What is the truth about the great recession and increasing inequality dialogues

Contents Increasing Inequality: First Dialogue 5 The Failure to Predict the Great Recession: Second Dialogue 29 Why Fiscal Austerity?: Third Dialogue 47 Rolling Back the Welfare State: F

What Is the

Truth About the Great Recession and Increasing Inequality?

Mario Morroni

and Increasing Inequality?

Mario Morroni

What Is the Truth About the Great Recession and

Increasing Inequality?

Dialogues on Disputed Issues and Conflicting Theories

Department of Political Sciences

University of Pisa

Pisa, Italy

ISBN 978-3-319-98620-3 ISBN 978-3-319-98621-0 (eBook)

https://doi.org/10.1007/978-3-319-98621-0

Library of Congress Control Number: 2018951401

Translation with updates from the Italian language edition: Nulla è come appare Dialoghi sulle verità sommerse

della crisi economica by Mario Morroni, © Imprimatur 2016 All Rights Reserved.

© Springer Nature Switzerland AG 2018

This work is subject to copyright All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broad- casting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.

The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use.

The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

This Springer imprint is published by the registered company Springer Nature Switzerland AG

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Acknowledgements

This book is an updated and revised edition of the Dialogues that were

originally published in Italian (Nulla è come appare Dialoghi sulle verità

sommerse della crisi economica, Imprimatur Editore, Reggio Emilia, 2016)

I am very grateful to Eugenio Biagini, Peter Clarke and Elizabeth Garnsey for their encouragement and insightful help I deeply appreciate the inval- uable comments on earlier versions of the Dialogues provided by Pietro Ferrari, Vladimiro Giacché, Maria Cristina Marcuzzo, Augusto Ninni, Alberto Pench, Marcello Ranucci and Elena Taverna I want to thank Janet Campbell, Dylan Macchiarini Crosson, Nick Garwood, Janet Henderson, Rossana Pagliolico McKeane and Martin Richards for careful reading and useful advice that have greatly improved the quality of the manuscript

I acknowledge the support by the University of Pisa and by the Clare Hall College for Advanced Studies, University of Cambridge, which offered a stimulating research environment throughout the writing process Finally, Maria Cristina Acocella’s professional editorial assistance is gratefully appre- ciated.

About this Book

An anthropology student and three economists meet at an airport They are waiting in a departure lounge; their flight grounded by fog The student, who knows very little about economics, asks her three travelling companions

a series of questions about increasing inequality, cutbacks to welfare systems, crisis management policies, the euro, environmental degradation and indus- trial policies enacted in the face of globalisation This is a rather lucky coin- cidence because nowadays it is rare for economists with different theoretical positions to be willing to engage in direct discussion with each other.

The protagonists debate the consequences of neoliberal economic policies that are based on the idea of efficient, self-regulating markets and that have been implemented over the last 30 years across the world by both right-wing and left-wing politicians The deep recession which followed the 2007–2008 financial crash has shown the fatal consequences of these policies and has encouraged the development of alternative visions The economic implica- tions of these different visions emerge clearly in the discussions.

In their answers to the student’s questions, the three economists are obliged to avoid their usual abstract and specialist jargon This makes the discussion comprehensible to the reader who is not an economist but aims

to get to the truth of the causes of recent economic events that have affected all of us, and that are often difficult to understand because of the mystifica- tion created by the use of jargon and political posturing.

Unlike most other writings on the Great Recession, the dialogue form has

an advantage, in the words of Galileo, it ‘presents the arguments … as much

viii About this Book

from one side as from the other’,1 highlighting the weak points of theories under discussions.

These nine dialogues have been used in public readings2 but can also be used to complement textbooks on macroeconomics and economic policy which usually omit, or else touch upon, very superficially, the theme of the recent economic crisis.

The first dialogue is about the sharply rising inequality over the last three decades within most advanced economies The second dialogue discusses speculative bubbles and why economists did not predict the crash of 2007–

2008 The third one concerns the policies of fiscal austerity and addresses the point that in macroeconomics, as in physics, nothing is what it may seem at first sight The fourth one deals with the consequences of rolling back welfare systems The fifth dialogue explores the roles of the state and markets The sixth one discusses the economic consequences of the very con- siderable German trade surplus and the euro crisis The seventh dialogue addresses the policies enacted to confront the crisis The eighth one deals with the problem of environmental degradation The last dialogue discusses the need to implement an industrial policy that favours innovation and safe- guards the environment.

The dialogues can be read in any order according to the reader’s interests

At the end of each chapter, there are notes that give references to sources and suggestions for further reading Definitions of the main economic concepts that are discussed in the dialogues are found in the Glossary.

Galilei, G (1632) Dialogo sopra i due massimi sistemi del mondo tolemaico, e

coper-nicano; proponendo indeterminatamente le ragioni filosofiche, e naturali tanto per l’una, quanto per l’altra parte Firenze: Gianbattista Landini, (1914) English edi-

tion: Galilei, G (1914) Dialogues concerning two new sciences (trans: de Salvio,

A., Crew, H.) New York: Macmillan

Contents

Increasing Inequality: First Dialogue 5

The Failure to Predict the Great Recession: Second Dialogue 29

Why Fiscal Austerity?: Third Dialogue 47

Rolling Back the Welfare State: Fourth Dialogue 65

The State and the Market: Fifth Dialogue 77

The Gigantic German Trade Surplus and the Euro: Sixth Dialogue 105

Crisis Policy: Seventh Dialogue 143

Environmental Degradation: Eighth Dialogue 165

Industrial Policies: Ninth Dialogue 183

The Protagonists

Agatha is a professor of Economics at a British university.

Max is a professor of Economics and Finance at a university in the United States, as well as being a consultant to a multinational financial company.

Forrest has recently completed his Ph.D in Environmental Economics at the university where Agatha teaches.

Sarah is in the third year of her Ph.D in Anthropology at the same versity as Forrest and Agatha.

uni-AGATHA Hi, Max, nice to see you! I saw your name on the programme for the conference

MAX Agatha, it’s great to see you! We seem to be on the same flight

AGATHA You know, I often think of the old days, when we were both dents and I remember those endless discussions we used to have after the lectures…

stu-MAX How could I forget?

AGATHA I can’t believe that it was twenty years ago … now look at you, … impeccably dressed… that grey suit, really smart

MAX Well, the years have flown by … although you haven’t changed a bit!

