Economic cataclysms such as the Great Depression or today’s ongoing collapse of global finance destroy commonly held understandings of political and economic reality. That is one reason why we call them cataclysms; such events occur precisely because no one with the power to do anything about them saw them coming. Icebergs spotted in time do not, after all, sink ships. But once the conventional wisdom has joined prosperity and confidence in the wreckage on the ocean floor of the global economy, we begin to hear of ‘the’ explanations for what happened. Such proclamations mark the times as surely as collapsed Ponzi schemes, falling governments, ruined banks and suicides among the former nouveaux riches. Thus, in the aftermath of the Depression, there emanated from various quarters announcements that the reasons for the catastrophe lay in policy errors by the Federal Reserve, in the Smoot–Hawley Tariff Acts, in stock trading on the margin, in vengeful treatment of Germany in the Versailles Treaty and so forth.
Similarly, the present-day plunge into the economic abyss has again brought forth a smörgåsbord of assertions about ‘the’ cause: mad scientists let loose in dealing rooms, squishy liberals dishing out mortgages to the coloured, inscrutable Chinese officials ‘manipulating’ their yuan, feckless American central bankers throwing the gasoline of low interest rates on a briskly burning fire of asset inflation, Robert Rubin and his cronies in the Clinton White House tearing up regulations, George W. Bush waging wars of choice while cutting taxes on the rich—the discriminating diner can pick and choose what best suits his or her ideological tastes and preconceptions.
In The Credit Crunch: Housing Bubbles, Globalisation and the Worldwide Economic Crisis, Graham Turner has placed on the buffet table his own explanation for what has gone wrong, and it is a good deal more appetizing than many. Turner lays the blame for the current crisis squarely at the feet of the holy of holies of conventional economic orthodoxy: the ‘unquenchable enthusiasm for raw free trade.’ Given the near-total absence of any warning of the crisis from right-thinking academic economists, the distaste of the latter for such an account should provide no grounds for rejecting Turner’s offering out of hand.
In 1817, David Ricardo set out the classic case for free trade: that a country can improve its economic well-being by channelling scarce capital into activities in which it enjoys a comparative advantage—that is to say, at which it is relatively more efficient. It then trades the resultant surplus for everything else it needs. The case says nothing about whether the territory in question enjoys a competitive advantage in such activities; i.e., whether it is more efficient than other countries in those activities. It simply states that the territory should specialize in what it does best. If every country follows a free-trade regime, trading what it is best at producing for goods which it makes less efficiently, economic output on both a national and a global level will rise. Yet simple as it may seem, the theory of comparative advantage is not immediately obvious. To this day it is often confused with competitive advantage—invariably so by advocates demanding protection for an industry facing cheaper or higher-quality foreign competition. They react like anyone else whose income is threatened by a given set of facts or chain of reasoning: by resolutely not seeing them.
Turner is not one of those. Nor is he advancing the argument common to economic nationalists—that a global regime in which each country uses static comparative advantage to determine its economic structure locks existing hierarchies of power and wealth among nations in place. (As the nationalists like to note, Japan’s comparative advantage in the late 19th century lay in silk and pearls; that of the mid-1940s, in cocktail favours and cheap toys.) Turner instead neatly inverts the economic nationalist argument. It is not that rich countries use free trade to keep poor countries poor, but rather that the rich in rich countries use free trade to make themselves richer, while keeping their own poor poor and eviscerating the basis of middle-class prosperity: stable jobs at high wages. Ricardo was alert to concerns that under a universal free-trade regime, capital would migrate to lower-cost countries, thereby impoverishing English workers. He dismissed these fears, due to the ‘difficulty with which capital moves from one country to another.’ But of course we live in a vastly different world, where the telegraph, fax, computer and Boeing 747 have progressively eliminated the ‘difficulty’ that sheer distance had posed to the free movement of capital in the early 1800s. Over the last generation, policy-makers in Washington, London, Basel and Davos embarked on a crusade to dismantle another sort of ‘difficulty’ hindering the free movement of capital: that posed by laws and regulations. Neo-classical economic doctrine gave this drive the imprimatur of Ricardian orthodoxy, but the real motive was to push down wages. ‘Free trade today is no longer driven by comparative advantage’, Turner writes, but rather by ‘the ability to maximize profits by cutting costs’; elsewhere he notes that ‘imports of cheap goods from low-cost countries have been fundamental to the downward pressure on wages for many workers’. Today, then, free trade has little to do with Ricardo’s picture of the Portuguese using their comparative advantage in wine-making or the Scots in sheep-shearing to make better lives for themselves. Rather, it has enabled ‘large multinationals to control and drive labour costs down . . . by moving jobs around from one country to another’. It is in this drive that we find ‘the heart of the debt problems facing the West.’
Turner devotes much of his book to an elaboration of how free trade coupled with deregulated capital markets led to ‘problems’ that have, since he finished writing in the spring of 2008, become full-fledged economic cataclysms. What Turner calls a ‘fundamental shift in the balance of power between capital and labour, or companies and workers’ led via free trade and deregulation to ‘concerted downward pressure on wages’, to which the ‘asset bubbles that are now bursting all across the industrialized West’ are ‘indelibly linked’. With the loss of high-paying, stable jobs, middle-class families managed to stave off for a time a downward lurch in living standards by reducing their savings while borrowing against their homes and equity portfolios. They could do so because the countries that were running trade surpluses with the West—the petroleum exporters; emerging markets such as China—were holding the proceeds of their surpluses in Western currencies, mostly the us dollar. By the very fact that they were denominated in such currencies, these surpluses were automatically re-invested in the West. Now it is a truism that too much money causes inflation. But the inflation that inevitably accompanied the rivers of money pouring back into the West from China, Kuwait and so forth did not find its way into goods and services. Free trade and the systematic transfer of production capacity to low-wage countries kept those prices from rising much.
Instead, the money was steered into markets for equities and real estate. It was this asset inflation that enabled the middle class temporarily to sidestep the consequences of the transfer of production capacity abroad, under a global regime of unrestricted free trade. Buffed-up stock portfolios seemed to give many families tacit permission to stop saving from current income; borrowings against the rising value of residences replaced the income lost when good jobs disappeared. Meanwhile, those rising values both induced working people to buy houses they could not afford and encouraged bankers to extend the debt that made the purchases possible. Western governments were loath to step in to break up the party. They kept corporate interests happy by zealously hunting down and eliminating the last remaining barriers to the ‘free movement of goods and capital’, while treating asset bubbles with benign neglect. By ignoring the bubbles, they ensured that the debt seen as a ‘panacea’ for falling wages would soar. But bubbles by their very nature blow up. Their defining feature is the divorce of prices from the cash flow the asset can conceivably generate: the dividends from a share of stock; the rents from a house or office building. Prices nonetheless continue to climb because practically everyone has convinced him or herself that the assets’ value can only go up, and because lots of money is chasing too few assets. Players enter the market precisely because they can raise the money. But at some point the money dries up—perhaps central banks tighten rates, private banks get cold feet, or, as in the summer of 2007, ‘private investors turned against us assets with a vengeance’. They can no longer be sold to a ‘greater fool’ since said fool can no longer find the money to buy them. The asset prices tumble; the bubble bursts, leaving ruin in its wake.