Public Values

Financial crisis vindicates the role of government

Letting the financiers regulate themselves leads to disaster - Mel Watkins.

Mel Watkins sees a new and positive role for government emerging from the financial crisis. OTTAWA, October 9, 2008 — The world financial crisis appears to have turned the tide against laissez-faire economics and restored the reputation of an activist role for government in monetary and fiscal policy. At the launch of PublicValues.ca this week, economist Mel Watkins said world opinion is swinging rapidly in favour of public intervention in the markets on behalf of ordinary people.

"This financial crisis and the global economic crisis... is giving the notion of an unregulated market a very bad name indeed," said Watkins, who, this year, was co-winner of the first John Kenneth Galbraith Prize in Economics.

"The debate is going to swing from how bad deregulation is to the need for re-regulation. Then the question will become, who gets to work that out" and in whose interest new regulations are made. If 'bail-outs' are in the works, is it just a bailout for Wall Street, representing the rich, the wealthy and the powerful? Or is it a bailout for people in general?"

 

"There's no evidence that Stephen Harper even knows he's in a box, much less has he the ability to think outside of it."

Watkins does not anticipate a 1930s-style depression, thanks to the existence of central banks. "We've seen the extraordinary activity of central banks in the last two weeks. We've seen how the Canadian central bank, in spite of Mr. Harper's insistence that all is well, has already pumped something in excess of $20 billion in increased liquidity into the economy."

He blames the financial crisis on the development of speculation in financial derivatives, which has been enabled through deregulation in the United States. "It has been impossible for the regulators to keep up with this innovative side of these derivatives. And the solution almost surely lies in regulation which will not only watch over, but sharply diminish a lot of this kind of casino-like activity going on."

Much of the crisis, he says, stems from financial deregulation in other countries that has eliminated "the kind of firewall that exists in the deposit banks," which have assets to back up their loans. The connection between deposits "and the investment banks with all their instability was essentially broken down and put the entire banking sector at risk in the process."

Had Canada allowed the kind of bank mergers and foreign bank buyouts for which big business had been applying pressure, the situation would be very different. "If that regulation had been not held to, Canadian banks would probably all have disappeared by now. Most of them would have become American banks and most of them would be going bankrupt at the moment as a result."

He said that the financial crisis likes this requires getting beyond rigid ideologies. "You're going to have to do some... thinking outside the box. And there's no evidence that Stephen Harper even knows he's in a box, much less has he the ability to think outside of it."

Watkins sees a world-wide change underway in how people see the role of government, and he doesn't think Harper understands. "He'll be dragged kicking and screaming to any new and positive version of the what the role of the state has now to be, now that we see that not having regulation, letting the financiers regulate themselves, leads to disaster."

Here is the full text of Dr. Watkins' address at the launch of PublicValues.ca:


It's a great time to be an economist. It's a bit like being a doctor in the midst of a plague, I suppose, provided no-one asks you whether you're in any way responsible for it. I certainly think the timing of launching this site is very good, indeed. Because what we're seeing now, particularly in this financial crisis and the global economic crisis, which is already the most serious that we've seen since the 1930s, this is giving the notion of an unregulated market a very bad name indeed.

So bad that George Bush hardly wants to leave the White House any more. So bad that McCain is probably going to lose the American election, exactly because of what's happened in the economy. So what we have I think is a very powerful case that can be made for a public presence and indeed what may well be the case is that the debate is going to swing from how bad deregulation is to the need for re-regulation. Then the question will become, who gets to work that out.

That's what we're seeing now with the so-called bailout package in the United States. Is it just a bailout for Wall Street, representing the rich, the wealthy and the powerful? Or is it a bailout for people in general? American politics is pretty exciting at the moment because of what's going on there. It's not just going to be an American phenomenon, I'm sure. We're certainly going to see some emergence of that here in Canada as well. So we have to be ready for those debates and ready to say, look, you're not re-regulating in a way that makes sense in terms of the genuine public interest.

One of the things, when you listen to the media, that you frequently hear being put to economists I've had the question put to me is whether this is going to become a Great Depression like the 1930s. And if the answer is that it won't — and I think that is the best answer at the moment it's going to be bad but not utterly catastrophic. The key reason is going to be because of central banks. We can go back and look at the difference between now and the 1930s, we have active central banks in a host of countries and they are in very close touch with each other on a regular basis.

And we've seen the extraordinary activity of central banks in the last two weeks. We've seen how the Canadian central bank, in spite of Mr. Harper's insistence that all is well, has already pumped something in excess of $20 billion in increased liquidity into the economy.

My point is a very simple one. The central bank is part of the public sector. My second point, I've already alluded to it, is to make sure the central bank understands that and doesn't just see itself as bailing out banks, but as being responsible for a whole broader range of responsibilties. It has been a long time since we've had a proper review of central banks themselves. We know how important they are, and they're too important just to be the creatures of the private sector itself.

We can also ask ourselves about the many things that appear to have caused what now will be almost certainly a very deep and long lasting recession. If we look at the financial side of it, I think there's two things we can see that have contributed to it that are germane to what we want to talk about.

