Written in June 2008, before many of the "Experts" had got it.......

THE MESS WE ARE IN

How Anglo-Saxon market fundamentalism is leading the world into recession

This article...

• Discusses the main causes of the global financial crisis (and why the UK is particularly vulnerable)
• Looks behind the immediate symptoms of the crisis to its deeper roots deep in the global financial system and why superficial pruning will not work
• Considers the case of the UK as a laboratory of market fundamentalism and a warning to others

The Economic Mess

It is now almost certain that the two largest free-market economies are about to plunge into recession, and not for the first time. The root causes are not hard to understand. Global financial markets, led by huge banks out-with the control of international institutions or national governments and therefore unconstrained by any form of regulation, indulged in serial orgies of speculation, taking higher and higher risks for ridiculous rewards. Eventually and entirely predictably, they ran out of road and the whole rotten system crashed. If it was only the banks that suffered that would be well-merited justice, but the fact is that the real sufferers are millions and millions of ordinary people; employees, borrowers, house-owners, the aid-dependent in poor countries and a host of others. Now governments and central banks are having to bail out the system to avoid total collapse - in other words, the tax-paying public, so betrayed by supine governments and regulatory authorities, is going to pay to bail out the system that caused their miseries in the first place.
There are of course a number of other causes - in particular the rising cost of fuel and the fact that the world is approaching the first real manifestation of fossil fuel and energy shortages. These problems will become more serious in future, but have in the short-term been exacerbated by active speculation in energy futures through the financial markets and rampant consumerism and debt in some developed countries.
As the crises evolve, voices are already being raised, exhorting us to believe that the current problems are but short-term blips, small blemishes on an otherwise benevolent free-market system. As demonstrated in other parts of this site (See Spreading the True Faith - how the free market message is promoted, in the Ideas that Shape our world section), there is no shortage of neo-liberal economic institutions and organs willing to leap to the defence of free-market fundamentalism at the drop of a hat. Most politicians in the UK and US are unlikely to confront the fact that the financial markets in their current form are doing more damage than good to society - they are deeply beholden to or dependent on them. (See politicians and the finance industry, Government, politicians and the economy section)
Many are arguing that the free market system is rather like Winston Churchill's description of democracy as a deeply flawed system, but infinitely better than the alternatives. They say that one of the flaws in the system will be periodic spells of boom and bust, bouts of irrational exuberance followed by 'corrections' that will return the system to a balanced equilibrium. This is wonderful economist-speak that trivialises something quite terrible. George Soros described the exuberance/correction tendency as being more like the actions of a demolition wrecking ball - and he is right. What the economists fail to mention is that 'corrections' mean ruin, starvation, misery, poverty, insecurity and stress for millions, but too many economists are more concerned with mathematics and models than with the psychology of human behaviour.
So let's look behind the immediate froth of the current evolving crisis and seek what underlying factors drive the world economic machine.
The neo-liberal free market system that has taken root deep in the world economic system is relatively new - its roots lie in thinking that evolved in Europe, but reached its full flower in the US and Britain in the early 1980's through the work of such as Milton Friedman which spurred Margaret Thatcher and Ronald Regan to revolutionary zeal. (See The remarkable ideas behind free-market economics, Ideas that Shape our World section)
Their beliefs were centred around the propositions that individuals and institutions would perform best if they were allowed to follow their interests with the least interference from government or regulatory authorities. The roles of government should be strictly limited to external relations and maintaining a framework of law and order, particularly preserving the ownership and use of private property. Governments were likely to be prone to corruption, inefficiency and incompetence and their powers should be driven back. With the passionate belief of zealots, they asserted that there was 'no alternative' to the free market system, arrogantly ignoring some very successful examples of social market economies. (See Economics at the service of Society - Social Market philosophies, Ideas that Shape our World section).
Deeper down, market fundamentalist beliefs were based on a model of human beings as essentially selfish animals, best served by trying to maximise their self-interest in a system that would be moderated by the fact that others were doing the same. Elaborate theories were developed to show how the mass pursuit of self interest would create a self-controlling system that would eventually benefit all. (See The remarkable ideas behind free-market economics, Ideas that Shape our World section)
Let us examine some of the fruits of this system of beliefs as we now can see them:

