Prospect event: On 17th September, Martin Wolf, described in the current issue of Prospect by the economist Kenneth Rogoff as “the world’s premier financial journalist,” will be visiting our London offices to talk about his new book, “The Shifts and the Shocks: What We’ve Learned—And Have Still to Learn—From the Financial Crisis”. To book tickets, click here.
In this brief extract from the conclusion to the book, Wolf assesses the political, as well as economic, damage caused by financial crises. Perhaps the most “insidious” legacy of the crash of 2008, Wolf argues, is a crisis of democratic legitimacy that breeds “outraged populism, on both the left and the right.” Recovering from the massive shock administered to the global financial system six years ago requires more than restoring western economies to growth. Political leaders need to learn the lessons of 2008 and act on them. If they don’t, Wolf concludes, “next time a big crisis arrives even our open world economy could end in the fire.”
Financial crises do more than impose huge costs: they have bigger and more insidious effects. Inevitably, such crises help undermine belief that a globalising economy is of benefit to the vast majority of people. They make people anxious and angry and rightly so. Angry and anxious people are not open to the world. They want to hide in their caves, together with similarly angry people.
Equally inevitably, crises undermine confidence in the elites. In democratic societies, a tacit bargain exists between elites and the rest of society. The latter say to the former: we will accept your power, prestige and prosperity, but only if we prosper too. A huge crisis dissolves that bargain.
Here then are three huge failures of the western elites.
First, the economic, financial, intellectual and political elites misunderstood the consequences of headlong financial liberalisation. Lulled by fantasies of self-stabilising financial markets, they not only permitted but encouraged a huge and, for the financial sector, profitable bet on debt. The policy-making elite failed to appreciate the risks of a systemic breakdown. The financial elite was discredited by both its behaviour and its need to be rescued. The intellectual elite was discredited by its failure to anticipate a crisis or agree on what to do after it had struck. The political elite was discredited by their willingness to finance the rescue, however essential it was.
Second, the past three decades have seen the emergence of a globalised economic and financial elite that has become ever more detached from the countries that produced them. In the process, the glue that binds democracy—the notion of citizenship—has weakened. The narrow distribution of the gains of economic growth risks exacerbating this development.
Third, in creating the euro, the Europeans took their project beyond the mundane into something far more important. The economic troubles of crisis-hit economies are evident: huge recessions, extraordinarily high unemployment, mass emigration and heavy debt overhangs. The constitutional disorder that has resulted remains insufficiently emphasised. Within the eurozone, power is now concentrated in the hands of the governments of the creditor countries, principally Germany, and a trio of unelected bureaucracies—the European Commission, the European Central Bank and the International Monetary Fund. The peoples of adversely affected countries have no influence upon them. The politicians notionally accountable to them are powerless.
The loss of confidence in the competence and probity of elites inevitably reduces trust in democratic legitimacy and creates outraged populism, on both the left and the right. Yet willingness to accept shared sacrifice is likely to be still more important in the years ahead than it was before the crisis. The economies of the western world are poorer than they imagined ten years ago. They must look forward to a long period of retrenchment. Making that both be and appear fair matters.
Every effort must be made to restore economies to growth. Every effort must be made, too, to ensure that a similar crisis will not recur without eliminating those aspects of an open world economy and integrated finance that are of benefit. This will require more radicalism than most recognise. We must not only learn the lessons about how the world economy went awry. We must also act upon them. If we do not, next time a big crisis arrives even our open world economy could end in the fire.
Martin Wolf’s “The Shifts and the Shocks” is published by Allen Lane (£25)