The 1936-1937 sit-down strike forced General Motors to recognize the United Auto Workers as the workers’ union.

It began on December 30, 1936, at Fisher Body No. 1 in Flint, Michigan: workers occupied General Motors factories, launching one of the key struggles in U.S. labor history. A Women’s Emergency Brigade brought them food; when the police tried to drive out the strikers with tear gas, the women broke the windows to give them fresh air. After 44 bitter winter days, the sit-down strike forced GM to recognize their union, the United Auto Workers.

It was no accident that Flint was the scene of this historic battle. One hundred years ago, when the city boasted the largest factory in the world – a Buick plant – the people of Flint elected a socialist mayor. But GM founding partner Charles S. Mott won two years later, campaigning on a platform whose first point was “Only men who are successful at business should run city affairs.”

A painting on display at the Alfred P. Sloan museum in Flint depicts the Women’s Emergency Brigade during the sit-down strike of 1936-37.

The U.S. auto industry pioneered not only mass production but also mass consumption. “The American citizen’s first importance to his country is no longer that of citizen but that of consumer,” the pro-business Flint Journal editorialized in 1924. “Consumption is the new necessity.”

By the early 1950s, when I was a baby and my parents moved there, Flint’s workers were earning the highest industrial wages in the nation. In an exhibit called “Flint and the American Dream,” the city’s Sloan Museum displays the household belongings of a typical auto worker of the era: the kitchen appliances, formica countertops, and chrome-and-vinyl furniture, the lawn mower and charcoal grill of my childhood.

Abandoned houses pockmark the author’s old neighborhood.

Flint’s American dream is now a distant memory. Starting in the 1970s, one auto plant after another shut down, a downward slide vividly portrayed in Michael Moore’s film Roger & Me. In the 1981 recession, Flint had the highest unemployment rate in the country. Today, despite the fact that Flint’s population has fallen to less than 60% of what it was in 1960, the city’s unemployment rate still ranks in the top 20 among the country’s 372 metropolitan areas. In the neighborhood of company-built bungalows where I lived as a toddler, the pavements are cracked, the median strips overgrown with weeds, and abandoned, burnt-out houses decay amongst the surviving homes.

How did this reversal of fortunes happen?

The reasons behind Flint’s collapse are not only the greed and sheer ineptitude of General Motors’ management, memorably depicted in Roger & Me, but also monumental public policy failures. These include:

• massive foreign borrowing, an overvalued dollar and unprecedented trade deficits, beginning in the Reagan era, the fatal macroeconomic nexus that decimated American manufacturing;

• the failure to grow Medicare into a nationwide single-payer health care system, leaving U.S. firms – alone among those of advanced industrialized countries – saddled with employer-provided health insurance costs that further eroded their competitiveness; and

• racial divisions, “white flight” to the suburbs, and ill-conceived expressways that tore apart the social capital that was needed to mount an effective local response to these crises.

The grim result is that the American auto industry, which already had pioneered planned obsolescence in consumer goods, went a step further: Flint became a disposable city.

What can we learn today from Flint’s history? In hindsight, the consumption-based social contract espoused by the Flint Journal was not sustainable. It turns out that being a consumer is not a substitute for being a citizen. Caring about things is not more important than caring about each other. Private goodies are not a worthy substitute for public goods. Government cannot be entrusted safely to captains of industry. Our ability to consume cannot be detached from our responsibility to govern ourselves.

So Flint’s American nightmare teaches us this: When we elevate consumption above citizenship, we imperil not only our democracy, but in the end our economy, too.

Regarding the Dodd-Frank Wall Street Reform and Consumer Protection Act, one can debate whether the “glass is half empty or half full,” but the verdict may not be known for years.  If the Act is the beginning of the end of years of laissez-faire and deregulation, then ultimately the verdict will be positive.  In the 1930s, the New Deal legislation was not accomplished through one law, but through a series of laws and regulatory measures.

I fully understand Jeff Madrick’s critique. The Act’s approach is far from being perfect, as it focuses more on plugging holes than on creating a new paradigm for financial markets. But, it has several redeeming features: reducing proprietary trading by banks; shifting an important part of derivative trading to central counterparties; providing consumer protections; and requiring reporting by extractive industries in ways that can significantly advance transparency.

European reforms are still nascent. Many laws are still in the pipeline – quarrelling between member state governments and the European Parliament has postponed the timetable for passage. In addition, reforms face opposition everywhere, especially from the financial services lobby.  To top things off, the European Union struggles with its inadequate institutional structure when it comes to dealing with the financial crisis.

