By Martin Wolf
Published: November 10 2009 21:03
Ingram Pinn illustration
“A crisis is a strange way to celebrate an anniversary.” This is the wry judgment of Erik Berglöf, chief economist of the European Bank for Reconstruction and Development.* Yet a crisis is what we see in countries that began the march from communism two decades ago. So, has capitalism failed, as communism did? In a word, “no”. Some transition countries are in crisis; transition is not. The same judgment applies elsewhere: capitalist countries are in crisis; capitalism itself is not. But reform is necessary. The great virtue of liberal democracies and market economies is their ability to reform and adapt. They have shown these qualities before. They must do so once again.
For those born, like me, shortly after the second world war, the cold war was the defining intellectual and political struggle of our lifetimes. With the collapse of communism ended a catastrophic epoch of millenarian politics and the delusion of a rationally planned economy. The freedom offered by democracy and the prosperity supplied by markets won. The fact that communism expired not with a bang, but with a whimper, we owe largely to Mikhail Gorbachev.
Yet 2009 is a sobering year from which to look back. A year ago, capitalism careered over a cliff. With vast effort, states have put it back on the road. According to Piergiorgio Alessandri and Andrew Haldane of the Bank of England, in a superb new paper**, the total gross value of interventions on behalf of banks has been $14,000bn (€9,400bn, £8,400bn). This is state capitalism.
What then does the crisis mean for the countries that exited from socialism two decades ago? What, too, does it mean for the world?
For the former, it has meant big falls in output. According to the EBRD, the fall in the gross domestic product of transition countries will average 6.2 per cent in 2009. Declines vary widely: from 18.4 per cent in Lithuania, 16.0 per cent in Latvia, 14.0 per cent in Ukraine and 13.2 per cent in Estonia – depression numbers – to 7.8 per cent in Slovenia, 6.5 per cent in Hungary, 6.0 per cent in Slovakia and 4.3 per cent in the Czech Republic. Poland’s economy is forecast to grow this year, by 1.3 per cent. In general, notes the EBRD, “the size of the output declines correlates with pre-crisis credit booms and external indebtedness”. The bursting of bubbles hurts.
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These collapses are real and worrying. But they need to be put in context. First, many countries in transition experienced big increases in output after the initial and largely inevitable post-Soviet collapse (see charts). Poland was the star. In general, the successful countries were those that reformed most seriously. Second, surprisingly perhaps, transition countries have made few reversals of reforms. As the EBRD report notes, “government changes since early 2008 have either led to no change with respect to the reform stance, or indeed favoured pro-reform parties”. This is quite consistent with what is happening in the emerging world, more broadly. The absence of a credible alternative economic model is evident. Populist adventurism also seems unattractive.
As recovery begins to gather force across the world economy, the great legacies of the collapse of the Soviet empire – the integration of much of Europe and the concomitant spread of freedom to Russia’s borders, if not beyond – remain intact.
Yet the crisis brings important lessons. The philosopher Karl Popper laid down the right approach. He distinguished the “piecemeal social engineering” intended to ameliorate specific ills from the “utopian social engineering” intended to transform society in its entirety – an aim that, in practice, “has led only to the use of violence in place of reason”.
The reformer must identify the cause of the malady before attempting treatment. In the case of this crisis, the failure lies not so much with the market system as a whole, but with defects in the world’s financial and monetary systems. Some of these failings are inescapable. The future is inherently uncertain. Big mistakes will be made. Where prevailing paradigms lead to risk-taking on an excessive scale, corrections are likely to be brutal. Where risk-taking involves large-scale leveraging of the balance sheets of the financial sector, corrections are likely to mean a collapse in both intermediation and the economy. Should collapse not be prevented, the consequences may, history tells us, be dramatic.
Happily, governments and central banks have learnt the lessons of the 1930s and decided, rightly, to prevent collapses of either the financial system or the economy. That is precisely the right kind of “piecemeal social engineering”. Similarly, big efforts have been made to rescue the crisis-hit countries of central and eastern Europe. Thus, support from the International Monetary Fund and the European Union has been between 4 and 6 per cent of GDP (or more) for the four eastern European countries that have accepted IMF programmes.
A similar pragmatism must now be shown in completing the escape from the crisis. That will require substantial rebalancing of global demand. It will also require further reforms. For transition countries, a reversal of financial integration is likely to be costly and unnecessary. The principal goals of reform must, instead, be to make the economy less vulnerable to shocks and to curb excessive credit growth in future.
Similarly, at a global level, radical reforms must be made in the financial and monetary systems. To put it bluntly, the banking system has been gaming the taxpayer on an intolerable scale. This must end, in one of two ways: the sector must be made subject to the market or become a heavily regulated ward of the state. Again, the curbing of huge credit bubbles must be an integral element in the formation of regulatory and monetary policies. Finally, the dependence of the global monetary system on the currency of an over-indebted superpower is neither desirable nor sustainable.
Anniversaries are a good time for taking stock. The collapse of Soviet communism was a glorious moment. It remains so, despite mistakes and disappointments along the way. But today’s crisis tells us of the failings of a euphoric capitalism. Capitalism will not now perish, as communism did. But the signal ability of liberal democracy is to learn and adapt. We learnt from the 1930s. We must now learn the lessons of the 2000s.
* Transition Report 2009, www.ebrd.com/pubs/econo/tr09.htm
** Banking on the State, www.bankofengland.co.uk
Copyright The Financial Times Limited 2009.
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