The following is the text of an address delivered by Sir Courtney at a tribute held in honour of Dr Trevor Farrell by the Economics Department , UWI, St Augustine on Wednesday, October 8th, 2008. The conference title was “The Economy 2008: Planning in a Turbulent Environment”
By Sir Courtney N Blackman
The Countdown to Crisis
I claimed earlier to have had a front seat view of the unfolding drama but neglected to tell you that the drama was of the genre of Greek tragedy. The Hero in the play is the personification of the CEOs of Wall Street investment and banking houses, the most powerful and best paid business leaders in the world. But the Hero is flawed by the vice of greed, and succumbs to the lowly but toxic “sub-prime” mortgage loan. President Bush is the unsuspecting human agent that Fate uses to set in motion a series of seemingly unremarkable events that conspired to ruin our Hero.
In 2002 President Bush persuaded Congress to pass a $1.6 trillion tax cut bill that, in one fell swoop, transformed President Clinton’s legacy of fiscal ”surpluses as far as the eye can see” into fiscal deficits that reached far beyond the horizon. (11) In so doing he transgressed the Keynesian principle of contra-cyclical macroeconomic policy in which surpluses accumulated in the economic upswing are drawn down in time of recession in order to kick-start economic recovery. The Bush tax-cuts effectively removed the fiscal policy option from the table, and the full load of economic stabilization fell on monetary policy which, as John Maynard Keynes famously observed, was like pushing on a string.. As the recession that had begun in 2001 deepened and the fear of deflation grew, the US Federal Reserve aggressively cut interest rates to as low as one percent, only to stumble into the classic Keynesian liquidity trap. The combination of low mortgage rates and easily available loans set off a housing bubble and spawned the deadly “sub-prime” mortgage loan.
A sub-prime mortgage loan is one made to a borrower who does not qualify for a loan at the most concessionary interest rate, and must therefore pay a higher rate to reward the lender for the extra risk he is taking. Some lenders find it more profitable to package and ’securitise’ sub-prime loans for on-lending to other investors. Between 2001 and 2004 the sub-prime mortgage market grew from $160 billion to $540 billion. Under pressure from the Administration and Congress, Fannie Mae, the Government sponsored mortgage insurer, brought on its books $300 billion of sub-prime loans that it either retained or sold to domestic and foreign investors – including some in the Caribbean. When the housing bubble burst in 2006 home prices fell precipitously, and in many instances homeowners’ equity fell below their mortgage indebtedness.
Meanwhile, our Hero had fallen victim to a most perverse incentive. At the Columbia Graduate School of Business in the 1960s, I was taught that Management was responsible for the “just” distribution of corporate earnings among all stake-holders – workers, suppliers, customers, Government, the Community and shareholders – the so-called “stakeholder theory”. Stakeholder theory was superseded in the 1990s by the principle of “maximization of shareholder value”. To align CEO interests to those of the shareholder, CEOs were paid an increasing proportion of their compensation in bonus awards of company stock and stock options as an incentive to put the interests of shareholders first. Whereas in 1980 stock options constituted only two per cent of executive pay in major corporations, the proportion is now estimated at over 60 per cent, while the ratio of corporate pay to the median wage of workers increased from about 35:1 in 1980 to over 350:1 today.
The linkage of CEO pay to stock prices exposed CEOs to a moral hazard that many of them could not rise above. Since an increase in stock prices also raised their own income, they began to manage the stock price and ceased managing the company, often “cooking” the books to inflate profits and push up the stock price. Enron and WorldCom are infamous cases of corporate greed leading to the destruction of enterprises, with the loss of shareholder investment and workers’ jobs and pensions. Many senior executives would be marched off to prison.
On Wall Street, the Management of revered institutions forgot that their primary fiduciary responsibility was the safety of their clients’ deposits and investments. Instead, they chased after off-balance-sheet profits from investments in exotic derivatives and hedge-fund bets. Tragically, it was the lowly sub-prime mortgage loan that brought our Hero down, and with him everyone else in the building and vicinity.
Throughout it all, Federal Reserve Chairman, Alan Greenspan, himself a confirmed Neo-Liberal, refused to regulate trading in the new and increasingly complex financial markets, confident the “free market” would regulate itself. (12) I have no doubt that it was the culture of selfishness emanating from the Neo-Liberal paradigm that led to our present predicament.
Life after Neo-Liberalism
The damage to the US economy and to the national psyche has been severe. The recession, already underway, can be expected to last for two or three years more. US consumers, who have suffered huge losses in the stock market and from home foreclosures, face rising unemployment. They will hardly be able to play their traditional role of buyer of last resort, and exports to the US, including oil, will certainly fall off. We in the Caribbean must brace ourselves for adverse times. It is especially important for trade unions to take note and modify their wage demands accordingly.
Kuhn’s first condition for a paradigm-shift has been satisfied, in that Neo-Liberalism has failed comprehensively; however, no obvious alternative waits in the wings. Nevertheless, the strong opposition by Congress to the “bailout” of Wall Street, a general revulsion to the conduct of Wall Street CEOs, and a call in most quarters for increased regulation of the financial sector, suggest weakening support for the Neo-Liberal paradigm. A Democratic victory next month might hasten the process.
Some Final Thoughts
Whether or not the Neo-Liberal paradigm is overthrown, reconstructed or merely modified, we economists in the Caribbean must not be content with hand-me-down economic models from so-called ‘mainstream’ economists. As my late friend Lloyd Best reminded us ad nauseam, we must tailor our economic models to fit our own history, culture, circumstances and aspirations. Indeed, that is what our New World Group of economists so gallantly attempted in the 1960s and 1970s. They failed, in my judgment, for epistemological, not intellectual reasons, and gave up the quest. But that is no reason why we should not try again to formulate a development paradigm that fits our needs – especially since Neo-Liberalism has failed in such a spectacular fashion.
In today’s climate of uncertainty, I suggest that you begin by going back to first principles. Here are some lines of approach you might consider:
1. Economies are comprised of people, not of graphs, mathematical symbols or statistical data.
2. The market is a concept; it does not cerebrate. Only people do. It does not know better than we do.
3. Only people, not economies and markets, have problems. Our theories must therefore be people oriented
4. The market is a social tool for the inexpensive, not optimal, allocation of resources. We must determine what we want it to do for us, not vice-versa. Moreover, it is useful towards the solution of only some, not of all problems!
5. If we can live with market outcomes, we accept them; if we cannot, we must intervene as robustly as needed – even as the Americans and Europeans have done in response to the current global financial crisis.
Finally, economic development derives from the efforts of people, usually working in groups. Their activities will be productive only if well managed. Good management promotes productivity, profitability, the creation of new capital and, ultimately, economic growth and development. On the contrary, poor management results in the destruction of capital and economic disaster – often with amazing swiftness, as the current crisis so vividly illustrates. This is the lesson that Dr. Trevor Farrell has relentlessly kept before us for over three decades, and it is for this reason that we honour him today.