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An agenda for social democracy

April 6th, 2009

That’s the title of a paper I’ve written for the Whitlam Institute, available (PDF) here Here’s the Whitlam Institute Press release. I won’t give a summary, urging you instead to Read The Whole Thing, but if you want a summary anyway, this piece by Mike Steketee in the Oz is pretty good.

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  1. Chris Warren
    April 6th, 2009 at 15:04 | #1

    I hope that in the near future, a harder critique of the problems of capitalism itself will emerge.

    This paper targets unrestrained, risk-shifting capitalism.

    Does this imply that a restrained capitalism, or a regulated capitalism, is desirable?

    Rudd also excoriates “extreme” capitalism, by which he seems to imply that there is a nice capitalism that is to be had.

    However the general trends from which we are all suffering now (deep, indelible, macroeconomic imbalance)are long-lived, and cannot be addressed by social democratic agendas of reform, stimulus, and summits.

    The real problem is “capitalism”, big, small, extreme, nice, regulated or whatever.

  2. fred
    April 6th, 2009 at 16:50 | #2

    Nice article JQ and a nice summary by Mike.

    More please.

  3. Michael of Summer Hill
    April 6th, 2009 at 18:56 | #3

    John, if my recollection is correct there were commentators in 2007 who argued that the so-called ‘tax cuts’ after 2008 may not be afforded. Today common sense tells you that the forthcoming tax cuts in July should be scrapped and replaced with a one-off payment for lower income earners.

  4. Bingo Bango Boingo
    April 6th, 2009 at 20:47 | #4

    “Does this imply that a restrained capitalism, or a regulated capitalism, is desirable?”

    Yes, this is the essence of social democracy: a detente with capitalistic behaviour. Prof. Quiggin is clearly a believer in the broader capitalist project, and of its primary modern-day incarnation, globalism. For example, the paper calls for a re-working of the international finance architecture, in part so that it facilitates freer international trade. Difficult to argue against that one, I would have thought.


  5. SJ
    April 6th, 2009 at 21:34 | #5

    Good paper, John.

    The morons currently in charge of NSW, though, would deny almost everything you’ve said in it, so implementation of the agenda might find a bit of resistance. :)

  6. April 6th, 2009 at 21:50 | #6

    As in Japan during the 1990s, the situation is most appropriately analysed as a Keynesian liquidity trap, where reductions in interest rates have no effect. In such a situation, monetary policy must be replaced by expansionary fiscal policy.

    I agree that interest rate targeting is confined by an inability to cut nominal rates below zero even as real rates can be too high. However this is a rather artificial liquidity trap. Japan ultimately dumped interest rate targeting and went to qantitative easing which escaped the trap and worked. If they had been targeting a Bancor type commodity basket or targeting Gold (ie some sort of gold standard) instead of interest rates then:-

    i) the process to increase liquidity (devalue the currency) would have been most straight forward and unconfined by traps.

    ii) they would not have got into the mess in the first place.

    Japans primary problem during the 1990s was deflation. As such the solution was relatively straight forward reflation even if the confines of interest rate targeting meant that the authorities took way too long to figure it out. This problem certainly did not call for a fiscal solution.

    Transactions in the global foreign exchange market, once confined to financing trade flows, peaked at around $4 trillion per day in mid-2008. At that pace, two days of foreign exchange trading would be sufficient to finance an entire year’s trade flows.

    This is not a product of economic liberalism. It is a product of floating exchange rates. Something that is quite unnatural and not at all consistent with free markets (even if proponents of floats like to say otherwise). Let us not forget that these are fiat currencies not market created currencies. If the worlds nations had continued to anchor their fiat currencies to gold (ie actively managed the value of their fiat currencies rather than using them to actively manipulating the price of credit for domestic political gain) or even if they had switched to a Bancor style alternative value targeting mechanism then we would not have had these huge daily speculative flows. The Chinese and the Russians are both making noises in this direction and hopefully sanity can be made to prevail.

    From the breakdown of the Bretton Woods system of fixed exchange rates5 to the present, domestic financial regulation has operated subject to the constraints imposed by unregulated global financial markets. This balance must be reversed. Global financial markets must be controlled and regulated so that they do not threaten the integrity of domestic regulation.

    What we need is for governments to either:-

    a) denationalise currency


    b) manage their imposed fiat currencies appropriately by giving them fixed reliable values.

    The Global Financial Crisis does indeed call for a radical reform process and some updated thinking. However the solution is not keynesian inspired neo-socialism. It is to embrace what Keynes was essentially on about with the Bancor and end the wrecking balls produced by the global currency casinos. Fiat currencies should not float.

