Divided we stand, united we fall
The market requires individuals to act in their own self-interest. But their decisions can add up to recession
Michael Prowse, Financial Times; Nov 10, 2001

The worst nightmare of economists - a fully synchronised global recession - seems to be taking shape before our eyes. The economic news from the US, continental Europe, Asia and Latin America was depressing before the September 11 attacks. Now it is uniformly grim.

Alan Greenspan, the veteran Federal Reserve chief, has reacted to the biggest fall in US employment since 1980 with yet another big cut in interest rates - to 2 per cent, the lowest in nearly four decades. But the efficacy of rate cuts in the present climate is doubtful, and the economic contraction that got under way in the third quarter seems to be still intensifying.

Gordon Brown, Britain’s ebullient chancellor, must already be wishing that he had not boasted so incautiously of ending the Tory cycle of “boom and bust”. He is likely to spend much of his second term at the Treasury grappling with the economic and social consequences of a serious downturn.

And he may find that many of his first-term initiatives - such as the US-inspired efforts to make welfare contingent on work - only complicate the task of managing New Labour’s first recession.

Brown’s boast revealed his incomplete grasp of the implications of globalisation. The world’s leading economies have always been interconnected, but the progressive removal of barriers to trade, direct investment and capital flows has increased their interdependence. This means that medium-sized nations such as the UK are even less in control of their economic fate than in the past.

And this implies that even if Brown had been clever enough to remove the domestic causes of boom and bust (something that was never in his power), he could not have removed their international causes.

To claim to have abolished boom and bust in a globalised world amounts to claiming that you have global capitalism in the palm of your hand. And that’s something that only the craziest of spin doctors could ever dream of claiming.

Hopes that plucky Britain might yet stay afloat even though everyone else is sinking are beginning to look naively optimistic. The problem is not just that many regions (and Asia in particular) are so dependent on exports to the US, but that investors, stockbrokers and corporate executives now share what sociologists would call a “collective consciousness”.

If what Keynes memorably called “animal spirits” are depressed on Wall Street, they are depressed everywhere because, in a globalised world, communication is instantaneous and geographical location next to irrelevant. The main players on Wall Street are global players. And the thoughts that flash through heads in one financial centre inevitably flash through heads in every financial centre.

If only recessions could be confined to a box marked “economics”. But, alas, this is rarely the case. Recessions break political reputations; sometimes they even break political parties. The problem, in part, is that they are usually so agonisingly drawn out. If the global downturn proves severe, the UK jobless rate, for instance, will not rise just for a few months. It could rise for a year or even longer, and this could devastate Labour’s reputation for economic competence.

And historical experience suggests that the public’s perception of “bad times” can persist for several years after a recession is technically over. If Britain were to slip into recession next year, anger over redundancies, bankruptcies, pay cuts and negative housing equity would probably not have dissipated by 2005, which is when Labour would hope to call the next election.

But a synchronised global recession could do more than break political reputations in Britain and the US. It could also break intellectual reputations, particularly those of the thinkers and organs that have done most to promote confidence in the “market paradigm” - the belief that just about every social problem is best solved by appealing to market mechanisms.

This is all the more likely if the driving force behind global recession is the same as it was in 1929-31: a steady collapse in equity prices and the consequent destruction of the financial wealth of many middle- and upper-class families.

The truth is that the market’s greatest strength is also its greatest weakness. It is essentially a mechanism for allowing decentralised decision taking. It encourages each of us to do whatever we judge will promote our own interests without knowledge of the decisions of others, and without regard for their interests. The problem is that the aggregate results of many individually rational decisions are often far from rational for all the agents considered as a group.

Take the behaviour of big corporations. Most see themselves as virtuous because they are aggressively cutting their costs. This seems to be in their own interest, yet by acting in this self-regarding way, they are reducing demand for each other’s products.

They pride themselves on their financial responsibility, but as they slash their own budgets they are actually creating the global recession that they so fear. They have neither the incentive nor the capacity to act in a way that would promote their own collective welfare, still less that of the wider community.

Economists, of course, are not unaware of these problems. The US is already fiscally reflating in an attempt to counter the negative effects of personal and corporate retrenchment.

But the process of globalisation has transferred so much decision-making power to individuals and companies that the collective irrationality of their separate decisions may prove much harder to counter through government action than in the past.

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