Tomorrow’sCapitalism

HowToMake
CapitalismBetter
ConclusionsfromtheTomorrow’s
Capitalismprogramme
ByTonyDolphin,SeniorEconomist,ippr

September2009

www.ippr.org/tomorrowscapitalism
 2 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

SupportingtheTomorrow’sCapitalismprogramme
ippr’soverallworkprogrammeonTomorrow’sCapitalismiskindlysupportedbyFriends
ProvidentFoundationandthegenerousdonorstoippr’sNextGenerationFund.

Aboutippr
TheInstituteforPublicPolicyResearch(ippr)istheUK’sleadingprogressivethinktank,
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publicpolicyissues.
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aspossible,whileourinternationalandmigrationteamsandclimatechange
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throughouttheUKforimprovedaccesstoappropriatefinancialservicesforthosewhoare
currentlyexcluded,particularlythoseonlowincomesorotherwisevulnerabletomarket
failure.Itparticularlywantstoencouragethinkingthatdealswiththecausesoftheproblems
andhowfinancialsystemsmightdeliversocialaswellaseconomicvalue.Establishedonthe
demutalizationofFriendsProvidentLifeOfficein2001andtheflotationofFriendsProvident
plc,itisindependentandhasitsownboardofTrustees.

ThispaperwasfirstpublishedinSeptember2009.©ippr2009
TheviewsexpressedinthispaperarenotnecessarilythoseofipprorFriendsProvidentFoundation.
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 3 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Howtomakecapitalismbetter:summary
Note:Thepapers ThispapersummarisesthefindingsoftheTomorrow’sCapitalismprogramme,organisedby
andeventsfromthe ipprinconjunctionwithFriendsProvidentFoundationin2009withtheaimofexploring
Tomorrow’s thefutureofourfinancialandeconomicsystem.
Capitalism
programmethat Todothis,wepresentedaseriesofdebates,seminarsandpapersfeaturingleadingexperts
arereferencedin andthinkersfromtheworldofeconomics,business,politicsandthemedia.Theresultwas
thispapercanbe adeeperunderstandingoftheflawsinherentintheneo-liberalmodelofcapitalismand
accessedat thestepsneededtocorrectthem,togetherwithavisionofsomeofthekeyfeaturesof
www.ippr.org/ ‘tomorrow’scapitalism’andthechallengesfacingpolicymakersastheyseektoimprovethe
tomorrowscapitalism currenteconomicandfinancialmodel.
Asynthesisofthisunderstanding,derivedpartlyfromthedebatesandreports,isprovided
inthisfinalpaper.Itdoesnotattempttocoveralltheterrainunderthisvasttopic
althoughitdoesdrawsomeimportantconclusions.
Inparticular,theprogrammehassuggestedcapitalismcanbemadebetterinthe
followingways:
• Internationaleconomiccoordinationneedstobeincreasedandinternational
organisationssuchastheIMFrequirereform.Recognisingtheirincreasingimportance
intheglobaleconomy,largeemergingeconomieslikeChinaandIndiamustbegivena
greaterroleinsuchinstitutions.Individualcountries,andgroupsofcountries,must
ensuretheyarenotpursuingpoliciesthatwillcreateglobaleconomicimbalances.
• EconomicgrowthintheUKmustbebasedlessonconsumptionandever-increasing
levelsofhouseholddebtandmoreonexportsandinvestment.Thiswillnothappenon
itsown.TheUKgovernmentmustbemoreactiveinaddressingmarketfailuresin
innovation,training,infrastructureandfinance.Inparticular,itshouldestablishan
IdeasBanktoimproveaccesstofinanceforbusinessinnovationandanInfrastructure
Banktosupportinfrastructurecosts;itshouldencouragelife-longlearningthrougha
transferablecreditsystemforallfurthereducationcourses;anditshouldsupportthe
effortsofuniversitydepartmentstospinoutbusinesses.
• Thereshouldbeaninternationallyagreedsetofregulatoryprinciplesforthefinancial
systembasedonresponsibility,accountability,thecollectionofrelevantinformation,
theindependenceofinformationandoversight.Regulatorsshouldunderstandthe
potentialeffectsacrossthewholefinancialsystemofdevelopmentsintheirmarkets,
informationgapsshouldbeclosedinderivativemarketsandcreditratingagencies
shouldbepaidbyinvestors,notissuers.Oncetheseprincipleshavebeenagreed,they
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shouldbeimplementednationallyandaninternationalbodyshouldbeestablished
withtheauthoritytoensureindividualcountries’regulationsarecompliant.
• Theremitofcentralbanksshouldbewidenedtoencompassassetprices.Theyshould
seektoidentifyassetbubblesintheirearlystagesandacttoburstthembeforethey
becomedangerouslylarge.
• Policymakersshouldfocusmoreonalternativemeasuresofprogress,suchasthose
basedonsubjectivewellbeing,anddowngraderealGDPgrowthastheultimatetarget
ofeconomicpolicy.IntheUK,theyshouldimplementpoliciesthatwouldmovethe
economytowardsamoreScandinavianversionofcapitalism,whichwouldproducea
moreequal,andthereforeahappier,society.
 4 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Introduction
FormypartIthinkthatcapitalism,wiselymanaged,canprobablybemade
moreefficientforattainingeconomicendsthananyalternativesystemyetin
sight,butthatinitselfitisinmanywaysextremelyobjectionable.
JohnMaynardKeynes,TheEndofLaissez-faire(1926)
Inthelast12months,capitalismhas,inthewordsofKeynes,been‘extremely
objectionable’.Theworldhasexperienceditsworstfinancialcollapsesincethe1930sandis
inthemidstofthedeepestrecessionsincetheSecondWorldWar.TheInternational
MonetaryFund(IMF)expectsworldoutputtoshrinkby1.4percentin2009(IMF2009b).
Accordingtoconventionaleconomictheory,thisshouldnothavehappened.Theneo-liberal
modelofcapitalismwhichhasdominatedforthelast30years–characterisedbylight
regulation,unfetteredmarketsandminimalstateintervention–wassupposedtodeliver
sustainableincreasesinwelfarebutitfailedtodoso.Someofthemodel’ssupporterswere
evenunwiseenoughtosuggestthattheeconomiccyclehadbeenabolishedandtheyhave
beenprovedverywrong.
Unsurprisingly,acatastrophicfailureonthisscalehasledtospeculationthatneo-liberal
capitalismispastitssell-bydate.Despitetheseriousnessoftherecentcrisis,however,
Keynes’sviewthatcapitalisminsomeformisabetterbetthanthealternativesonoffer
remainstrue.Capitalismhasproducedfarthesuperioroutcomesintermsofsocialwelfare
andpersonalfreedom.Itisunlikely,therefore,thatcapitalismwillbeabandoned.However,it
willhavetochange.Justastheneo-liberalformofcapitalismreplacedtheregulatedform,
whichdominatedWesterneconomiesfromtheendoftheSecondWorldWarthroughtothe
1970s,soanewformofcapitalismislikelytoemergeasaresultofthecurrentcrisis.The
neo-liberalmodelisdestinedsoontoberegardedas‘yesterday’scapitalism’,butitisnotyet
clearwhatwillreplaceit.Thisisthetimetoaskwhat‘tomorrow’scapitalism’mightlooklike.
Ofcourse,atthisstage,itistooearlytoanswerthisquestionwithanycertainty.Justasno
oneinthemid-1970scouldhavepredictedaccuratelythewaytheneo-liberalmodelwould
developtoencompassprivatisation,thedefeatofinflationandtheemergenceofan
economically-powerfulChina,soitisunlikelythatwecan,today,predictaccuratelythe
courseofthenext30years.However,byidentifyingsomeoftheflawsintheneo-liberal
modelwhichhelpedcreatethepresentcrisis,lookingatwaysinwhichtheycanbecorrected
andaskingwhatpeoplereallywantfromtheeconomicsystem,wecan,perhaps,beginto
envisagewhattomorrow’scapitalismwilllooklike–andwhatitshouldlooklike.

Neo-liberalcapitalismincrisis
Economicandfinancialsystemsdifferfromcountrytocountry,evenwithinthedeveloped
economiesofNorthAmericaandWesternEurope,andtheyarealwaysinflux.Buthistorians
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arelikelytoidentifytwodominanteconomicmodels,inAnglo-Saxoneconomiesatleast,in
theperiodfromtheSecondWorldWaruptothepresentday.
Thefirstmodel,whichlastedfromthe1940sthroughtothe70s,wascharacterisedbyahigh
degreeofgovernmentinterventionintheeconomy,bothdirectlyandthroughtheuseof
regulation.Macro-economicpoliciesweregearedtomaximisingemployment,largelythrough
fiscalpolicy,whilerecognisingatrade-offbetweeninflationandunemployment.Although
thismodeldeliveredverydesirableoutcomesinthe1950sandearly60s,aperiodwhichsaw
rapideconomicgrowthintheUnitedStatesandEurope,itfellintodisreputeinthe
stagflationaryeraofthe70s.However,itssuccessordidnotreallyemergeuntiltheearly80s,
usheredinbytheReaganadministrationintheUSandtheThatchergovernmentintheUK.
 5 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Forthenext30years,aneo-liberalmodelofcapitalismdominated.Thismodelwas
characterisedbylightregulation,unfetteredmarketsandamuchreducedrolefor
governmentintheeconomy.Macro-economicpoliciesweregearedtokeepinginflation
low,largelythroughmonetarypolicy,asthebestmeansofsecuringeconomicgrowth
and,thus,alowlevelofunemployment.Until2008,itssupporterswereabletoargue
thattheneo-liberalmodelhadprovedtobeagreatsuccess.Inflationhadbeenlargely
conqueredindevelopedeconomiesandinthevastmajorityofdevelopingeconomies
too.Unemploymentrateswerelow.FormerSovietstates,EasternEuropeancountries
andChinawereallfullyengagedinthecapitalisteconomyandworldtradewas
expandingatarapidpace.(Criticswhopointedoutunsustainableaspectsofallthis
growth–includingresourcedepletionandclimatechange–werebrushedaside.)There
wereproblemsalongtheway–recessionsinmanycountriesintheearly1990sandthe
Asiancrisislaterinthatdecade–buttheseseemedasmallpricetopayfortheprogress
thatwasbeingmade.
Meanwhile,intheUK,theeconomyexpandedcontinuouslyforarecord17yearsfrom1992
to2008andunemploymentfelltoaround1.5million–itslowestlevelsincethe1970s.
Followingthegranting,in1997,ofindependenceovertheconductofmonetarypolicyto
theBankofEngland,inflationremainedwithinonepercentagepointofitstargetratefor
almostadecade.Althoughtherewereworriesthatallwasnotwellbeneaththesurface,
theseheadlinenumbers,ongrowth,unemploymentandinflation,seemedtoogoodtoargue
with.(SeeFigure1below.)
Itisnowclear,however,thatthissuccessbredcomplacency.Inturnthisledtoexcessiverisk-
takingandultimatelytothefinancialcollapsethatengulfedtheglobalbankingsystemin
2008,tobefollowed,inevitably,byrecession.AspredictedbyHymanMinsky,aonce
forgottenUSeconomistinwhoseworktherehasrecentlybeenagreatrevivalofinterest:
‘Thedynamicsofacapitalisteconomywhichhascomplex,sophisticated,andevolving
financialstructuresleadstothedevelopmentofconditionsconducivetoincoherence–to
runawayinflationsordeepdepressions’(Minsky1986).
Investors,companies,householdsandgovernmentsallcametobelievethateconomic
volatilityhadbeenconquered,thateconomicagentsbehavedrationallyandthatfinancial

