The collapse of Lehman Brothers on 15 September 2008 unleashed the worst global downturn since the Great Depression of 1929. And it was almost entirely unanticipated. Ten years on is a good time to ask what governments, policymakers, and economists might learn from this catastrophe – how to prevent future ones, and how to overcome them if they happen. Of these two, prevention is far better than cure. Once a downturn gathers momentum, the scale of intervention needed to reverse it becomes frighteningly large. Budget deficits balloon, public debts soar, governments take over banks – all conjuring up visions of looming state bankruptcy, or worse, state control over the economy. So the most important question is: how can these catastrophes be prevented?
By prevention, I do not chiefly mean trying to stop the semi-regular fluctuations of the business cycle. Capitalist market economies exhibit rhythms of economic activity. The political economist Joseph Schumpeter called them waves of creation and destruction, or perhaps they simply arise from temporary mistakes of optimism and pessimism. The authorities already possess the tools to dampen, if not altogether prevent, these fluctuations – if they want to. Central banks can use interest rates to restrict or expand credit; government budgets have built-in stabilisers, with revenues falling when the economy turns down, and rising when it expands.
Ten years after the financial crash, the timid left should be full of regrets
Beyond this, central banks could vary the reserve requirements of member banks counter-cyclically; local authorities could keep a buffer stock of public works – local improvements – which could be quickly expanded and contracted as unemployment rises and falls. Finally, there is a question of the “norm” around which the fluctuations might be allowed to occur. Should policy aim to maintain “high” full employment or be satisfied with “low’” full employment – the difference being between (say) an unemployment rate of 2-3% and 4-5%?
But the job of preventing economic collapses (of the order of 5% to 10% of national income, with unemployment doubling from “normal” times) requires far more ambitious thinking. Such collapses can happen at any time because, as John Maynard Keynes taught, the future is uncertain. It was the rapid spread of contagion through the banking system that brought it low in 2008. This was because big global banks held each other’s heavily insured risky assets. When the value of these assets collapsed, the banks and their insurers went bust. They then had to be rescued because they were “too big to fail”.
If the economy is allowed to fail, the “cure”, as the events of the past 10 years have shown, is very difficult. A severe recession is bound to increase the government’s deficit. This is because the government’s revenues automatically fall and its expenditures automatically rise, with extra payments to the casualties of the slump, whether households or banks. A continually rising deficit, financed by public bond issues, rapidly raises the national debt to seemingly astronomical heights. So a politically irresistible demand arises to “cut” the deficit. Cutting the deficit by cutting welfare becomes the litmus test of a government’s determination to “put its accounts in order”. This is what happened over most of the industrial world from 2010 onwards. Known as “austerity”, it was implemented in Britain by George Osborne, the Conservative chancellor of the exchequer