Like a wayward child, capitalism needs a firm hand

Perhaps it’s the floundering economy that’s made a rock star of Paul Krugman. An economist who teaches at Princeton University, Krugman and his prescriptions for dealing with the recession have taken center stage in the discussion about extricating ourselves from this mess

Last updated on May 04, 23

Posted on Oct 09, 09

3 min read

Perhaps it’s the floundering economy that’s made a rock star of Paul Krugman. An economist who teaches at Princeton University, Krugman and his prescriptions for dealing with the recession have taken center stage in the discussion about extricating ourselves from this mess.

He was certainly the center of attention in Waterloo last weekend as The Centre for International Governance Innovation (CIGI) hosted its annual conference, bringing together a range of policy experts to discuss the global economy. Krugman delivered the keynote address, meeting with the media beforehand to field questions.

Krugman, the winner of the 2008 Nobel Prize for Economics, has in fact enjoyed celebrity status for some time for his prolific writing and his ability to explain sometimes arcane economic theory in language accessible to the public – he’s written a popular op-ed piece for the New York Times since 1999.

His star ascended even higher as the George W. Bush formula continued to tank and Barack Obama came to power. Krugman’s take on economics is essentially Keynesian, refuting the Milton Friedman philosophies embraced by the U.S. Republican party and its most ardent right-wing supporters.

He welcomed the massive stimulus spending in the U.S. In fact, he thinks more is needed, perhaps as much as three per cent of that country’s GDP, or some $900 billion. Even with that, he’s not overly optimistic there’ll be a turnaround in the near future.

“I worry that this thing can go on for a long time,” he says.

While we might be at the technical end of the recession, with some measure of growth and a rebounding stock market, the indicators that matter most to average people, particularly employment figures, continue to worsen, he notes.

Stimulus spending helped pull some parts of the economy back from the brink, but won’t help employment numbers until late next year; if the last two recessions are any indication, the job market will lag the technical recovery by 18 months.

He admits to being surprised by the fragility of the financial system, which experienced a meltdown akin to the bank runs of 1930-31.

“I thought that was impossible. But there have been a lot of surprises, most of them nasty.”

Given the level of personal debt, the consumer spending orgy that fueled the last boom is unlikely to be repeated as we look to recover this time. Those excesses, especially the unprecedented borrowing to buy homes, led to the bubble bursting and the eventual collapse. Now, the near-zero levels of savings are likely to increase – we’re saving more for a rainy day – but not likely to rebound to the eight or nine per cent seen in the past: we’ll spend, but will likely do so more wisely, he suggests.

Americans lost $11 trillion in wealth in this downturn. They’ll be looking to get some of that back. In the absence of a consumer-led recovery, more stimulus will be needed. Ideally, he says, we need a source of demand, something on the scale of the invention of the Internet or the railroad to drive major business investment.

Even with that kind of investment, the U.S. system, which has such a profound influence on the rest of the world, needs an overhaul, particularly in the rules governing financial institutions, Krugman argues.

In his latest book, The Return of Depression Economics and The Crisis of 2008, he notes that regulations were loosened, allowing the rise of what he calls the shadow banking system. These were the real culprits, largely unregulated parts of the financial system that passed out loans like candy and then, eschewing risk, rolled high risk mortgages into what were touted as safe investments.

“As long as housing prices kept rising, everything looked fine and the Ponzi scheme kept rolling,” he writes.

Homeowners thought the good times would continue, with rising prices covering off the fact they’d overextended themselves on their mortgages. Lenders paid no heed to the loans, “because they didn’t hold on to them. Instead, they sold them to investors, who didn’t understand what they were buying.” This “securitization” of home mortgages involved “assembling large pools of mortgages, then selling investors shares in the payments received from borrowers.”

Many of these lenders were organizations such as investment banks which fell outside the regulatory system, having been minor players in years past. By the time Lehman Brothers collapsed in 2008, the top five investment banks had $4 trillion on the books. The deregulation frenzy didn’t even come into play, though “malign neglect” saw many oversights by the overseers, Krugman says.

What’s needed now is tighter regulation. There used to be such controls, but over the past three decades or so, governments “threw away the rulebook.”

A liberal in the American sense of the word, he likens his political position to the social democrats of Europe. He still favours a market system over any other.

Referencing Michael Moore’s new film, Capitalism: A Love Story, Krugman says the capitalist system is here to stay, but requires ground rules – “capitalism with adult supervision.”

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Steve Kannon

A community newspaper journalist for three decades, Steve Kannon is the editor of the Observer.

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