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It’s not all bad: the costs and benefits of financial crises

The unsustainable has run its course

After twenty years of acting as the ‘consumer of last resort’ for the world, the American public does not have the savings to consume strongly – and may not for several years. Job losses may prolong the increase in saving. Unemployment in the US is already at the highest level since 1983, and likely to rise a great deal more. The number of people who have left the workforce because they were discouraged from lack of available work has risen. This has long-term implications for the way the US economy works.

We know what to expect. There have been enough financial crises since 1971; an average of eleven countries a year are affected either by banking or currency crises, an unprecedented rash of crises. Throughout the twenties and the Great Depression there were at most only five countries afflicted at a time. Developed countries have been largely spared; more than ten of the recent average annual crises occurred in developing nations. Scandinavia and Japan provide the only reliable indications of how developed countries react.

Dear old Stockholm – and Helsinki

From the mid-1980s until 1990, Norway, Sweden and Finland experienced a financial boom with many of the characteristics of the recent boom in the US and Europe. Deregulation of the financial system had provided competition to local banks, encouraging lending to commercial and residential housing. The boom turned to bust with the global downturn of 1990. Whereas the UK and US experienced problems with banks, the Scandinavian countries suffered wholesale collapse.

The Soviet Union from the mid-1980s began to reform, based on perestroika (restructure) and glasnost (openness). Optimism about the end of the division of Europe lifted already high economic confidence in the Scandinavian countries. The Scandinavian countries were among the first to benefit from the thawing of relations between East and West.

In 1989, presidents George Bush senior of the US and Mikhail Gorbachev of the Soviet Union declared the Cold War was over. Defence spending in Sweden had been falling as a share of GDP, and the displaced capacity was directed by the government into civilian manufacturing. The term ‘peace dividend’ was coined in 1990 and was eagerly embraced in Scandinavia. Bank lending, already strong, grew stronger still. Commercial and residential house prices rose sharply, together with indebtedness.

Things did not follow a straight path to the new world order, imagined by the West. The Soviet Union collapsed in 1991 and with it the largest export customer for Finland. Finnish trade with Russia fell 70 per cent in 1991. Banks, already wildly overextended to property, suffered badly. Sweden was less exposed to the Soviet Union, but was exposed to the downturn in Finland. The openness of the three Scandinavian countries and the degree of over-leverage meant the bursting of their property bubble was accompanied by a banking (and insurance company) crisis. The three followed similar strategies: creating a ‘bad bank’ and nationalising many of their lenders.

Economic performance suffered a shocking collapse. Unemployment rose abruptly. All three countries had low rates of unemployment till the financial boom of 1987–90, which saw unemployment rates fall to almost zero (Sweden fell to 1.1 per cent unemployment rate in June 1989, Finland also bottomed out at 2.1 per cent in the same month. Norway reached a low of 1.7 per cent at the end of 1986).

From 1991 onwards, the three countries saw a massive contraction in economic growth and a large rise in the jobless population. Swedish unemployment rose to 9.4 per cent in August 1993. Finland, with a smaller economy than Sweden and close trade links to the disintegrating Soviet Union, suffered much more from the financial crisis of the early 1990s. Between 1990 and 1993, Finnish GDP contracted 13 per cent and in 1994 unemployment rose from 3.5 per cent to 20 per cent. Neither Sweden nor Finland returned to the low levels of unemployment they had been used to before the crisis. Norway managed to contain the jobless rate to a peak of 6.2 per cent. Partly because the country was aided by the benefits of a large boost from the oil industry, employment eventually returned to about 3 per cent. This did not happen in Sweden or Finland for many years.

The Scandinavian experience is held up as a model response to a banking crisis. The speed with which the authorities reacted and the efforts to clear the banks of bad debts have been studied by the Federal Reserve, the US government and others as a lesson in how best to deal with a financial collapse. Sweden and Finland were ‘good financial crises’, with swift nationalisation, transparent accounting of the problems and the establishment of special funds to deal with the problem assets. Within five years, the scars of the disaster had healed, and growth rates were again rising more strongly than their larger neighbours – particularly Germany.

They run, chanting revolution

While it might have been a ‘good financial crisis’ in retrospect, the Scandinavian experience undermined the dominant Social Democratic party in Sweden. It allowed other political thought to enter the political discourse for the first time since the Second World War and liberal and free-market philosophy emerged as an alternative to the previous orthodoxy. Welfare policy, the cornerstone of Swedish politics since the end of the Second World War, was constrained for the first time. Neutrality, the centrepiece of defence policy, was also shelved. Both policy changes were likely to have occurred without the collapse of the Swedish banks, but events hastened the demise of these cherished institutions.

American political change has already begun after the recent crisis, relatively quietly. Barak Obama may represent a radical change in the history of African Americans, but his politics represent continuity thrust into extraordinary circumstances. A mark of the continuity of political trust is the continuation of party political criticism. Republicans, despite the extent of financial damage to their country, continue to provide a distinctly party political critique of the administration.

