Firms in a Neoliberal Transition: The Case of Mexico 1990-1994
Danby, Colin, Journal of Economic Issues
Situating Moral Hazard
This paper takes issue with a bifurcation in analyses of the crises that often follow neoliberal reforms. As is evident in the literature on the recent East Asian crises, analysts tend to split into a neoclassical camp that blames national governments for not being quite neoliberal enough and a structuralist camp which attributes financial collapse to properties of the international economy.
The run-up to these crises typically includes startling levels of private sector risk taking, including large short positions in foreign currency. In the aggregate this activity creates financial fragility that deepens the subsequent crises and widens the damage they do to output and employment. Advocates of neoliberalism have explained some of this private risk taking with the concept of "moral hazard"; structuralist critics have dismissed this explanation as yet another effort to blame governments for what are actually inherent flaws in neoliberal reform.
This paper attempts to rescue the notion of moral hazard from the orthodox, methodologically individualist literature in which it is usually couched. It uses the example of Mexico to argue that relations between states and large firms are often more institutionally complex than portrayed in either neoclassical or structuralist accounts. (1) Such complexity is not mere detail but goes to the basic question of the conditions under which private accumulation takes place. In the Mexican case I will show that an ostensibly neoliberal reform had the perverse effect of strengthening implicit state insurance against exchange-rate losses by large firms.
First, then, a word on how the term "moral hazard" has been deployed with regard to the more recent East Asian crises. Paul Krugman (1998,1999) told the story in terms of three generations of crisis models. First generation models blame currency crises on actual fiscal deficits and accompanying monetary expansion--in this category we would put the conventional "monetary approach to the balance of payments." The policy lesson is tighter money and less public borrowing. Second generation models revolve around people anticipating future monetary or fiscal laxity by a government: "when investors begin to suspect that the government will choose to let the parity go, the resulting pressure on interest rates can itself push the government over the edge." Governments are supposed to avoid this by credibility-enhancing measures like central bank independence (Grabel 2000).
Krugman (1998) noted that the first two categories fail to explain the East Asian crises of 1997-1998 and proposed a story focusing on ill-regulated banks which drew in state-guaranteed deposits while they made high risk loans. The result was that "moral-hazard-driven lending could have provided a sort of hidden subsidy to investment" (1999, 2), (2) This approach ingeniously re-introduces the key features of the first two generations of model: it depicts a pattern of government behavior that not only creates an actual (though hidden) fiscal deficit but also a contingent liability that may force future fiscal and monetary laxity. Lance Taylor's comment is appropriate:
The leitmotif of an alert private sector chastising an inept government recurs. This time the state encourages reckless investment behaviour. All a sensible private sector can be expected to do is to make money out of such misguided public action. (1998, 668)
The literature Taylor critiqued does indeed use the term "moral hazard" in a markedly a priori way, with little historical or institutional nuance, to designate a large assumed class of state interventions. (3) However, I argue that Taylor too hastily put aside all notions of moral hazard and too broadly dismissed stories of state failure, This paper argues for a kind of joint state and private sector failure that can usefully, if not exhaustively, be described in moral hazard terms. …