  7. SJ
    April 6th, 2009 at 22:11 | #7

    The Bancor was proposed as a means of moving away from the gold standard. See Eichengreen and Bordo, 1993, A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform

  8. April 6th, 2009 at 22:30 | #8

    I would say it was proposed as an improvement on a gold standard. The argument being that a basket of commodities is somehow more reflective of stable value then a basket of one commodity (ie gold). That may in fact be the case however such a shift would have involved a reduction in transparency relative to the gold standard which was a major point of merit. And it would have introduce a new haggling point over the composition of the commodity basket which would no doubt be a regular political football. None the less the Bancor retained all the essential features of a gold standard in terms of fixing the value of currencies and being an international reference point.


  9. Chris Warren
    April 6th, 2009 at 22:32 | #9


    The problems of capitalism within a domestic economy are the same as in the international context.

    Free trade is capitalist trade.

    Regulating it, taxing it, subsidising it, is not the answer, in the long-run.

    In any case, how can you have free trade in some factors if not in others?

    What is this free trade?

    “Fair is foul”.

  10. SJ
    April 6th, 2009 at 22:36 | #10

    Terje, I’m not about to accept the Wikipedia entry as authoritative, because you’re its author, and you have no relevant qualifications.

    The gold standard is dead. Forget about it ferchrissake.

  11. Bingo Bango Boingo
    April 6th, 2009 at 22:46 | #11

    “The Bancor was proposed as a means of moving away from the gold standard.”

    Way to miss the point by a million miles, SJ.


  12. SJ
    April 6th, 2009 at 23:08 | #12

    Sorry, tldr, BBB.

  13. silkworm
    April 7th, 2009 at 00:50 | #13

    Taxation is the mechanism by which the private good is made to serve the public good. The higher the tax rate, especially on the highest salary earners, the greater the public good is served.

  14. observa
    April 7th, 2009 at 01:24 | #14

    From JQ’s highlights-

    “In the light of the financial crisis, only social democratic policies can provide individuals and families with security to manage the risk and uncertainty of a market economy”

    To which Austrians would ask how are all those social democratic central bankers and their management of risk and uncertainty over the years doing? (not to mention the deep skepticism of one Harry Markopolos no doubt) If only JQ could have his ideal social democratic policies without those pesky policymakers intruding eh?

    “Banking must be clearly separated from speculative financial activity.”
    As if punting on the ability of a prospective homeowner to pay you back over the next 25-30 years wasn’t ever speculative financial activity is beyond me. Of course with social democratic policies like Freddie, Fannie, soothing and smoothing by central bankers, etc over the years, all my naive concerns were totally unwarranted

    “Speculative financial enterprises must bear the full risk associated with their activities, without any public guarantee or support.”
    No argument from me but tell that to all those social democrats and bailout Keynesians in charge now.

    “Social democrats must learn from the mistakes of that era[post war social democratic] and retain what was valuable in economic liberalism, including a commitment to sound fiscal policy..”
    “sound fiscal policy”-Please explain? Those deficit billions and trillions of deficits do tend to boggle the mind. True we can expand taxation to fund everything from wasteful hybrids, FHOGs, solar subsidies,rainwater tanks, garden mulch right down to worm farms, but somehow I’m skeptical that social democratic tide will lift all boats. However, given the recent surge in stock markets, perhaps resort to the printing press will have the desired effect. Austrians predict massive stagflation of course, but we’ll have to wait and see on that.

    Overall I’d have to say I’m skeptical of JQ’s new found enthusiasm for the social democratic tide surging over us. I’d agree that this is no temporary phenomena with a quick return to normality and business as usual, but I’d differ on the analysis of why that’s so. Demographics is the obvious with those BBers in their prime in the early 80s and the beginning of that alphabet soup of finacial intermediation. FI that started out as a necessary anf good thing to allow a generation to leverage and borrow for homes, cars and businesses and assume the reins of power from old capital. The internet startups and the new technologies and smarter ways of doing things but at some stage it would turn into the greatest Madoff Scheme the world has ever seen, compliments of Western central bankers asleep at the wheel, or leaving the wheel completely in those capable Asian hands. Yes Reagan/Thatcherites all, that couldn’t get enough of those free markets in their prime, but suddenly they’re all JQ’s precious, social democratic Keynesians now.