• It would appear that market fundamentalism, rather than harnessing the power of finance for the general good, has allowed those with wealth and power to use it in setting up a system that perpetuates their power and excludes the vast majority. So rather than creating a self-regulating system, greed and power have allowed rich nations, institutions and individuals to distort the rules to suit themselves - ignoring the wider interest. The fruits of this are manifest in vast inequalities of wealth and poverty, tax evasion, tax havens away from prying eyes, the creation of super-rich classes and swathes of uncontrolled speculation, allowing huge amounts of legal and illegal hot money to flow around the world financial system from sheltered tax havens.
• Governments in those countries that have most enthusiastically espoused market fundamentalism have indeed proved themselves to be weak, incompetent and somewhat corrupt - but not for the reasons advanced by the free-market zealots. Instead they have allowed themselves to be bullied and 'recruited' by wealthy institutions and individuals, to the point that they have little influence on events. It is almost certain that the current crop of leading politicians will not have the slightest inclination or chance to pursue serious reform of the system, having made a truly Faustian bargain with the global finance industries. This means that governments are unlikely to challenge the torrent of free-market propaganda flowing through a largely enthusiastic media.
• The populace at large in free-market economies like the UK and the US have been gulled into defining themselves as consumers (rather than citizens), whose psychological well-being is conditioned by what they buy and own. That this malaise has been fostered by the financial services and consumer industries is undeniable - but it has suited politicians to encourage consumerism too - it makes people easier to control. An example of muddled thinking confusing consumption with citizenship was John Major's Citizens' Charter which was nothing of the sort. It was very light on citizenship and strong on peoples' rights as consumers. The banking and finance sector has also played its full part, bombarding people with offers of immediate gratification through credit and debt. In this way, many ill-informed people have taken on massive debt to support lifestyles they were led to believe were their right - one cause of the current credit crunch that has yet to reveal the true magnitude of the miseries to come for millions.
• All of this misery and corruption is being played out in developed economies. But we should not forget the even greater misery bestowed on people in poor countries. Led by the twin heralds of free-market economics, the IMF and World Bank, both of which are dominated by the developed countries and particularly the IMF, (See Globalisation and its Discontents, Joseph Stiglitz, Penguin Books, 2002) untold damage has been done to poor countries with fragile economies.

In the name of promoting free markets, loans and grants have been made conditional on creating a 'level economic playing field' that has allowed banks and companies from developed countries to move in and dominate local enterprise, destroying local economies and exacerbating poverty. Proponents of free markets trumpet the fact that the number living in dire poverty (less than $1 per day) has dropped below 1 billion, but this statistic is distorted by the growth of the Chinese and Indian economies - neither of which is a glowing example of pure market fundamentalism. The fact is that the state of the poor in many African and South American countries remains dire and is likely if anything to get worse. The condition of the Russian economy and society is another indictment of imposing rampant free-market economics on a culture that was unready and had none of the institutions needed to control a market. Some may refer to growing GDP per head in Russia, but much of this is driven by a drop in population caused by gross public health problems and a chronically low birth-rate.

WHAT OF THE UK?

The 'marketisation' of the British economy - Thatcher and her 'sons'

Britain, under Margaret Thatcher and what Simon Jenkins described as "Thatcher's sons", John Major, Tony Blair and Gordon Brown (Thatcher's Sons - A Revolution in Three Acts - Penguin Books 2006),has probably followed free-market dogma to a degree unparalled in the developed world. Certainly the US, supposedly the champion of market fundamentalism, is actually one of the most protectionist nations, using overt and hidden subsidies, and protectionist acts to stop foreign incursions into 'sensitive' industries as well as its global military and diplomatic reach to single-mindedly tip the playing fields in its favour.
British governments on the other hand, have espoused free-market economics with almost religious fervour. Margaret Thatcher's government initiated a process of privatisation and deregulation that administered shock treatment to a sclerotic UK economy mainly distinguished by bureaucracy, excessive union power and inadequate management. Baroness Thatcher took on and destroyed the power of the unions and then initiated a massive programme of privatisation. Most of the public utilities, telecommunications, public transport and many other industries were passed across to the private sector. North Sea oil was passed lock, stock and barrel to private companies, social housing was sold wholesale at knock-down prices, the London financial market was abruptly deregulated; and the massive revenues thus created were used to lower taxes and kick-start a consumer revolution.
The role of government was radically diminished, (some would say rubbished and undermined), in a process that brought in the private sector to many previously publicly managed activities.
There are still many people who regard the Thatcher revolution as a golden age and hanker for the return of the Iron Woman. But in many ways, Margaret Thatcher and 'Thatcherism' the dogmas associated with her have not gone away. Her successor, John Major was unable to escape from the clutches of the Thatcherites and successive Conservative leaders tried and failed to establish successor philosophies. In fact, the contemporary party is still riven with papered-over cracks. But Baroness Thatcher need not have worried, Tony Blair and New Labour actually espoused most of her doctrines, especially enthusiasm for the free market as being the elixir that would make the economy vigorous. Gordon Brown, Blair's successor, seemed for a short while to be moving away from neo-Liberal free market economics, but seems unable to escape the clutches of market fundamentalism.