AGATHA You know, I missed you when you left for the United States to do your Ph.D

MAX The first few months were rather hard, but it was an incredible ence in the States They reward talent and dedication there…

experi-AGATHA Hey look, we aren’t the only ones… Here comes Forrest, a league of mine, with his partner Sarah That couple over there: the casually

col-Prologue

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M Morroni, What Is the Truth About the Great Recession and Increasing Inequality?,

https://doi.org/10.1007/978-3-319-98621-0_1

dressed guy with the strawberry blonde hair and that tall blonde with the vaguely oriental-looking blue jacket … They’re coming this way …

FORREST Hi Agatha, wow, great to see you! Sarah has taken a few days’ leave

to come with me

AGATHA Great idea I thought you might be on this flight, Forrest Max, let

me introduce you to Forrest and Sarah This is Max, a friend of mine from college …

MAX … Yes, some years ago…

AGATHA … And now he’s a professor of Economics and Finance in America.FORREST Ah, yes, I know of you, pleased to meet you

AGATHA Forrest has just got a grant at our university to research the nomic impact of global warming

eco-MAX So Forrest, you are lucky enough to be a colleague of Agatha’s here in jolly old England?

AGATHA Sarah’s studying anthropology and she’s a polyglot, as well as a really good climber, like Forrest … They go off to the Swiss Alps whenever they can

SARAH I know the Alps well – they are the mountains of my childhood We both love trekking and cross country skiing

AGATHA And do you still sail, Max?

MAX Yes, these days I’ve got a really fast catamaran When work permits, I go sailing on the lake with my wife I’m a freshwater economist, you know …SARAH I must confess I hadn’t heard of that sort of economist

FORREST Well, in the States they talk about economists as being freshwater

or saltwater

SARAH But what does freshwater or saltwater have to do with economics?FORREST Freshwater economists are those who teach at the universities near the Great Lakes The most famous of these is the University of Chicago, a stronghold of the neoliberals, on the shores of Lake Michigan The saltwater economists are those who work mainly at the various universities close to the Atlantic or Pacific coasts, and they belong to the various schools that are shaped, in one way or another, by the theories of John Maynard Keynes.MAX … Saltwater fish…

AGATHA … Yes, that’s right… as you well know, I’m a true saltwater mist, as you call it The Keynesian theories have proved their worth in the face of the great crash of 2008 Anyway, I can’t help but be a saltwater crea-ture: you know how much I love the sea and swimming

econo-MAX Do you still spend your holidays on that splendid Tuscan island?

AGATHA Yes, whenever I can I fly there with my husband and our two kids

My grandparents are from there

MAX It sure is a lot colder here than there

SARAH Hey look outside!

AGATHA Oh yes, the fog’s getting thicker!

Prologue 3

MAX The airport’s completely blanketed

FORREST You can’t see a thing

SARAH I’m afraid we’re going to be stuck here for a while

AGATHA Look at the board: “Delay due to severe weather conditions”

FORREST Oh damn!

MAX We’re stuck here

AGATHA We might as well get comfortable?

SARAH Listen, when I hear people talking about economics, I usually feel completely lost Why don’t we make the most of being stuck like this … and you explain to me a few of the more obscure aspects of the crisis? For example, what do you think about inequality? In recent years there has been increasing concern about this

MAX Inequality is a spur to improvement and it fosters economic growth.AGATHA But Max, it’s just the opposite

FORREST Increasing inequality is a very worrying economic and social problem

MAX Alright, alright! I can see you’re already ganging up on me

SARAH As emphasised by the sociologist Zygmunt Bauman, real dialogue isn’t about talking to people who believe the same things as you.1

AGATHA Actually, I learn more from scholars I disagree with

SARAH Yes, it’s important to discuss with those whose ideas are the opposite

of your own

FORREST A piece of advice that few economists listen to!2

MAX Sarah, since you’re the only one of us who’s not an economist, you should try to be an impartial judge

SARAH I’ll try, but I’m not sure I’ll be up to it

AGATHA You’ll certainly be less biased than a lot of economists

MAX Why don’t we order something from the bar while we’re waiting for news about our flight?

AGATHA OK … I reckon we’ve still got a long wait … Take a look outside; the fog’s really thick now Strange, at this time of year

MAX This bar seems OK Let’s sit here I’ll get the drinks Yours is a coffee, right, Agatha?

AGATHA Yes please

MAX I knew it! I remember you used to love strong coffee And what about you, Sarah? … No, let me guess A fruit juice… freshly squeezed orange …

no sugar

SARAH How did you guess?

MAX Professional secret Forrest, will you come with me?

FORREST Yes, sure

…

SARAH These armchairs are very comfy!

AGATHA Doesn’t this building, with its immense windowed ceilings and those columns with all those beams radiating out from them like the branches of gigantic trees, remind you of a thick forest engulfed in fog?

SARAH Speaking of forests makes me think of Kurosawa’s film Rashomon If

you remember … the protagonists find shelter from the bad weather … All four of them are witnesses to a crime that was committed in the forest and all of them tell a different version of what happened A bit like you – you don’t seem to agree much about the interpretation of increasing inequality.AGATHA Yes, we do have different points of view

MAX Here’s your coffee, Agatha

AGATHA Thanks, I needed it

FORREST And the orange juice for Sarah

SARAH Great, many thanks!

MAX As you can see, Forrest is happy with his glass of pure tap water, while I carry on drinking this soft drink despite Forrest’s pleas to boycott the multi-national that produces it…

References

de Querol, R (2016, January 25) Social media are a trap - Interview to

Zygmunt Bauman El País https://elpais.com/elpais/2016/01/19/inenglish/ 1453208692_424660.html Accessed Sept 2017

Francis, J (2014, August 29) The rise and fall of debate in economics Blog on

History, numbers, and some theory http://www.joefrancis.info/economics-debate Accessed May 2016

AGATHA Actually, income inequality has risen almost everywhere long before the blast of the 2007 global financial crisis Since 1980 the income shares of the richest 10 per cent of the population has increased in the United States,

in Canada, in Europe, in India, in China and in Russia, even if at different speeds.2

FORREST In the United States, the rising inequality was one of the causes of the crisis Looking at the lowering of real wages …

SARAH Excuse me for interrupting, Agatha, but you speak of ‘real’ wages, what does that mean? Are there ‘unreal’ wages?

AGATHA No, no When we talk about real wages we mean the purchasing power of salaries

SARAH OK, I get it

AGATHA As I was saying, with the lowering of real wages, many lies in the United States fell into debt in order to maintain their previous consumption levels This favoured the increasing reliance on loans for the acquisition of long-term consumer goods, the explosion of the speculative bubble, and the consequent private debt crisis.3

fami-FORREST Capitalists were rubbing their hands together: low wages and a decreasing share for labour of the national income,4 but at the same time high levels of consumption thanks to the ease with which individuals could

Increasing Inequality

First Dialogue

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accrue debts In the United States, before the financial crash, in order to boost consumption, the banks were giving mortgages that surpassed the prices of the houses being bought, creating an unstoppable increase of real estate prices It was clear that the consumption boom, bloated by easy credit, was not going to last long… With the first signs of stress in the real estate market everything ruptured.