Figure1.UK
unemployment Unemployment (000s)
andinflation 3500 Retail price inflation (%) 25

Source:Officefor 3000 20
Retail price inflation (%)
Unemployment (000s)

NationalStatistics
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2009
2500 15

2000 10

1500 5

1000 0
80 83 86 89 92 95 98 01 04 07
Year
 6 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

marketswereefficient.Risingassetpricesmust,therefore,bejustified.Asmarketconfidence
thatnothingcouldgowrongincreased,sobankersandotherfinancialagentstookbigger
andbiggerrisks,secure–theyfelt–intheknowledgethatanylossescouldbecontained.
Thiswasanassumptionthatprovedcalamitouslywrong.
Inparticular,abeliefbegantogrowthatUShousepricescouldnotfallandthisencouraged
moreandmorehouseholdstobecomehomeowners(andanincreasingnumbertobuyextra
propertiesasaninvestment).Theywereabletodosobecausemortgagelendersmadeloans
availabletothem.HouseholdmortgagedebtoutstandingintheUSrosefrom$5.3trillionat
theendof2001to$10.5trillionattheendof2007–almostdoublinginjustsixyears(US
FederalReserve2009).Newsub-primemortgages–loanstohouseholdswithpoorcredit
recordsoruncertainincomes–rosefromaround$200billionin2002(7percentofthe
total)toover$600billionin2005and2006(over20percentofthetotal)(Jaffe2008).
Manyofthesemortgageshadlow‘teaser’rates,meaningthatinterestpaymentswerekept
lowforoneortwoyearsbeforebeingresettoamarketrate.Sureenough,thisinfluxofnew
buyershelpedpushuphouseprices,fuellingthemyththattheycouldneverfall.
Meanwhile,thelenderswerebusyoffloadingtheirriskbysecuritisingmortgages–bundling
themupintobonds,knownasmortgage-backedsecurities(MBS),whichcouldbesoldto
investors.Inturn,financialengineersinbanksandotherfinancialinstitutionscreated
anothersetofinstrumentsoutoftheseMBS,oftenbycombiningthemwithcorporatedebt
(bondsissuedbycompanies).Thesecomplexinstruments–collateraliseddebtobligationsor
CDOs–weredividedintodifferenttiers,eachwitharatingfromacreditratingagency,
allowinginvestorstoinvestonlyinthosetiersthatsuitedtheirriskappetite.Toenhance
returns,investorsoftenusedleveragetopurchaseCDOs,sodebtwithinthefinancialsystem
grewrapidlyalongsidehouseholddebt.
AlthoughsomeobserversexpressedalarmattherapidgrowthofdebtwithintheUS
economy,itdidnotcreateanyproblemswhileUShousepricesweregoingup.However,
therecameapointwhenpriceshadrisensofarthatthemyththattheywouldkeeponrising
becameimpossibletosustain.Thiswasquicklyfollowedbyarealisationthatpricescouldfall
sharply,particularlyinsomeofthemore‘bubbly’markets,suchasFlorida,Californiaand
Nevada.

Figure2.House
priceinflationin 25
theUnited
20
States(%)
15
10
Source:
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S&P/Case-Shiller % 5
2009 0
-5
-10
-15
-20
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Year
 7 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Formanysub-primelenders,fallinghousepricescreatedhugeproblemsbecausetheycould
notaffordthehigherinterestpaymentsthatwererequiredoncetheirperiodofpayinga
teaserrateexpired.Theyhadbeencountingonre-mortgagingtheirpropertyandfoundthat
theycouldnotdosobecauseitwasnowworthlessthantheiroriginalmortgage.Atthis
point,peoplestartedreturningthekeystotheirpropertiesandwalkingawayfromtheir
mortgages.Asmortgagedefaultratesstartedtocreepup,soholdersofMBSandCDOs
startedtoworrythattheywouldnotgettheirmoneybackandlookedtosell.Unsurprisingly,
theyfoundfewpotentialpurchasersandpricesfell.Thiswasaproblemforinvestorswhohad
boughtwiththehelpofborrowedmoney.Aswellaspotentiallylosingalloftheirown
investment,theyfoundtheyheldanassetworthlessthantheloantheyhadusedtobuyit.
Inturn,thisbecameaproblemforthebanksbecausetheycouldnotgettheirmoneyback.
TheproblemswerenotconfinedtotheUS.Itsoonbecameclearthatbanksandother
financialinstitutionsaroundtheworldhadboughtCDOsandotherinstrumentsbacked
ultimatelybytheUSmortgagemarket.Acatalogueoffailuresandbankruptciesfollowed.In
early2007,specialistUSsubprimelendersbegantoreportlosses;inJunetwohedgefunds
runbyBearStearnswerereportedtobeinserioustrouble;andinSeptembertherewasa
‘run’onNorthernRock–thefirstonaUKbanksince1866.
Moreproblemsfollowed.MajorUSandEuropeanbankswrotedownthevalueoftheir
capitalbybillionsofdollarsduetolossesassociatedwiththeUSsubprimemarket.InMarch
2008,theFederalReserveengineeredthetakeoverofBearStearnsbyJPMorganChaseand
inJuly2008theUSTreasuryhadtobailoutthetwolargeUSmortgageagencies.However,
whenLehmanBrothers,thefourthlargestinvestmentbankintheUS,gotintoserious
troubleinSeptember2008,theBushAdministrationdecidednottosupportit,anditwas
forcedtofileforbankruptcy.Withhindsight,thiswasthemomentwhenthecrisispassedthe
pointofnoreturn.Banksbecameunwillingtolendtoeachother.Moneymarketinterest
ratesrosewellabovethelevelofofficialinterestratesandthecreditcrunchbeganin
earnest.
Oncebanksranintotroubleofthismagnitude,itwasinevitablethatthefinancialcollapse
wouldspilloverintotherealeconomy.Desperatetorebuildtheircapitalbases,banksbegan
tocutbackonlending.Credit-worthyhouseholdsandcompaniesfoundthattheycouldno
longerborrowthefundstheyneededtopurchasehouses,tomakeinvestments,orsimplyto
keepcompaniesafloat.Spendingwascut,workerswerelaidoffandeconomiesfellinto
recession.Theauthoritiesrespondedbyeasingfiscalpolicy,cuttinginterestratesand,most
importantly,introducingaseriesofmeasurestoshoreupbanks’capitalpositions.However,
bythetimetheyactedthedownwardmomentumwastoogreattoarrest.
Confidenceamongbusinessesandhouseholdshaddescended,surveysshowed,tothe
lowestlevelsonrecord(althoughinsomecasesthedataonlycoverthelast20or30years,
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inothersrecordsgobacktothe1950s).Thiswas,inlargepart,duetothefinancialcollapse,
buthigherenergyandfoodpricesaddedtothefeelingofgloom.Thecrudeoilprice,which
hadbeenrisingsteadilysincethebeginningof2002,reachedapeakof$147abarrelinJuly
2008,sendingpetrolpricesandenergybillssoaring.Meanwhile,thepricesofmanybasic
foodstuffsalsorosesharply.FoodpriceinflationintheUKreached13percentinAugust
2008,itshighestrateforover25years.Householdsfoundtheirdiscretionaryspending
powerseverelysqueezedandcutbackonnon-essentialitems.SalesofcarsintheUK,for
example,fellbyaroundaquarter.Sotherecessiondeepened.
Studiesshowthatrecessionscausedprimarilybybalancesheetproblems(thatis,excessive
debt)tendtobeworsethanrecessionsthatresultfromatighteningofmonetarypolicyto
controlinflation.Theyalsoshowthatsynchronisedrecessionstendtobeworseforindividual
 8 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

countriesthanrecessionsinasinglecountry.Wearenowexperiencingaglobalbalancesheet
recession,soitisnosurprisethat,fortheglobaleconomy,itisturningouttobethedeepest
sincetheSecondWorldWar.TheIMFnowforecastsa1.4percentdeclineinglobaloutputin
2009–thefirstdeclineinover60years–anda3.8percentfallinadvancedeconomies
(IMF2009b).The Economist magazinereportsthatthisyearoutputisexpectedtocontract
in50ofthe57countriesitreportson(TheEconomist2009)1.
IntheUK,outputhasalreadyfallenbyalmost6percentfromitspeakandfurtherdeclines
areexpected.Unemployment,whichfluctuatedataround1.5millionbetween2001and
2005,hasrisento2.38million,andiswidelyforecasttoreach3millionin2010.Intheinitial
stagesofthecrisis,therewerefearsthattheUKwouldfarequitebadlybecauseofits
relativelyheavydependenceonthefinancialservicesindustryanditsownhousingmarket
bubble.Sofar,however,thishasnotbeenthecaseandthebiggestdeclinesinoutputhave
beenineconomies,suchasJapan,Germany,Singapore,TaiwanandKorea,thatareheavily
reliantonexportsofmanufacturedgoodsforgrowth,andinemergingeconomieslikethe
BalticStates,whichdependedstronglyoninflowsofcapitalfromoverseas.TheUK
Governmentishopefulthatgrowthwillberestoredbytheendoftheyear,althoughmany
independentforecastersstillthinkthattherecoverywillnotcommenceuntil2010.