    While demographics was an important factor in the Great Moderation, there was something else that contributed to its to unprecedented length and breadth. The rise of the ‘graduate class’ in parallel to it, so much so that it became indistinguishable from the crude demographics and would ultimately fool the Greenspans everywhere. That very graduate class would upend the domination of the moneyed classes and their sole preserve of tax planning, capital gains, and negative gearing, etc not to mention their exclusive access to higher return wholesale money markets and the like. As central bankers slept, the world around them was changing with a graduate class beginning to gorge itself on the new alphabet soup, a process that began in Australia way back with the floating of the dollar and Hill Samuel’s pioneering cash management trust, that would breach an hitherto impregnable bastion of the moneyed classes. The graduate classes would pour in through that breach by the billions and now trillions, to access all the same benefits until the day the music stopped with Lehmans signalling they were mostly all subprime, or funny moneyed. They’re all Keynesians now by gum, watching the demise of their super funds, share portfolios and negatively geared properties, with the soup kitchen staring them in the face, particularly if they work in the alphabet soup industry.

    JQ sees a great social democratic awakening, but I think he’s somewhat blind to the new reality. That reality may hit him when the new political champions of the graduate classes run out of bailouts, handouts and subsidies to pander to all their past aspirations. This skeptical Austrian fan will wait and see if JQ can get all these lift dwellers to climb his taxation stairs to social democratic nirvana. They’re a sorry lot to be sure but I’ve yet to see them practically reconciled. We’ll see.

  15. conrad
    April 7th, 2009 at 06:57 | #15

    Silkworm: “The higher the tax rate, especially on the highest salary earners, the greater the public good is served”
    and from the paper: “The absence of a well-developed welfare state, an inevitable result of a low-tax policy, has produced massive social unrest and the collapse of a number of governments, from Iceland to Latvia.”
    All this stuff about tax rates is a bit strange — suddenly all countries with serious current problems are “low tax countries”. This includes my favorite example Iceland, which looking at wiki entry was in fact a _high_ tax country (41.6% of GDP in 2007).

  16. TerjeP (say tay-a)
    April 7th, 2009 at 08:48 | #16

    SJ – I created the Wikipedia entry for the Bancor over 3 years ago. A lot of other people have reviewed it since then. It does have some references for the key claims of the article. However I did not present it as authorative merely as informative.


  17. Ikonoclast
    April 7th, 2009 at 10:19 | #17

    That is an excellent article, Professor Quiggin! It shows the way forward in all the broader policy areas. You don’t need my praise but you have it anyway. :)

    I have a few minor quibbles which might help you tighten the argument in one or two places.

    1. You say “Fiscal policy (taxing and spending) is the central business of government.” I think if you reviewed that thought you would recast it. Fiscal policy is a means to an end and not the end itself. The central business of a social democratic government is surely the social democratic program. Fiscal policy is one of the means to that end.

    I think most economic liberals and social democrats of good intent would agree that their goal is the greatest good of the greatest number. That is their “end”. They simply differ over which program will deliver it best.

    2. Casting the social democratic program as being a “risk management” response to markets is effective and appealing. It does away with those divisive and (perhaps) archaic appeals to class struggle ideas. Social democracy, very correctly, is able to don a market-utilitarian garb under this argument.

    However, I think the argument needs to be bolstered with a further and more direct appeal to the practical ideal of democracy. By ‘practical ideal’ I mean highlighting the fact that democracy gives the otherwise (relatively) powerless individual the ability to counteract corporate power. Abuse of corporate power has been a central feature of the build up to the GFC.

    The argument could then be furthered in a manner which returns to the risk management issue.

    If we see (well-regulated) markets as mechanisms for making good collective intelligence decisions (as opposed to excessive central planning), then we can also see democracy as collective intelligence decision making capacity with a broader base than corporate decision making processes. Thus the proper exercise of democracy must restrain and reduce the risks which can be generated by corporate decision making with its limited sectional interest focus.

    That is rushed but I hope it’s clear enough.

  18. Alice
    April 7th, 2009 at 11:06 | #18

    JQ – a breath of fresh air!

    I knew I liked being here – not for the trolls and the crazy extreme ideas.. but for the treasures. This article is one…congratulations, well done.

  19. jquiggin
    April 7th, 2009 at 12:19 | #19

    #15 A fair catch, Conrad. This para definitely needs fixing

    Thanks to everyone who’s commented for generally positive reactions and useful suggestions.

  20. Monkey’s Uncle
    April 7th, 2009 at 13:35 | #20

    One of the biggest problems with social democracy is that it largely relies on the success of the private enterprise economy to continue to produce the economic surpluses that can then be redistributed through the tax system to finance the expanded role of the public sector.

    In that sense, social democracy is a more contradictory or ambivalent philosophy than either outright socialisation of the bulk of the means of production, or small-government, free market approaches.

