The Great Depression of the 1930s was a spectacular practical demonstration of the contradictions of “laissez-faire capitalism”. John Maynard Keynes, the renowned economist, writing in the midst of the Depression, had attributed the failure of markets, especially financial markets, to their intrinsic incapacity to distinguish between “speculation” and “enterprise”, and to get dominated by the activities of speculators to a point where “enterprise becomes the bubble on a whirlpool of speculation”. As a result, the level of employment and output in the economy, and hence the livelihoods of millions of people, became dependent on the whims and caprices of a bunch of financial speculators, “a by-product of the activities of a casino”.

Keynes was opposed to socialism and was a defender of the capitalist system, but he saw that major repair had to be done to the capitalist system if it was to survive. The repair he recommended was “socialization of investment”, i.e. state intervention to ensure that the level of investment in the economy was such as to achieve “full employment”.

The basic argument that “laissez faire capitalism” is fundamentally irrational (in so far as it makes employment and output the by-product of the activities of a casino) and hence needs to be replaced by state intervention, has never been successfully refuted by neo-liberalism. Indeed, intellectually, neo-liberalism has always been vacuous, in the most elementary sense that the assumptions required by neo-liberal theory to show the salutary consequences of the unfettered operation of markets, are either palpably unreal, or at palpable variance with other assumptions required for the same demonstration, making the argument logically inconsistent.

The resurgence of neo-liberalism against the Keynesian position therefore was a result not of its intellectual persuasiveness, but of its being promoted by the new hegemonic entity in world capitalism, namely international finance capital, whose ideology it constituted. Of course, the Keynesian prescription for capitalism, i.e. state intervention in demand management, had ceased to work. But this fact did not mean that the Keynesian diagnosis was wrong, and nobody has succeeded in proving otherwise. What is more, the fact of the Keynesian medicine not working any longer was itself the result of the emergence of international finance capital.

The state whose intervention Keynes had advocated was necessarily a nation-State, and in a world where finance was globalized, i.e. in a world characterized by international finance capital, the capacity of the nation-State to pursue policies of its choice was necessarily undermined: any set of policies not to the liking of international finance capital would provoke the flight of such capital to other shores, reducing the original host economy to dire straits. Keynes was aware of this constraint upon demand management and hence was very particular that “finance above all must be national”. But the spontaneous tendencies of capitalism, towards the concentration of finance in larger and larger blocs and its deployment all over the world in quest of speculative gains, operated even within the regime of Keynesian demand management, and ultimately undermined it from within.

Undermining the old regime however was not enough for finance capital. An alternative new regime had to be erected, which would facilitate the global movement of finance by removing all barriers to such movement; which would permit finance capital to pick up “for a song” profitable public sector enterprises and scarce and valuable natural resources that had been largely nationalized, following decolonization in the third world; and which would turn the State from being a Keynesian (or for that matter a Nehruvian) State into one that was actively engaged in promoting the interests of international finance capital, of which the domestic financiers and high bourgeoisie constituted a component part. This transformation, which required not just the thwarting of Keynesianism (or of Nehruvianism or of third world nationalism, generally) but actually transcending the latter, institutionalizing an alternative regime to the ones that were in force, had to be sustained by an ideology. Neo-liberalism was that ideology.

Neo-liberalism had not disappeared during the heyday of Keynesianism. It had been overwhelmed, but it continued to exist, pushed to the fringes and advocated by die-hard believers like Milton Friedman who were looked upon with amused tolerance by “mainstream” economics, even as debates within the latter centred on different versions of Keynesianism. Even Richard Nixon had famously said in 1971: “we are all Keynesians now”. Neo-liberalism’s emergence from the shadows was the theoretical counterpart of the emergence to dominance of international finance capital, through inter alia the progressive removal of capital controls, which had characterized the Bretton Woods System, first in the advanced countries during the sixties and later in the developing countries.

What is occurring in world capitalism now is a re-affirmation of Keynes’ proposition that financial markets, precisely because they get dominated by speculators, function like casinos. Financial crises, resulting in severe Depressions, are inherent to the functioning of this “free market” system. In fact, efforts by the State to prevent such crises, through “bail-out” packages, when successful in the short-run, have the perverse effect of further emboldening the speculators to become even more reckless, and hence creating the potential for even more severe crises in the future. Financial crises in this sense resemble earthquakes: if they do not happen for some time, then when they do happen they are even more severe. Government intervention to prevent such crises in an economy dominated by finance capital and hence open to speculation, prevents a current crisis by creating the conditions for a far more severe future crisis. To say this is not to suggest that the government should allow financial crises to occur, but to argue that the neo-liberal regime that permits financial crises to occur at all should be transcended. (Many including myself would argue that this is not possible without transcending capitalism itself, but that discussion need not detain us here).