Tomorrow’scapitalism:theoptimist’sperspective
Inthemidstoftheworstglobalrecessionsincethe1930s,itisalltooeasytobepessimistic,
particularlywhenprominenteconomistssuchasPaulKrugman,whowasawardedtheNobel
PrizeinEconomicSciencesin2008,aresogloomyabouttheeconomicoutlook.Krugman
fearstheworldeconomyoverthenextdecade–ortheUSandEuropeatleast–will
replicatetheexperienceofJapanfollowingtheburstingofitsbubblein1990.Asheputsit:
‘Theriskforalongstagnationisreallyhigh’(Hutton2009).Attheheartofhispessimismis
aconcernthatitwilltakebanks,companiesandhouseholdsseveralyearsatleasttocleanup
theirbalancesheets.Untiltheydo,heargues,thereisnoprospectofdynamicgrowth,anda
highpossibilityoflittleornogrowth.
Foramoreoptimisticview,itisnecessarytoturntoeconomistswhoapproachtheirsubject
fromacompletelydifferentperspective.Someeconomichistorians,forexample,arguethe
financialcollapsewasaninevitableconsequenceofthewaythecapitalistsystemassimilates
technicalchange.Theirmessageisthat,ifhistoryisanyguide,thecurrentrecessioncouldbe
followedbyanewglobalgoldenage.
Technologicalrevolutions2 haveinthepastbeencharacterisedbyasurgeindevelopment
thatcomesintwophases,withamajorfinancialcollapseinthemiddle.Thefirstphase,the
‘installationperiod’,isledbyfinancialcapital.Apowerfulclusterofnewindustries,centred
onthenewtechnology,develops,creatingexplosivegrowthandstructuralchange.The
secondphase,the‘deploymentperiod’,isledbyproductioncapital.Newmulti-purpose
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technologiesallowtherevolutiontopercolateandmoderniseexistingindustries,creating
majorproductivitygains.Thus,ultimately,technologicalrevolutionstransformthewhole
economy.

1.ThesevenexceptionsareChina,India,Pakistan,Indonesia,Vietnam,EgyptandPeru.
2.Therestofthissectionisbasedonapresentationentitled‘GrowthAftertheFinancialCrisis’givenby
CarlotaPerezon1JuneaspartoftheTomorrow’sCapitalismprogramme.Arecordingisavailableat
www.ippr.org.uk/tomorrowscapitalism/events.asp?id=3459&tID=3336
 9 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Eachsurgehasitsownuniquecharacteristics,reflectingthespecifictechnologicalchange
thatistakingplace,butalsothepolitical,socialandculturalconditionsofthetime.
However,therearealsocommonpatternsanditisthebeliefthatthesepatternsrecur,which
underpinstheideathatwemaybeonthebrinkofaglobalgoldenage.Iftheydo,thenwe
arecurrentlyinthedifficultperiodbetweenthetwophasesofaninformationtechnology
andtelecommunicationsrevolution.The‘installationperiod’,ledbyfinancialcapital,has
drawntoacloseandthe‘deploymentperiod’,whichwillbeledbyproductioncapital,has
yettocommence.Theonlysignificantdifference,sofar,fromthehistoricalpatternisthat
themid-surgebubbleoccurredintwostages–thetechnologybubble,whichburstin2000,
andthecreditbubble,whichburstin2007.
However,theseeconomichistoriansalsopointoutthatgoldenageshavenotjusthappened
inthepast.Itislikelythatinstitutionalinnovationwillbenecessaryforareturntohealthy
growthintheeconomiesoftheOECD(OrganisationforEconomicCooperationand
Development)andextensivegrowthacrossthewholedevelopingworld.Toensurethis
happens,governmentswillhavetoregulatetorestrainfinancialexcesses.Governmentsalso
needtosupportlong-terminvestmentinproductivecapacityandtore-establishsocial
cohesionthroughmoreevenincomedistributionandbettersocialsafetynets.Iftheydo,
thensocietywillbenefitfromthepotentialofthenewtechnologiesintermsoffull
employmentandenhancedwell-being.
Correctingtheflawsinneo-liberalcapitalismthroughchangestotheinternationalorder,the
UKeconomyandfinancialmarkets,whilealsoreassessingwhatcapitalismismeanttodeliver
could,therefore,deliverfarbetteroutcomesoverthenext20yearsthanmostnowimagine
possible.

Tomorrow’scapitalism:theinternationalorder
Oneofthecausesoftheglobalfinancialcrisisandrecessionwasafailuretosuccessfully
integrateChinaandotheremergingeconomiesintotheglobalcapitalisteconomy.Large
amountsofcapital,principallyfromAsianeconomiesandoilexportingcountries,flowedinto
theUSandotherWesterneconomies,loweringlong-terminterestratesandhelpingtofuel
housepricebubbles.Thesecapitalflowswerematchedbylargecurrentaccountsurplusesin
AsiaandlargecurrentaccountdeficitsintheUSandothercapitalimportingcountries.

Figure3.
Currentaccount 1.5
balances(%of
globalGDP) 1

0.5 United States

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Source: Euro Area

International 0
% Japan
MonetaryFund -0.5 Emerging Asia
2009a
Oil exporters
-1

-1.5

-2
97 98 99 00 01 02 03 04 05 06 07 08
Year
 10 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

TheseimbalanceshavetheirrootsintheAsiancrisisof1997and1998.Duringthisperiod,a
numberofAsianeconomies,whichhadbeenrelyingoncapitalflowsfromoverseastoboost
domesticspendingandgrowthintheireconomies,foundthattheycouldnolongerattract
externalfunds.Asaresult,theircurrenciescollapsed,spendinghadtobecutbacksharply
andtheyendureddeeprecessions.Theauthoritiesintheseeconomiesrespondedby
adoptinganewsetofeconomicpriorities.Nolongerwouldtheybereliantonoverseas
capitalforgrowth.Instead,theywouldseekexport-ledgrowth,runcurrentaccountsurpluses
andoffsetthembytransferringtheirexcesssavingsoverseas.
Meanwhile,Chinawasadoptingasimilarmercantilistattitude.Byretainingcapitalcontrols,it
wasabletopreventitscurrencyrisingontheforeignexchanges,whichhelpedittosustain
strongexportgrowth.Thisresultedinmassivecurrentaccountsurplusesandanimbalance
betweendomesticsavingandinvestment.Astheoilpricerose,oil-exportingcountriesfound
themselvesinasimilarsituation.
TheresultwaswhatBenBernanke,nowGovernoroftheUSFederalReserve,hascalleda
‘savingsglut’inAsia,andmorerecentlyinoil-exportingeconomies.Thesesurplussavings
wereusedtobuygovernmentbondsandsimilarinstrumentsinWesterneconomies,helping
toholddownlong-terminterestrates,includingUSmortgagerates,andsostimulatingasset
prices,includingUShouseprices.
Chinaandotheremergingeconomieshadothereffectsontheglobaleconomy.Inparticular,
China’swillingnesstoparticipateintheglobalcapitalisteconomyadded,potentially,
hundredsofmillionsofpeopletoitsworkforce.Unsurprisingly,thishadtheeffectof
reducingtheshareofwagesinglobaloutput(becauselabourwasnowarelativelyabundant
resource)andincreasingtheshareofprofits.Asaresult,householdscouldonlyaffordtobuy
alltheavailableoutputbytakingonmoreandmoredebt3.IntheUK,forexample,
householddebtincreasedfrom109percentofdisposableincomein1999to176percentin
2007,atrendthatcouldnotbesustainedforever,aswearenowfindingout.
Thefinancialcrisisandrecessionhavealreadybeenthestimulusforactionatthe
internationallevel.TheG20groupofcountrieshasmettwice,inWashingtonDCin
November2008andinLondoninApril2009.AnothermeetingisplannedforSeptemberin
Pittsburgh.Thefocusofthefirsttwomeetingswas,rightly,themeasuresnecessaryto
restoresomesortofnormalitytotheglobalbankingsystemandtolimittheextentofthe
recession.TheLondonSummitinparticularwasjudgedasuccessaftertheleadersagreeda
$1.1trillionprogrammeofsupportfortheglobaleconomy–mainlytobechannelled
throughtheIMF.However,attheirnextsummit,itwillbetimefortheG20leaderstostart
lookingforward:firsttotheCopenhagenSummitinDecember,whendecisionsneedtobe
madeoncontrollingcarbonemissions,andsecond,tochangesintheinternationalorderthat
arerequiredtomaketheglobaleconomymorestable.Thelattergoalwillrequire
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policymakerstotakeactionbothattheinternationallevelanddomestically.
Internationally,theIMFandWorldBankarelongoverdueanoverhaul.Theywereestablished
aspartoftheBrettonWoodsagreementin1944andhaveremainedlargelyunchangedever
since;theyarestilldominatedbytheUSandEurope.Thefirstchangethatisrequired,
therefore,istoacknowledgetoday’seconomicrealities:Chinaisnowtheworld’ssecond
largesteconomyandisontracktobeitslargestwithinfifteenyears.Itwillhavetohavea
greatersayintherunningoftheworldeconomy,aswillIndia,RussiaandBrazil,whichwillall

3.ThispointismadebyGerryHolthaminhispaperfortheTomorrow’sCapitalismprogramme:Global
DimensionsoftheFinancialCrisis(Holtham2009).
 11 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

beamongtheworld’stopteneconomiesby20274.Thiswillrequirehithertodominant
countries,inparticulartheUSandtheUK,toacceptadiminutionintheirpower.
ThiswillmakeiteasierfortheIMF,inparticular,totakeonanewroleofmonitoringeconomic
andfinancialdevelopmentsatagloballevelandbringingpressuretobearonanyeconomy
(orgroupofeconomies)thatislargeenoughtopotentiallyunbalancetheglobaleconomy
andthatispursuingpoliciesthatareactuallyunbalancedenoughtodoso(Holtham2009).In
reality,ofcourse,thismeansprincipallytheUSandChina(thoughtheyarealmostmatchedin
sizebytheEuropeanUnionasawhole).By2027,accordingtoGoldmanSachs,theUSand
Chinawillbothbeapproximatelyfourtimesthesizeoftheworld’snextlargesteconomy
(India).TheIMF,however,canonlydosomuchtoencouragegovernmentstochangepolicy.
Peerpressurewillbecrucial.Inthisrespect,anenhancedrolefortheG20willbeimportant,
whiletheG8groupingofcountries,whichincludesRussiabutnotChina,IndiaorBrazil,no
longerhasausefulroletoplayininternationaleconomicmatters.
TheimmediateimperativesforUSpolicyarefairlyclear.Oncetherecessionhaspasseditwill
beleftwithalargefiscaldeficit–probablyoftheorderof12or13percentofGDP–anda
stillsizeablecurrentaccountdeficit.Actionwillneedtobetakentoreducethefiscaldeficit,
whileensuringthattheprivatesectorremainsinsurplussothatthecurrentaccountdeficit
alsoshrinks.
Chinaisamorecomplexproblem.TheriseofChina–andofAsiamoregenerally–isalong-
termphenomenon,whichwasgoingonfordecadesbeforethecurrentcrisisandislikelyto
continueformanydecadestocome.Theregion’sinfluenceinglobalinternationalaffairsis
boundtoincreasewithitseconomicsizebutitwillhavetoaccepttheresponsibilitiesand
obligationsthatcomewiththatextrainfluence5.Itspriorityshouldbetostopexporting
capitaltotherestoftheworld,andtotheUSinparticular.Thiswouldnotjustbeforthe
goodoftheinternationalorder,butwouldbebeneficialtotheChineseeconomytoo.China
hasalreadyaccumulatedforeignexchangereservesamountingtoalmost$2trillion,mostly
denominatedinUSdollars.Thereislittlesenseinaccumulatingmore.Moregenerally,itis
illogical,andcountertothenormalhistoricalpattern,forarelativelypoorcountrylikeChina
tobeexportingcapitaltoawealthycountryliketheUS.Itcould,andshould,beputtomore
productiveusewithintheChineseeconomy,forexampleinthedevelopmentofpublic
provisionofhealthcareandeducation.
ThepresentcrisiswillhaveshowntheChineseauthoritiesthattheireconomyisnot
dependentontheUSoranyothereconomy.Itisstillforecasttogrowbyabout7percentin
2009despitethedeeprecessionbeingexperiencedbymostoftherestoftheworld.Asa
result,Chinaislikelytobecomemoreassertiveinshapingtheinternationalordertoreflect
itsownperspective.However,itwillnotbeabletodominateinthewaythattheUShas
donesinceBrettonWoods.Thenewinternationalorderwillhaveanumberofimportant
www.ippr.org/tomorrowscapitalism

