A good example of a dangerous prescription from a wrong diagnosis

Prof Philip Booth writes for Europe's World

Prof Philip Booth writes for Europe's World magazine, commenting on an article by former Danish Prime Minister Poul Nyrup Rasmussen, in which Rasmussen blames the recent economic crash on an adherance to neo-liberal rules and calls for a new type of social democracy to be followed.

In economics, false policy prescriptions arise from false premises. This is one of many problems with the article by Poul Nyrup Rasmussen. He argues that adherence to neo-liberal rules led to the financial carnage. It is difficult to believe that anyone familiar with international banking regulation, European Union regulation or the millions of paragraphs of national regulation can seriously believe that it was neo-liberalism that led to the financial crash. Yes, there was bad regulation – the socialist regulatory approach certainly did fail – but it is not true that there was no regulation.

Closer to the truth is that US corporatism created a tinder box in the banking system. Throughout the US financial system, risk is underwritten by the taxpayer. This arises from weak personal bankruptcy law; the state mortgage securitisation houses Fannie Mae and Freddie Mac; Federal and State requirements to provide loans to poor risks; and the continual bailing out – over several decades - of financial institutions. It is true that financial institutions made huge mistakes. But it is no wonder they made huge mistakes given the incentives they faced. Regulation and the tax system further distorted the decisions of banks, discouraging good risk management and encouraging gearing.

To be fair to Poul Nyrup Rasmussen, this is not caused by socialism. But it is not neo-liberalism either. The “welfare state for bankers” has had predictable effects and has its roots in US corporatism and misguided social policy.

Rasmussen also ignores the serious problems that have been caused by the growth of the state in recent years. He argues that cuts will put the EU economy to sleep. There is simply no evidence for that. Fiscal expansions over long periods have failed to produce economic growth in Japan. Fiscal retrenchments, as the EU’s own evidence shows, have quickly led to renewed economic growth. In many EU countries, the growth of state spending has been relentless and structural – it has had nothing to do with the financial crisis. In B