Therefore, Europe is still battling over whether the new European supervisory agencies will have only weak coordinating functions or enforcement powers.  Member state governments, mainly in Britain, but also in Germany, are unwilling to transfer the necessary powers and competencies to the European level.  Still more ridiculous is the fact that the planned supervisory authorities for banks, insurance companies and securities will probably be set up in different countries – thus weakening their capacity to work together closely. This demonstrates how national egotism impedes rational solutions.

The US reform – even with its weaknesses – puts pressure on the European Union to follow suit. The Dodd-Frank-Act is a clear sign to European countries and others that their corporate subsidiaries in the US will be imperiled if they fail to adopt similar provisions.

Without a doubt, one of the disappointing facts is that the compromise struck in the US Congress does not include the levy on banks intended to raise up to $90 billion. The intention — to make the institutions responsible for the crisis foot the bill for it — was not realized and taxpayers are left “holding the bag.” Comparable resistance to proposals is evident in Europe.  For instance, some European governments are blocking the introduction of a European Financial Transaction Tax. To me, this is, together with the loopholes in the Volcker rule, the clearest example of how powerful banks fend off reform.

The priorities for the future are clear. In my opinion, we have to work more intensively on the root cause of weak legislation – namely, regulatory capture and lobbying. We find ourselves trapped in a vicious circle: As long as the financial sector retains its influence on financial market reform, regulators will not enact and enforce the desired rules. But to reduce this influence, we would need financial market reform to diminish the sector’s grip on its regulators. As the Dodd-Frank Act opens the way for hundreds of new rules to be set by the regulators within the next 6 to 36 months, a large part of the work still lies ahead and its quality will depend very much on how much regulators conform to the industry’s will.

In Europe, lawmakers of all the major political parties called out for help in countering the power of the financial services industry. As this “call” states, it is fine if  “[financial] companies make their point of view known and have discussions on a regular basis with legislators. But it seems to us that the asymmetry between the power of this lobbying activity and the lack of counter-expertise poses a danger to democracy. Indeed, this lobbying activity should be balanced by that of others. [...] As European elected officials in charge of financial and banking regulations, we therefore call on civil society (NGOs, trade unions, academic researchers, think-tanks…) to organize to create one (or more) non-governmental organization(s) capable of developing a counter-expertise on activities carried out on financial markets by the major operators (banks, insurance companies, hedge funds, etc …) and to convey effectively this analysis to the media. [...]“.  We hope for a strong response to this call.

In a 1965 essay, the great development economist Albert Hirschman bemoaned the tendency of those in his profession to look for the next panacea. Unfortunately, various panaceas have come in and out of fashion since Hirschman wrote.

During three decades of neo-liberalism, development economists and policymakers have celebrated three inter-related strategies:  (1) free markets, (2) private ownership, and (3) private international capital flows. The latter refers to several types of flows—loans by foreign banks, foreign direct investment (i.e., the purchase of more than 10% of the assets of a foreign corporation), portfolio investment (i.e., the purchase of foreign financial assets, such as stocks or bonds), and worker remittances (i.e., the funds that migrant workers send home generally to their families, but sometimes also send collectively through “home town associations” to fund infrastructure projects in their towns of origin). Policy in the neo-liberal era sought to maximize all four of these financial flows.

Especially after the Asian financial crisis of 1997-98, many policymakers turned particular attention to maximizing the receipt and the developmental impact of remittances. This was especially the case among those developing countries that were not terribly successful in attracting other types of international private financial flows, as these have long been highly concentrated among a small handful of large, rapidly growing developing economies. Indeed, maximizing the migration of healthy workers and garnering the remittances they sent home became a kind of default development strategy in many countries. Jamaica and the Philippines are examples of countries where policymakers came to conflate the export of their people (especially nurses and domestic servants, respectively) and the import of their remittances with a real national development strategy.

For a while, the strategy seemed to work. Remittance flows to developing and post-Communist countries grew rapidly between 2002 and 2007. Remittance inflows are more than twice as large as foreign aid inflows, and nearly half as large as total foreign direct and portfolio investment to the developing world. They are also far less concentrated in larger developing countries than are other types of international private capital flows. In many developing countries, recorded remittances were and still are the largest source of external finance of any sort. Remittances are also less volatile than other international private capital flows. And, historically, they have been counter-cyclical, since migrants tend to send more remittances to their countries of origin following downturns, crises, natural disasters and political and civil conflicts in their countries of origin. This counter-cyclicality contrasts sharply with all other international private flows, which are strongly pro-cyclical and hence can contribute to economic instability during crisis.