players:ChinaandtheUS,butalsotheEuropeanUnionandIndiaandmaybeablocofLatin
Americancountriestoo.Iftheycooperatewitheachother,theywillhaveamuchbetter
chanceofpreventingthedevelopmentinfutureofeconomicimbalanceslikethosethatwere
attherootofthecurrentcrisis.

4.LatestprojectionsfromGoldmanSachsshowChinawillbetheworld’slargesteconomyin2027,India
thethirdlargest,RussiasixthandBrazileighth.SeeFaulconbridge2009
5.BillEmmottandMartinJacquesbothemphasisedthispointattheTomorrow’sCapitalismdebateon
theInternationalOrder,20May2009.Recordingsareavailableat
www.ippr.org/tomorrowscapitalism/events.asp?id=3473&tID=3336
 12 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Nooneshouldimaginethiswillbesimple.TheUS,inparticular,islikelytobereluctantto
acceptalesserroleinglobaleconomicaffairs.Andindividualcountrieshavealwaysfoundit
difficulttoputasidewhattheyperceivetobetheirnationalinterestsforthegoodofthe
globaleconomy.Itisunlikelytheywillfinditanyeasierinthefuture.Therewillcontinueto
betensionsbetweenglobalisationandeconomicnationalisation,creatingariskthatthenew
internationalordercouldprovejustasunstableastheoldone.Itisaloteasiertomakethe
casethattomorrow’scapitalismshouldincorporateaninternationalorderbasedon
cooperationthanitistoseehowsuchanordermightbebroughtabout.

Tomorrow’scapitalism:theUKeconomy
Yesterday’scapitalismdidnotjustproduceimbalancesbetweencountries;italsoproduced
imbalanceswithinthem.ItisnowacceptedthattheUKeconomybecameunbalancedover
thelastdecade,withgrowthoverlyreliantonahandfulofsectorsandultimatelyfuelledby
unsustainablelevelsofdebt.
Consumerspending–fuelledbyrisinghouseholddebt–grewatanannualrateof3.2per
centoverthetenyearsto2008,whiletherewasa2.6percentrateofincreaseforrealGDP.
Importsgrewmuchfasterthanexportsinordertofillthegap.Constructionalsoboomedin
responsetosoaringhouseprices.Meanwhile,thefinancialfirmsintheCitygrewstrongly,
whilemanufacturingstagnated.Attheendof2007,outputinmanufacturingwasnohigher
thanithadbeenatitspreviouspeakattheendof2000.Outputinthebusinessservicesand
financesectorincreasedby36percent(anannualrateof4.5percent)overthesame
period.AndtheGovernmentwasabletousebuoyanttaxrevenues–inpartfromtheCity–
tofundlargeincreasesinpublicspending,particularlyonhealthandeducation.
Theseimbalanceswerereflectedindevelopmentsinthelabourmarket,inparticularinthe
sevenyearsfrom2001to2008whengovernmentspendingwasincreasedatarapidpace.
Overthisperiod,employmentintheUKrosebyjustover1.75millionintotal,butthis
growthwasheavilyconcentratedintwosectors:publicadministration,educationandhealth
ontheonehandandbanking,financeandbusinessservicesontheother.Employmentin
thesesectorsincreasedbyalmost2million–morethanthetotalincrease–while
manufacturingemploymentfellbyalmost1millionoverthesameperiod.Atthesametime,
therewasanincreaseofabout2millioninthenumberofpeopleemployedinskilled
occupations–managers,professionals,associateprofessionalsandskilledtradespersons–

Figure4.
ChangeinUK
Agriculture, hunting, forestry & fishing
employmentby
Energy & water
industry,2001
Q2to2008Q2 Manufacturing
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(thousands) Construction
Distribution, hotels & restaurants

Transport, storage & communication

Source:Officefor
NationalStatistics Banking, finance, insurance, business services
2009 Public administration, education & health

Other services
TOTAL

-1000 -500 0 500 1000 1500 2000

thousands
 13 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

andadeclineof0.75millioninthenumberofsemi-skilledandunskilledworkers,particularly
inclericalandsecretarialroles,andinprocessingandmachineoperation.
Adeeperanalysisofemploymentbyindustryandoccupationsuggeststherewerefourkey
driversofdevelopmentsinthejobsmarketovertheperiodfrom2000to2008.Increased
competitionfromlow-wageeconomiesandrapidtechnologicalprogressledtoareductionin
demandforunskilledandlow-skilledworkersinbothmanufacturingandserviceindustries.
Stronggrowthinpublicspendingandtheboominghousingmarketwereassociatedwith
largeincreasesinjobsineducationandhealthandinconstructionandrealestate.
Someofthesetrendshavealreadyreversedasaresultoftherecession.Forexample,there
hasbeenabigdeclineinemploymentinthefinancialandbusinessservicessectorsincethe
middleof2008.Buttherehavealsobeenlargefallsinemploymentintheretailsectorand–
extendingthetrendoftheprevioussevenyears–inmanufacturing.RebalancingtheUK
economywillnothappenautomatically.
Inbroad,macroeconomicterms,itisnotdifficulttoseewhatisrequired.Consumerspending
needstogrowlessquicklythantheoveralleconomy,leavingroomformorerapidgrowthin
exportsandincorporateinvestment,particularlyintheexportindustries.Thisshouldbe
achievedbythehouseholdsavingratioreturningtoamorenormallevelandthehousehold
debttodisposableincomeratiobeginningtofall.Thesavingrateplummetedtoalowof-
0.8percentinthefirstquarterof2008buthadalreadyclimbedbackupto3percentby
thefirstquarterofthisyear.Itprobablyneedstosettlearoundthe8to10percentlevel
(theaverageratefortheperiodfrom1970to1999was8.7percent).

Figure5.UK
household 16
savingrate(%) 14
12
Source:Officefor 10
NationalStatistics
% 8
2009
6
4
2
0
-2
70 73 76 79 82 85 88 91 94 97 00 03 06 09
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Year

Strongergrowthinexportsandinbusinessinvestment,relativetohouseholdspending,
wouldtiltthebalanceofgrowthintheUKeconomytowardsmanufacturingandawayfrom
services.ThisshouldbemadealittleeasierbythefallinSterlingoverthepasttwoyears.
Thepoundiscurrentlyabout20percentloweragainstboththeUSdollarandtheEurothan
itwasinthemiddleof2007.Ifthisfallissustained,dependingontheresponseof
companies,thecompetitivenessofUKindustrywillbeboosted.
AnyrebalancingoftheUKeconomywillhaveprofoundeffectsonthelabourmarket.The
mostsignificantchange,comparedwiththelastdecade,willoccurinthepublicsector.Real
publicspending(totalmanagedexpenditure)increasedatanannualrateof4.2percent
 14 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

between2000–01and2007–08andthenumberofjobsinpublicadministration,education
andhealthrosefrom5.8millionin1999to7millionin2006(someofthesejobsareinthe
privatesector,buttheoverwhelmingmajorityoftheincreaseoccurredinthepublicsector).
However,thisyear’sBudgetenvisagedrealspendinggrowthofjust3percentin2010/11,
followedbythreeyearsinwhichspendingdoesnotincreaseatallinrealterms(HMTreasury
2009).Furthermore,withdebtinterestandwelfarepaymentssettoincreaserapidly,
departmentalspendingwillhavetofall,inrealterms,iftheseplansaretobefulfilled.
Inevitably,thiswillmeanloweremploymentinthepublicsector.
Thereisalsolikelytobelittleornogrowthinemploymentinretailingandotherassociated
sectors,ifconsumptionisgrowinglessrapidlythantotaloutput.Thesameislikelytobetrue
ofemploymentinthefinancialsector.AlthoughtheCityboomedintheyearsupto2007,
thesectorinaggregateshedjobs,particularlyinretailbankingandininsuranceandpension
funding.Asfinancialinstitutionsseektorebuildtheirprofitmarginsoverthenextfewyears,
morejoblossesseeminevitable.ThedifferencenowisthattheCityappearslikelytobeless
buoyanttoo.
Theremustalsobesomedoubtabouttheabilityofthemanufacturingsector,inaggregate,
tocreatejobs,eveniftheeconomyrebalances.Fromitspeakin2000toitspeakin2008,
manufacturingoutputdidnotincreaseatall,whileemploymentfellbyover1million–an
annualrateofdeclineof3.7percent.WithChinaandotheremergingeconomieslikelyto
continuetoincreasetheirshareinworldmanufacturingoutput,fortheUKeventoholdonto
itspresentsharewouldrepresentsomethingofanachievement.Ifitcandoso,then
employmentinmanufacturingmightbestabilisedandthatisaboutthebestoutcomethat
canbehopedfor.