Change looks more disruptive in the UK, where the entire political class has been attacked. The government of Gordon Brown first looked as if it was able to use the financial emergency to remodel itself as a protector of national interest. The bounce in popularity was brief, and by early 2009 the political disarray was so pervasive that effective government was all but suspended. And it looks as if there will be a change in the contractual trust between voters and politicians.

Interestingly, it seems the political class most damaged in the aftermath of the crisis is not the executive itself, but the legislature, the Houses of Parliament, which continues a trend towards a presidential style government that has emerged informally since the election of Margaret Thatcher in 1979. While the recent criticism of Parliament – especially for financial sins such as wrongful expenses claims – was heightened by the near-collapse of the British banking system in late 2008, the long-term trend has been away from constituency representation for some time.

Some British politicians recognise the link between the financial crisis and their plight. David Cameron, leader of the opposition Conservative party, summarised the trust lost by politicians and explicitly linked it to the financial crisis:²

‘Of course the immediate trigger of the anger over expenses is the realisation of what some MPs have actually been doing with taxpayers’ money. But the fundamental cause is, I believe, something different. It is, in fact, the same thing that made people so angry about the bankers who got rich while they were bringing the economy to its knees… when it comes to the things we ask from politics, government and the state – there is a sense of power and control draining away; having to take what you’re given, with someone else pulling the strings. And then when people see MPs caught cheating but still clinging on… bankers reaping their bonuses despite breaking the economy… and bureaucrats whose incompetence is never punished… they see a world that is built to benefit powerful elites, and they feel a terrible but impotent anger.’

The early 1990s brought political change even to the long-standing political structure of Sweden. In July 1991, prime minister Ingvar Carlsson led Sweden to apply to join the EU. The stability of the economic bloc was a strong inducement to join – an appeal to something more solid.

Carlsson’s overtures to the EU were never enough to save the government. The 1991 elections in Sweden brought the Moderaterna (liberal-right) government of Carl Bildt to power, who blamed the policies of Social Democrats for the economic collapse. He received enough support for the wholesale disruption of the Swedish model. Monopolies were dismantled, tariffs reduced. Under pressure from international financiers, including hedge funds, the krona was floated. Unemployment rose from already high levels. Swedish economist and politician Carl Hamilton suggested the recession that accompanied Bildt’s dismantling of the Social Democratic model was as bad as the financial crisis itself; it was ‘a human and economic waste without parallel in the entire history of Sweden’.

Negotiations to join the EU began in February 1993 and the referendum on entry the next year gained much more support than reported in earlier years. Isolation and neutrality were much less appealing in the aftermath of the Cold War and the bursting of the financial bubble. The Social Democratic government ‘had lost its confidence that it could manage the national economy. It turned away from full employment and adopted price stability as the main concern of economic policy. At this stage, membership (of the EU) suddenly became attractive as a solution for the continuation of capital accumulation after the failure of both Keynesianism and the “third way”.’³

It is not clear what America or Britain can join to deflect domestic crisis, and unlike crises of the past, the current one challenges liberal capitalism, rather than pushes political leaders towards it. The Swedish decision was a clear turn away from the uniquely Scandinavian identity that had informed policy. It was also a sign of international integration. The Swedish government ministries that led the decision to join the EU were those linked to international trade, such as the foreign ministry. Those ministries that had to deal with the domestic problems of the financial crisis – such as the labour ministry – were not consulted. In the aftermath of the recent financial crisis, the consensus on market-oriented politics has been damaged without any viable option being in place; there is no political route to offer salvation. The ‘third way’ of politics is too recently associated with Clinton and Blair and old-style socialism has proven its flaws too painfully for anyone seriously to consider returning to the state-run model.

Old relationships are sure to be challenged. In the early 1990s, neither the Finns nor the Norwegians were consulted before the Swedish application to join the EU was made. The leaders of both countries ‘were taken aback by the move. President [Mauno] Koivisto [of Finland] has even noted that he felt Sweden, in order to gain a head start on its eastern neighbour, would have preferred Finland not to apply… in challenging the continued salience of Swedish neutrality, the collapse of the Cold War order facilitated a Swedish application.’⁴ The Swedish decision to open discussions with the EU marked a break in the tradition of sharing discussions with other Scandinavian countries, reflecting the dominance of new internationalism, as compared with the previous regionalism.

Finland had its own economic reasons for joining the single currency – principally the loss of its trading partner in the fall of the Soviet Union. The country joined the EU on 1 January 1995, along with Sweden and Austria. The deeper Finnish recession that followed the financial crisis encouraged more commitment than in Sweden to the full integration of the continent. The country was a founding member of the European single currency four years later, while Sweden continued with its own currency. So the Scandinavian financial crisis unpicked nearly a hundred years of political alignment in both Sweden and Finland within four years.

Despite the political refocus, the Scandinavian crisis did show that quick response from an alert government could curtail the worst of the damage. But the damage could still be extensive, and the politicians running the country at the time would still suffer. It also showed that strategic change with immensely important long-term implications (joining the EU and the single currency) could be taken very quickly. It changed the way the Scandinavians saw themselves forever, oriented their economies to the West more firmly and set them on a course to a high-technology future. No longer would Finland be thought of only as a wood pulp producer.

