Democracy and the Financial Markets Jayati Ghosh

A famous quotation that is commonly attributed to Paul Volcker, former Chairman of the US Federal Reserve, is “In my next life, I want to be all-powerful. So I want to be reborn as the bond market.” Over the past half century, various developing and “emerging” markets were forced to learn about this power of financial markets the hard way, as volatile inflows and outflows of capital (in the debt markets and in stock markets) created boom and bust cycles that often left a trail of devastation in real economies.

People in these countries also grew familiar with their own government representatives looking nervously over their shoulders for signs of financial market approval or disapproval, and tailoring their policies to meet the expectations of these markets. The desire of governments to attract global capital, and then to prevent capital outflow, dominated over the justified demands of citizens for fulfilling their social and economic rights in terms of basic needs and dignity. Despite electoral systems and the need for government to establish some public legitimacy, politically, there was little doubt about which of these forces has been stronger.

The media in most developing countries were not just chroniclers of this trend of the growing power of finance to affect national economic policy making. They were also active (and often enthusiastic) participants in the process, vesting financial players with significant public voice. The behaviour of the stock market (which rarely if ever reflected the real economy) was treated as important news at almost every hour and given a lot of prominence in daily news; opinions of those representing financial markets in different ways were given a great amount of time; even the analyses of media persons were coloured by the perspective of finance capital. Merchant bankers and hedge fund managers would raise their eyebrows at the size of the fiscal deficit, or at some proposed taxes on capital, and governments would quake and rush to modify their measures.

Worst of all, the dominance of the markets appeared to permeate the political system to such an extent that whichever government happened to be in power, the economic and financial policies would be broadly the same. Governments that alienated the people by privileging the interest of capital over the people would get defeated by the electorate; the newly elected government would come in and do the same thing. Since “technocratic” leaders were more favoured by financial markets, governments led by supposedly apolitical “technocrats” less affected by political pulls and pushes, and more subject to the supposedly iron laws of the markets, also became more common.

But all this was for developing countries, the subalterns of the global system. In the “mature” democracies of rich capitalist countries, however much the will of the people was actually thwarted by economic processes, the formal structures of democracy were not just retained but also given explicit recognition and importance.

That was then. Things have changed quite a bit in a relatively short time. In economic history books of the future, November 2011 may well be remembered as the month when European leaders explicitly placed the appeasement of financial markets over the requirements of political democracy.

Consider two countries at the centre of recent action. In Greece, the elected Prime Minister George Papandreou, and his Socialist party government, had already put in place severe budget cuts and other austerity measures designed to reduce the public deficit so as to appease the financial markets sufficiently to bring down the rising yields on Greek government bonds. Greece had already availed of bailouts from the IMF and the European Central Bank, and requires still more infusion of funds. But the measures being insisted upon are essentially counterproductive, because they force an economy that is already into a downward spiral into further contraction, and thereby make the deficit to GDP and public debt to GDP indicators look even worse.

It is evident that some debt restructuring is inevitable. And so the European Union, in a major first, negotiated directly with bankers – through the Institute for International Finance in Washington DC, a global association of financial institutions. This resulted in yet another package designed to “save” Greece, but actually to save the bank responsible for overlending, with a declared 50 per cent write down of debt (though in fact the loss faced by banks would be much less) and further severe austerity measures to be imposed on Greece in the effort to “rebalance” the economy.

These measures are not just macroeconomically misguided. They are also deeply unpopular with the Greek public, who see themselves as being forced to pay for irresponsible banking practices, with massive unemployment, falling real wages, reduced public services. (Incidentally, the widespread myth in northern Europe – about lazy Greeks lying in the sun drinking ouzo while hardworking Germans support them – is completely false. Real wages in Greece are significantly lower than in Germany; average working hours in Greece are significantly longer than in Germany; the rate of productivity increase in Greece in the decade preceding their crisis was one of the fastest in Europe.)

The simmering anti-austerity mood in Greece finds expression in strikes and street protests, which have become commonplace. When the latest round of such cuts was insisted upon by the EU, Papandreou announced that he would have to take strategy to a popular referendum. Of course, this should have been done much earlier. It is not even clear if he intended to phrase the question in such a manner as to ensure a “yes” vote to give legitimacy to further cuts. But the very possibility of such democratic referral and the associated uncertainty created outrage and fury among European bosses.

Like an errant schoolboy, Papandreou was quickly summoned to Cannes where G20 leaders were meeting. According to reports, he was subjected to a humiliating dressing down by the Gang of Four of Angela Merkel of Germany, Nicolas Sarkozy of France, Christine Lagarde of the IMF and Jean Claude Juncker, head of the eurozone group. He was told in no uncertain terms that any such moves to refer to public opinion amounted to “disloyalty” that would not be tolerated, and that Greece would not receive the next crucial tranche of EU-IMF money of 8 billion euros if it persisted with this plan.

Papandreou returned to Athens, cancelled the referendum, and even resigned in the process, as his position had now become untenable. A “government of national unity” has been set up, to be run by former banker Lucas Papademos. No career politician was found acceptable by the markets, only an insider (he has been Governor of Greece’s Central Bank and Vice President of the European Central Bank) whose stated priority is to keep Greece in the eurozone at all costs, with no mention at all of what the people of Greece might happen to want.

In Italy, where bond markets next turned their attention, the head to fall was that of Silvio Berlusconi, whose period in power has been more noted for salacious scandals and aggressive buffoonery. Bond yields in Italy touched the declared danger mark of 7 per cent; other European leaders then announced openly that Berlusconi had to go. As it happens, he should have gone much earlier, for a variety of other crimes.  But the EU leaders now felt that his departure was necessary “to calm the markets”. And so go he eventually did, announcing that he would resign once the Parliament passed further austerity measures that were also “required” by the markets.

The new government in Italy is even farther from any democratic norm than that in Greece. It is headed by another economist/banker, Mario Monti, who has the added advantage for the markets of having worked for a trusted institution like Goldman Sachs (which was heavily involved in helping the earlier Greek government to fudge its accounts to conceal the extent of its debts and deficits). Mr Monti runs a government composed entirely of “technocrats” rather than any representatives of political parties: bankers, businessmen and former bureaucrats, who are completely in tune with the expectations and requirements of finance capital.

As if these examples are not enough, elected leaders in Europe are now more openly expressing their intellectual and policy subservience to financial markets in different ways. Recently, Finland’s Minister for Europe has argued that the eurozone’s six Triple A-rated countries should have a greater say in economic affairs within the single currency and act as its inner decision-making core, because “a country that is not triple A rated is not going to be the best one to give you advice on your public finances.” So now credit-rating agencies are going to decide which governments in Europe get to make the decisions for all of the eurozone!

Note that these credit rating agencies have almost universally underperformed massively especially in the past decade, missing signs of fragility, over-reacting after the event and generally behaving in procyclical and herd-like ways that are typical of financial market functioning in general. Yet elected leaders in Europe are seriously suggesting that they hold the key to which governments can be more “trusted” to make crucial decisions for the people of Europe.

It is hard to see how any of this can be taken seriously, but this is actually the way that governments in Europe are currently responding to the advancing crisis. It does not follow that these efforts to placate finance at all costs will be possible, though, since this subservience to financial markets is now more questioned by the people. Governments may have decided to sacrifice democracy to the markets, but the people may still not let this happen.

(This article was originally published in the Frontline, Volume 28, Issue 25, December 3-16, 2011.)