The worms in the entrails of the UK economy

At first sight, the Thatcher years and beyond seemed to have created a wonderful new British economy based on dismantling the 'old' economic order, based on a strong science, technology and manufacturing sector; replacing it with services, finance and consumerism. The virtues of the new British model have been loudly trumpeted, accompanied by blasts of schadenfreude as the supposedly old-model economies represented by Germany, France, Japan and others have failed to match UK growth.
But there is quite a different way of looking at what has happened. Quite simply, the UK has been through a massive spree during which monstrous amounts of cash have been raised by divestment and disposal of large parts of the national asset base in the form of industries, resources and know-how.
In place of these an economy has emerged that is almost totally dependent on consumer goods and consumer spending, housing and property and the finance industries. The precious resource of North Sea oil has been blown without any lasting benefits in terms of investment. Norway by contrast has used its oil resources prudently and well to invest in developing infrastructure in the form of a road and rail system that supports a highly dispersed population; excellent education and health facilities, and in building up a national pension pot that will mean that no Norwegian will ever retire poor.
Britain, which had a far larger resource, is left with virtually nothing and a legacy of inadequate transport, poor pension provision and deplorable inequality leading to a seemingly permanent underclass. About one-quarter of the UK population are relatively poor, suffering from health and educational deprivation, poor housing and very little prospect of improvement.
If readers think that this is pessimistic, please go to Noteworthy Facts about UK Society, the state we are in, Cannon Fodder section.
Successive governments have allowed the wholesale disposal of UK companies, many of their skills and most of their intellectual property to foreign competitors. The net result has been the evisceration of the science and technology sector, or at least the part of it represented by large British companies. Further impacts are an oncoming shortage of engineers and scientists and their know-how in growth sectors such as nuclear energy.
In parallel, the government has encouraged the growth of the mainly London-based finance sector, which has busily undermined investment in science and technology to the point that the UK economy is now dependent on largely foreign-owned investment banks and the like. This means also that the UK is little able to withstand blatant bullying and blackmail from this sector and also from the largely tax- exempt coterie of super-rich people residing in London and the Home Counties. All of this is in blatant contradiction of the aspirational statements made by such as premier Gordon Brown about Britain as a powerhouse of enterprise, science and technology. See Gordon Brown's vision, Government and Politicians section.
Sensible leadership and stewardship of companies has been replaced by 'shareholder value', in reality the domination of industry by finance. Management has been replaced by measurement and targets and trust has been destroyed by neo-liberal doctrines such as Agency Theory, which dictates that managers cannot be trusted and must be rigorously targeted, measured, sanctioned and rewarded by a superior authority.
The period of market fundamentalism that started with Margaret Thatcher will be seen by future generations as a slowly evolving disaster. The supposed triumph of privatisation and the free market will be exposed as a confidence trick. The sell-off of a large swathe of the technology sector, the abdication of government from seeking to influence the financial markets on behalf of society, the blowing of North Sea oil revenues, the creation of rampant consumerism and associated debt, the disastrous showing of many privatised utilities and the shameful con of private/ public 'partnerships' will come to be seen as manifestations of ignorant dogmatism and wilful neglect of the long term welfare of the economy.
Thus the four legs upon which the supposed UK economic miracle has been based - the finance sector, consumer spending, growth in the housing sector and government spending conceal a terrible in-balance in the economy.
Signally missing is investment, especially in R&D and associated capital spending and the 'boring' old-economy manufacturing sector, in reality the repository of many of the skills required for a modern developed economy. The investment banking industry is markedly averse to long-term investment in science and technology, the so-called Venture Capital industry is dominated by value extracting private companies that wouldn't dream of investing in start-ups in science and technology - even 3i's, originally set up to invest in incubator companies, announced recently that it was withdrawing from this activity as it was too risky. Britain has been a lousy performer in manufacturing, especially amongst larger quoted companies. The reasons are quite simple for those with an eye to see and half a brain: they are lack of management skills; speculation, short-termism and a distinct aversion to sustained investment in technology and engineering by the City, leading to under-investment, a lack of competitive stamina, low productivity, a huge balance of payments deficit and a seriously unbalanced economy.
(See The City doesn't like investing in technology, Investment Markets Section, Our Financial/Industrial System).
Just how serious matters are can be seen from the following extracts. Some of then relate back to 2002, so what is happening now is a frightful indictment on the lack of understanding and foresight on the part of economists and government alike.