    It is hard to see where the revenues are going to come from to support an expanded public sector at this stage. Significant tax increases will probably kill off what is left of the productive economy.

  21. Ikonoclast
    April 7th, 2009 at 14:56 | #21

    Social democracy, allied with a mixed economy approach is not a contradictory or ambivalent philosophy at all. It is less ideological and more practical than either doctrinaire socialism or doctrinaire free market philosophy.

    Surely the goal of all good political economy (politics and economics are always entwined) is to deliver the greatest good to the greatest number? It is clear now that pure socialism fails the test (too little incentive) and unfettered capitalism also fails the test (boom and bust, unproductive speculations and uncontrolled negative externalities).

    Sadly, there is this modern ideological need to see things only in terms of simplistic extremes (pure socialism or pure free markets) rather than to take the trouble to develop appropriate social and economic policies on a case by case basis across the spectrum.

  22. Alice
    April 7th, 2009 at 17:29 | #22

    Ikonoclast – I agree. Social democracy gives you the opportunity to do just that. To take a middle pathway (what is the middle?? balanced is a better word – balanced or the middle – its a big range – a bell curve less the ends – and can change depending on economic activity or needs or circumstances of different sectors or inequities or failures in some sectors or down to practical matters like where we need need transport or where we dont etc… with no particular bias imposed on who should do the job (or which group is best to do it – if one party fails to deliver – then all bets are off and its back to the drawing board). Social democracy is a view which can be applied on a case by case basis.

    It neither confers authority or superiority for the particular task required and nor does it remove it.

    Its a method to examine eg the problem of high unemployment and correct it by the most practical and the fastest means possible. It doesnt exclude the private sector as a creator of wealth or employment and nor does it exclude the state as a creator of wealth or employment.

  23. Fred Argy
    April 8th, 2009 at 08:49 | #23

    This is a very interesting piece, John. I have four queries.

    First, on page 13, you restate three firm principles of economic liberalism. The first and last I agree with. But what is the second about? How do you propose to reconcile low unemployment with low inflation?

    Secondly, there is no mention of IR. Why?

    Thirdly, on page 5 you complain about “the grotesque inequalities of opportunities and outcomes”. I know what is needed to curb bad opportunities (and how closely related they are to outcomes) but what sort of criterion have you got in mind to influence outcomes? Is there a particular inequality measure you have to pay attention to?

    Fourthly, how exactly are you dealing with the so-called “reduced incentive” effects of a welfare state on page 3? I do not see further mention of it.

  24. Chris Warren
    April 8th, 2009 at 09:39 | #24

    MOnkey’s Uncle

    As I recall, a low Tobin tax can assist here.

    Although this does not provide a long-run solution.

    When the stockmarket takes its next big dive into the abyss (maybe this week????), our policy makers will finally have to realise that domestic production is more valuable than international production.

    Cuts to foreign purchases of military toys – with a switch to domestic production will also resuscitate the domestic economy which can then support taxes.

  25. jquiggin
    April 8th, 2009 at 14:07 | #25

    First, on page 13, you restate three firm principles of economic liberalism. The first and last I agree with. But what is the second about? How do you propose to reconcile low unemployment with low inflation?

    As stated, I don’t think there is a long-run trade-off between the two. For at least two decades after 1945, low unemployment coexisted with low inflation, and I think the subsequent inflationary surge can be explained in terms of mistaken judgements by governments, trade unions and business

    Secondly, there is no mention of IR. Why?

    I left out quite a few things I would have liked to cover. In the case of IR, I haven’t got a clear view of what the future will/should look like

    Thirdly, on page 5 you complain about “the grotesque inequalities of opportunities and outcomes”. I know what is needed to curb bad opportunities (and how closely related they are to outcomes) but what sort of criterion have you got in mind to influence outcomes? Is there a particular inequality measure you have to pay attention to?

    I tend to prefer looking at particular points in the income distribution (top 1 per cent, median, bottom quintile) rather than single numbers like the Gini. But it depends on the purpose at hand

  26. SeanG
    April 9th, 2009 at 05:14 | #26


    Below is the first part of my response to the article:

    We must start by asking your definition of “risk” and “uncertainty”. If we take the definition provided by Frank Knight that risk is “quantifiable” while uncertainty is “unquantifiable” I believe that this will help provide a more detailed analysis/critique of your work.