Research on remittances has established that they are an important source of social and economic support to families, regions and even governments since they augment consumption after crises, they often allow poor families to pay for school, medical expenses and housing, they fund small business development and, in some cases (such as in Mexico) they have provided financial support to infrastructure projects.

Less well-known research on remittances also revealed that they have other more complex, some times negative political, economic and social effects on recipient countries. For example, in a paper on the political economy of remittances, I review evidence from studies that find that large inflows can cause exchange rates to appreciate. I argue there as well that dependence on remittances can induce what I term “public moral hazard.” By public moral hazard I mean that the receipt of large volumes of remittances can cause states in the developing world to reduce expenditures on public goods that have traditionally depended on public support, such as public investment in infrastructure and social services.

Relatedly, others have argued that remittances can protect governments from the political consequences of poor policy choices.  Some also argue that migration and the receipt of remittances undermines “political voice” in recipient economies (using another of Hirshman’s concepts) because they reduce the incentives for the efficacious members of society to advocate for governance improvements.

Notwithstanding these complex effects, many policymakers worried at the start of the global crisis that the number of migrants and the amount of money that they sent home would diminish dramatically because so many countries are making migrants unwelcome and because job opportunities in some of the main host countries were drying up. Initially this seemed to be the case – officially  recorded  remittance  flows  to  developing  countries  fell by around 6  percent  in 2009 from their level in 2008. This fall was far more modest than initially forecast. It seems that migrants—many of them very poor—are doing all they can to continue to live abroad and to send money home to their even poorer families, even when this means that those already living on the edge have to make even greater sacrifices.

As a recent Oxfam study reports, these sacrifices are being borne most heavily by women and children in both sending and recipient countries.  Anecdotal evidence also suggests that “reverse remittances” are now occurring, as some families in the countries of origin send money to migrants so that they can remain in their adopted country.

At present, those who forecast remittances are surprisingly upbeat. They predict a recovery of global remittance flows in 2010-11 (though, to be fair, the forecast acknowledges numerous possibly mitigating factors, such as rising anti-immigration sentiment in many countries, the fragility of the global recovery, etc.). The most reasonable explanation for this optimistic forecast is in fact quite dismal: conditions in the poorest countries may become so bad in the next few years that further migration is induced despite the myriad obstacles, and migrants will continue to send money home to desperate families, even at the cost of their own consumption.

On the other hand, remittances may well slow to a trickle, given the likelihood that the recession will worsen in some of the world’s wealthiest economies (no doubt thanks to the austerity-obsessed G-20), which may in turn induce legislation or activism that makes migration even more untenable.  Were this to occur, we might find that members of the policy community who, just a few years ago, celebrated the developmental impact of remittances are compelled to recognize the limitations of these and other international private capital flows. We may learn that remittances do not suffice as substitutes for economic development strategies that mobilize and channel domestically-generated resources.

Utopian thinking that features one panacea or another is habit forming. Indeed, we see that the Indian government has recently fallen back on external capital flows by taking steps to make it easier for foreigners to engage in portfolio investment in the country.  But we can hope that this is among the last gasps of a discredited development strategy.  Indeed, this seems to be the case, as several TripleCrisis bloggers have noted in their discussions of the new thinking and institutions that are emerging in the developing world (e.g., Diana Tussie, Matias Vernengo, Kavin Gallagher and myself).  None of these initiatives points to a single panacea, and that is something that we can be sure Hirschman himself would appreciate.

Gerald Epstein

On July 21, 2010, President Obama signed into law the long awaited “Dodd-Frank Wall Street Reform and Consumer Protection Act”.  Press reports widely anointed it “the most sweeping financial reform since the Great Depression” and President Obama echoed that view, claiming that, among many other virtues, the law would bring about the end of tax-payer bailouts of “too big to fail” (TBTF) banks.

Yet, not everyone is convinced. Matt Taibbi was typically scathing: “… it was…ultimately a cop-out, a Band-Aid on a severed artery. If it marks the end of anything at all, it represents the end of the best opportunity we had to do something real about the criminal hijacking of America’s financial services industry…See you at the next financial crisis.”

An email message from a colleague summed this up succinctly: “News of the … bill was released; bank stocks rose – enough said.”

Still, something of value did happen in the protracted fight over financial reform.

Robert Johnson of the Roosevelt Institute captured the spirit: “What is heartening is to see how so many people and organizations … have contributed the energy to learn and engage and push relentlessly for reforms against the monied odds… This is the first act of a many act play (emphasis added).” These included groups like the Americans For Financial Reform, a coalition of 250 labor, community and consumer groups, SAFER, a group of economists and other analysts, Demos, a progressive “thinktank”, Bankster USA, a media, and Roosevelt Institute, among others.

