid significantly more than average workers. This point has no relevance to the essay, but Rudd is hoping he can play on envy to convince his reader that “successful businessmen are bad because they’re rich”.
One of his main targets is the Austrian economist Frederick Hayek, though it is clear from the essay that Rudd has never read (or understood) Hayek’s work. The essay wrongly claims that Hayek only believed in the market, at the expense of civil society. The truth is that Hayek strongly believed in the power of both the market and civil society. Rudd absurdly suggests that Hayek thinks “a person’s worth should be primarily … determined by the market.” This shows astounding ignorance of Hayek.
The evils of capitalism are then extended to cutting spending on education (even though real per capita spending has increased), inaction on climate change (even though billions of dollars have been spent), and removing minimum labour standards (even though that has not been done). Rudd is complaining about a neo-liberal world that doesn’t exist, and so that entire rant (over a page) actually has no relevance to the 2008 crisis.
And just to prove that he has no appreciation of liberal thought, Rudd tries to link “neo-liberalism” with “neo-conservatives” who are apparently “their ideological bedfellows in the foreign-policy sphere”. The claim is so jaw-droppingly wrong that it seems like Rudd is simply making it up as he goes along.
After considering the non-existent and misunderstood neo-liberal approach, Rudd declares that it has been a “spectacular failure” and should be abandoned. Does this mean that he wants to cut government spending by 3% of GDP to take it back to the same level as 1980? Does this mean he wants to undo the liberal reforms of the Hawke/Keating government? Or does it mean that Rudd is actually ignorant of recent economic history?
Keynes is alive
The Rudd essay is proudly Keynesian, though the glib references to Keynes & FDR “saving capitalism” seems to indicate a profound ignorance of the depression era. The great depression was caused by a number of factors, some of the central ones being excessive contractionary monetary policy and government protectionism.
The absence of these factors was a critical difference between the great depression and the 2008 world recession.
But still, Rudd wants to use the “crisis” of “extremism” to justify his preferred agenda of greater government control. He calls for more government bail-outs of failed businesses, more activist fiscal policy (ie debt & deficits), increased government regulation (specifically including international regulations), an “activist state” aiming at the “common good”, and more wealth redistribution.
Rudd particularly wants to promote his preference for “classic Keynesianism, pure and simple”, and especially his stimulus package. Citing the “liquidity trap” (for which there was little evidence in Australia, as many firms still wanted to borrow) Rudd justifies a massive build up of debt & deficits. Unfortunately for him, the cold hard evidence of his stimulus package shows that it will produce little benefit for a high cost.
It seems likely that Rudd doesn’t actually understand what “liquidity trap” means, nor does he understand the fiscal policy transmission mechanism, or the links between foreign borrowing and net exports. These issues aren’t common knowledge, but if Rudd wants to increase government control of the economy then he should at least understand how it works.
Liberal Party
Of course, Rudd wants to use his warped economic understanding to attack the Liberals, claiming it as the “home of neo-liberalism in Australia”. It is true that the Liberal Party (like the pre-Rudd Labor Party) supported some liberal reform over the last 30 years, and it is true that there are some Liberals who admire the liberal philosophies of Hayek and Milton Friedman.
But Rudd’s attack fails because it is simply not true that the Howard Liberal government pursued a Hayek agenda. Indeed, many economic liberals were frustrated at Howard’s unwillingness to pursue liberal reform.
Rudd claims that Howard cut education and health spending, but the truth is that spending went up (even adjusted for inflation and population growth). Besides labour market changes, the rest of Rudd’s complaints are marginal issues of what the Howard government didn’t do… not changing the punishment for already illegal cartel behaviour, not limiting private debt, not over-riding State government responsibilities, not preventing some business mergers, and not formalising deposit insurance. Rudd quotes Howard as saying “we should avoid the resort to re-regulation.”
If “no new policy” is an example of “extreme capitalism” or “free-market fundamentalism” then what would Rudd call it if the Howard government had actually reduced the size of government?
Rudd wants to paint himself as the moderate compromise candidate and the Liberals as the extremists. In truth, it was the Howard government that pursued a “business as usual” mixed economy, while the Rudd reforms are a step into the unknown of super-sized government intervention.
The sad and scary truth is that the author if this new big-government agenda doesn’t understand economics.