The flawed UK economy - a profile

Only the UK amongst OECD countries had a lower share of GDP spent on R&D in 2000 than in 1981. In Britain, in 2000, it was 1.9%, in the US, 2.7% and Germany, 2.5%.
Much of the quoted company technology sector has been purchased by foreign competitors. The R&D spend of foreign-owned companies in Britain also declined by 3% in 2004. So foreign-owned companies are not bridging the gap caused by generally decreasing R&D investment by UK companies.
(OECD).

Dividends paid to investors by FTSE 100 companies in 2005 were 164% of R&D spend - as opposed to 46% in US S&P 500 companies and less than 20% in Germany, France and Japan. Capital expenditure in many British companies has trailed behind the levels of many foreign competitors. This is not just a trivial statistic, as research indicates that there are strong links between R&D, related capital spend, and added value of output, productivity and eventually profitability. The needs for R&D and capital expenditure are highest in advanced physics, chemistry and knowledge-based industries (DTI, NIESR).

In 2002, foreign-owned manufacturing companies in Britain created 24% more gross added value per head than British counterparts and had 133% higher net capital expenditure - they also paid substantially higher wages (NIESR).

In 2002, 40% of UK's top exporting companies were foreign-owned and nearly 50% of Britain's gross exports came from foreign-owned companies. In 2002, about 10% of the largest (FTSE 100) British companies were left in the once-mighty high-knowledge physics and chemistry-based sectors, as opposed to over 20% in the US, and over 50% in Germany, Japan and France. By comparison, there are 29 companies in general utility, services and retailing sectors, which export virtually nothing (Authors' research).

Productivity and added value per head is lower in Britain than in many developed countries. Furthermore, the gap between Britain and foreign competitors is not narrowing, despite government exhortation, many studies and investigations by Harvard Business School professors. Productivity per head in the UK came 17^th out of 20 developed countries in 2000. The UK was just ahead of Portugal. Ireland came 2^nd. By 2003, this figure had improved - Britain came 15^th, behind the US, France, Norway and Ireland, amongst others (Institute of Economic Affairs).

UK competitiveness - Item Club report

Item Club review, July 2006, reported by Allister Heath in 'The Business':
"British exporters have fallen behind in the race to sell goods to China, reinforcing concerns about the ability of UK plc to compete with its main rivals, a leading think tank will warn on Monday.
Plummeting competitiveness caused by surging costs and weak productivity growth mean that the UK is selling only $5.5 billion a year to China, compared with $30.7bn for Germany, $9bn for France and $6.9 billion for Italy, the research from Ernst and Young's Item Club reveals.
Peter Spencer, the Item Club's chief economic adviser, said: "The whole thing looks absolutely shocking. There is no good news in this report at all.
Until UK manufacturers manage to break out of the vicious circle of low profitability, low investment and a lack of cost control the medium-term prospects for exports remain poor". He also said that the UK economy had just enjoyed "seven years of plenty" based on heavy spending by government and the consumer. Now these sectors are over-borrowed and can no longer take the lead in driving the economy. This leaves GDP growth critically dependent on exports, investment and ultimately the strength of the world economy. The (Item) club is predicting that export growth for 2006 will officially stand at 15% - however once these figures are adjusted for VAT fraud the headline figures stand at a much more modest 9%.
Spencer said: "When seen against the background of the boom in world markets, it's actually very disappointing"

What are the wider implications of poor export performance?