Figure6.UK Output
manufacturing Employment
outputand 120
employment
(1993Q1=100) 110

100
Source:Officefor
NationalStatistics 90
2009
80

70

60
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93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Year

Itseems,therefore,thatmostofthegrowthinemploymentintheUKincomingyearswill
havetooccurinprivateservicesectors–otherthanfinanceandretailing.Thisrepresentsa
verydisparategroupofcompanies.Somearewell-paid,suchasmanagementconsultancy,
andothersareglamorous,likethecreativeindustries.Buttherewillalsobealotofless
skilled,lesswell-paidandlessglamorousjobsinthesesectors.Theageingofthepopulation,
forexample,willleadtoincreaseddemandforcarers.
Insectorterms,therefore,tomorrow’scapitalismmaynotseetheUKeconomyrebalance,as
muchasgooffinanotherdirection.Afteradecadeofemploymentgrowthledbythepublic
 15 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

sector,constructionandretailingwhilemanufacturingemploymentslumped,weshould
expect–orratherhopefor–severalyearsofgrowthledbypartsoftheprivateservice
sector,withemploymentinmanufacturingstabilising.
Inordertospeedtheeconomy’sreturntofullemployment,however,theGovernmentwill
needtobemoreactive.Thishasalreadybeenrecognised,andtheDepartmentsfor
Innovation,UniversitiesandSkillsandBusiness,EnterpriseandRegulatoryReform(since
mergedintotherenamedDepartmentforBusiness,InnovationandSkills)publishedaWhite
PaperinAprilentitledNewIndustry,NewJobs toaddresstheseissues.Itidentifiesfourareas
ofmarketfailurewheretheGovernmentcanplayarole:innovation,skills,financeand
infrastructure.Cynicshave,however,pointedoutthatthesemarketfailureshavebeenknow
aboutforsometimeandthattheypersistdespitepreviousgovernmenteffortstocorrect
them.Thechallenge,therefore,istodesignspecificpoliciesthatwillalleviatethem6.
IftheUKistoreturntofullemploymentoverareasonableperiodoftime–andrecent
historysuggestsitwilltakeatleastsevenyears–theGovernmentandtheBankofEngland
willhavetogettheirmacroeconomicpoliciesrighttoensurethereisadequatedemandin
theeconomy.Bankswillalsoneedtoberecapitalisedsothattheycanincreaselending,
particularlytobusinesses.ButtheGovernmentalsoneedstoaddressfailingsonthesupply-
sideoftheeconomy.Tomorrow’scapitalismrequiresmoreactivistgovernmentpoliciesinthe
areasofinnovation,trainingandinfrastructure,notjustduringtherecessionbutpersisting
aftertheeconomybeginstorecover.

Tomorrow’scapitalism:financialmarkets
Developmentsinfinancialmarketsarecentraltothecrisisandrecessioninwhichwenow
findourselves.Itisunthinkablethattheywillbeallowedtocontinuetooperateinfuturein
thesamewaythattheyhaveinthepast.Increasedregulationisverylikelyforbanksandfor
otherfinancialmarketsandthisshouldbeunderpinnedbyaguidingsetofprinciplesthat
canthenbeappliedtospecificmarkets,suchastheUKmortgagemarket.
Overthelast25years,thecultureoffinancialmarketshaschangedconsiderably.Financial
institutionshavetransformedfromownersoffinancialassetstotradersofthem.Thisshift
hasbeenaccompaniedbyadeclineinprofessionalprideintheCityandthedevelopmentof
aculturethatisdifferentfromthatoftherestofsociety.Providingaservicetoclientsisnow
secondarytomakingaquickprofit.Thiscultureenabledbanksandotherfinancial
institutionstocreatecomplexdebtinstruments,likecollateraliseddebtobligations(CDOs),
whichtheybarelyunderstoodthemselves,andsellthemontoclientswhounderstoodthem
evenless.
Financialinstitutionshavealsodiscoveredtheyarenotascleverastheythoughttheywere.
Keynessaid,‘Practicalmen,whobelievethemselvestobequiteexemptfromanyintellectual
www.ippr.org/tomorrowscapitalism

influence,areusuallytheslavesofsomedefuncteconomist’(Keynes1935).Inthisinstance,
bankers,hedgefundsandtherestwereslavestotheeconomistswhotoldthemthatpeople
wererationalandfinancialmarketsefficient.Theybuiltcomplexriskmeasurementsystems,
basedonthesetheories,whichtoldthemthattheirpositionsweresafebecausetheywere
well-diversifiedandtheyignoredthesceptics,suchasNassimTaleb(2007),whowarnedthat
thesemodelscouldnotcopewithextremeoutcomesand,crucially,thattheseextreme

6.JonathanClifton,TonyDolphinandRachelReevesmakeanumberofrecommendationsinthisareain
theirpaper BuildingabetterbalancedUKeconomy:Wherewilljobsbecreatedinthenexteconomiccycle?
presentedataTomorrow’sCapitalismseminaron19May2009(Cliftonetal 2009).
 16 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

outcomestendtohappenmorefrequentlythanstatisticalmodelswouldsuggest.However,
eventshaveprovedTalebrightandthecombinedwisdomofthefinancialsystemwrong.
Itseemsobvious,therefore,thattomorrow’scapitalismrequiresatransformationofculturein
theCityaswellasenhancedregulation,asmuchtosavethefinancialsystemfromitselfasto
stopitcreatinganothercrisisfortherestoftheeconomy.However,itwillbeverydifficultto
changethisculture.Althoughtherehasclearlybeenabreakdownintrustbetweenthebanks
andtherestoftheeconomy,thereislittletosuggestthattheCityacceptsitwasresponsible
andthatithasamajorroletoplayinrestoringtrust.Forexample,afterGoldmanSachs
reporteda$3.44billionprofitforthesecondquarterof2009,therewasspeculationthat
averagepay(salaryandbonuses)atthefirmwouldbe$1millionthisyear.
However,Citypractitionersarenotsolelytoblame.Therehasalsobeenamassivefailureof
accountability,whichallowedbankerstodowhattheydid.Remunerationcommitteesdid
notcontrolbankexecutivesthroughappropriatepackages.Auditorsdidnotsoundalarm
bellsoverwhatbanksweredoing.Institutionalshareholdersfailedtoquestionbanks’
behaviour–indeedtheyeggedthemon,forexamplesupportingtheRBSboard’sdecisionto
buyABNAmro.Andregulatorsfailedtoappreciatethescaleofsystemicriskthatwas
developing.TheCity’s‘friends’werejustasculpableasthebankersthemselves.
IftheCityanditssupportersareunwilling,orunable,toalteritsculturefromwithin,change
willhavetobeimposedonitfromwithout.Somechangesseemobvious.Limitsshouldbe
placedonremunerationpackagestoensuretheyonlyrewardlong-termsuccess,notshort-
term(andunsustainable)gains.Andinstitutionalinvestors,suchaspensionfunds,should
thinkabouthowtheycanencouragetheCityawayfromitstradingmentalityandbacktoa
longer-term‘buyandhold’approach.
Therewillalsohavetobechangesinregulation,sincetheoldruleshavebeendemonstrated
tobeclearlyinadequate.Thisdoesnotnecessarilymeanmoreregulation–theUSalready
hasthemostheavilyregulatedfinancialsector,butthisdidnotstopfinancialcrises
developingthere.Whatisneededisbetterregulation.
Thefinancialsystemshouldbeunderpinnedbyfiveprinciples:responsibility,accountability,
relevantinformation,independenceofinformationandoversight.Thefinancialcrisiscame
aboutbecauseofalackofresponsibilityandaccountability,afailuretoproduceindependent
informationandaninadequatedegreeofvigilanceamongmarketparticipants.Thesefive
principlesshouldnowbeusedasthefoundationonwhichacoherentsetofregulationsare
built7.Forexample,regulatorsshouldunderstandthepotentialeffectsacrossthewhole
financialsystemofdevelopmentsintheirspecificarea,informationgapsshouldbeclosedin
derivativemarketsandcreditratingagenciesshouldbepaidbyinvestorsratherthanissuers.
Itoughttobecomparativelyeasytoagreetheappropriatesetofprinciplesatagloballevel,
www.ippr.org/tomorrowscapitalism

forexampleamongtheG20.Individualcountriescouldthenbeallowedtoimplementthem,
takingaccountoflocalcircumstances,withaglobalbodysetuptoensurecompliance.
IntheUK,oneareawherethefinancialsystemhasclearlyfailedismortgagelending–and
notjustinrecentyears.Therehavebeenseveralhousingmarketboomsandbustsoverthe
last40years.However,whatmakesthelatestonedifferentisthatitledtothecollapseor
takeoverofanumberofdemutualisedlenders,andthefirstrunonaUKbankforover140
years.Thiswastheresultofrecklessborrowingandlendingbehaviourasseniorexecutives

7.ThisargumentissetoutbyDavidPitt-WatsonandcolleaguesinTowardsanAccountableCapitalism,
presentedataTomorrow’sCapitalismseminaron26March2009(Davisetal 2009).
 17 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

foughtformarketshare–andforhigherbonuses8.Fundswereraisedontheshort-term
wholesalemarketsandthenoffered–atverygenerousloan-to-valueandloan-to-income
ratios–toprospectivehomebuyers.Inthemostextremecase,NorthernRockcreatedthe
‘Together’mortgage,whichcombinedastandard95percentsecuredmortgagewithan
unsecuredpersonalloanof30percent(upto£30,000),effectivelyallowingsomepeopleto
borrowupto125percentofthevalueofthepropertytheywerepurchasing.Meanwhile,
therewasalsoaboominbuy-to-letmortgages.TotalmortgagelendingintheUKmorethan
tripledfrom£115billionin1999to£364billionin2007.
ThelasttwoyearshavebeendisastrousfortheUK’smortgagelenders.NorthernRockfirst
gotintodifficultiesinSeptember2007andwasnationalisedinFebruary2008.Bradfordand
BingleyandAllianceandLeicesterarenowownedbySpain’sBancoSantander.The
Derbyshire,CheshireandDunfermlineBuildingSocietieshaveallbeentakenover.Their
strategyofborrowingshort-terminthewholesalemoneymarketsandlendinglong-termin
thehousingmarkethasbeenshowntobefundamentallyflawedbythecreditcrunch.Ithas
alsobeendisastrousforthehousingmarketandfortheUKeconomy.
Forthisreason–andgiventheUK’shistoryofhousingboomsandbusts–allowing
mortgagelenderstocontinuetooperatetheirownstrategiesisnolongeranoption.
Mandatorylendingguidelinesformortgagelendersareneededinanefforttominimisethe
riskofhistoryrepeatingitself.TheseguidelinesshouldbebasedonDavidPitt-Watson’sfive
principlestounderlieallregulation:responsibility,accountability,relevantinformation,
independenceofinformationandoversight.Theyshouldinclude:limitsonloan-to-valueand
loan-to-incomeratios,restrictionsonbuy-to-letandself-certifiedmortgagesandchangesto
remunerationpracticesatmortgagelenderstoensurebonuspaymentsreflectperformance
overseveralyears.
Thereisanoverwhelmingcasefortomorrow’scapitalismtoincorporategreaterregulationof
thefinancialsystem.Banksandotherfinancialinstitutions,ledbyseniorexecutivesseeking
tomaximisetheirshort-termbonuses,tookhugegambles–andlost.Theresulthasbeena
severecreditcrunchleadingtoadeepglobalrecession,millionsofpeoplelosingtheirjobs
andmassivetaxpayerbail-outsofthebanks.Thiscannotbeallowedtohappenagain.There
willhavetobechangesinmacroeconomicpolicy–centralbanksshouldtargetassetprices
aswellasconsumerprices.Buttherewillalsohavetobechangestothefinancialsystem.
Anumberofwritershaveproposedacounter-cyclicalapproachtobanks’capital
requirements,forcingthemtoholdmorecapitalwhenlendingishighandassetpricesmight
beovervaluedwhileallowingthemtoholdlesscapitalwhentheoppositeisthecase.There
isalsopopularsupportforcontrolsonremunerationandincentivestoencouragebankersto
takealongerperspective.Theremayalsobeastrongcaseforseparatingretailand
investmentbanking.Retailbankswoulddotheboringbusinessoftakingindepositsand
www.ippr.org/tomorrowscapitalism

makingloanstohouseholdsandcompaniesandwouldbecoveredby‘lenderoflastresort’
protection.Investmentbankswouldbeallowedtoindulgeinmoreexoticfinancialpractices,
butwithnogovernmentprotection.
Itwill,however,bedifficulttomakefundamentalchangestoregulationinonecountry
alone.Internationalcooperationisrequiredtopreventsomegovernmentsundercutting