Nation columnist, William Greider, got it right: “Think of this as Round One. …Instead of congratulating Democrats for enacting timid measures, we should show them what we have in mind for Round Two.” He says to put forward the good ideas that were developed during the reform fight but were blocked, defeated or, “swiss cheesed to death”. These included the Brown-Kaufman “end TBTF” legislation to limit bank size and place a hard cap on bank leverage;  the Mendez amendment that would force off-balance-sheet assets and liabilities back out into the light  to try to avoid the situation where, for example, Lehman’s balance sheet looked great the quarter before it went belly-up; a ban proposed by Senator Dorgan on “naked” credit default swaps to reduce the kind of massive gambling that helped to tank AIG; and there were others.

In addition, Round Two should strengthen positive measures that did make it through, such as “The Consumer Financial Protection Bureau” that can reduce significant consumer financial abuse if a strong leader like Elizabeth Warren, is named to head it; the battered new regulatory framework that is supposed to bring the multi-trillion dollar derivatives market controlled by five major banks under control; the weakened  “Volcker Rule” originally designed to eliminate trading by banks for their own accounts with tax-payer-supported money (deposits and bank access to Federal Reserve liquidity support) and to restrict banks’ investments in the gambling casinos of hedge funds and private equity firms; Senator Al Franken’s proposed legislation to eliminate conflicts of interest, increase oversight and rein in the credit rating agencies, which might not be implemented if the regulators can find a “better” alternative.

This exposes the round two rub in a nutshell: the Act deliberately left most of the details of the key reforms up in the air, to be decided by rule makings and studies during round two in over 10 different domestic agencies and in overseas bodies like the Basel Committee on Banking reform.  Indeed, the Act calls for 243 rulemakings and 67 studies to be held over several years, with the final rules being in phased in over as many as 12 years.

How all this turns out depends on the balance of forces in this fight. And so far, things do not look great. While the financial lobby is strong and organized nationally and internationally, key progressive forces that fought for reform, including the crucial Americans For Financial Reform (AFR), has lost most of its funding and at best, has now splintered into multiple smaller and under-funded groups pushing for reform. It is important to remember that within the framework of the law itself there is currently the potential authority for breaking up the banks, outlawing dangerous derivatives, controlling dangerous compensation schemes, and ending tax payer bailouts. But if the bankers and their allies win, there is also the real possibility of just hitting the restart button and going back to the bad old days.

To prevent this, the Americans for Financial Reform, SAFER, and other groups need economists and other specialists to get involved in the analytical/educational fight. If you want to and are able to help, please contact: Wendi Wallace, Americans for Financial Reform, 202-263-4571 (www.ourfinancialsecurity.org).

Diana Tussie

Every economic crisis buries some practices and gives rise to new ones. What we see today is a move away from what Robert Wade called the “High Command “of global finance and the rise of less formalized institutions. The G-20 may be one of these.

So far the G-20 summit agenda focused heavily on the question of the regulation of international financial markets. In addition, the G-20 leaders made a commitment at their first summit in November 2008 to press on with the reform of the Bretton Woods institutions in order to give greater voice and representation to emerging and developing economies. Two years later the Toronto summit closed on a dull tone.

The G-20 resolved to have all of its members halve their deficits by 2013 and to stabilize overall debt by 2016. Brazil and Argentina along with India and China were strongly against cutting back spending at this early point in the global economic recovery. It was Brazil’s Finance Minister, Guido Mantega, who warned the G-20 not to balance budgets on the backs of the world’s poor.  Other agendas remain mostly ignored. As these initiatives move with extreme paucity, it may be that other mechanisms, particularly those at a regional level, gain momentum.

After the East Asian crisis countries in the region made efforts to expand financial cooperation through the Chiang Mai Initiative. With the largest worldwide reserves, these countries have the capacity to create a quite-significant pooling arrangement.  In Latin America, after the Argentine meltdown, steps to expand the regional provision of development finance have gained momentum. The Andean Development Corporation has become a major project lender throughout South America while the newly inaugurated Bank of the South with an initial capital of $20 bn is also expected to start operations promptly. (See Vernengo, “Public Banks and Development.”)

Regional development banks have for a long time enabled the existence of alternative windows for access o finance. Many argue that the case for more pluralism may even be stronger in the area of balance of payments support given the controversy over the IMF’s hold and its conditionality.