MAX For goodness sake! Up till now I’ve listened patiently without ing, but this to me seems like a very naive interpretation of the causes of the crisis The increasing inequality that occurred in the United States had no role whatsoever in the explosion of the real estate bubble The opposite is true: the cause was the attempts of the state to counterbalance and reduce disparities in the distribution of income through an expansion of the mort-gage market and an increase in consumption This was the primary cause of the crisis The policies of organisations financed by the American govern-ment, like Fannie Mae and Freddie Mac, were responsible for the bursting

interrupt-of the speculative bubble

SARAH Fannie and Freddie … right… are they friends of Winnie the Pooh?MAX No no, they are two government-sponsored companies that gave loans

to people who were not able to pay them back The actions of the ment polluted the real estate mortgage market, and Fannie Mae and Freddie Mac are the main culprits of the burst of the real estate bubble that led to the financial crash The government repeatedly refused to intervene and break the monopoly of these semi-state-owned enterprises

govern-SARAH I’ve heard about the real estate bubble a few times

MAX Yes, exactly that, created thanks to public support

AGATHA Look, Max, you’re getting it wrong What you’re saying about the responsibility of Fannie and Freddie for bloating the speculative bubble is

an urban legend In the years immediately preceding the crisis, Fannie and Freddie could not provide subprime mortgages, and furthermore they only covered a very tiny percentage of mortgages for the acquisition of homes.5

SARAH Do you mind if we end this discussion on whose fault it was … Fannie, Freddie or The Three Little Piglets, and instead go back to the issue

of rising inequality? There is increasing concern about this

FORREST Agatha is right The gap between the rich and the rest had grown long before the crisis The lion’s share of productivity gains in the last

30 years has gone to the very rich The 2007 crisis has further worsened quality and has increased the disparities in income distribution, education and health services Inequality has many dimensions: income, wealth, edu-cation, health, life expectancy, opportunity, gender and regional disparities.6

ine-AGATHA Fiscal austerity has contributed to the increase of inequality because those at the bottom of the income distribution lose more than those at the top, for the simple reason that those at the top rely far less on govern-ment-produced services Moreover, in the years that followed the global

Increasing Inequality 7

financial crisis, in advanced economies the highest-earning 1 per cent has further increased its share of aggregate income The top 0.1 per cent has gained even more and so on The increase in inequality has also happened in most European countries.7

FORREST The number of working poor has crept up over the past decade There is a link between increases in non-standard forms of employment and the expansion of the proportion of people at risk of in-work poverty Even in Germany, the strongest economy in Europe, there has been a huge growth of so-called mini-jobs with part-time or zero hours’ contracts and in the number of working poor.8

AGATHA In some advanced countries, the huge increase in house prices has exacerbated the income distribution problem For instance, in the United Kingdom the gap between house prices and earnings has grown larger The cost of home ownership has become increasingly prohibitive Whereas in the mid-1990s low and middle income households could afford a first-time buyer deposit after saving for around three years, today it takes the same households twenty years to save for a deposit.9

SARAH Very true

FORREST Many tend to overlook the problem of rising inequality Robert Lucas – one of the most influential neoliberal economists and a recipient of the Nobel Prize in Economics – affirmed, “of the tendencies that are harm-ful to sound economics, the most seductive”, according to him, “and the most poisonous, is to focus on questions of distribution”.10

AGATHA Yes, I am aware of that

FORREST As to the decreasing income share of the 99 per cent, Warren Buffett, one of the richest men in the world and a staggeringly successful investor, said: “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.” The increase in income inequality is caused by the financialization of economies, an increase in labour flexibility, the weakening of trade unions and the rolling back of the welfare state that has not compensated for vulnerabilities created by globalisation processes.11

AGATHA You are right Income distribution is not a natural event; it rather depends on economic policies that are adopted by governments and reflects the strength of relationships between classes The level of profits is also influenced by corporate tax systems and the possibility of huge tax avoid-ance and profit shifting from one country to another, the free public money poured into the banks in the aftermath of the 2007 crisis, artificial monop-oly rights, relaxation of regulations, and implicit permission for substandard

MAX To put it simply, a situation is Pareto efficient when no one can improve their own wellbeing without worsening someone else’s.

FORREST Pareto efficiency does not guarantee an acceptable distribution of income A situation in which one person has everything can correspond to Pareto efficiency The fact is that in the process of trading, the initial social inequalities in the distribution of resources remain unchanged, even if they are socially unfair and harmful for the economy Besides, large inequalities can negatively affect the ability of people to trade as they wish.13

MAX But inequality is fundamental to economic growth because it creates the motivation to work hard

AGATHA I don’t deny that at all

MAX The financial rewards gained by those who produce wealth are incentives that favour those who take business risks, innovate and invest

AGATHA Actually, Keynes affirms the necessity of a certain level of inequality

in the distribution of wages to create incentives that favour economic ity and full employment.14

activ-MAX So you’re forced to say I’m right

AGATHA No, I am not! Keynes intended a certain level of inequality in the distribution of income, not the enormous differences that have appeared in the last three decades It’s a matter of proportion There’s a big difference between 30 to one, and 300 to one!15

FORREST There is a widespread ignorance about the scale of inequality For instance, most Americans underestimate to what extent incomes are une-qual The average American puts the current ratio of CEO to unskilled worker pay at 30 to one; their preference is for about seven to one But the actual CEO-unskilled wage ratio in the United States is 354 to one.16

MAX Inequality reflects the appropriate rewards of market-related economic activity.17 Whether you like it or not, inequality is inevitable as a result of differences in education, skills, experience, effort and luck

AGATHA Detailed empirical studies suggest that education and skills explain

at most only a third of wage inequality.18

MAX Isn’t it more important to restore economic growth than to worry about how the gains from growth are distributed?19

FORREST According to a popular and old theory, everyone benefits from growth, including the poor However, this theory, which is known as “trick-le-down economics”, has little historical support.20

MAX In any case you’ll agree with me that high taxes for the rich are tive because they lower investment and have a negative effect on growth Lower tax rates spur growth.21

destruc-AGATHA There is no theoretical or empirical basis for this, especially in countries like the United States where most investment is financed by debt and firms are able to deduct the cost of new investment from their tax bill.22

Increasing Inequality 9

FORREST Cutting corporate tax rates leaves corporations with more money This is good for their owners but does not mean that they will invest and hire more workers Tax rate cuts will line the pockets of oligopolists and their shareholders Tax cuts for corporations are regressive because their owners tend to be rich.23