8.ThisanalysisandtherecommendationsforchangearetakenfromProfessorChrisHamnett’spaperfor
theTomorrow’sCapitalismprogramme:TheMadnessofMortgageLenders:Housingfinanceandthe
financialcrisis(Hamnett2009).
 18 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

othersinthehopeofattractingfinancialactivitytotheircountry.ThisiswhytheG20
should,asapriority,establishtheprinciplesonwhichglobalregulationistobebasedand
setupaninternationalbodytoensureindividualcountries’regimescomplywiththese
principles.

Tomorrow’scapitalism:assetpricebubbles
Fewwoulddisagreewiththepropositionthattomorrow’scapitalismwillbebetterifasset
pricebubblescanbeavoided.Suchbubbles,whentheyburst,havebeencentraltomostof
themajoreconomiccrisesofthelastthreedecades.
AlanGreenspan,ChairmanoftheUSFederalReservefrom1987to2006,usedtoarguethat
centralbanksarepoorlyplacedtojudgewhenassetsareovervaluedandabubbleis
developing.Hesaidthattheyshouldwaitandseeifabubbleburstandthentakeactionto
dealwiththeconsequences.Thus,hedidnotactwhenthe‘dot.combubble’wasinflatingin
thelate1990sbutcutinterestratesaggressivelywhenitburstin2000.
TheGreenspandoctrinehasbeendiscreditedbyrecentevents.Ifaburstingbubblecan
causedevastationonthescaleseenoverthelasttwoyears,thenitisclearlybetterfor
centralbankstopreventitinflatinginthefirstplace.Ifthismeanstheymightoccasionally
actunnecessarily–counteringariseinassetpricesthatwasjustifiedratherthana‘bubble’–
thatwouldseemasmallpricetopayfortheavoidanceofanothercrisisandrecessionlike
thecurrentone.
Itwouldbeevenbetter,ofcourse,ifmarketbehaviourcouldbechangedsothatbubblesdid
notdevelopinthefirstplace.Tounderstandhowlikely,orratherhowunlikely,thatis,itis
necessarytounderstandthepsychologyoffinancialmarketsandinparticularhowthe
co-evolutionofhumannatureandthefinancialmarketshavecreatedanenvironmentin
whichassetbubblescandevelop9.
Assetpricebubblesrequireaninitialideaorparadigmshift–whatpsychoanalystscalla
‘phantasticobject’–tocreateasenseofexcitementinfinancialmarkets.Thisideaisalways
new,abitcomplicatedandperhapsnottotallyunderstoodanditappearstoofferthe
potentialformassiverewards.Excitementattheprospectofsharingintheserewards
becomesseparatedfromanxietyabouttheriskofaloss.A‘divided’mentalstateresults,in
whichgreeddominatesfear.Acrossthemarketasawhole,asassetpricesrisestoriesdevelop
tosupportthenewparadigmandthemediaandinvestorsgetcaughtupintheexcitement.
‘Groupthink’develops,creatingpressurewithinthesystemtoparticipateinthebubble.
Peoplewhoexpressdoubtsarewidelymockedandrisk-taking,inaggregate,becomes
excessive.Emotionstakeover.
Ifhumannaturemakesassetpricebubblespossible,thestructureofthefund
managementindustryfacilitatestheirdevelopment.Fundsareadvertisedasdelivering
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exceptionalperformance–bothprovokingthebeliefthatwellabove-averagereturnscan
beearnedandputtingpressureonfundmanagerstooutperformtheirpeersbyawide
margin.Tomeettheseexpectations,fundmanagershavetoseekoutexceptional
opportunitiesbecause‘ordinary’performanceisnotgoodenough.Thismakesthem
predisposedtogettingcaughtupintheexcitementofnewideasandthinkingabout
rewardandriskinadividedstate.Thetendencyoftheindustrytofocusonperformance
overashortperiodoftime–monthsratherthanyears–makesthingsevenworse.

9.MuchofthissectionisbasedonProfessorDavidTuckett’spaperAddressingthePsychologyof
FinancialMarkets,presentedataTomorrow’sCapitalismseminaron14May2009(Tuckett2009).
 19 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Eventually,thoughitisdifficulttopredicthowandwhythiswillhappen,peoplerealise
assetpricevaluationscannolongerbejustified,evenbythemostoptimisticassessments
ofsupportersofthenewparadigm,sopricesstarttofall.Theflimsinessofsomeofthe
storiesthathavebeensupportingpricesbecomesapparent.Withinthefinancialsystem,
thereisanemotionalswitchtorevulsion.Thebubbleburstsandassetpricescollapse.
Thedot.combubbleisaclassicexampleofhowthispsychologicalcycledevelops.
Internetretailingwasanewideathatwasclearlytransformingtheeconomyandtheway
wealllive.Earlymoversintheindustrywereincreasingmarketsharerapidlyand
companyanalystsprojectedextraordinaryfuturegains.Thepotentialrewardsfrom
investingindot.comcompaniesseemedenormous,whiletherisksappearedtobe
minimal.Howcouldtraditionalcompanieshopetocopewiththenewcompetition?Share
pricesofthenewcompaniessoared,butthemajorityoffundmanagerscontinuedtobuy
them.Thosewhodidnotunderperformedsignificantlyand,inmanycases,losttheirjobs
asaresult.
Investorsandthemediaboughtthehypeeventhoughthestoriesneededtosupporttherise
insharepricesbecamemoreextreme.Fundmanagers’mentalitywassodivided,withgreed
completelydominatingfear,thatfewwereabletodetachthemselvesfromthehypeuntil,in
March2000,themarketfinallypeakedbecausevaluationsweresoextremethattheycould
nolongerbeignored.Pricesbegantofall.Thestoriesthathadunderpinnedtheirrisewere
exposedasflimsy–andinsomecasesfraudulent.Revulsiontookoverandshareprices
crashed.

Figure7.The
dot.combubble
(Nasdaqindex) 6000

5000
Source:Yahoo!
Finance, 4000
http://finance.yah
3000
oo.com/q/hp?s=
%5EIXIC 2000

1000

0
94 95 96 97 98 99 00 01 02
Year
www.ippr.org/tomorrowscapitalism

Yetonlyeightyearslateranotherbubblehadbeeninflated–thistimeinCDOsandrelated
debtinstruments–andittoowasbursting,illustratingperfectlyhowbadthefinancial
systemisatlearningfromitspastmistakes.Afteracrash,thesystemlooksforsomeoneto
blame,ratherthantakingtheopportunitytolearn.Thedot.combubblewasblamedonAlan
Greenspanforkeepinginterestratestoolowaroundtheturnofthemillennium,oncrooked
financedirectorsandonroguecompanyanalysts.TheCDObubblewasblamedonAlan
Greenspanforkeepinginterestratestoolow(again),onpeopletakingoutmortgagesthey
couldnotaffordandonChinaforsendingitsexcesssavingtotheUS.Learningrequiresan
‘integrated’stateofmindinwhichuncomfortablethoughts–likefeelingguiltand
 20 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

responsibility–canbeacceptedandabalancedsenseofrealityobtained.Thefinancial
systemisnotgoodatacceptingblameandresponsibility,preferringinsteadtomoveonto
thenextopportunity.Itdoesnot,therefore,learn.
Sincehumannatureisnotgoingtochange,tomorrow’scapitalismshouldinvolvemajor
changestothefundmanagementindustry–andtoinvestors’expectations.Awidespread
acceptancethatitisnotpossibleforeveryonetobeatthemarketandthatchasingthenext
‘bigthing’islikely,ultimately,toresultindisappointmentwouldreducethepossibilityof
assetpricebubblesdeveloping.Thiswillrequireamajorcollectivere-examinationoftheway
savingsaremanaged.
Intheabsenceofsuchachange,regulatorsshouldbegivenextraresponsibilities.First,they
needtounderstandthepsychologicalprocessesthatcreatebubbles.Second,theyneedto
putinplacemechanismstodetectwhenabubblemaybeindangerofforming–by
identifying‘phantasticobjects’andbeingpreparedtotakeaviewonthevalueoffinancial
assets.Thiswillrequireagooddealofdetachmentfromthefinancialsystemitself,otherwise
theyriskbeingcaughtupinanyexcitement.Third,theyneedthepowerstoprickabubble
initsearlystages–whetherbyusinginterestrates,irrespectiveofwhatishappeningto
consumerpriceinflation,orthroughsomeothermechanism.
Itwillnotbeeasytopreventbubblesdevelopinginfuture.Itishumannaturetogetcaught
upintheexcitementofnewideas.Butcentralbanksandregulatorsshoulddomorein
tomorrow’scapitalismtoslowtheirdevelopmentandlimittheirpotentialtocausethesortof
damagethattheburstingoftheCDObubbleisnowinflictingontheglobaleconomy.One
ofAlanGreenspan’spredecessorsasChairmanoftheUSFederalReserve,William
McChesneyMartinJunior,whoheldthepostfrom1951to1970,describedthejobofa
centralbankasbeing:‘totakeawaythepunchbowljustasthepartygetsgoing’.Itisa
dictumthatshouldguidecentralbanksandregulatorswhendealingwithpotentialasset
pricebubblesinthefuture.

