Governments and markets: Time to get serious

How can we all learn from a crisis? Today, we find ourselves in a disappointing, if not altogether unexpected, predicament. The very governments who took bold and decisive action in the period of the financial crisis 2008-09 to bail out banks and keep financial markets alive now find themselves on the receiving end of severe punishment from financial markets. How could this be?

To make matters more frustrating, the rating agencies which came under sharp fire during the crisis for their blinkered support of what proved to be worthless financial products that destroyed the savings of millions of people, are now forcing governments back against a wall. From demanding spending cuts and tax cuts on profits, to forcing hasty privatisations, the effects have been to put at risk the ability of governments to do the job they were elected for.

The OECD argued two years ago that we should not return to business as usual, and while financial markets were in intensive care, the critical role governments play as partners in our economic systems was reaffirmed. Now several governments are simply too weak with debt to play that role with any confidence. What if the employment crisis continues, how will countries cope then?

How did this sorry situation come about? Has the revival of governments been that shortlived? Why have the financial markets turned so bitterly on their saviours?

Let’s remember: it was barely two years ago, in the wake of the sub-prime disaster, that everyone, from experts to politicians, and right across public opinion, was quick to call for better regulation, better alignment of incentives and more effective enforcement and oversight of public policies.

The debt crisis was partly a logical consequence of people spending, or being invited to spend, more than they earned, but it was not that simple. Massive overborrowing on one side of the equation was fed by very lax over-lending on the other. No assets, no income, no job–you could still borrow to “buy” your house. Government regulators in all countries must shoulder their part of the responsibility in this. And so, indeed, must governments, not just in terms of oversight, but because they also borrowed in overleveraged financial markets, exposing their taxpayers to massive indebtedness should the house of cards one day come tumbling down.

And tumble it did. But while the initial hangover has been painful for everyone, it has lasted longest for governments and taxpayers. More or less everywhere, governments have been doing what markets understandably expect and taking drastic measures to deal with the debt crisis: reducing the number of public servants, cutting their salaries, “reviewing” spending programmes, closing tax niches, postponing public investments in areas such as roads and education, and yes, increasing taxes. And as if that were not enough, governments are now obliged to borrow at unsustainable rates on the financial markets.

Alas, ordinary people do not seem to appreciate the very decisive response governments took in the crisis. Their trust in government has actually fallen to lower levels than before. Do they believe governments conceded too much to the whims of private investors and imposed too much of the costs on their own voters? After all, the discussion two years ago about a new start, new paradigms and carrying out the reforms needed to prevent moral hazard, there is every sign that some lessons have not been learned.

The good news is, it is not too late to put matters right. In fact, we have no choice but to step back and at least examine the course we have taken, and maybe change it altogether if we are to restore lasting confidence in government and financial markets, and avert future crises.

But first, this means answering some searching questions:

Were the Keynesian-style rescue packages used by governments the wrong response at the time? The answer to this depends on each country, but in general, should we have focused less on bailouts and stimulus, and more on banking reform, and even calling the bluff of “too big to fail” by ensuring investors took a bigger hit?

Have governments simply failed to explain their actions comprehensively to the population, making it clear that there would be no free lunch? Or were they too nervous to question the consensus that restoring full health to our financial markets came first?

Have policymakers missed a golden opportunity to reset the balance between markets and governments, as many of them wanted to do at the height of the crisis? Or could it be that policymakers are simply bad managers, not just in handling a crisis, but also now when so-called fiscal consolidation–no, let’s call it austerity–has been allowed to take priority over other public policy goals?

There are no easy answers to these questions, nor answers that would apply to every crisis-affected country in the same way. Nevertheless, we must face some facts.

First, fiscal consolidation is hurting purchasing power, particularly among those who depend on social funding. Civil servants are being culled too. The upshot is weaker consumer demand, enfeebled public sectors and weaker growth. Will the private sector be willing and able to come to a rescue, and soak up the unemployed?

Second, many political leaders who were at the helm in combating the financial crisis are paying the price for their “courageous” action by losing elections, being ejected from government or being forced to rule in unstable minorities. That’s how democracy works, but this kind of political instability could prove costly, and should really be factored into consolidation and debt repayment strategies.

Third, the diktat of fiscal retrenchment has put severe strains on public policies. Governments have been reduced to debtors who have to do whatever private creditors–and some central banks–believe is necessary to pay back their debt and regain the benediction of the financial markets. How then can government regain the trust of ordinary people and businesses? There is a risk here of a downward spiral which must be broken.

Fourth, the speed and scope of consolidation has sparked a very rich debate about the role of governments, be it in the way public services could be provided by the “third” sector of associations and committed citizens, in public-private partnerships (which are not easy to get right for either side) or even in the withdrawal of governments from education, health or pension systems. Innovation in the public sector has become a “must”, the only “must”.

To be sure, a crisis is a terrible opportunity to waste and a good time to reform, but haste can also be the enemy of good reforms. Policymakers faced with tough reform choices really must take the time to ask themselves how streamlining the state in the heat of the crisis can be organised over the medium term.

Fifth, financial markets showed how limited they were in 2008-09, then quickly regained their dominant role in society. But have they adapted their post-crisis mindset to become the instruments we need to help us build a stronger, fairer and cleaner world? It may be too early to say, but judging by recent profit growth and consequent bonus payouts (even in loss-making rescued banks), and the re-emergence of opaque financial products, the disconnect between the financial establishment our societies rely on and the daily needs of the wider world seems greater than ever.

In short, policymakers have to be given room to step back and assess the situation. The OECD has to help them provide the evidence they need for evaluating the crisis strategies they have adopted, to see how government can stay in the driving seat, at least as co-pilots. If they do not, and succumb to undeserved short-term pressure from creditors, then the risks are large. For instance, important efforts to address climate change, green growth, biodiversity, social inclusion, poverty and countless other essential public policy objectives that were front-burner policy issues before the crisis will lose steam.

No doubt investors will argue that they are innovating, funding research and new products, and spreading development. And many of them are. But this is not about semantics; it is about facts. In particular, the business community, even financial investors, cannot afford governments to be crowded out of the marketplace.

So what can be done to defend the public interest? Who else can take up the baton? Governments did their bit during the crisis and are still doing their bit to show how seriously they believe in the market basis of our societies. But they are running out of ladder. It is time for that proven and trusted approach to running successful market economies to re-emerge: governments and markets depend on each other and should support each other too. Both will benefit if they show they are serious about the public interest.

For more views by Rolf Alter, see


©OECD Observer No 284, Q1 2011

Economic data

GDP growth: -9.8% Q2/Q1 2020 2020
Consumer price inflation: 1.3% Sep 2020 annual
Trade (G20): -17.7% exp, -16.7% imp, Q2/Q1 2020
Unemployment: 7.3% Sep 2020
Last update: 10 Nov 2020

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