    You start by discussing the Government’s role in reducing individual risk by the state sharing the risk. The other side of this equation is the “reward” that must come. Traditionally the argument has been the greater the risk the greater the reward. However you make a broad and sweeping generalisation:
    “The set of policies traditionally associated with social democracy may be regarded as responses to a range of risks facing individuals, from health risks to uncertain life chances”
    Are these risks from birth or uncertainty from living one’s life? Having medicare does not guarantee that the risks from birth are gone but rather the uncertainty that walking across the street will result in getting hit by a bus.
    Further, risks to health are taken up by insurance companies. One pays a premium for the insurance company to respond by paying the hospital cost in the event that one is hit by a bus. Using actuarial models and vast reams of statistics they put together a risk profile and the premium is commensurate to that.
    Not everyone can pay and this is where the government comes in. It is not the failure of the free market but rather the uncertainty that someone cannot pay or that someone’s employer cannot pay. It is the risk of life that no one can completely mitigate. The Government can plug the gaps but it is the height of arrogance to assume that policies can suddenly mitigate every risk and uncertainty especially since uncertainty is by definition unquantifiable and humanity is not equal.

    You stated that:
    “Risk and inequality are closely linked. On the one hand, the greater the risks faced by individuals in the course of their life, including the risk associated with differences in initial opportunities, the more unequal society is likely to be.”
    You assume that risk only equates with the negative – that it explodes a person is left to pick up the pieces rather than acknowledge that it can take someone from the gutter to the heights. This is the reward aspect of risk taking that without risks comes no reward. Without taking the risk of placing a small amount of capital in a business no revenue or income will come from that to expand to enjoy a higher lifestyle.
    Further, while there is statistical evidence linking where one is born to the outcomes in life it is wrong to assume that opportunities alone account for everything. Differences in ability, luck, uncertainty, natural curiosity and natural risk-taking, natural aversion, social aversion, cultural characteristics all come into play. Assuming that everyone is equal does not work and is impractical.

    Professor Quiggin, you stated somewhat incorrectly that:
    “radical inequality in outcomes, such as that associated with massive rewards to financial traders, encourages a search for opportunities to capture the benefits of risky actions while shifting the costs of such actions onto others, or onto society as a whole.”
    It is right that if you take the risk then the person must be prepared to accept the punishment but it is incorrect to be so presumptive that what can be applied to a few (bailed out banks/traders) can therefore be applied to the entire business sector as a whole. The search for increase in risk is a quantifiable game – in trading it can come from client request for 10% return instead of 9% or that a small business believes that it can service a niche market. It leads to inequality because that is the nature of life – one who risks gets the return but it is the great social democratic Fannie Mae and Freddie Mac where socialised losses and privatised returns helped lead to the underwriting of 40% of the subprime market in the United States. If you are advocating that those who want the risks should accept the punishment then fine. But if you want the benefits of risk to be socialised then there is no incentive to take risk.

    “If individuals are to have security of employment, income and wealth, governments must establish the necessary legal and economic framework and enforce its rules.”
    Whose rules? Societies? The Governments? The Constitution? How about private property? Do you realise that society changes so the acceptable rules 10 years ago is no longer the same today as it would be different 10 years hence? When you put together rules are you suggesting that security of employment should be a “right” which therefore creates an “obligation” on the provider of employment! Who takes the risk when that does not play out? Are you prepared to say that due to Government policies securing employment that when a business is punished by a bad employee the government will compensate the business?
    This is the problem with taking the risk/uncertainty principle and applying to society or the government (social democrats see no difference): you want to mitigate the risk forgetting that someone always carries the risk and where there is no return then the risk will never have initially been borne.

    You make the typical mistake of assuming that Government and society is interchangeable and that society and communities and the government are indeed homogenous:
    “The interpretation of social democracy as a collective social response to risk and uncertainty may be illustrated by considering some of the core functions of the welfare state, such as health care and education.”
    What is “collective”? 51% of the population who votes for one party or the ten people who sit in a room devising a policy or the three academics writing a dissertation? So often people such as yourself call for collective action as if the needs of one person are exactly the same needs of another. As if one community and another believe the exact same things. Humanity is not homogenous. That is why collective action tends to be underwhelming.

  27. jquiggin
    April 9th, 2009 at 06:23 | #27

    Sean, these all seem to be arguments from first principles, which are unlikely to be resolved. Typically, arguments of this kind, without consideration of the empirical evidence, lead to extreme and unsustainable political conclusions (Marxism and laissez-faire economics being obvious examples).

    If you want a debate, you’ll have to make the case against my claim that, based on the experience of developed countries, including the current crisis, we would be better off if government took a more active role.

  28. SeanG
    April 9th, 2009 at 06:28 | #28

    I think I will debate that – I am still writing out a critique but after another few pages am still on risk-reward in society. If I keep this up my entire day will be devoted to writing a rebuttal that it longer than the article itself and wholly critical rather than being constructive.