Tomorrow’scapitalism:whatdoestheUKwantfromcapitalism?
CapitalismhasbeenextremelysuccessfulinWesterneconomiesoverthelastcentury.Living
standardshavesoared,infantmortalityrateshaveplungedandlifeexpectancyhasincreased.
Itisnowhavingthesameeffectacrosslargepartsoftherestoftheworld.Giventhese
successes,fewarepreparedtosuggestcapitalismshouldbeabandonedinfavourofa
completelydifferentsystemofeconomicmanagement.However,therearemanyvarietiesof
capitalism–thosefoundintheUS,JapanandScandinavia,forexample,areverydifferent
fromeachother–andtheyallseemtowork.Capitalismneednotmeanaslavishacceptance
ofunfetteredfreemarkets.Societiescanchoosewhichvarietytheypreferandpolicymakers
shouldtrytoreflectthatchoiceintheiractions10.
www.ippr.org/tomorrowscapitalism

Historically,theemphasisintheUK,asinthevastmajorityofcountries,hasbeenon
maximisingoutputgrowthandmateriallivingstandards,andthisremainsaprimaryaimof
policytoday.However,someeconomistsarguethatbetterindicatorsofacountry’sprogress
arenowavailable.Theyproposemeasuringimprovementsinwelfareeitherthroughtheuse
ofan‘objectivelist’orbymonitoringsubjectivewell-being(thatis,happiness).Inshort,the
objectivelistapproachisbasedonthebeliefthattherearecertainitemsthatareobviously

10.PaulOrmerodmadethispointattheTomorrow’sCapitalismdebate‘Whatdowewantfrom
capitalism?’,23April2009,recordingsavailableat
www.ippr.org/tomorrowscapitalism/events.asp?id=3440&tID=3336
 21 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

‘good’–food,education,health,security–andthatifacountryhasmoreofthem,things
mustbegettingbetter,whilethesubjectivewell-beingapproacharguesthatthebestwayof
measuringprogressisbyaskingpeoplehowhappytheyare.
Advocatesofthislastapproachcitesurveysshowingpeopleindevelopedeconomiesarenot
gettinghappier,despiteeconomicgrowthandincreasedmateriallivingstandards,andcallfor
thefocusofpolicytobeswitchedfromoutputmeasures,suchasGDP,tohappinessitself.
Theyrejectthematerialismofrecentyears,whichtheyseeashavingbeencharacterisedbya
‘getrichquick’mentalityandhyper-consumerism,andproposeamuchbroaderassessment
oftheaimsofsociety,basedonfactorssuchashealthandhumanrelationships11.Someeven
arguethatdevelopedcountriesshouldadopta‘steadystate’policy–effectivelytargetingno
furthereconomicgrowth.Ifhigherincomesdonotmakepeoplehappier,theysuggest,then
thiswouldnotresultinalossofwelfare,relativelytoaworldinwhicheconomiescontinued
togrow.Atthesametime,itwouldhelpaddressconcernsoverclimatechangeand
environmentaldegradation.
However,traditionaleconomistsarequicktopointoutthatwithouteconomicgrowthin
developedeconomieswecannotimprovepublicservices;poorerworkershavelesschanceof
earningmore;andgrowthindevelopingeconomies,whichcanbethedifferencebetweenlife
anddeath,islikelytobelower.Morefundamentally,theyargueinnovationandproductivity
growthareinherenttocapitalism,makingithardtoimaginehowasteadystateworldwould
workinpractice.Forexample,ifstableoutputiscombinedwithimprovingproductivitythere
willbereduceddemandforinputs,includinglabour.Unlessthisistoresultinever-increasing
unemployment,everyonewouldhavetoagreetoworkless.Butitisnotclearthatthisis
whatsocietywants,orhowthiscouldbeachievedgivenourcurrentinstitutional
frameworks.Onpracticalgrounds,therefore,thereseemslittleprospectthattomorrow’s
capitalismwillabandoneconomicgrowthasaprimaryaimofpolicy.
Thereisageneralacceptance,however,thatthisrecessionwascaused,inpart,byexcess
consumerism–andthebuild-upofdebtthataccompaniedit.Thisshouldbeanopportunity,
therefore,tomakethecaseforalessconsumer-orientedsociety.Economistsusuallyphrase
thisdebateintermsofamoveawayfromconsumptionandtowardsmoreexportsand
investmentspending.Butthereisalsoacaseforthinkingaboutwhetherwewantless
consumptionandmoreleisureorlessconsumptionandmore,andbetter,publicservices.It
maybedesirable,forexample,fortheUKtomoveawayfromtheAmericanmodelof
capitalismandalittleclosertotheScandinavianmodel.Therehaslongbeenatensioninthis
countrybetweenadesiretohaveAmericanlevelsoftaxation(low)andScandinavianlevels
ofpublicservices(highqualityandexpensive)butpoliticianshaveshiedawayfromforcing
peopletofaceuptotheinconsistency.Thecurrentcrisiscreatesanopportunitytohavethat
debate.
www.ippr.org/tomorrowscapitalism

Scandinaviancountriesarenotableforbeingmoreequal,andinparticularforhavinglower
povertylevels,thantheUK.Thishasnotbeenatthecostoflowerlivingstandards,butit
doesseemtohavebroughtbenefitsintheformofgreatersocialmobilityandhigher
recordedlevelsofhappiness.RichardWilkinsonandKatePicketthaverecentlyshownthat
societiesthataremoreequal,suchastheScandinaviancountriesandJapan,haveamuch
lowerincidenceofmentalillnessacrossthewholepopulation(notjustamongthepoor)than
themostunequalsocieties,suchastheUKandtheUS(WilkinsonandPickett2009).

11.ProfessorRichardLayard,MadeleineBuntingandKateGreenallarguedalongthesegenerallinesat
theTomorrow’sCapitalismdebate,‘Whatdowewantfromcapitalism?’,23April2009,recordings
availableatwww.ippr.org/tomorrowscapitalism/events.asp?id=3440&tID=3336
 22 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Theeraofneo-liberalcapitalismbroughtincreasesinincomeinequalitiesintheUK,together
withdiminishedsocialmobility.ResearchsuchasthatofWilkinsonandPickettstrongly
suggestsitwouldseemtobebeneficialforsocietyasawholeiftomorrow’scapitalismcould
produceamoreevendistributionofincomeandwealth.

Tomorrow’scapitalism:challengesforprogressivepolicymakers
Tomorrow’scapitalismwillbringmanychallengesforpolicymakersbutthebiggestoneis
likelytobehowtoadapttoaneraofpublicsectorausterity.Thecrisisincapitalismmight
appeartobeagreatopportunityforprogressivepoliticiansbecauseitoffersaonce-in-a-
lifetimechancetoredesignthecapitalistmodel.Atthesametime,itisathreatbecause
progressiveshave,inthepast,usedsomeofthebenefitsofunfetteredgrowthtofinance
theirpolicyaims.Intomorrow’scapitalism,thegrowthofoutputandgovernmentrevenuesis
likelytobeslowerandpublicspendingwillbeconstrainedbytheneedtoreduce
governmentdeficitsbuiltupduringtherecession.
Unlesspoliticiansarepreparedtomakethecasefortaxestobepermanentlyhigherasa
shareofnationalincome,theywillhavetoachievetheiraimswithoutincreasingreal
spendinginmostareas–andwhilecuttingspendinginsome.Thisisgoingtorequirea
concentrationofresourceswheretheycandothemostgood.Thus,iftaxingtherichmoreis
notanoption,thentheymayhavetopaymoreforsomeservices,orreceivelessinstate
support,sothatfundscanbedirectedatthemostvulnerableanddisadvantagedinsociety.
Moregenerally,therewillbeatendencyfortheGovernment,whenithastomakecutsin
publicspending,toexpresstheviewthattheprivatesectorissomehowintrinsicallygood,while
thepublicsectorisnot.Thiswillmakeithardtomakethecaseforthepositivethingsthatthe
publicsectorcando,suchasdeliverbetterschools,betterhospitalsandabetterenvironment.
Anditwillmakeitveryhardtoarguethatfuturegrowthwouldbebetterusedtoalleviate
socialproblemsthantomaketheveryrichevenricher.Thefactthatopinionpollsshowthe
majorityofthepublicsupporttheGovernment’sdecisioninthe2009Budgettointroducea50
percentrateofincometax,despitewidespreadoppositioninthepress,suggeststheargument
maynotbecompletelylost12.However,thiscouldjustprovetobeashort-termreactiontothe
crisisandtheperceivedroleofhighly-paidbankersinbringingitabout.
AspecificissuethatmightactasalitmustestfortheintentionsoftheGovernmentischild
poverty.ThepresentgovernmentpledgedinMarch1999toeliminatechildpovertyinthe
UKby2020.By2005,significantprogresshadbeenmade:thenumberofchildrenlivingin
povertyhadfallenfrom3.4millionin1998/99to2.7million.However,progresshasslowed
sincethenanditnowseemsunlikelythattheGovernmentwillhititsinterimtargetof
halvingchildpovertyby2010.RecentresearchbyDonaldHirschattheJosephRowntree
Foundationsuggeststhattherewillstillbe2.3millionchildrenlivinginpovertyin2010/11
andthatonpresentpoliciesthiswillincreaseto3.1millionin2020/21(Hirsch2009).
www.ippr.org/tomorrowscapitalism

Whetherfuturegovernmentsarepreparedtoacttogettheeradicationofchildpovertyback
ontrackwillsaymuchabouttheirprogressiveintentions.
Hirscharguesthatchildpovertycannotbeeradicatedbygovernmentspendingandtax
creditsaloneandthat,astheeconomyrecovers,gettingparentsintojobswillbeparticularly
important.Moregenerally,anothermajorchallengeforpolicymakerswillbetobringabouta
significant–andpermanent–reductioninthenumberofpeopleclaimingout-of-work
benefits13.Althoughunemploymentfellto30-yearlowstowardstheendofthelong

