The Global Economic Crisis Three Explanations Come with Their Own Policy Prescriptions

By Palley, Thomas | Pittsburgh Post-Gazette (Pittsburgh, PA), October 8, 2012 | Go to article overview

The Global Economic Crisis Three Explanations Come with Their Own Policy Prescriptions


Palley, Thomas, Pittsburgh Post-Gazette (Pittsburgh, PA)


Many countries are now debating the causes of the global economic crisis and what should be done. That debate is critical because how we explain the crisis will influence what we do.

Broadly speaking, three explanations exist.

Explanation No. 1 is the "government failure hypothesis" associated with the Republican Party. It claims the crisis is rooted in the U.S. housing bubble, which was due to government intervention in the housing market and failure at the Federal Reserve. Government intervention drove up house prices by encouraging home ownership beyond people's means, while the Federal Reserve pushed interest rates too low for too long in the prior recession.

Explanation No. 2 is the "market failure hypothesis" associated with the Clinton wing of the Democratic Party. It claims the crisis is due to inadequate financial regulation. First, regulators allowed excessive risk-taking by banks. Second, regulators allowed perverse pay incentives within banks that encouraged management to engage in "loan pushing" rather than "good lending." Third, regulators pushed deregulation too far. Together, this permitted financial excess that fueled consumer debt and the house price bubble.

Explanation No. 3 is the "destruction of shared prosperity hypothesis" associated with the labor movement and New Deal Democrats. It claims the crisis is rooted in the radical free market philosophy of Milton Friedman and Ayn Rand that has guided economic policy for the past 30 years. The resulting flawed policy infected financial markets via inadequate regulation, but that is just one part of a much larger problem.

The radical free-market approach was adopted in the late 1970s and early 1980s. From 1945 to 1975 the U.S. economy was characterized by a "virtuous circle" Keynesian model built on full employment and wage growth tied to productivity growth. Productivity growth drove wage growth, which fueled demand growth and full employment. That provided an incentive for investment, which drove further productivity growth and higher wages.

After 1980 the Keynesian model was gradually replaced by an anti- worker free-market model that cut the link between wages and productivity growth and created a new economic dynamic.

Before 1980, wages were the engine of U.S. demand growth. After 1980, debt and asset price inflation became the engine.

The new conservative economic model can be described as a "policy box" that pressures workers from all sides. Corporate globalization put workers in international wage competition via corporation- friendly free-trade agreements and business off-shoring. Relentless anti-government policy attacked the legitimacy of government and pushed deregulation regardless of dangers. In labor markets, corporations attacked unions and policy weakened worker protections and wage supports like the minimum wage. …

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