Bill Jamieson in 'The Business' sets the scene, under the headline, "Speedy growth followed by a soft landing? I wouldn't count on it". He questions the sustainability of UK economic growth based on government spending and high levels of consumer debt: ......"The composition of these (growth) numbers begs searching questions about the quality and sustainability of the growth story. It is largely the result of continued buoyancy both in consumer and government spending. And both are a function of high and unsustainable borrowing. The strength of the consumer sector in particular looks ever more vulnerable as evidence mounts of astonishing levels of personal debt and rising insolvencies.
Similarly the public finances are showing signs of stress......

Balance of Trade Trends

The following table shows the true magnitude of Britain's declining international competitiveness.
The years chosen are 1982, when the Conservatives came to power under Margaret Thatcher, 1997, the year New Labour was elected and the figures for 2005. This shows that the disastrous slide in manufactured exports and the balance of payments has occurred under both governments.
One point to notice is that the growth of services exports is far slower than the precipitous decline in manufacturing. So, whilst the growth of exports in services is to be welcomed, it is not compensating for the far faster decline in manufacturing.

Balance of trade (red = deficit, black = surplus)
£billion

So, manufacturing industry is crucial to Britain's economic well-being - a fact that is played down by many commentators.

UK share of world trade is in long-term decline

Share of world exports - % change.

The British disease.

There has always been a rather sniffy approach from various English elites towards 'trade and industry' (perhaps rooted in Victorian class-consciousness), in the ignorant belief that these are dull occupations and rather inferior to the manipulation of money.
It is therefore acceptable to go into something in finance, the professions, media, entertainment or fashion, but not - Lord save us from boredom and dirty fingernails - manufacturing industry.

The Effects?

With the connivance of ignorant politicians, and as a result of the known aversion of the City to support investment in companies involved in complex technologies plus a fair deal of management incompetence, Britain has lost its once pre-eminent place in most modern manufacturing industries. The real tragedy is that we are rapidly losing the clusters of advanced skills and know-how that underpin all modern manufacturing industries, leaving us with often foreign-owned assembly plants - like Peugeot's recently closed car plant at Ryton. And the government's declared intent to develop nuclear power generation will expose the fact that we will be almost entirely dependent on foreign engineering skills, as we have wasted most of the home-grown version.

The Reality

U.S estimates confirm that a large proportion, about two-thirds of knowledge-based industries are in the manufacturing sector. So Britain is denuding itself of the intellectual capital and skills needed to run a modern competitive economy. This is not the case in Japan, Germany, Korea, the Nordic countries and France - even the US has a higher proportion of manufacturing companies than Britain.
A place in the modern globally competitive economy depends on full possession of all the advanced knowledge and processes that lie behind the activity of final assembly/'manufacturing'. Peugeot were able to close their Ryton plant easily because it did not contain any of that advanced know-how. It was simply a sort of Third-world assembly plant. Peugeot's vital knowledge, experience and skills in automotive design, development and engineering are located in France. This means that they have the choice to assemble cars anywhere.
Every time a UK-owned science or technology company is bought by a foreign competitor, there is a near-certainty that the advanced skills and knowledge embedded in their organisations will 'leach' over time to another country. We know this, because foreign companies in Britain invest less and less in the UK on the vital underlying Research and Development processes that create future advanced products and systems.

The British Tragedy - the Faustian Compact with market fundamentalism

The future success of the British economy and the prospects of a significant proportion of its citizens have been seriously damaged by a succession of British governments and a coterie of one-eyed economists. As a result, the UK has sleepwalked into a position in which it is dangerously dependent on housing and property, retailing and consumer goods the finance sector and government spending.
At the heart of it all are the dominant finance and property industries.
As the travails of these sectors spread to property and consumer spending, so will the terrible effects of the Faustian compact with free-market fundamentalism and the finance industries made by Baroness Thatcher and her 'sons', John Major, Tony Blair and Gordon Brown become evident. It is highly likely that New Labour will be sucked into this damnation as well as its current leader. Tragedy is: there is no evidence that the Conservatives, the possible government in waiting will improve matters - there is ample evidence that they, like their predecessors, have also made their deal with the Devil. See Politicians and the finance industry, Government and Politicians Section.
Longer-term revival of the UK's competitive position will only come from a resurgent economy in the science and technology sectors and this seems a distant prospect. But it would help greatly if some far-sighted politicians and advisers were to show signs of accepting the needs for radical change - which will amongst other things need to be led by government support of the kind provided in sensible economies as in Japan, Germany, Korea and the Nordic countries.