Europe: Is the Union over?

Let Them Eat Credit: Has Financial Capitalism Failed the World?

That crucial question was in the air when Institute for New Economic Thinking Senior Fellow Lord Adair Turner spoke in May at a special Head to Head debate hosted by Al Jazeera at England’s legendary Oxford Union.

Turner’s answer was that capitalism itself didn’t fail. Instead, it’s the theories behind the economic models that have dominated the world over the last few decades that gave way.

“I am concerned that we haven’t been radical enough in our reform.” Turner said.

What we need, he suggested, is new thinking to get the global economy back on track and to avoid repeating the same mistakes that got us into this mess.

A former chairman of the United Kingdom Financial Services Authority, Turner faulted regulators and central banks for enabling a capital regime that allowed the international banking system to become wildly overleveraged. He also faulted the overly complex global regulatory scheme and called for simple rules to help stabilize the financial sector.

Turner described the current situation as “a car without shock absorbers driving along a motorway without crash barriers, and because of that, we’ve crowded a bunch of people into the driving cab to look over the driver’s shoulder.”

A more sensible approach, he suggested, would be to establish simple capital ratios designed to significantly increase the amount of equity banks are required to hold.

“The most fundamental mistake is to allow banks to do too much business on a light level of capital,” Turner said. He called for leverage ratios closer to 20% because of the importance of the financial sector to the economy. “There just wasn’t enough capital in the banking system, [in 2008],” he said. We need to make sure that next time is different.

Turner also suggested that inequality in the United States was a significant factor in the severity of the financial crisis.

“In the U.S. you had an expansion of inequality,” he said. “And you had a political culture where you couldn’t possibly say the answer was to redistribute income.” The result was that, “the political response to inequality was, ‘let them eat credit,’” which only contributed to the subprime boom.

Speaking about austerity in Europe, Turner suggested that the focus on short-term fixes to deficits has failed. He repeated his call for considering more radical options such as so-called “helicopter money” – central bank funding for government spending – instead of continuing austerity measures destined to fail in places like Greece.

“Greece will not pay back the full amount of this public debt,” Turner said. “This is a fantasy.” And mistakenly continuing to pursue austerity will only make the problem worse, while continuing to inflict suffering on many.

In addition, Turner believes that fixing the financial system will enable society to address another critical global challenge – climate change.

“We will not solve climate change with an entirely free financial system,” said Turner, who was also the Chairman of the U.K.’s Committee on Climate Change. He suggested that governments will have to play a significant role in any solution.

We have to be able to use the financial system to help solve the problem, he said. “But it needs to do it within a policy framework that is clearly set by the government.”

In each case, Turner called for the failed economics of the past to be replaced by new thinking that will help solve the most pressing economic issues of the 21st century. Outdated and wrong economic ideas have led us to where we are now. So while capitalism itself may not have failed, the old thinking that has dominated the economic discussion has.

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