First, the financial district not only in the United States has been incredibly inventive in creating new kinds of financial instruments, or so-called derivatives, which permit of a very considerable amount of speculation in futures markets and so on. It has been impossible for the regulators to keep up with this innovative side of these derivatives. And the solution almost surely lies in regulation which will not only watch over but sharply diminish a lot of this kind of casino-like activity going on.

The central banks should be doing something on a global basis, not just in a situation of crisis, but in a situation of regulating at that kind of global level. And sometimes smaller countries are more effective than the big ones in taking a leadership role in calling for that kind of changes in governance. My point there is simply that these are instruments that are not under regulation and that it's clear that we cannot rely on self-regulation by the financial sector itself.

The other thing is that there has been a process that's pretty global of active deregulation of the financial sector in the last couple of decades, most clearly so in the United States but also in the EU, in the US where the kind of firewall that exists in the deposit banks with their stability and the investment banks with all their instability was essentially broken down and put the entire banking sector at risk in the process.

In other words, deregulation has contributed powerfully to this situation that we're now in. Now, we should point out that one of the kind of remarkable things that's happening at the moment, I certainly want to sound like Mr. Harper at all, but Canadian banks haven't gone bankrupt yet. They have in so many countries now that it's kind of surprising. How come this hasn't happened in Canada?

And I think it's essentially a tribute to the fact that there's been less deregulation in Canada of the financial sector than there has been in other countries. We have not utterly there's been some breaching of the firewall but it's still essentially a banking system based on deposit banking with the stability that comes out of that. And secondly, to ride a longstanding hobbyhorse of myself, we have not permitted foreign ownership in the banking sector. It isn't too hard to see that if that regulation had been not held to, Canadian banks would probably all have disappeared by now. Most of them would have become American banks and most of them would be going bankrupt at the moment as a result.

So that regulation we just sort of scorned in this age of globalization, turns out probably to be a critical thing that has helped to save I have to be careful not to overstate my case about what's going to happen next in the Canadian banking sector. The conclusion I'm drawing from all of this is obvious. That more active government, positive government, the State, is the solution. It's not the problem, as we've been told now for two or three decades by the neo-Conservatives.

The final point I would make about the role of government is that economists have, every since Keynes in the 1930s, made a distinction between monetary policy and fiscal policy and I've been talking here really about monetary policy, about the role of the banks. But one of the arguments that was made, and a very important argument in the 1930s, was that monetary policy was not sufficient if you had a really serious downturn. You had to have fiscal policy, taxation policy, spending policy as well.

One of the things that the neo-Conservatives have run on is that every political leader now seems compelled to say that under no circumstances will a deficit ever be tolerated. Well, I noticed that in today's newspaper Mr. Harper occasionally wakes up and smells the coffee. Discovered that in fact whoever is the next Prime Minister of Canada may well face a deficit just by doing nothing. It's going to happen anyway.

What are you going to do in those circumstances? Are you going to actually raise taxes or cut spending and actually increase unemployment? So the lessons that some of us learned when we learned our economics back in the 1950s when Keynesianism ruled the world —that's also coming back. I did my own graduate work in the United States, and American business never liked the notion of going beyond monetary policy to fiscal policy.

They tried to stop that and the whole Chicago revolution around [economist Milton] Friedman when they attempted to show that monetary policy was sufficient, period. I think we're now moving back there are long cycles here we're now moving back into an era where we can press hard and hope to get much more progressive government than we've had before. Now people say: what is the answer. Well, a lot of the answer is relearning what we've been told wrongly was wrong.

I think ideologies are in many ways just ideas that get solidified and taken over, in this case, by some very powerful people. I think if we're facing a real crisis, which we are, you're going to have to do some, as they say, thinking outside the box. And there's no evidence that Stephen Harper even knows he's in a box, much less has the ability to think outside of that.

What we're going to need, as I implied already, we're going to need new national policies and we're going to need new global policies and we're going to need national leaders to do things in their own country and to take a leadership role in getting these changes in global governance. I just don't, you know, Stephen Harper may not be literally a clone of George Bush but he's the Canadian version of George Bush.

George Bush, as I said already, can only leave the White House to appear before business audiences at the moment. Even they may boo him off the stage shortly. What's happened in the last month or so is just an incredible change. If you watch television a lot, the kinds of questions that CNN now puts or ABC or any of these networks. There's been a sea change in this mentality. I don't see Stephen Harper he'll be dragged kicking and screaming to any new and positive version of the what the role of the State has now to be, now that we see that not having regulation, letting the financiers regulate themselves, leads to disaster.

Mel Watkins is a Professor Emeritus in Economics and Political Science at the University of Toronto. He serves on the Straight Goods Board of Directors and the Maher Arar Support Committee.

Privatization vs. Public Values Frame
  Unregulated free markets / Regulations to keep speculation in check
  Laissez-faire / Protection for the public

Posted: October 09, 2008

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