The ‘disciplining role of markets’ should be replaced by the disciplining role of democracy

When we elect governments we should expect that they will do what they promised and represent our best interests. We don’t expect them to represent a small, privileged sector of the economy at the expense of the rest of it. The problem is that we overlay these aspirations onto an economic ownership system which has a different logic to our understanding of the operations of a democratic state. And mainstream economics gives reverence and priority to the logic of capitalism rather than ensuring that the quality of democracy is maintained. Which reflects its origins – as an apologist for the unequal ownership of the material means of production and the consequences that arise from that inequality. We keep seeing a restatement of that priority from prominent policy makers and while that generation is in charge it will be hard to really shift the paradigm.

Late last year (November 5, 2020), the head of the Bundesbank, Jens Weidmann gave a speech in London to the Official Monetary and Financial Institutions Forum (OMFIF) – Too close for comfort? The relationship between monetary and fiscal policy – which exemplifies the sort of ideological resistance that is going on among mainstream policy makers to the more pragmatic choices being made by governments facing catastrophic consequences arising from the pandemic.

It highlights the contradictions of our lives.

On the one hand, is global capital, which reflects the inequality in property ownership that defines capitalism.

Its strategic plan is to harness the capacity of the state, to reconfigure it, to ensure that the policy space provides the least resistance to its ambitions to maximise profit.

Only the smallest proportion of its operations relate to anything that advances well-being of the people in general.

The wealth shuffling creates massive wealth for a tiny few in relative terms.

It will engage in widespread fraud, lie, bully and more to achieve its objectives.

We could eliminate the vast majority of the financial sector and most of us would be better off.

When capitalist hegemony was dominated by industrial capital – the robber barons – it was easier to control the capitalist lust because the surplus value production required reaching agreements with industrial labour.

And through our governments, we could strive for social democratic goals using interventionist fiscal policy, because capital required production of things for it to prosper.

That is not to say that the state didn’t provide substantial support for the surplus generating machine.

Of course it did. It developed mass education and training systems, public health, public transport, public infrastructure and all sorts of advantages that capital could leverage off at no expense.

State procurement contracts were essential and we developed an understanding of the military-industrial complex which grew out of the benefits derived from fiscal policies that ensured full employment and strong growth.

There was always a conflictual distributional struggle – bosses wanting more and paying less, workers want higher pay for less work – but, mostly, this was mediated by the role of the state.

But neoliberalism changed all that.

The state abandoned its role as a mediator of the conflictual goals of labour and capital, and, instead, began to operate as an agent for capital.

In that role, the state started to use its legislative and regulative power to reduce the capacity of trade unions to achieve wage gains, to protect workers, to even represent workers as the concept of ‘independent contractors’ emerged to avoid statutory minimum labour conditions and more.

The state privatised public entities, putting more wealth into the speculative domain, which meant, for example, that essential public goods (telecommunications, energy, water and more) became objects of financial speculation, which distorted and, as we have seen, compromised their original purpose.

Think Texas at the moment.

The state also embraced the emerging Monetarist doctrines which also resulted in reduced employment growth and elevated levels of unemployment and reinforced the attacks that were made in the industrial relations domain that reduced wages growth and redistributed national income towards profits.

This was going on at the same time as global supply chains were widening and the narrative in the 1970s conflated the opening up of trade and supply across borders with the emerging Monetarism and its microeconomic expression in the form of deregulation, privatisation etc.

That conflation, promoted by the pro-capital interests on the Right, completely fooled the progressive forces of the Left, and social democratic political forces were coopted into becoming part of their own destruction.

Thinks British Labour mid-1970s, French socialists 1980s, Australian Labor Party 1980s and beyond, New Zealand Labour Party 1980s – and a whole raft of progressive parties all around the world.

They were compromised and became neoliberal machines because they failed to differentiate between the rise (and advantages) of global supply chains and the shift in ideology towards neoliberalism.

We can have the former without the latter.

But the conflation gave global financial capital the freedom to proliferate and that made the link between profit and production less obvious.

And capital through its lobbying power has also meant that there is now democratic deficits rising all around the world. So, we don’t even get to express our political choices on an even playing field.

But the incompatible logic between democracy and capitalism and the compromise of the former by the latter has brought the world to its knees.

Why? Because capitalism has always required the state to attenuate its tendency to crisis.

Crisis creates social havoc and that, in turn, makes the voice of the people stronger – such that governments cannot blithely ignore us.

And the pandemic has meant the capitalism is now on state provided life support. Without the state support, substantial proportions of capitalist enterprise would fail now and that has meant that the pro-capital apologism of mainstream economics is being (termporarily) ignored in favour of fiscal dominance and the use of monetary policy to support that dominance.

This is a major shift away from the claims that monetary policy has to be independent of the political aspirations of the nation – that is, the democratic expression – which for several decades has been the way neoliberal ‘depoliticisation’ has operated to allow elected politicians to use fiscal policy in an irresponsible way (austerity bias), but, at the same time, shift the responsibility for that destructive conduct to external bodies like the IMF and so-called ‘independent’ central bank boards.