AGATHA Yes, indeed The available empirical evidence suggests that, if income is concentrated in the hands of a few, the aggregate demand will be reduced because the rich have a lower propensity to consume, that is, they consume a lower share of their income Since investments depend on the level of future demand, high income inequality keeps aggregate demand low and therefore hampers economic growth The results of recent surveys car-ried out by some researchers of the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and many other authors, show that, in advanced economies, a redistribution of income in favour of the poorest has a positive impact on growth Countries that are characterized by less inequality have more rapid growth.24 The large disparities in the distribution of income negatively affect the development and work capacity of those who come from low-income families, because their chances to access high levels of education diminish Good quality edu-cation and health systems are fundamental to raise the quality of human capital and productivity The point is that increased inequality limits growth because it reduces social mobility, economic opportunities and social cohesion.25

MAX Just a minute Empirical results on the relationship between ity within countries and growth, which are based on comparisons between nations with very different characteristics, are less reliable than you may think The evidence on this is very mixed depending on the set of countries you take into consideration.26

inequal-AGATHA That is true, but if we consider advanced economies, data show that excessive inequality leads to lower economic growth Higher taxes for the super-rich will cut inequality without hitting growth.27

FORREST More than the problem of economic growth, what worries me is that the large inequality limits security, health and education Recent stud-ies have demonstrated that, in developed countries, many health and social problems are correlated only minimally with the average income of the country, but rather the level of income inequality

SARAH Could you explain, please?

FORREST In these countries, the higher the level of income inequality, the lower the level of wellbeing, health and life expectancy A large body of empirical evidence shows that, in societies with large income differences, life expectancy is low, murder rates are higher, drug abuse is more common and more people are imprisoned Although the poor suffer the biggest effects of

inequality, the advantages of living in a more equal society extend even to the very well off.28

SARAH Yes, I believe you’re right: in rich countries the effects of inequality go right across the whole society But what happens in poor countries?

FORREST In poor countries, profound income inequality has a serious adverse impact on the opportunities of many people, not only with regards

to health and education, but also to nutrition and to having a roof over their head.29

SARAH Exactly The large inequalities in incomes and poverty limit people’s freedom of choice We have to consider that the decision to emigrate from very poor countries becomes an ‘escape towards freedom’.30

FORREST Amartya Sen analysed the connection between individual freedom and the concrete opportunities provided by education and health.31

MAX Well, in my opinion, Sen is a political philosopher, not an economist

I don’t think he deserved the Nobel Prize in Economics At that point you might as well have given it to Mother Teresa of Calcutta

FORREST Actually they did give it to her

MAX But not for economics!

AGATHA The problem is that you, Max, like many of our colleagues, use an over-restrictive definition of economics, and you will not consider different points of view

FORREST Recently, the lack of an in-depth comparison between different economic viewpoints has been the subject of heated protests from students

in many universities in the U.S and in Europe.32

AGATHA Yes, that news was heard all around the world As far as Sen is cerned, I’m afraid I completely disagree with you Max Amartya Sen made a great contribution to our discipline, studying, among other things, what the indispensable economic conditions to exercise individual freedoms are, and the role of the state in guaranteeing that these freedoms can be effective Sen

con-is a true liberal thinker

FORREST The redistributive role of the state is essential in offsetting increases

in market income inequality and in giving equal opportunities to all zens Years ago, I was lucky enough to attend one his courses: Sen is a fan-tastic lecturer! They were the most amazing lectures I have ever attended in

citi-my whole life

SARAH Yes, so you’ve told me several times!

MAX You know, I’m starting to like you

SARAH OK, let’s go back to the increasing differences in the distribution of income I saw that a book on this topic, written by a French economist, had huge success, but right now I can’t remember the name of the author

AGATHA It’s not hard to guess: Thomas Piketty.33

SARAH Right, Piketty

prop-FORREST Yes indeed, very low social mobility is matched with highly skewed income distribution Let’s remember that in past decades the growth of ine-quality was mainly the outcome of a constant and considerable decrease in top marginal tax rates, the enormous profits of the financial sector, the rise

in unproductive economic rents, and skyrocketing incomes of top ers and professionals, as well as strong competition from emerging countries regarding product prices, with the consequent compression of the net wages

manag-of industrial workers in industrialised countries

AGATHA That’s exactly how it is

FORREST In my opinion, in advanced countries increasing inequality is the result of three interacting factors: the strengthening of capital versus labour, increasing individualism and the withdrawal of the redistributive role of the state by decreasing taxes on high incomes, and reductions in the provision

of public services through non-market systems, such as education, health, social security and pensions.37

SARAH We could say the retreat of politics

AGATHA Yes, in short, rising inequality has been caused mostly by huge gains made by the banking sector and the lowering of tax rates on higher incomes

FORREST During the Cold War period after the Second World War, the structure of personal income tax was very progressive, with the marginal tax rate increasing by ranges of taxable income, up to a top rate of 85–90 per cent, but employment and gross domestic product (GDP)38 grew at a con-stant and rapid pace Starting from the 1980s, the situation has changed The substantial income growth of the super-rich is due to the reduction of the tax rates that they pay, which is around 30 per cent, but thanks to very widespread tax-avoidance, the actual rate can easily be reduced to 15 per cent The multi-millionaire Warren Buffett recognised that the weight of taxes is very unfairly distributed and he called for an increase of marginal income tax rates for high-income individuals.39 In the United States, the

super-rich can pay a lower average percentage of personal income tax than their secretaries.

AGATHA In the U.S., it is hard for politicians to stand for election without

a great deal of financial support, so voters only get to choose among didates whose views are affected by the interests of the wealthy Democracy has been damaged to the point where wealth is being redistributed up, not down

can-FORREST There is little difference, from this point of view, between Democrats and Republicans

MAX I cannot but agree As recently observed by Richard Posner, the real corruption is the ownership of Congress by the rich Members of Congress are slaves to donors They own them.40 The revenues of large companies often rival those of national governments The market power of corpora-tions is transformed into political power generating a self-reinforcing spiral Interaction between concentrated corporate power and politics is a threat to the functioning of free market economies and democracy.41

AGATHA You are right The more wealth that corporations and super-rich individuals accumulate, the more resources they can deploy to influence governments; the more they can influence governments, the more they can secure policies that suit their interests; the more they do that, the more wealth they accumulate Economic and political powers reinforce each other There is a clear contradiction: on the one hand, neoliberals advocate policies that increase inequality such as low taxes on the wealthy, poor pub-lic services and deregulation of business activities; on the other, increasing inequality leads to a self-reinforcing process that is completely contrary to neoliberalism’s own principles, according to which there should be no polit-ical lobbying that alters market functioning.42

SARAH This sounds like a bitter irony!