Western Europe provides a prime example of regional financial cooperation in the post-war period. The U.S, through the Marshall Plan, catalyzed the initial phases of this process, which underwent step by step deepening until the emergence of the European Payments Union (EPU), eventually leading to the current monetary union. In its day the EPU played a reserve-sharing role. Today some supporters of regional institutions  have even suggested that the IMF could emerge in the future “as the apex of a network of regional reserve funds – that is, a system closer in design to the European Central Bank or the Federal Reserve System than to the unique global institution it currently is … A denser network of institutions seems better adapted to a heterogeneous international community, and it is likely to provide better services and give stronger voice to smaller countries”.

Hand in hand with the sprucing up of project lending, regional reliance on the IMF has dropped dramatically.  In 2005, Latin America made up 80% of the IMF’s lending portfolio, a share which had dropped to 1% by 2008.  While IMF loans to Latin America stood at $48 billion in 2003 they dropped to less than $1 billion before the crisis. With the onset of the crisis, three Central American countries, Mexico and Colombia have applied for loans. But the crisis has not changed the long term trend, which has been favored by booming commodity markets.  While most countries paid off their debts, Argentina is also refusing to follow precedent and go back to the IMF  in order to renew negotiations with the Paris Club. Reversing the trend from borrowers to lenders, in June 2009 Brazil, Russia and China announced that they would buy IMF bonds in order to reduce their dependence on the dollar and diversify foreign currency reserves.

Regional payments clearinghouses are also making progress towards decoupling trade operations from the US dollar. In October 2008, Argentina and Brazil agreed on a local currency payments system.  In Brazil, exporters may now operate in the real, while Argentines may operate in pesos.  With elimination of the need to go through a third currency exporter can set prices in their home currency, and hence thus being insulated from exchange risk. The system now covers about 20% of trade.  In a similar line, in October 2009, the SUCRE, or Unitary System for the Regional Compensation of Payments, was set up among Venezuela, Cuba, Bolivia, Ecuador, Nicaragua, Honduras, the Dominican Republic, Antigua and Barbados, as well as San Vicente and Granada.

If meaningful IMF reform continues to prove politically difficult, the relevance of these arrangements might grow. Not only would they allow for decentralization and greater pluralism in international financial governance. They can also contribute to global stability by reducing the US burden to provide liquidity to the world economy, much in the same way the EPU did in its time. But they might also throw some useful sand into an entirely free-flowing regime of finance.

As George Soros noted in his recent NY Review of Books piece, before the recent G20 meeting in Toronto, Germany’s deflationist stance was the minority position. By the end of the meeting the American reflationary stance was the minority position. Abruptly, and against the apparent ‘we are all Keynesians now (again)’ love-fest of 2008-2009, the G20 signed up to halve their budget deficits by 2013. Government spending, it seems, has to stop.

Now the G20 does have a point. There is too much debt in the system, from consumers, to corporations, banks, and sovereigns. But as I blogged in a recent piece for Foreign Affairs, the G20’s endorsement of “growth friendly fiscal consolidation” relies on the same fallacy of composition that brought on the banking crisis. Back in the glow of the ‘Great Moderation’ regulators assumed that by making individual banks safe you make the system as a whole safe. Unfortunately, as the world discovered through learning terms like ‘CDS daisy-chains’ and ‘serial correlation,’ that turned out to be a really bad assumption. Now, in a re-run worthy of Nick-at-Night, we are about to simultaneously retrench in the middle of a recession in order to restore growth.

Those who warn of the dangers of debt argue that ‘normal service has been resumed.’ For all the Keynesian ferment the simple fact remains that markets react to bad policy, and bloating government debt to prevent a normal market correction was bad policy.

While appealing in a ‘bulimia bad/dieting good’ moralizing sense, such a view ignores that, according to the IMF, of the 39.1 percent (average) increase in government debt across the OECD only 12 percent of that increase was discretionary. The rest was a direct result of bailing out the banks. So it’s more than a little ironic to note that what the G20 are responding to – Eurobond market pressures – are coming from the same banks that used those bailout funds to buy super-cheap underwater assets while short-selling the government debt generated in the process of saving their assets.

But, irony apart, there is a bigger intellectual puzzle here. Why do some economic ideas refuse to die despite the stunning lack of evidence for their veracity? For the arguments used to justify retrenchment really don’t stand up to much scrutiny.

The first such idea is the consistent denial by deficit hawks of fallacies of composition: that the whole is hardly ever reducible to the sum of its parts. Due in part to the insistence on micro-foundations for everything in mainstream economics (thereby ignoring such processes as emergence, recombination, evolution) the same thinking that saw moral hazard as the only conceivable problem in banking (whoops!) now see debt as the only thing holding back recovery.

