Monday, March 09, 2009

The story that keeps on giving

Kevin Rudd's latest contribution to The Monthly (now available online)is a story that keeps on giving. If it weren't enough that former Liberal leader (and PM) John Howard had a go at it, it is now Malcolm Turnbull's turn, writing in the Oz.

It really is an interesting exercise that these leading Liberals have embarked on. Rudd in his essay has not sought to criticise capitalism per se, merely neo-liberalism and is attendant "extreme capitalism". In coming out and criticising the Rudd piece they are, I think unwittingly, allowing themselves to be driven to the right. Let's face it the avowed wisdom in Australian politics (and indeed of public choice theory), that the party that occupies the middle ground wins.

The criticism that Rudd was first touting himself as an economic conservative and is now criticising previous economic policy misses the point that Rudd has probably never waivered from the late twentieth century view of "social democracy" which is that markets are efficient but not always equitable, and that markets on their own are inherently unstable. But like a latter day health professional who would promote "harm minimisation" as the correct response to the illicit drug menace, the modern social democrat aproach to markets is that they mostly work but can fail.

Turnbull himself seems to lay two charges at Rudd. The first is that in his attacks on neo-liberalism he is revealing himself to be a socialist. The second is that Rudd is a hypocrite as he has personally benefitted from the policies of neo-liberalism.

On the first charge, Turnbull wrote;

Well, all of that is cast away now. Instead, he preaches social democracy. It is important to remember that social democrat (sic) was a term created by avowedly socialist political parties in Europe who wanted to emphasise that they were (unlike their communist comrades) committed to achieving a socialist society through democratic means as opposed to violent revolution.

This is actually a piece of revisionism. The non-communist socialists of Turnbull's recollection are democratic socialists. Social democrats and democratic socialists are, in fact, different creatures. Social democrats are a bread of democrats who argue that true democracy is not achieved until not only is the political playing field levelled (by the vote) but the socio-economic playing field is also levelled - their most common catch-phrase is "equality of opportunity" and is associated with social goods like quality public education for all and universal health care. Robert Menzies was more social democrat than he was neo-liberal. The party he named the "Liberal Party" was modelled on the nineteenh century European concept of liberal, not the laissez-faire imaginings of the neo-liberals.

Turnbull's piece may have worked in its attempts to portray Rudd as a dangerous left-winger if it were not for his attempt to label Rudd a hypocrite because of his wife's business interests. It is unclear from the article whether Turnbull's complaint is that Therese Rein has engaged in capitalism as such, or wether it is because her particular business survived on outsourced government programs.

If it is the former it is a poorly laid claim as Rudd is not anti-capitalist. If it is the latter it is also vacuous, as the policy would have been pursued by Howard whether Rein was a participant or not. The fact that the firm specialises in finding work for the disabled and that this was its founding principle without the issue of subsidies seems to have escaped Turbull.

In any case, exactly how far is one meant to go in not participating just because of a philosophical difference? Rodney Cavalier, a man who would still describe himself as a true socialist, disclosed in his pecuniary interests as a NSW Minister that he held shares in BHP. When pursued by the then opposition over this apparent conflict he said words to the effect of "There is nothing in the socialist scriptures that says you have to impoverish yourself in the capitalist phase." (Anyone who can find the exact quote in Hansard would be appreciated).

The criticism of Rein was a great error as it has led to a number of critical stories. This has resulted in the ultimate charge - Rudd as dangerous socialist - being lost.

Meanwhile Paul Sheehan has mounted his own attack in the SMH. Sheehan's critique is, like Turnbull's, first based on a criticism of Rudd as being inconsistent, though Sheehan likens it to Whitlam (without any real explanation). His first criticism is that Rudd sprayed "the entire $20B surplus he inherited up against the wall". Sheehan should take a first course in macroeconomics and learn about automatic stabilisers - when an economy turns downwards the Government's revenues decrease (less income and expenditure to tax) an its outgoings (mostly in transfer payments in pensions and other benefits) increase. That alone took care of the surplus.

Sheehan's second claim is that "The evolution of his economic position has been an opportunistic fraud, exposed by those on his own side of politics." It is probably news to anyone in the ALP that Michael Costa and Mark Latham are still on their side of politics - there is some doubt they ever were.

His third claim comes from Niall Ferguson's website in what is now a much quoted view that Government's are doing the wrong thing solving the current problem by creating more debt. Before discussing this let's remember that Ferguson is first and foremost a historian (I happen to be currently reading his entertaining Empire: How Britain made the modern world), albeit an economic historian.

His prescription is probably right that the medium to long term requirement is a reduction in debt, but that does not mean it is the immediate solution. The immediate solution is to ensure that lots of otherwise viable businesses (and households) don't collapse simply because of a suddent contraction of credit. The core assumption here is that the contraction of credit is excessively large motivated as it is by the underlying information problem - no one knows what a reasonable credit risk is anymore. Step one has to be stabilising this situation.

Steps two and three are to then reduce the total debt position and to fix the information problem permanently. The first is already happening in the many companies that are raising new capital, and will continue firther when national governments sell down their positions in banks. The second is caught up in the general question of the regulation of the financial system. Let's return to an earlier topic and the existing regulation of the finance sector. In Australia and most other countries the focus of financial regultion has been on the capital adequacy of deposit taking institutions, thus measuring the security of bank deposits. Various new products were constructed as "off balance sheet" - as they were funded through wholesale fund markets they didn't count for capital adequacy.

The extent of the problem depended o how much of the business of banks wound up in these activities. The assumption was that as all these activities were between financial institutions the borrowers and lenders didn't need legislative protection they could all make their own informed inquiries. Three things went wrong with this; (1) the borrowers relied pon ratings from ratings agencies that were based on wrong assumptions and biased by the changed business model for the rating agency (based on fees from the lender rather than from the borrower), (2) institutions themselves started to rely upon market volume as justification rather than questioning fundamentals and (3) the consequences of error were not confined to the parties involved in the transactions.

These errors are easily fixed by bringing an end to "off-balance sheet" activity, simply requiring appropriate capital adequacy rules for all lenders. There are some other tricks that can then be applied including discounting the weighting of assets that might be going through price bubbles - a capital markets version of automatic stabilisers.

In summary, Kevin Rudd is on the right track in his criticism of the form of capitalism practiced over the last two decades, his short term prescriptions are right - but he needs to do a whole lot more work on formulating and enunciating the "regulatory" policies and philosophy that needs to underpin the remaking of global commerce. Malcolm Turnbull meanwhile just needs to figure out some strategy and stick to it.

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