AGATHA Yes, indeed

FORREST Large companies were very successful in obtaining the repeal of the regulations of their activities and in weakening antitrust action.43

AGATHA Not only that In recent decades, giant corporations have ated special, sometimes secret, agreements with the governments of some countries to avoid paying taxes

negoti-MAX It’s a well-known phenomenon called the ‘regulatory capture’ in nomic literature

eco-SARAH Decreasing standards of living undermine the confidence of citizens that the representative governments serve their interests.44

AGATHA This leads to political polarization

SARAH People’s worries are aggravated by immigration The mass of grants and refugees with very different cultural traditions exacerbates the concerns of citizens about the identity of their local communities and increases the fear of strangers or foreigners.45

immi-Increasing Inequality 13

AGATHA In some very poor countries, after so many years of terrible wars, the huge and relentless migration towards advanced economies is under-standable International policies have contributed to increasing the instabil-ity in many areas

FORREST It is true, but uncontrolled immigration generates a political tion of people who are afraid that their position in the labour market could

reac-be weakened by competition from an immigrant labour force which offers its labour at a lower rate of pay

SARAH This was one of the crucial factors in the UK referendum on Brexit.AGATHA Econometric evidence overwhelmingly suggests that there is no proof that immigration in the UK lowers real wages.46

FORREST Although the evidence shows that immigration does not decrease real wages, this does not make most people change their opinion because they have perceptions that immigration must reduce wages in some way.47

AGATHA Of course, this is a misleading individual perception because it does not take into account the macroeconomic effects Net immigration increases aggregate demand and therefore also the demand for labour of the native population.48

MAX It is true There is a very widespread misconception about immigration Labour mobility is a positive factor

AGATHA The diversity of traditions and cultures is an important resource that fosters economic growth and innovative activity Max and I are immi-grants The academic community both here in the United Kingdom and in the United States has always benefited very much from the scientific contri-bution of foreigner scholars

MAX Absolutely The United States is an immigrants’ country

AGATHA Immigrants are mostly young As a consequence, they contribute

to the social welfare system more than use it In other words, they help to stabilise public finances.49

FORREST Immigration rejuvenates the labour force only if it consists of a never-ending stream of immigrants Once the inflow stops, the age structure will revert to its original trajectory.50

SARAH Some people’s hostility to immigration stems from their attachment

MAX As shown in the British Election Study, voters tend to grossly

overesti-mate the number of immigrants.53

AGATHA Right-wing newspapers cover immigration in a way designed to generate hostility and right-wing politicians try to take advantage of people’s concerns about it.54 When poor people think that their economic problems arise from people that are even poorer, very wealthy people have won.

FORREST I agree, but there is a fierce opposition from people who have paid most of the cost of the neoliberal globalisation and who are getting very few advantages from it Free markets have produced a tiny cadre of win-ners and an enormous army of losers Many middle- and working-class households are in deep economic difficulties Markets do not guarantee an acceptable distribution of income People are concerned and are increasingly discontented.55

MAX Alas, there is a worrying upsurge in economic nationalism, xenophobic and anti-globalisation movements.56

FORREST There is also a rampant hostility to political establishment and progressive elites that have promoted neoliberalism and corporate globalisation

AGATHA We are witnessing a ‘great regression’.57

SARAH Trump’s election and Brexit show all this

FORREST Large scale immigration, increasing costs of globalisation, job losses, depressed wages and growing inequality are leading to a worryingly strong surge of far right-wing parties, openly neo-Fascist or neo-Nazi.58

SARAH We cannot leave the management of this huge immigration towards Europe just to the action of single countries, to the various Non-Governmental Organisations which rescue migrants who risk drowning crammed on floating wrecks, or to the goodwill of people who receive them.FORREST There is also a widespread phenomenon of overexploitation of ille-gal immigrants who work in the black economy

AGATHA Yes, it is absolutely necessary to have a general plan implemented

by multilateral organisations What you are saying is making me to think about it Perhaps you are right I have to reckon that in the last few years we have overlooked the fact that a too-rapid and uncontrolled inflow of immi-grants weakens bonds of solidarity, erodes the ties required to sustain the welfare state,59 leads to a distrust of experts, a rage against ruling classes and

a rejection of centrist political parties

SARAH It seems to me that increasing inequality is a threat to democracy How much more can society take without been destabilized?

MAX I am starting to think that we have overlooked the possible negative consequences of increasing inequality I have to admit that perhaps govern-ments have gone too far in reducing tax rates at the top of the income dis-tribution and it was a big mistake to favour tax avoidance and profit shifting

by giant multinational corporations.60 People’s reaction to rising inequality has led to recent resentment-driven electoral phenomena, dangerous pro-tectionist policies, limitations to the openness of the trade market and free

Increasing Inequality 15

movement of capital This is a threat to the functioning of the free market economy Vulnerable people have to be protected from the inevitable conse-quences of competition and globalisation.61

FORREST I see, that is not for the good of the people, but for the good tioning of free markets!

func-AGATHA It’s undeniable that the enormous increase in inequality contributed

to the explosion of the Great Recession, and that mindless fiscal austerity has intensified the distributive problem These factors have reduced stand-ards of living, security and individual opportunities, and have further low-ered economic growth.62

FORREST Since 1980 neoliberal politicians have claimed that their ket-oriented economic policies were favouring the creation of wealth and were tending towards economic progress and great enrichment for all, but this promise has not been kept

mar-SARAH You, Forrest, said neoliberal politicians I hear talk about neoliberals

or liberals, but the difference between them is not clear to me

FORREST In a nutshell, we can say that a neoliberal is a person who supports

a large amount of freedom for markets, with little government control or spending, and low taxes, while a liberal believes in or allows more personal freedom and development towards a fairer distribution of wealth and power within society.63

AGATHA Yes, indeed There is a huge difference between neoliberals and liberals

FORREST The neoliberal agenda has introduced tax cuts for the rich, forced open national markets to trade and capital, pushed deregulation on econ-omies which have led to the credit bubble, boom-and-bust cycles, huge growth in inequality and misery for millions of people.64

AGATHA This is what has happened Neither the United States, the United Kingdom nor the countries of the Eurozone have experienced faster eco-nomic growth compared to decades prior to 1980, the era of welfare capital-ism and Keynesianism Nor have there been fewer crises On the contrary, the IMF has identified more than 120 banking crises and 200 currency cri-ses since then, a dramatic increase.65

SARAH What can be done?