  29. jquiggin
    April 9th, 2009 at 07:58 | #29

    Write at whatever length you think you need. I’ll be happy to put it up as a PDF link.

  30. Chris Warren
    April 9th, 2009 at 08:57 | #30


    Are you being a troll here:

    “Typically, arguments of this kind, without consideration of the empirical evidence, lead to extreme and unsustainable political conclusions (Marxism and laissez-faire economics being obvious examples).”

    Marxists could label you and many other ALPers with extreme labels as well. Although this is a bad habit.

    I doubt whether you know sufficient Marxist theory to make such a statement.

    Usually this kind of comments arise from a misunderstanding of Marxism (sometimes deliberately so).

    I think it best if you delete the word “extreme” from your vocabulary.

  31. Ken N
    April 10th, 2009 at 10:20 | #31

    As others have said, an interesting piece of speculation. JQ is probably fairly correct about the political reaction to the GFC: more regulation, bigger government, higher taxes.
    Following that, I expect slow growth -caused by regulation and increased government participation in the economy – productivity improvements are very small in government provided services. Also higher inflation as a result of the hangover from the current loose monetary and fiscal policies. Governments almost never get the timing right and the political resistance to pulling back on spending and increasing interest rates will be very great.
    So, probably we will have something resembling the stagnant 70s when we had a period of mediocre to very poor government.
    Then, along will come something resembling the Hawke-Keating government to realize how the policies are holding back the country’s potential and we will enter once again a period of high growth and low inflation.

  32. Paul Williams
    April 10th, 2009 at 12:12 | #32

    I’m not convinced that the GFC was caused entirely by “economic liberalism”.

    Surely the sheer number of sub-prime US mortgages owes something to the likes of the Community Reinvestment Act. This was used to coerce banks into lending to people who would not qualify under a normal credit assessment.

    The worthy aim was to enable poorer people, mainly blacks, to enter the housing market. That sounds like a “social democracy” option rather than “unrestrained capitalism”.

    Fanny and Freddy were left holding these toxic assets because their losses were backed by taxpayer guarantees. Once again, hardly unrestrained market forces.

    The fact that unethical rentseekers in the financial industry made huge money repackaging and onselling these loans is not the cause of the crisis but a symptom of it.

  33. Russell
    April 10th, 2009 at 22:50 | #33


    At the very end of your essay you say that “the growth in trade in goods and services has been overwhelmingly beneficial … a new international settlement must encourage trade …”

    Can you please comment on the fact that trade/transport is a major contributor to the greenhouse gas problem. How do you deal with the contradiction of promoting trade while having no solution to this very serious problem?

    And also, isn’t there a contradiction in criticising the free market ideology while advocating more free trade? Isn’t free trade supposed to be based on free markets? If, say, the US can massively subsidise its agricultural exports thereby destroying its competition, that’s not much of a basis for ‘free trade’. If you want free trade shouldn’t you be in favor of free domestic markets (no doubt impossible, but economists love abstractions) ??

  34. Alice
    April 11th, 2009 at 22:41 | #34

    Paul Williams
    Fannie and Freddie is being made the scapegoat by the conservatively inclined (and the liberally inclined)and this is quite untrue. Neither Fannie nor Freddie sold the subprimes that caused the collapse. In fact they held mostly prime mortgages. They were forced to pick up some of the fallout from other lenders post 2007. In addition these were private institutions but the only thing that saved them from being up to their necks in subprimes (or CDs)or toxic assets like AIG and other exposed private financial institutions (private sector excess) is because they were run to a congressional charter (that is, as strange as this may sound to you.. Fannie and Freddie had higher standards written into their charter).

    The biggest mistake ever made was in privatising theem under the Johnson admin. Thats where the trouble started for Fannie and Freddie but they were not the cause of the subprime meltdown. That can in all likelihood be blamed on the irresponsible removal of important regulations like the Glass- Steagall Act under the non watchful eye of the Bush administration.

    Prior to that they were a very successful government models (and business model) for some decades. Anyway this conversation has all been played out before in other links.

    What you suggest about Fannie and Freddie is quite untrue.

  35. Donald Oats
    April 12th, 2009 at 08:04 | #35

    Commission-based lending sure doesn’t help either. A third-party seller gets paid on number of loans and/or volume – hardly difficult to see the ticking bomb there, in a low inflation environment. And why didn’t these sellers get rapped across the knuckles for limbo-dancing style loan assessment criteria? Because once made, the loan becomes backing for the mortgage-backed security market; well, at least after some statistical multiplexing with a better class of bank loan, to bring down the variance. No doubt some kind of mortgage insurance got written (by AIG? :-) ) as well?