Keynes had said with remarkable prescience: “As the organization of investment markets improves, the risk of the predominance of speculation does, however, increase.” One of the “improvements” in the organization of financial markets in recent years has been the development of the “derivatives” market, the total value of trade in which in 2007 was 40 times the total gross domestic product of the world economy! And confirming Keynes’ prognosis, this has been a major stimulus to speculation and hence a major factor behind the severity of the current financial crisis. Loans made by investment banks for instance are “cut up” and re-bundled for sale to others in the derivatives market. This has two important consequences: first, the risks associated with holding claims upon the ultimate borrowers get hidden from those who hold these claims. Derivatives in short lead to risk-concealment, which means that the euphoria of a boom in the prices of assets, against which loans are made, continues much longer than would have otherwise been the case. Secondly even when the risks are not concealed but are known, the market ensures that the least risk-averse are left holding the maximum risk. This too, by lowering the general level of risk-aversion in the economy, implies that speculation continues much longer than would have otherwise been the case. It follows that the development of the derivatives market has the effect of prolonging speculative booms, and hence intensifying the magnitude of the crash when it finally comes.

All these factors have been at work in the current financial crisis. Its root cause lies in the unfettered operation of financial markets, which is an essential part of the neo-liberal package and which is promoted by finance capital. The fact that Indian financial institutions have largely escaped this crisis is precisely because, thanks to the pressure of the Left, “financial liberalization” has been somewhat checked, despite the best efforts of Manmohan Singh and the other leading luminaries of our neo-liberal contingent. Not that India will escape the consequences of the world financial crisis, but this is because the shifting of funds by the Foreign Institutional Investors will result in a mutually-reinforcing downward movement in the prices of stocks and of the rupee, and also because any recession in the world economy within the neo-liberal regime will entail the import of unemployment into our economy and a crash in the prices of cash crops for the peasantry. (The collapse of the financial giants on the Wall Street has already put a question mark over the employment prospects in BPOs and Call Centres).

But this transmission mechanism will at least not be supplemented by an additional imported financial crisis, as is happening with British and continental banks, because financial liberalization has not proceeded far enough, and certainly not as far as our domestic neo-liberals would have liked. Likewise, if capital account convertibility had gone through, as those setting up the successive Tarapore Committees had wanted, then the collapse of the stock market, and the threat to the value of the rupee in the foreign exchange market, would have been far greater than now, since it is not just FIIs but even the domestic wealth-holders who would be shifting funds out of the country. Similarly, if pension funds had been deployed on the stock-market as the neo-liberals had wanted, then the loss in their value would have meant either acute suffering for the old-age pensioners or an inordinate drain on the government’s budget for rescuing pension funds.

Ironically, Chidambaram has been reportedly shoring up the stock-market by asking public sector banks to buy up stocks, an option that would have been denied to him if his own advocacy for privatizing public sector banks had succeeded. Ironically too, the most ardent advocate of privatizing insurance in the country was the AIG, the world’s largest insurance company, which is at present in the doldrums and rescued only through a loan of $85 billion by the U.S. government.

The country has been spared all this because of the stout opposition mounted by the Left and other progressive forces against neo-liberal policies. But it is also important to draw a salutary lesson from all that has happened. Any economy is ill-served when its affairs are entrusted to a group of persons who are wedded to an ideology that is intellectually vacuous, and owes its apparent triumph only to the fact of its being promoted by the self-serving needs of international finance capital.

That ideology however has run its course. The solution to the crisis that its triumph has precipitated is increasingly being seen to lie in the part-nationalization of financial institutions in the capitalist world, which represents a negation of its basic premise. Originally it was thought that an “injection of liquidity” was all that was needed to overcome the crisis. But the obvious question was: injection of liquidity where? The reason why credit has dried up all over the capitalist world is an increase in the lenders’ perception of risk, since the solvency of the borrowers has become suspect owing to the presence of a plethora of “toxic” securities in the system. If A does not have the confidence in the solvency of B so as to be willing to lend to B, then simply improving A’s access to liquidity is unlikely to make any difference. Of course if B’s access to liquidity can be improved, then, since B is of dubious solvency and hence cash-strapped, this may help overcome the crisis, provided that this liquidity is available on a fairly long-term basis and provided that B uses it wisely. The only way that such liquidity can be made available without arousing public ire is through part-nationalization, whereby the government injects funds in lieu of equity. The European governments, especially U.K. and Germany, have accepted this idea, and Gordon Brown has already put it into practice. The Americans however have been reticent, which is why Treasury Secretary Paulson’s original “bail-out package” (involving simply the government’s buying out “toxic” securities) had such a rough weather (though Paulson now seems willing to consider nationalization). Likewise even measures like guaranteeing inter-bank loans, which European governments have announced, are unlikely to get public support unless control over the behaviour of banks is exercised as a quid pro quo. The rescue operation from the crisis therefore will entail in a basic sense an abandonment of neo-liberalism.

If nothing else, the extreme public anger against the international financial oligarchy will ensure this. In the face of this anger, directed against a bunch of greedy speculators who have brought the world economy to the brink of ruin, the hegemony of finance capital that underlay neo-liberalism is unlikely to persist in the old form. How the crisis and its sequel unfolds remains to be seen, but the world will not go back to what it was before.

October 18, 2008.