FORREST For example, we could stop governments from engaging in the dreadful ‘race to the bottom’ over the reduction of corporate tax rates This has shifted an increasing share of taxation away from corporations and super-rich individuals on to lower and medium earners.66

AGATHA Tax exemption for single transnational companies should be sidered an illegal state aid that distorts competition We have to harmonize corporate taxes and fight tax havens In the United States and in many other OECD countries, policies have often been deliberately designed to enable

con-tax avoidance via con-tax havens According to a senior officer of the United States’ administration: “It is, ultimately, about freedom”.67

MAX It is very difficult to do something against tax havens because of national sovereignty

FORREST I know Tax havens are by design secretive and opaque, but they should be subordinated to international tax law After thirty years of all the gains for people who brought us the bubble, payback is coming

SARAH It seems to me that we are going in the opposite direction Think of Trump’s recent tax bill

FORREST Oh yes, indeed The distributional consequences of that bill are staggering He has sold out the working-class people who brought him to power, while pursuing policies to boost the income of his fellow billionaires

To give you an example, Trump’s tax bill sets a subsidy for private jets, but dramatically increases the tax burden for graduate students by counting as taxable income their ‘tuition waiver’, which they receive in exchange for their labour as teaching and research assistants.68

AGATHA Without a redistributive policy, it will be very difficult to move on from the Great Recession and stop the upsurge of xenophobic movements and anti-systemic parties

FORREST There is the serious danger that neoliberals could see the rise of xenophobia and far right parties as the source of allies against their social democrats and green critics To counteract this risk, a democratic, popular mobilisation is needed.69

MAX No one wants to create the conditions for a dictatorship to emerge.70

AGATHA Flirtation with xenophobia is a dangerous game for neoliberals to play because anti-globals interfere with free trade and free movement of capitals After the Second World War, European conservatives had to learn that their alliance with Nazism and Fascism had been disastrous

FORREST In the post-WW2 period, the fear that the majority of the ate would turn communist played an important role in favouring the mix of welfare state and Keynesian policies.71

elector-AGATHA In the 1950s and 1960s European leaders realised that the market economy, when combined with social policies and government-driven eco-nomic management, produced a better world than communist states were achieving in Eastern Europe A similar conversion is now required of neo-liberals who have to depart from the destructive path of increasing inequal-ity and have to be aware of the serious dangers for democracy of the upsurge

of populist far-right parties.72 States should play a redistributive role by radically changing tax systems, ending tax cuts for the rich, enhancing pro-gressivity of personal income taxes, taxing real estate and land, applying an adequate tax rate on capital income, taxing financial transactions, reducing tax avoidance by big corporations, combatting profit shifting, raising val-ue-added taxes on luxury goods and consumption items that increase pol-

Increasing Inequality 17

lution, decreasing taxes on labour, taxing labour-saving machines (such

as a tax on using robots), fighting evasion, introducing an effective mum wage, increasing inheritance tax, applying appropriate basic income transfers, starting a new housing programme, improving access to quality education, and investing in early childhood education and health services This would foster economic growth and improve the sharing of gains from growth.73

mini-MAX You don’t want much! Get real, Agatha…

AGATHA Eleanor Roosevelt once said that the future belongs to those who believe in the beauty of their dreams We need a New Deal

FORRESTER I mostly agree with Agatha, but I don’t share her faith in the benefits of economic growth

SARAH It seems to me that Agatha’s ‘to do list’ against increasing inequality is not a dream, but could well be a part of a programme of a democratic left party …

AGATHA Yes, it could be, but a progressive left that does not share the liberal political ideology

neo-Notes

1 Krugman (2013, Dec 15)

2 Alvaredo et al (2017, p 6)

3 Wisman (2013); Krugman (2013, Dec 15); Screpanti (2013 in 2014,

pp 125–140); The Economist (2014, Mar 1); Mian and Sufi (2014, pp 17–25)

4 As highlighted by Franzini and Pianta (2016, p 50), in 1991 labour’s shares

“ranged from 59 per cent (in France and Australia) to 66 per cent (in the UK and Japan); by 2013 they had fallen below 60 per cent everywhere but the UK, and as low as 55 per cent in Italy and Australia.”

8 Screpanti (2013 in 2014, p 190, fn 129); The Economist (2016, June 25a); Eurofund (2017, pp 1, 16–20)

9 Macfarlane (2017, Nov 13)

10 Lucas (2003, p 20)

11 Stein (2006, Nov 26); Tridico (2017, pp 1 ff.)

12 Chang (2013, Apr 5).

13 Sandel (2013, p 123); Deaton (2017, July 15)

14 Keynes (1936 in 1978, pp 374–375); cf Skidelsky (2016, June 23)

15 In 1978 the remuneration of “the top managers of the top 350 US firms was greater than that of the average employee by a ratio of 30 to one; by 2013 the ratio had increased to 296 to one, powerfully reflecting the new power

of capital over labour” (Franzini and Pianta 2016, pp 52–53)

16 The Economist (2017, Dec 18)

17 Crouch (2017, p 3)

18 Franzini and Pianta (2016, p 51)

19 Krugman (2013, Dec 15)

20 Stiglitz (2001, p vii); Polanyi (1944)

21 The Economist (2014, Mar 1) Max’s statement on income tax reflects the position of the late Chicago School According to Paul Samuelson, there were two Chicago schools “The first Chicago School was that of Knight, Viner, and Simons …The second Chicago school ought properly to be asso-ciated with the names of Milton Friedman, George Stigler, Aaron Director, and Gary Becker This second Chicago School is called the Friedman Chicago School for short.” The first Chicago School “advocated use of the market, but recommended redistributive taxes and transfers to mitigate the

worst inequalities of the laissez-fair system” While the second “has lost the

Simonsian imperative to use the tax system to modify economic ity…” (Samuelson 1991, p 538, quoted in Ebenstein 2015, pp 86, 94)

22 Stiglitz (2017, July 27); The Economist (2017, Nov 18)

23 Krugman (2017, Oct 14); The Economist (2017, Nov 18; 2017, Dec 9)

24 Ostry et al (2014, p 4); International Monetary Fund (2017, pp ix, 5)

25 The Economist (2012, Oct 13; 2014, Mar 1); cf Rodrik (1999); Wilkinson and Pickett (2009); Cingano (2014); Summers (2014, p 69; 2016, Feb 15,

p 2); Solow (2014); Berg and Ostry (2011); Atkinson (2015); Zucman (2015); Saez and Zucman (2016); Scarano (2018); Franzini and Pianta (2016, p 53) Inequality in income distribution is generally measured by the Gini index This index ranges from 0 to 100 (or from 0 to 1 on the decimal scale) If it is equal to 0, income is split equally and all receive an equivalent slice If it is equal to 100, one person gets everything Ostry et al (2014, p 18) show that a high Gini index on disposable income corre-sponds to slower growth of GDP per capita An increase of 5 points in this index lowers by half the average annual growth

26 International Monetary Fund (2017, pp ix, 5–6, 12–13)

27 Ibid.; Elliott and Stewart (2017, Oct 11)

28 Wilkinson and Pickett (2009, pp 18–24); Pickett and Wilkinson (2017, Oct 18)

29 For a discussion of the issue of poverty from a historical perspective see Chilosi (2012)

Increasing Inequality 19

30 Deaton (2013)

31 Sen (1992, 1999) See also Chang (2010, Chaps 17, 20); Deaton (2013,

pp 191–193)