    Placing all of the blame upon FM is to ignore the chain and each of its links.

  36. Paul Williams
    April 12th, 2009 at 10:19 | #36

    #35 #36

    Quite clearly I’m not placing the blame on Fanny and Freddie for the original mortgages.

    As I understand it, the loans were made by local banks under threat of penalty under the CRA. They were forced to write the loans to people who would not normally qualify. The aim was to help poor people get into home ownership.

    That sounds more like social democracy than economic liberalism to me.

    Once the loans proved beyond the capacity of the mortgagees to repay, then wouldn’t economic liberalism allow that property to be repossessed?

    And wouldn’t social democracy deem it to be a greater good that those people stayed in their homes and the mortgage be picked up by taxpayers?

    Which of those two options has been predominantly followed?

    The shonky financial dealings that apparently allowed bankers to make buckets of money and offload the bad loans onto others maybe wouldn’t have happened if normal rules of creditworthiness had been followed originally?

  37. Alice
    April 12th, 2009 at 17:24 | #37

    The subprime loans were made to people who had no job no income (ninja loans) and liar loans (you tell us what you earn…and we wont do any credit checks).
    That is no social democracy initiative. That is fraud. It was knowingly making bad loans because you could bundle them as collateralised debt instruments and on flog them to someone else across the US and the world. No bank was forced to do that under threat from the CRA – that is nonsense. The financial institutions that pushed the sale of these loans were tied to the large financial institutions (or were the large financial institutions)and used commission agents in many cases. It was pure fraud (because house prices were rising and while ever they rose …and the more bad loans they granted the more house prices rose and rose and rose…but not of it was sustainable and when they fell they took sound borrowers down with them because their house prices fell too and they then defaulted).

    It was grossly negligent supervision and removal of regulation and a hands off approach of the US financial sector by US regulators. The US was not so long ago critical of the bad loans that China had on its banks accounts. Yet China and other Asian banks didnt pile into risky housing loan based toxic investments and quietly built up foreign reserves and their financial system is more tightly regulated throughout. Now the debt on US banks accounts is monstrous.

    It was too much liberalism. In fact it was fraud and it was laissez faire which is perhaps the same thing.

  38. Paul Williams
    April 12th, 2009 at 21:43 | #38

    Professor Quiggin, in his paper, proposes a long term response to the global financial crisis which shifts the risks from individuals and families and places the hand of government firmly on the economic tiller.

    It appears to me that the laws requiring Fannie and Freddie to devote a large proportion of their activity to meeting affordable housing goals is not consistent with the proposition that the risk has been falling on individuals.

    Those laws seem more consistent with the government hand being on the tiller already.

    No doubt Professor Quiggin will be able to point out where I have misinterpreted the situation :) , But I cannot see that unchecked economic liberalism is the only cause of the GFC.

  39. True Believer
    April 13th, 2009 at 12:16 | #39


    Personally I doubt whether the CRA had much to do with the sub prime mess. The CRA has been around since the late 1970s and sub prime loans only exploded during the last few years. They were made, securitised, rated and transferred around the world by private institutions who simply got it wrong when assessing their real worth.

  40. Paul Williams
    April 13th, 2009 at 13:21 | #40


    There were changes made to the CRA, especially in 1995, such as making approval of new branches conditional upon a satisfactory CRA rating, and using input from lobby groups for part of the banks rating.

    These changes were followed by the said explosion in subprime loans.

    While I’m not disputing the need for sensible banking regulations, I don’t see that the GFC has been caused entirely by economic liberalism.

    Without the social democratic underpinning of pressure to write dodgy loans, plus taxpayer assumption of the risk via Fanny and Freddy, would the subprime situation have grown to such significance?

  41. Ubiquity
    April 13th, 2009 at 13:54 | #41

    Fannie, the Federal National Mortgage Association, and Freddie, the Federal Home Loan Mortgage Corp., don’t lend money, to minorities or anyone else, however. They purchase loans from the private lenders who actually underwrite the loans.

    It’s the process called securitization, and by passing on the loans, banks have more capital on hand so they can lend even more.

    The private banks that provided much of the subprime lending would not have taken on riskier subprime loans without the implicit support of Fannie and Freddie securitisation services effectively removing the risky supprime loans off the books of the private banks.

    This is clearly a moral hazrd instigated by Fannie and Freddies GSE image status and its capacity to securitise as a result of government regulation.