The second originates with Ricardo, was formalized by Barro, and ends up driving the 2010 June ECB report (the Summa Theologica of the orthodox) which lays out the rationale for retrenchment. That is, consumers are said to operate with ‘Ricardian equivalence’ regarding their balance sheets and will discount fiscal stimulus as future debt. As such, only fiscal consolidation, not fiscal stimulus, will produce growth if “the share of consumers discounting the future effects of fiscal retrenchment (i.e. so called ‘Ricardian’ consumers) is high.”

So how do we know this is the case? Well according to the ECB report a bunch of small countries (Ireland, Finland, Denmark) non-simultaneously reduced debt and still grew during the global asset and export boom in the 1990 and 2000s. So that clearly applies to all states facing a global recession today. But more fundamentally, there is an asymmetry in this argument that is also swept aside. Why are these Ricardian consumers, at least in the US, who always vote for tax cuts (which should auger future tax rises and should be discounted) and happily spend themselves into oblivion, are presumed to behave quite differently regarding government debt?

Third, lurking in the background is that pièce de résistance of 18^th Century thinking: crowding out. If you ignore the whole/parts distinction, and you do think that consumers are rational expectations zombies as regards government debt, then it follows that if you cut debt growth must reappear automatically – right? The ECB seem to think so since they argue that once government spending is reduced this will result in “the freeing up of revenues to finance more productive expenditure or growth-enhancing tax cuts.”

But all of this rests on a rather strong counterfactual. That the only thing holding back a huge investment spurt isn’t uncertainty over the future, or the fact that major indices are heading in the wrong direction, or that investing heavily in a middle of a recession is not seen as good management: its simply government ‘getting in the way.’ OK, let’s have a look at places where government didn’t get in the way, like Eastern Europe. Take Latvia for example, where the reward for eschewing debt was a fall in fourth quarter GDP in 2009 of 17.7 percent, a rise in unemployment to 16.6 percent, and a collapse of government finances, the theoretical beneficiary of this belt-tightening, because of falling tax receipts. Yeah – that worked.

As John Quiggin points out in his forthcoming book, Zombie Economics, some economic ideas are like zombies: they never die. And like Zombies they persist by eating the flesh of the living. When retrenchment starts to bite here, and not in Latvia, you’ll see what I mean.

Mark Blyth is Professor of International Political Economy at Brown University.

August 2010 brings news on global growth which is disconcerting to say the least. Numbers from countries across the globe suggest that the incipient recovery characterising the world economy may already be losing steam. The US economy recorded a lower 2.4 per cent growth in GDP in the second quarter of this year compared to a much more comforting 3.7 per cent in the first quarter. This news followed the evidence that industrial production in Japan fell by 1.5 per cent in May. And finally, an (unusual) index of demand growth in China, which is being looked to as the driver of global growth, shows that demand is stabilising. The purchasing managers’ index (PMI) published by the China Federation of Logistics and Purchasing slipped from 52.1 in June to 51.2 in July, closer to the 50 point level that signals positive growth.

These changes may not be substantial or even indicators of a medium term shift in growth trends. But with the world sitting on worries of a potential second dip, they are receiving attention. The search for instruments to drive the recovery is still on. Yet the pressure to curtail public spending and reduce public debt is strong in most contexts. This leaves monetary policy as the alternative to generate a recovery.

But clearly fiscal and monetary levers are not on par when used to drive growth or reduce absorption. This is an issue that is forgotten when conservative reaction against deficit spending and public debt decries a proactive fiscal policy and defends retrenchment even when growth is slowing. Consider for example the reduction of growth in some contexts because of a decline in credit provision and/or credit off-take. It must be noted that this squeeze on credit flows is not so much the effect of central bank initiatives in the form of, say, increased reserve requirements. In a complex financial world with multiple markets, institutions and instruments, monetary policy is rarely too effective in influencing anything but the interest rate.

Credit flow is influenced more by the state of confidence. If banks and other financial institutions are more risk sensitive because of economic and financial conditions and borrowers are worried about taking on additional debt because of accumulated commitments and uncertain earnings prospects, the provision and off-take of credit shrinks irrespective of government policy. It is only when the government or central bank is in a position to directly influence banking behaviour that fear of “overheating” can generate responses that constrict credit flows further.