32 There has been much dissent about the contents of the economics courses

on this side of the Atlantic and on the other In a nutshell, the students criticize: the lack of analytical tools capable of understanding the trends in the real economy; scant comparison between alternative explanations of the Great Recession and rising inequality; the adoption of a very narrow defi-nition of economics, which is based on the analytical instruments adopted (mainly mathematical models of optimization and equilibrium), instead of being grounded in the field of investigation See, for example, the open let-ter and the abandonment of the classroom protest of a group of students

of the Economics course taught by Gregory Mankiw at Harvard University The letter of the students is published in the Harvard Political Review (2011, Nov 2); the clumsy response of the teacher is contained in Mankiw (2011, Dec 3) Cf Inman (2013, Nov 11); Chang and Aldred (2014, May 11)

33 Piketty (2013)

34 Giles (2014, May 23); Rowthorn (2014); The Economist (2014, May 3a;

2014, May 3b; 2014, May 3c; 2014, May 31; 2015, June 6); Baker (2014, Apr 21); Ruccio (2014, Apr 30)

35 Piketty (2013, pp 22 ff.); Atkinson (2015); Romer (2015, p 93) Cf Chang (2010, Chap 13); Stiglitz (2012); Blyth (2103 in 2015, pp 13–14); Boushey et al (2017); The Economist (2017, May 20)

36 Solow (2014); Piketty and Saez (2003); Reich (2007 in 2008, pp 105–114); Wisman (2013); Atkinson (2015); The Economist (2015, Jan 24)

On the sharp decline in mobility see Chetty et al (2017) For the increasing preference for privilege over competence, see Franzini and Pianta (2016, p 53)

37 Franzini and Pianta (2016, pp 52–54)

38 Gross domestic product (GDP) measures the value of all the goods and services produced within a country in a given period of time, usually three months or a year The final goods and services represent the value added produced by all enterprises, including public administration GDP corre-sponds to the gross domestic income produced

39 Wearden (2011, Aug 15); Blyth (2013 in 2015, p 242)

40 Interview of Richard Posner in Schechter (2017, Mar 28)

41 Zingales (2017, pp 113–114, 122); The Economist (2014, May 17)

42 Crouch (2017, pp 5–6) On empirical studies of the distribution of wealth see Schneider et al (2016, Chap 3)

43 Crouch (2017, pp 5–6) In an interview during the Stigler Center’s ence on concentration in the U.S., Judge Richard Posner declared antitrust dead (Schechter 2017, Mar 28)

52 Richard Thaler in Lynskey (2017, Dec 2).

53 Wren Lewis (2017, Dec 16)

54 Ibid

55 Metcalf (2107, Sept 18) On opposition and resistance to neoliberal formations see Cahill and Konings (2017, pp 49–51)

56 See Skidelsky (2017, May 17)

57 See della Porta (2017, p 33)

58 See Rodrik (2016, July 11); The Economist (2017, July 22); Giacché (2015) Polanyi (1944 in 2001, p 257) points out that the revolt of the

“socialist proletariat” or “fascist lower middle class … was a reaction to the disintegration due to the failure of the initial nineteenth-century wave of liberalism This determined the rise of two ‘apparently contradictory’ princi-ples, which are”—according to Polanyi—“interrelated: sovereignty and ‘jus-tified’ intervention in the affairs of other countries” (p 261) On this see the discussion in della Porta (2017, pp 28–29)

59 Skidelsky (2017, Nov 22)

60 At the end of this dialogue Max changes his mind and embraces the concern

of the first Chicago school about inequality See Note 21

61 In his speech at the Economic Policy Symposium of the Federal Reserve, held in Jackson Hole, 25 Aug 2017, Mario Draghi quoted Polanyi (1944) who observed that “if the dislocation created by an open market goes beyond a certain point, protectionism is society’s natural response” Draghi concluded that “multilateral cooperation is crucial in responding to con-cerns about fairness, safety and also equity By encouraging regulatory convergence, it helps protect people from the unwelcome consequences of openness And protection ensures that we do not lapse into protectionism over time” (Draghi 2017)

62 Wisman (2013); Krugman (2014, Jan 28)

63 Cambridge Dictionary online in https://dictionary.cambridge.org/dictionary/english/, accessed Sept 2017 According to Monbiot (2016, Apr 15), the term neoliberalism was coined at a meeting in Paris in 1938 Among the delegates were Ludwig von Mises and Friedrich Hayek

64 Metcalf (2017, Aug 18)

65 Fricke (2017, May 26)

66 Crouch (2017, p 53)

Increasing Inequality 21

67 DeLong and DeLong (2015, Sept 28); Tang (2017, Oct 24)

68 Roubini (2017, Dec 11); Ricard Thaler in Lynskey (2017, Dec 2); Schuhrke (2017, Dec 3)

69 Crouch (2017, pp 57, 64–5)

70 Skidelsky (2018, Apr 13)

71 Petri (2018)

72 Crouch (2017, pp 7, 60, 64–65); Mitchell and Fazi (2017, p 19)

73 DeLong and DeLong (2015, Sept 28); Atkinson (2015, 2016); Franzini and Pianta (2016, p 55); The Economist (2016, June 25b; 2017, July 1) Cf Draghi (2017); International Monetary Fund (2017) For the recent discus-sion of pros and cons of taxing robots, see Bill Gates in Delaney (2017, Feb 17); Shiller (2017, Mar 22); Visco (2017, May 2)

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MAX Indeed, the crisis took everyone by surprise No one was expecting it

It was an unpredictable shock: the appearance of a true ‘black swan’, as we say.2

SARAH I remember that the economists were even reprimanded by Queen Elizabeth in November 2008, during her inaugural visit to the London School of Economics’ new building With wonderful candour the Queen asked: “It’s awful … Why did nobody see it coming?”3

MAX When the real estate bubble burst in the United States, it was thought that it would have had limited consequences because, ultimately, the hous-ing sector represented only 4 per cent of the US GDP The Federal Reserve and the government believed that it would be unlikely that the housing sec-tor’s crisis would spread to the whole economic system In essence, people thought it would be a limited and short-lived adjustment of the economy.4

SARAH Really?