    This is not economic liberalism. This is a moral hazard brought about by government regulations. The government was clealry trying to be popular not a economic liberal. The government clearly aided and abetted in this fraud. In fact It was the instigator of the fraud. Why so ? without the capacity of Freddie and Fannie to securitise these second rate mortgages it would have been the private banks who would have to have worn the risk and I expect they wouldn’t have done so.

  42. boconnor
    April 15th, 2009 at 12:20 | #42

    John, really excellent paper. Thanks for posting it. Just a few points:

    Page 5, para 13: “In the long term, markets cannot manage the risk associated with the fact that some people will have chronically worse health than others.” Health insurance markets unencumbered with restrictions on risk rating (eg community rating requirements) can price health coverage for those chronically ill, and manage the risk through differential pricing. The result is that only the rich can afford to pay the premium. This leads to the injustice of the chronically ill being left without coverage, clearly a failure of social policy for those who believe in market solutions to health insurance. But the failure is not in the ability of markets to price the insurance and manage risk. It’s the failure of such solutions to provide universal coverage for all who are ill. That goal can best be achieved through government health insurance schemes.

    Page 6, para 13. “From the 1980s onwards, businesses routinely dismissed employers in large numbers, not as a last resort, but as a preferred method of making already substantial profits even larger.” If we accept that the role of private companies is to maximise profit then this behaviour seems both rational and reasonable (within a marketplace of competitive firms). Alternatively we could expect businesses to be sub-optimal profit maximisers in order to deliver higher social ideals but that would confuse the roles between the public and private sectors. And if such cost cutting delivered lower prices for goods and services (again assuming a competitive market) then that is overall a good result for consumers.

    Page 7, para 3: “Fiscal policy (taxing and spending) is the central business of government.” The use of the word “the” implies that fiscal policy is the most important business of government at present. I would argue that it is one of the areas of focus but should not be seen as the only area for government attention. There are still many areas of social policy that require thoughtful and detailed responses from government. Access to due legal process for the poor, protection of children from abuse, public housing, reduction in inequalities between indigenous and non-indigenous Australians are just some areas where taxing or spending by itself is not going to deliver the changes needed. The challenge for social democracy is to solve (or at least make improvements) in these areas with creative and innovative policies, and with as much vigour as the tackling of the GFC. I know that your focus in the paper was on the policy responses to the financial crisis, but I fear that other social policy issues will be downplayed as being less important while governments grapple with sorting out the problems in the financial markets.

    Page 9, para 11: “It seems likely that additional public debt of 20 to 30 per cent of national income will be incurred”. Would appreciate a link or reference to how this was calculated.

    Page 12, para 2: “Most Australians say they would prefer improved services to tax cuts, but governments of both parties have offered tax cuts anyway.” One of the early lessons learned by those that study marketing is that just because a focus group of consumers say they will buy your product does not mean they will actually do so when they walk down the supermarket aisle. It would be a brave political party that goes to an election promising increased taxes to pay for increased services, when their competitor promises reduced taxes. It not clear that the political consumer (the elector) will buy that deal. We could argue that the tax cut stuff with the major political parties is just knee-jerk “me tooism”. Or it could be the rational behaviour of parties that understand what electors are really willing to say yes to.

    Page 12, para 3: “Expanding provision of these services [human services sector] will make a major contribution to the restoration of full employment.” Provided such expansion is focused on addressing social policy outcomes, and not just an end in itself to get the employment numbers up. Public expenditure should be efficient. The problems of the past that you allude to in page 13, para 5 would include expansion of public sector programs and employment without any clear social objective or sense of measurable result that government was seeking to achieve. This provided some ammunition to the economic liberals to pull back government expenditure and shrink the size of government. They should not be given such a leg up in the future.

  43. Alice
    April 15th, 2009 at 14:19 | #43

    Paul and Ubiquity

    It is a completely false premise to apportion the blame for the GFC on Freddie and Fannie and the CRA. The GFC was very much more related to a lack of or a laxity in administration of sound regulation that any existing regulation. The only regulation changes that contributed actively to the GFC was the removal of the Glass Steagall Act and the refusal to monitor particular hybrid debt instruments (undertaken under the Bush administration). If you are suggesting that the removal of regulation (risky financial deregulation) was a regulatory oversight then in that sense you may have a point.

  44. Donald Oats
    April 15th, 2009 at 15:30 | #44

    What is the equivalent of Freddie and Fannie in the UK? In Spain? Both of these countries screwed up royally with their own housing failures, and I am not aware of any FM/FM?

  45. Boris
    April 18th, 2009 at 08:55 | #45

    This is just silly. Government caused the problem by allowing and encouraging fractional reserve, and via fiat money, and now John says government is the solution.

    John. Try learning some economics. It helps to understand the material.

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