What Keynes warned us about globalisation

OPINION: Summer reading is a retreat from this world. My summer lectionary has included Predicament, Ronald Hugh Morrieson's amazing tale of innocence and experience in 1960s Taranaki, William Philpott's stupendous panorama of the battle of the Somme and a magisterial survey of the advance of religious insight across the Middle East, South Asia and China during the axial ages.

But for a disquieting account of the world we inhabit, I have been gripped by Robert Skidelsky's Keynes - The Return of the Master.

Both my wife and I had grandmothers who were caught up in the financial maelstrom of the 1930s. Both had lost their husbands. Both relied on income from mortgages prudently arranged by their husbands to provide for them. Both saw those mortgages cancelled. In the tidal wave of defaults that engulfed the world, settled expectations and carefully laid plans were swept aside as governments struggled to spread the losses around.

It was, as they say routinely in Baghdad, collateral damage to innocent bystanders.

This was the civilisational crisis to which John Maynard Keynes applied his laser-sharp, unconventional and at times subversive intellect. To Skidelsky we already owe a magisterial three-volume biography of this genius. Now, in the throes of the worst meltdown since the thirties, Skidelsky has attempted a biopsy of our current malady and asked what Keynes would have had to say. His diagnosis is threefold.

First, the crash has exposed an intellectual failure long ago identified by Keynes: the fallibility of the efficient markets hypothesis as a reliable tool for modelling all economic behaviour. Financial tools designed to cope with manageable risks have been hubristically extended to the management of irreducible uncertainties. Far from limiting risks, they have magnified them. The conflation of uncertainty with risk has exposed the limits of laissez faire.

Second, Skidelsky fingers the potential for international imbalances through misaligned currencies to store up serious trouble. In Keynes' day, it was the accumulation of gold reserves by the United States without compensating foreign investment.

The postwar settlement hammered out at Bretton Woods did not follow Keynes' blueprint. But the case for international supervision of currencies admitted there remains a live debate in a world in which towering foreign exchange surpluses are being amassed by East Asian economies and invested in US Treasury bills.

It is not the financial flows which are the problem: it is the use to which they are being put. Chinese surpluses have been used to fund deficits that US taxpayers have been disinclined to fund. The result has been a consumption binge and debt pile-up that threatens the stability of the world's reserve currency and with it all manner of geopolitical certainties.

As Skidelsky puts it, "if the US wants to run an empire, it has to be in a position to tax the world. Piling up debt is a shadow tax but payment is voluntary and depends on the perception that the US is providing public goods for the whole world".

China's view of what constitute desirable public goods is unlikely to match America's.

Third, and most controversially, Skidelsky questions the unmitigated benignity of globalisation. Keynes considered that globalisation ran political risks that should at least call for caution on the part of policy makers.

The issues have changed since the 1930s. Today it is the health and environmental safety of long supply chains that raises consumer concerns.

One thing is clear. When uncertainty engulfs markets and the trust on which billions of transactions rely evaporates, there is nothing fair about the political rescue efforts that are entrained.

Governments have indulged in an orgy of public expenditure and nationalisation. They can unwind that through taxes, inflation or both. My grandmother's experience will be repeated. Further collateral damage will be added to that which has already been wrought.

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Skidelsky's own "Keynesian" prescription for the way forward is, appropriately enough given his career, confined to academia. He wants a restructuring of the way economics is taught. Modern economics has masked radical uncertainty with sophisticated, but ultimately fallible, mathematics. He invokes Keynes' injunction that economics is a moral rather than a natural science. Economics must be imbibed in the company of history, moral philosophy, sociology and politics.

He insists that macroeconomics must be protected from the encroachment of the methods and habits of microeconomics. The claim here is that we can't construct our understanding of the macro picture - the world of peoples, governments and cultures - from a model of rational expectations held at the micro level. The macro world is one of conventional or herd instincts that, left unchecked, can lead to disaster.

As I commenced my political career, the academic world had described governmental failure in chilling terms. We returned to "classical" economics with a vengeance. No-one foreshadowed a world in which banks and businesses were too big to fail. It will be interesting to see how the next crop of politicians squares that circle.

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