12.AdamLentmadethispointattheTomorrow’sCapitalismdebate,‘CapitalismandtheChallengefor
ProgressivePolitics’,16July2009
13.NickMathiassonandFraserNelsonmadethispointattheTomorrow’sCapitalismdebate,‘Capitalism
andtheChallengeforProgressivePolitics’,16July2009.
 23 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Table1:Keyout-of-workbenefits:levels(thousands)
Date Jobseeker’s Incapacitybenefits LoneParentson
Allowance (ESA/IB) IncomeSupport Other Total*
May1997 1620 2616 1014 256 5506
Nov1997 1432 2651 983 247 5312
Nov1998 1325 2644 939 229 5137
Nov1999 1036 2675 930 218 5007
Nov2000 1184 2723 906 197 4861
Nov2001 1036 2746 879 179 4763
Nov2002 960 2777 856 161 4731
Nov2003 913 2781 832 154 4680
Nov2004 830 2772 797 158 4556
Nov2005 901 2711 779 156 4546
Nov2006 949 2673 776 161 4559
Nov2007 818 2642 742 167 4369
Nov2008 1092 2603 729 173 4326
Latest** 1560 2610 720 179 5069
Source:DepartmentforWorkandPensions2009
*ThenumbersonJobseeker’sAllowancearefortheUK,whiletheothercolumnsareforBritainexcluding
NorthernIreland,sothisissomethingofahybrid.**June2009forJSA,MayforIB/ESAandLoneParents,
November2008for‘other’

economicexpansionfrom1993to2007,thetotalnumberclaimingout-of-workbenefitdid
notfallbelow4.25million.
Iftomorrow’scapitalismistobemoreinclusive,itcannotinvolveoverfourmillionpeoplein
theUKeffectivelybeingsegregatedfromtherestoftheeconomy.
Policymakerswillalsohavetodecidehowfartoimpingeontheactionsofcompanies,
particularlycompaniesinthefinancialsector.Thisisnotjustamatterofregulatingtheir
activitiestoensurethatlabourlawsarecompliedwith,orthatbanksarelesslikelyto
collapseinfuture.Itisaboutthecultureofbusiness.Thecurrentcrisiswasbroughton,in
largepart,bythe‘getrichquick’mentalityoftheCity,whichputshort-termprofitabilityand
personalgainaheadofallotherconsiderations.However,backedbytheargumentsof
Americanbusinessschools,thismentalityhasspreadmorewidelyinthebusinesssector,
leadingtoanexcessivefocusonshareholdersandtheremunerationofseniorexecutivesand
toolittleconsiderationofcompanies’employeesandtheirobligationstothewider
community.Itmaybethatthe‘stakeholder’approachtobusinessgovernance,whichplaces
moreemphasisonthesewiderobligations,isanideawhosetimehascome.
www.ippr.org/tomorrowscapitalism

Somecommentatorshavearguedthatcompanieswilldevelopagreaterdegreeofcorporate
socialresponsibilitybecausetodosowillincreaseprofits.However,ifthatwerethecase–or
morepertinentlyifbusinessleadersbelievedittobethecase–theywouldhaveacted
already.Morelikely,ifgovernmentwantsmoreresponsiblecompanies,itisgoingtohaveto
imposeconstraintsonthem.Atthesimplestlevelthiscouldjustmeanlegislationtolimit
non-executiveremuneration.Moreambitiously,itcould,forexample,involvemeasuresto
ensurethatcompanyboardscontainrepresentativesfromtheworkforceandsocietyin
general.
 24 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Conclusions
Theaimsoftheippr/FriendsProvidentFoundationTomorrow’sCapitalismprogrammewere
toidentifysomeofthemajorflawsintheneo-liberalversionofcapitalismwhichhas
dominatedintheUnitedStatesandtheUnitedKingdomsincetheearly1980s;tospecify
somedesirablefeaturesofthecapitalistmodelofthefuture;andtosuggesthow
policymakersmightbegintopursuethem.
Identifyingtheflawswasnotdifficult.Amongthemostimportant,‘yesterday’scapitalism’:
•FailedtosuccessfullyintegrateChinaintotheglobalcapitalisteconomy
•Allowedglobaleconomicimbalancestobuilduptoanunsustainableanddangerous
extent
•Failedtocontrolcreditgrowthinkeyeconomiesandatagloballevel.
•AllowedeconomicgrowthintheUKtobecomeveryconcentratedinafewsectorsof
theeconomy
•Generatedasuccessionofassetpricebubbles,mostrecentlyintheUSandother
housingmarkets
•Helpedcreateatradingmentalityinfinancialmarkets
•Didnotincorporateadequateregulationofthefinancialsystem
•Toleratedmaterialism,consumerismandgrowinginequalities
•DidnotstopoverfourmillionpeopleintheUKremainingonout-of-workbenefits.
Ultimately,theseflawscombinedtoproducetheworstfinancialcollapseandthedeepest
globalrecessionsincethe1930s.
Inthemidstoftherecession,itiseasytobegloomyaboutthefutureanditcouldtakea
numberofyearsbeforethebalancesheetsofbanks,householdsandbusinessesarerepaired,
allowingeconomiestogrowstronglyagain.However,previousfinancialcriseshavebeen
followedbyperiodsofstrongeconomicgrowthandthesamemightbetrueofthiscrisis.If
thebenefitsoftechnologicalchangeareallowedtospreadthroughouteconomies,thenext
20years,asopposedtothenexttwoorthree,couldbeprosperous.
However,historysuggeststhiswillrequirechangestothecurrentmodelofcapitalism.Here
ishowcapitalismcanbemadebetter:
•Greaterinternationalcoordinationisneededtoensuredevelopmentsintheglobal
economy,suchasaggregatecreditgrowthandeconomicimbalances,aresustainable,
totackleclimatechange,toestablishregulatoryprinciplesforthefinancialsystem
www.ippr.org/tomorrowscapitalism

andtoensureachievementoftheUnitedNations’MillenniumDevelopmentGoals.
•Majorcountries(andgroupsofcountries)mustbepreparedtotakeaccountofglobal
aswellasnationalinterestswhendrawinguppoliciessuchasexchangeratepolicies.
•Internationalorganisations,suchastheIMF,mustbereformedtogiveamuchgreater
roletolargeemergingeconomies,particularlyChinaandIndia.
•EconomicgrowthintheUKhastobebasedlessonconsumptionandever-growing
levelsofhouseholddebtandmoreonexportsandinvestment.
•TheUKgovernmentmustbeactiveinaddressingmarketfailuresininnovation,
training,infrastructureandfinance,forexamplebycreatinganational‘Ideasbank’
and‘InfrastructureBank’.
 25 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

•Thefinancialsystemshouldoperateforthebenefitofthewholeeconomy,notjustin
itsownnarrowinterests.
•Thereshouldbeaninternationally-agreedsetofregulatoryprinciplesforthefinancial
system,basedonclearlinesofresponsibilityandaccountability,thecollectionofall
relevantinformation,ensuringthatinformationisindependentandproperoversight
ofthewholesystem.Aninternationalbodyshouldbesetupwiththeauthorityto
ensureindividualcountriescomplywiththeseprinciples.
•IntheUK,theseprinciplesshouldleadtosignificantchangesinthemortgagemarket,
includinglimitsonloan-to-valueandloan-to-incomeratios.
•Theremitofcentralbanksandregulatorsneedstobewidenedtoencompassasset
pricesandcentralbanksshouldacttoburstassetpricebubblesbeforetheybecome
dangerouslylarge.
•Thefundmanagementindustryshouldbemorelong-terminitsoutlookbecauseits
focusonshort-termperformancehelpsinflateassetpricebubbles.
•Centralbanks,orotherregulators,shouldhavegreatercontroloverthelending
activitiesoffinancialinstitutions,inaggregateandindividually.
•Policymakersshouldfocusmoreonalternativemeasuresofprogress,suchasthose
basedonsubjectivewellbeing,anddowngraderealGDPgrowthastheultimatetarget
ofeconomicpolicy.
•IntheUK,policymakersshouldimplementpoliciesthatwillmovetheeconomy
towardsamoreScandinavianversionofcapitalism.Thiswouldproduceamoreequal
societyand,theevidencesuggests,ahappiersocietytoo.
Thesefeatureswillnotbeeasytodevelop.Progressivepolicymakersfaceanumberof
challenges:
•Thelongertherecessionlasts,thegreatertheriskofincreasedeconomicnationalism
andtheharderitwillbetoachieveinternationalcooperation.
•Eveniftherecessionendssoon,theestablishedpowers–theUSandEurope–will
findithardtoacceptalesserroleinglobaleconomicaffairssoastomakeroomfor
thelikesofChinaandIndia.
•ItwillnotbeeasytobreaktheUKpublic’sloveaffairwiththehousingmarketand
consumerism.
•PreviousUKgovernmentshavefailedinattemptstoaddressmarketfailures.
•ChangingthecultureoftheCityofLondonwillbeextremelydifficultbecausethe
www.ippr.org/tomorrowscapitalism

‘getrichquick’mentalityhasbecomesodeeplyingrained.
•Theconditionsneededforabubbletostarttoinflatewillinevitablyreappearand
regulatorswillhavetobetoughenoughtoactrapidlytoburstthem,eventhoughit
willmakethemunpopular.
•Theneedtobringgovernmentdeficitsdownoverthemediumtermwillbea
constraintonwhatgovernmentcando.
•Developingandimplementinganeweconomicandpoliticalphilosophyisan
inherentlydifficultandlong-termproject.
 26 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

Thesuccessoftomorrow’scapitalismindeliveringbetteroutcomesforallwithdepend,in
largepart,onhowsuccessfulpolicymakersareinmeetingthesechallenges.Manyinvolve
greatercooperation:betweengovernmentsinternationallytoagreesustainableeconomic
policiesandregulatoryprinciples;betweengovernmentandtheprivatesectortotackle
marketfailures;betweenthefinancialsectorandtherestoftheeconomytoensurethat
credit-worthycompaniesandhouseholdscanaccesstothefundstheyneed;andbetweenall
partsoftheeconomytosecuremoreequitableoutcomesandimprovedwell-beingforall,
notjusttheluckyfew.
In2004FriendsProvidentFoundationpublishedacollectionofessays–TheRightUseof
Money (Darton2004)– puttingforwardwaysinwhichmoneymightbeusedinamore
positiveway.Someauthorsproposedfundamentalchangestotheeconomicandfinancial
system;somecalledforclearermoralandethicalprinciplestodriveeconomicdecisions;and
somequestionedthewaymoneywasbeingspent.Intheboomyears,from2004to2007,
thesemessageswerelargelyunheeded.However,thefinancialcollapseandeconomic
recessionhavemademorepeoplequestionthevaluesthatunderpintheeconomicsystem
andbecomeopentochange.ThemessagesofTheRightUseofMoney remainaspertinent
astheywerein2004andtheTomorrow’sCapitalismprogrammehasservedtore-emphasise
someofthem,suchasPollyToynbee’scallforreducedinequality,whichwasechoedby
speakersatourdebate‘Whatdowewantfromcapitalism?’.
Neo-liberalcapitalismcametobecharacterisedbyincreasingself-centredness.TheRightUse
ofMoney highlightedanalternativevisionoftheeconomicandfinancialsystem.Itistobe
hopedthattherecentfinancialcollapseandeconomiccrisiswillleadtoanewversionof
capitalismmoreinlinewiththisvision,oneinwhichthereismorecollaborationandbetter
outcomesforall.
www.ippr.org/tomorrowscapitalism
 27 Tomorrow’sCapitalism|HowToMakeCapitalismBetter

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