It is well accepted that it is the loss of confidence and the legacy of negative household balance sheets that is holding back credit flow and consumer spending in the US, for example. This suggests that triggering recovery requires relying more on a fiscal stimulus rather than monetary policy initiatives. Restoring confidence and repairing household balance sheets would prove impossible if the US government were to cut back on its stimulus. It is perhaps the waning of the fiscal stimulus and evidence that the push to curtail it is gaining momentum that could explain the facts that growth is once again flagging in the US.

In fact countries which relied heavily on credit to stimulate their economies are facing new problems. In China, for example, the government is worried about the fact that excessive reliance on lending as part of the stimulus package adopted in the wake of the global crisis has encouraged speculation. Real estate prices have skyrocketed and even insiders have reported banks are burdened with loans of poor quality given to local governments to finance infrastructure projects. A review has identified about Rmb1,550 billion of such loans on bank balance sheets. Not surprisingly China’s banks (including Agricultural Bank of China and ICBC) are rushing to market to raise funds to shore up their capital base. In the event, the government has chosen to intervene directly to rein in  such credit to both dampen speculation and hold back errant banking practices.

There seems to be a message here. If intervention to sustain recovery is seen as warranted, it is fiscal policy that must take the lead. This is also true because, if the will is there, governments can tax to reduce deficits and rein in debt. Households and firms cannot do that and must wait for growth or a government bailout.

Over the last thirty years there has been a significant change in the role of public banks.  Neoliberal policies suggested that central banks should be independent of the Treasury, and should concentrate their efforts on inflation targeting.  Further, development banks, where they existed, were discouraged as tools for industrial policy, that is, they were precluded from providing subsidized credit for specific economic sectors.  On the other hand, the tendency was to use development banks as instruments of the process of privatization, providing credit for mergers and acquisitions.  Finally, the international financial institutions (e.g. IMF, World Bank, etc.) were used to spearhead the process of liberalization, and credit was only available to those that adopted the neoliberal policies.

It is important to emphasize that central banks were established in Europe (e.g. the Bank of England) primarily to raise loans for the government, and that the role as fiscal agent of the Treasury still was one of the main purposes for their existence until very recently.  For example, the Federal Reserve during the Great Depression agreed to maintain the interest rate on long-term treasury bonds at 2.5%.  That allowed the fiscal expansion (with deficits that eventually were larger than 20% of GDP, double their current size in the US now) of the New Deal and War effort to be sustainable.  Low rates of interest imply that government debt grows at low rates, and as the economy grows and government revenues increase the Treasury can repay its loans without difficulty.

Almost as important as the low interest rate policy was the foreign exchange policy.  Central banks could, by intervening in the foreign exchange market, buying and selling foreign currencies and using exchange controls, maintain a depreciated currency, favoring domestic production over imported goods.  In reverse, high interest rates and appreciated currencies sometimes were used to favor the financial sector and importers, in order to weaken domestic industrial production and employment and to reduce the bargaining power of workers.

In addition, public banks have been not only important lenders to the state, but also they were heavily involved in lending directly to industry.  Central banks in the developed world provided subsidized credit for industrial activities.  In developing countries the role of development banks was more important, and the incredible rates of growth in South Korea and Brazil (until the 1980s) cannot be understood without the Korea Development Bank (KDB) and the Economic and Social Development National Bank (BNDES in Portuguese).

In South America, within the context of the rise of left of center governments over the last decade, there has been a significant change in the role played by public banks harking back to their role as promoters of development of the pre-neoliberal era.  At least three examples of institutional innovation that have changed the role of public banks in the region are worth noting.

In Brazil, BNDES received R$ 100 billion (approximately US $ 55 billion) loaned by the federal government in 2009 for its operations.  This loan allowed the Bank to increase significantly its funding capabilities to support long-term investment projects and made relevant anti-cyclical efforts feasible in the context of the crisis.  It must be noted that total investment in 2009 corresponded to 16.8% of GDP and of that about half corresponded to the purchase of new machinery.  Since, the BNDES total lending was about 4.5% of GDP in 2009, one may conclude that about half of all purchases of equipment were financed by the BNDES, which explains why the Brazilian economy will continue to have vigorous growth in the midst of the crisis, in spite of having the highest real rate of interest in the world.

Second, it has been recently announced that the Central Bank of Argentina will start to make subsidized loans to stimulate local production and reduce the dependency of imported inputs.  This follows the decision to use the central bank reserves to pay for external debt commitments, after the defenestration of the neoliberal head of the bank.

Finally, the region has moved ahead with the plans for the new Bank of the South, an alternative to the current financial architecture, that involves reduced dependence on external funds, with increasing use of the currencies of the region rather than the dollar, greater degree of cooperation in the region and a move towards a common monetary system underpinned by policies to promote full employment and poverty reduction.