MAX Yes, indeed It was thought best to let the market itself solve the lem, bringing down real estate prices to the point where investors would consider it a good deal to buy again, therefore stabilising the situation However, the housing crisis spread quickly into the banking sector and then into the real economy

prob-The Failure to Predict the Great Recession

Second Dialogue

© Springer Nature Switzerland AG 2018

M Morroni, What Is the Truth About the Great Recession and Increasing Inequality?,

https://doi.org/10.1007/978-3-319-98621-0_3

AGATHA The domino effect was due to the repeal of bills that that were introduced after the 1929 Great Depression in order to regulate banking activity, and to new financial instruments that had the main objective of bypassing the remaining regulations These changes entailed a huge increase

in the leverage and in the level of risk taken by the financial sector This pushed the economy towards catastrophe

MAX I don’t agree The financial innovations have facilitated the recourse to credit and for many years have sustained economic growth If anything, the problem lies with the policies pursued by Alan Greenspan, President of the Federal Reserve in the years preceding the 2007-2008 crisis Interest rates were kept too low for far too long and an implicit guarantee was given that the central bank would prop up banks, which were ‘too big to fail’, and get them out of trouble This implicit guarantee was known as ‘Greenspan put’ The monetary policies of Greenspan, influenced by the neo-Keynesian paradigm, induced banks to adopt speculative behaviour, anticipating they would be rescued later by the government In cases of lack of liquidity or of insolvency, therefore, they wouldn’t have to pay the consequences of their imprudent behaviour.5

AGATHA I’d like to remind you that Alan Greenspan is a prominent sentative of neoliberal thought Greenspan’s monetary policy was not influ-enced by the Keynesian vision, but by the interests of big banks

repre-FORREST We should also say that the remuneration systems based on bonuses encouraged short-term, high-risk operations and extremely high levels of indebtedness Bank managers’ bonuses should be fixed in a way that brings their interests in line with those of shareholders and savers, and ultimately with the long-term interests of the banks themselves.6

MAX But bonuses serve exactly this purpose: to align the interests of the ager with the interests of the bank owners

man-AGATHA Well it doesn’t seem to have worked Bonuses have had the effect of pushing the decisions of managers towards short-term gains, ignoring long-term results and systematic risk

FORREST There was a series of appalling deceptions and frauds, evidenced by the tens of billions of dollars’ worth of fines that the financial institutions and banks negotiated so as to avoid going to trial.7 And this is just the tip of the iceberg

AGATHA Some newspapers called the bank managers who committed these huge scams ‘banksters’.8

FORREST The selling of bonds guaranteed by a portfolio of mortgage loans, without any sort of control, triggered a chain of frauds The intermediaries involved in this chain had a strong interest in deceiving investors with false indications of the quality of loans The buyers were convinced they were buying safe bonds, instead they were being duped It was a fraud of vast

The Failure to Predict the Great Recession 31

proportions, but no one was ever punished Not a single person was asked

to return the amounts of money wrongfully pocketed thanks to cheating.9

AGATHA Fines should be have been levied on those who committed the frauds, not the banks, and definitely not the shareholders or taxpayers The idea that shareholders control banks is a myth It is the management that is responsible Therefore, it should be the CEOs, top managers, the auditors and the rate agencies who pay.10

MAX I admit that the wrongdoing of many banks was not punished, but according to the law it is the financial institutions themselves that are responsible, not their managers Moreover, it must be doubted whether it makes sense to impose a penalty so large that it imperils the survival of a bank itself.11

FORREST In the end, those who were responsible for the frauds were teed complete immunity…

guaran-AGATHA The fact is that big banks were above the law Big banks were seen

as “too big to jail”…12

FORREST Yes, indeed, and the financial institutions were saved with public funds…With the exception of Lehman Brothers

MAX At the time, I signed a petition, proposed by John Cochrane and Luigi Zingales of the University of Chicago, against plans for bank rescues.13

When Lehman Brothers failed, many, including myself, thought it was ter to let it fail, avoiding any help from the state Letting it fail not only avoided a transfer of money from the taxpayers to the creditors of Lehman Brothers, but also avoided generating the phenomenon of moral hazard, that is banks in the future could feel justified to take excessive risks because they think they will be bailed-out

bet-SARAH And that would mean?

MAX A rescue would have prevented any interest from future creditors in choosing the more trustworthy banks, and would have favoured the tak-ing of excessive risks by the operators of the banking sector Therefore, we thought that it would have been better to avoid adopting rescue mech-anisms and to let insolvent banks fail and then start up again from the beginning In other words, to let markets carry out the beneficial ‘creative destruction’ of inefficient economic activities

AGATHA The expression ‘creative destruction’ is typical of the evolutionist theory of Social Darwinists

FORREST But when referring to the financial crisis, it’s completely leading This expression was introduced by Marx and then later popular-ised by Schumpeter who refers to it in precise circumstances: the process

mis-of entrepreneurial innovation New methods create inevitable problems for industries that have continued to hang on to traditional methods The inno-vations destroy the existing industries It’s just as simple as that The con-cept of creative destruction, used in a cavalier fashion by many neoliberals,

is deceiving because, in reality, the financial innovations of the last two ades have brought us nothing but disaster.14 In this case, a more appropri-ate expression would be something like ‘destructive creation’ or ‘destructive innovation’.15

dec-AGATHA There’s no doubt that the crisis that blew up in 2007 didn’t tribute to creating new activities on the ruins of destroyed old ones Letting Lehman Brothers fail was not a good idea The cost of its bankruptcy was four times the sum that the state would have shouldered if they had guaran-teed the reimbursement of 2,000 billion dollars of subprime credit

con-MAX … and after the bankruptcy of Lehman Brothers it was evident that the ramifications were far more extensive than we believed

FORREST The optimism of those who recalled the Schumpeterian concept of creative destruction was very much brought into perspective after the rapid contagion, the fall and the subsequent bail-out with public funds of Bear Stearns, AIG, Northern Rock, Lloyd’s Bank, Anglo-Irish Bank, Kaupthing, Landsbanki, Glitnir and more than one hundred other banks.16

MAX It was absolutely impossible to forecast this rapid contagion… Excuse

me, my phone is ringing I’ll be back in a minute

FORREST Financial market liberalisation and free capital movements made banks more vulnerable to contagion.17

AGATHA The tendency to disregard the possibility of contagion derives partly from the use of macroeconomic models of general equilibrium based on the

‘efficient market theory’ and the figure of the ‘representative agent’

SARAH What do you mean?

AGATHA The International Monetary Fund, the central bank offices and those of the multilateral organisations apply theories and utilize economet-ric models that are not up to the task of predicting crises.18 These models hypothesize the existence of a single agent, meaning a single ‘representative’ subject, with rational expectations, whose choices coincide with the aggre-gate choices of a set of individuals with different preferences and behaviour.SARAH If I understand well, these are one-man models

AGATHA Exactly They are mathematically sophisticated without ing the actual fundamental features of macroeconomics A one-man model doesn’t allow for consideration of human interaction, which can produce unexpected results that are not intended by the individuals involved This brings about radical uncertainty: people do not realise possible future out-comes or do not have sufficient computational ability to figure out their probability distribution Many were deceived by the application of these inadequate models Economists are very good at making models, but not good enough at choosing the one most suited to the task at hand.19

represent-SARAH Why? Does economics offer a large range of different models?

AGATHA Yes, of course, we have not only the representative and tional agent models In economics there are many different models accord-