The mainstream macroeconomists claimed that we should ‘assign’ the macro policy instruments towards monetary policy and away from fiscal policy – which is just fancy terminology to say that fiscal policy would no longer target full employment and ensure that non-government spending gaps were more or less continually closed and that central banks would use unemployment as a policy tool rather than a policy target.

They asserted that this policy regime would make us all be better off.

That hasn’t happened. We are, in general, worse off, while a small proportion of people have gorged themselves on massive wealth creation at the expense of the rest of us.

More people are starting to realise that.

But the mainstream won’t give up to easily.

Jens Weidmann’s speech exemplifies that resistance – he was particularly focused on “the problem of fiscal dominance”.

He admits that during the pandemic that:

… fiscal policy has taken the lead. And quite rightly so. It has both the democratic legitimacy for heavy interventions and the custom-fit instruments.

So acknowledging two important factors:

1. Fiscal policy is a flexible instrument which can be targetted spatially and demographically and impacts directly on the spending and income stream, whereas standard monetary policy (interest rate adjustments) is a blunt (indirect) instrument with ambiguous effects.

2. Fiscal policy discretion is directly tied to our notion of democratic participation and responsibility, while monetary policy is the domain of unelected, and, largely unaccountable board members.

So by supporting a regime that prioritises monetary policy over fiscal policy, one is using an inferior macroeconomic policy tool which expands the democratic deficit.

Weidmann then moved on to discuss the “risk of fiscal dominance”.

He said:

1. “government bond purchases … [by central banks] … risk blurring the line between fiscal and monetary policy” – this is the usual claim that the two arms of policy should be independent of each other except that fiscal policy should be subjugated to monetary policy under this New Keynesian mainstream consensus.

The fact is that the two arms of policy can never be independent. Fiscal policy directly impacts on bank reserves, which require monetary policy liquidity management operations to take into account or lose control over interest rates.

The two arms have to work in a coordinated fashion – on a daily basis.

2. “The problems are particularly pronounced in a monetary union with fiscally autonomous member states. Here, such purchases involve the fundamental risk of mutualising sovereign liability risks through the central banks’ balance sheets” – so a commentary on the Eurozone.

The reality is that the ECB is funding fiscal deficits across the 19 Member States despite all the denial about that.

If the ECB didn’t, then the common currency system would have collapsed in 2010 with the insolvency of several nations, given they surrendered their currency-issuing capacity.

Such behaviour is thus endemic or intrinsic to the maintenance of the currency because the founders’ design was deeply flawed and unsustainable.

It doesn’t mean that misery has been the norm. But in an existential sense, if the ECB does “mutualise sovereign liablitity risks” the system collapses.

3. “Decisions on the redistribution of liability risks should be taken – if at all – by parliaments and governments, not by central banks” – again about the Eurozone.

This statement is true but the reality that it is the ECB that is sustaining the system is just a statement of the reality that the fiscal autonomy of the 19 Member States is so compromised by the fiscal rules that they are unable to defend their own economic and financial systems.

That is where the democratic deficit arises in Europe. It is by design. The states will never be able to redistribute liability risks effectively because they cannot.

4. “the Eurosystem central banks have become the Member States’ biggest creditors – and that was the case even before the current crisis” – which is just a restatement of my point under (2 above).

The central banks are the biggest creditors of the Member States because otherwise many of these states would have gone broke during the GFC because bond markets would have refused to fund them on viable terms given the expanding credit risk.

All the result of a dysfunctional monetary architecture.

5. Then he makes the fundamental point:

For the part of sovereign debt that is on our books, funding costs are decoupled from the capital market. The interest on those bonds flows to central banks, which distribute them back to their treasuries as part of their profit. That weakens the disciplining role of markets. Thus, the incentives for sound budgeting diminish, especially as the EU’s fiscal rules are weak.

This is the mainstream position.

It is taught to university students all around the world as if it is truth. It appears in textbooks (not mine). It is pushed in the financial media.

It is a basic denial of democracy and reveals clearly the role the economic profession plays in supporting that denial.

Why should the ‘capital markets’ have some priority over making judgements over government policy?

The answer economists will give is because they fund the government spending over tax revenue.

Of course, once you blow the cover on that lie – that bond investors are funding the government deficits – then the question I posed starts to bite.

Why indeed?

There is no reason for maintaining a system where bond investors have the discretion to express their own ideological preferences by punishing governments that deviate from those preferences.

That is a neoliberal contrivance to compromise democracies and tilt the capacity of government to benefit the top-end-of-town.

Conclusion

The “disciplining role of markets” should be replaced by the disciplining role of democracy.

We vote.

If we don’t like what government is doing with its fiscal policy interventions then we vote them out in favour of an alternative.

A government cannot do that much damage in one electoral cycle.

We will not break out of this destructive neoliberal era until we abandon the idea that the ‘capital markets’ should in some way be the arbiters of responsible policy settings.

The ‘markets’ are always self interested.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.