The recent global economic crisis has affected the poor in developing countries most, in part because they are the weakest to deal with such a crisis. Their weakness is partly due to the practices of neo-liberal ideas imposed on them by international financial institution (IFI) during the last couple of decades. The emergence of the crisis raises a fundamental question: is there any hope that the lessons learned will lead to a turning point in favour of “development”? It should, but I doubt whether it will, and the danger is that the next global crisis would emerge in the trading system.

The great depression of 1930s was a turning point as the Keynesian macroeconomic policies dominated the scene for a couple of decades. By contrast, Keynes’ ideas on international development policies, presented after the Second World War, were turned down. So was his proposal for the creation of ITO in favour of the Bretton Woods institutions and WTO.

Meanwhile, two schools of thought were propagating ideas on development theory: neo-classical economists, (e.g Jacob Viner, I. Little, A. Krueger, Bhagwati); and their opponents, i.e. the developmentalists. The neo-classical view was simple, but hypothetical and “mechanical”; their ideology was based on their belief in “laissez-faire” and “laissez-passer”. Further, they disregarded the important role of socio-political factors in economic development; considered man only as a factor of production rather than the ultimate beneficiary of growth; made no distinction between growth and development.

The developmentalists (e.g  Prebisch, Kalecki, Myrdal, Streeten, Kaldor, and the Latin American structuralists, etc.) tried to deal with the real, rather than hypothetical, world: in any country, economic activities take place in an environment, with its particular socio-economic, structural and institutional characteristics and international setting; international trade is influenced by power relations of the trading partners; market failure is rampant, hence there is a need for government intervention. In two respects, however, they are in an inferior position than the neoliberals: their real world is of course more complicated than the hypothetical world of neoliberals, so they cannot easily provide a simple solution for economic problems; unlike neoliberal institutions, they have not been in a power position.

A couple of events have shifted the pendulum in favour of neoliberals further since the early 1970s.  The energy crisis in early 1970s, the consequential increase in indebtedness of developing countries and their need for external finance, the emergence of Reaganism and Thatcherism and the involvement of  a number of neoliberals (e.g. I. Little and A. Krueger and in the international financial institutions (IFIs)). Market-oriented development and universal trade liberalization became the religion of neoliberals and IFIs; it was intensified with the emergence of “Washington Consensus” and trade liberalization during the Uruguay Round. The USA’s interest in pushing for universal trade liberalization was based on the belief that it would remedy the current account deficits of the country.

In practice, the USA’s deficits have grown further; financial activities have taken over productive activities, the world economy has become more unstable, leading to one financial crisis after another. The recent crisis has been the worst since the Great Depression.

The crisis did not stop “hypocrisy” which had prevailed by the IFIs and governments of developed countries in both trade and macroeconomic policies. Not only had developed countries agreed partially with liberalization of international trade by continuing agricultural protectionism, but they also paid little respect to the rules on which they had agreed through GATT-WTO. Regarding the financial crisis, their “market fundamentalism” ideology would dictate that the crisis should have been left to be sorted out by the “market”. But suddenly the intervention in the market in developed countries became fashionable and was also endorsed by the IFIs. The USA alone injected over one trillion dollars into the economy, mostly to rescue the banks from bankruptcies. By contrast, IMF continued putting pressure on poor countries to cut government expenditure! Most of these countries are located in Sub-Sahara Africa where according to the World Bank in 2005, 51% of their population (about 391 million) lived under $1.25 a day. Further, most recently the Managing Director of IMF recommended that developing countries should shift to a “consumption-led growth”.  His recommendation contradicts not only IMF’s advocacy of export-led growth in the past, but also the IMF policy of putting pressure on poor countries to cut government expenditure!

The Sub-Saharan African countries, and many other ACP countries, are also under the pressure of the EU to liberalize trade in manufactured goods on a reciprocal basis, but the EU would like to maintain its own protectionist policies in agriculture. Neither the USA nor the EU appreciate the fact that ultimately imports by the poor countries have to be paid for by export earnings which, in turn, depends on supply capabilities, i.e. the level of development of the countries. And acceleration of development of the poor countries will not be achieved by pursuing “market fundamentalism”.

The pressure on these countries for universal trade liberalization, through EPA and/or WTO, will lead either to further de-industrialization, human misery and/or rebellion to undermine the global trading system-even if the USA did not break away from the system. Will neo-liberals and neo-liberal institutions hear this wake-up call?