The Past as Future? The Contribution of Financial Globalization to the Current Crisis of Neo-Liberalism as a Development Strategy

Bretton Woods was grounded in the Keynesian view that financial markets are innately too unstable to be given free rein. This view, which also shaped the financial policies of developing countries during the 1st post-war quarter-century, was gradually displaced during the 2nd post- war quarter-century by Neo-liberalism, with financial market liberalization and heavy reliance on freely mobile international capital as its leading components. However, their adoption by the industrialized countries has been associated with exchange rate misalignments, excessive debt leveraging, asset price bubbles, slower and more unstable output and employment growth, and increased income concentration; and additionally in the developing countries by more frequent financial crises, exacerbated by over-indebtedness that forces many of them to adopt pro-cyclical macroeconomic policies that deepen their output and employment losses. This paper contends that the association reflects causality, rooted fundamentally in the innate propensity of financial dynamics to go off track along the lines of Minsky’s Financial Instability Hypothesis, an elaboration of Keynes’s view. An open economy extension of this hypothesis explains the frequency of banking/currency crises in the 2nd quarter-century in the developing countries far better than the convoluted “blame the victim” post-mortems that until recently have been the staple of the IMF. Its recent publications show the IMF analysts moving part way toward the Keynesian view of financial instability, but with a major disconnect between the empirical findings and their implications for theory and policy. As yet there is neither overt abandonment of the efficient market theorizing that had underpinned the IMF’s earlier enthusiasm for financial liberalization, nor candid reconsideration of its opposition to capital controls and other dirigiste policies implied by the Keynesian view. Probably this is because IMF policies are not “owned” by its bureaucracy or membership at large, but by the major financial center countries. Still, the worried discussions among these center countries that global financial discord could lead to deeper financial crises, debt deflation, intensified beggar-my-neighbor trade and currency competition, and the formation of antagonistic regional blocs have a 1930s aura. Optimistically, this could lead again, as at Bretton Woods, to coordinated stabilization policies, among at least the Big Three financial powers, that would also ease the way for developing countries to return to dirigiste development strategies. More likely, a reprise of the 1930s will be needed to create the political climate for accepting all this. Given the odds, developing countries should carve out their own policy space, with capital controls as prerequisite for widening that space.