Yet while it encouraged such large changes, the crisis failed to change some fundamental aspects of society, despite throwing up huge challenges. The unique welfare system, perhaps the defining social feature of Scandinavia, remains largely intact in all Nordic countries, with most of the population returning to support the model that had seemed so broken in the aftermath of the crisis. It is debatable whether this was because the Scandinavians are predisposed to this system, or whether they were lucky that world growth provided enough of a cushion.

Not so relaxed: recovery in Thailand

Other countries have suffered more than Scandinavia, with less good fortune in the rebound from crisis. The Asian Tiger recovery from the crisis of 1997–98 was marked by the ghost of the past, both political and economic. Thailand in particular found adjustment difficult. The economy shrank nearly 11 per cent in 1998, and when growth returned it was at lower rates. Thai unemployment rose by three times the pre-crisis level.

In some ways, Thailand followed the same policies in recovery as it followed in the lead-up to the crisis. Thailand’s reliance on manufacturing increased from 39 per cent of output in 1995 to 42 per cent in 2002, while both services and agriculture continued to shrink.⁵ Thailand experienced a sharp adjustment between domestic growth and exports, reflecting the adjustment to the current account deficit. Exports grew from 40 per cent of GDP in 1995 to 73 per cent by 2007. International trade therefore aided Thai recovery in the same way it aided Scandinavian countries. Thailand also followed a more typical export-led model of development, similar to that followed by Japan and Korea in the years after the Second World War. The re-focus on exports has been followed by Indonesia, Malaysia and China.

Thai politics has always been volatile, when it is not held in check by a military strong man. Just as Scandinavian financial catastrophe brought wholesale challenges to the political consensus, the emergence of political participation after the Asian crisis was seen as a solution to problems brought about by the devaluation of the baht, particularly the corruption that was exposed during and after the crisis. Political participation rather than relying on existing political institutions was seen as a way forward. The economic costs, therefore, were accompanied by political costs for the incumbent elite.

Thai economist Pasuk Phongpaichit says:

‘The parliamentary system had simply been co-opted into the bureaucratic state. The battle was still between the people and the state, the people and paternalist domination, the people and rabop upatham, the patronage system which now encompassed not only bureaucrats but elected representatives… With this declining faith in “democracy” as the route to a better political future, and in parliamentary institutions as a mechanism of change, the idea of “civil society” has been seized upon to play the [role] as the repository of hope.’

The political reform movement gained momentum and in October 1997, after the devaluation, Thailand enacted the sixteenth constitution together with a broad range of reforms, including the establishment of an electoral commission, a decision that was hastened by the emergence of the crisis.

But, just as in Sweden, the old guard fought back. The focus on a single party government led to the near-dominance of the Thai Rak Thai (TRT) party led by Thaksin Shinawatra. In 2001, the party ‘ran the most expensive and populist election campaign ever in Thailand’. It offered $23,000 to each village and suggested farmers could postpone their debt repayments for several years. The success of TRT was built on the slowness of recovery following the Asian crisis.

Thai politics was authoritarian during the Cold War. Politicians seemed to recognise a need to develop civil institutions after the Asian crisis and that it was inappropriate for military involvement in politics. This did not stop a coup d’état from ousting Thaksin in 2006.

Despite the integration of Thailand into the wider world through exports, it has not been followed by a similar move in politics. Even in 2008, the old tendency towards authoritarianism was at work, with protests against the government causing the forced removal of the prime minister in December 2008.

Political reform in Indonesia seems to have achieved much greater strides than Thailand, partly because it began with fewer advantages. The Asian crisis precipitated the end of the Suharto regime in May 1998, after three decades of dictatorial rule. Real reform began in 1999 and democratic reforms have been meaningful. The People’s Consultative Assembly (MPR) and the People’s Representative Council (the House of Representatives) gained much wider powers to challenge the executive, which they have exercised. Candidates for political office engage directly with voters in ways that were alien just over a decade ago. The media too has become lively with political debate, although violence against journalists remains a problem.

For several years in the wake of the Asian crisis, Indonesia appeared threatened by Islamic terror. The Bali bombings in 2002 seemed to show the country running away from tolerance, led by the Jemaah Islamiyah. But the group has lost influence and strength, partly due to police operations against senior members of the organisation, partly because the population has little sympathy with the aims of the organisation.

Indonesia’s comparative advance and Thailand’s comparative political regression were both a reaction to the initial political instability brought about by the crisis of 1997.

Japan: what recovery?

The costs of financial crisis for Japan, of course, are endless. The country has yet to recover from the bust of its bubble economy collapse in 1990. The first ‘lost decade’ is likely to turn into a lost twenty years, maybe longer. Its growth rate remains anaemic and is not likely to recover because of a falling population. Not surprisingly, the country’s regional power has been eclipsed by China.

Compared with the West, Japan’s unemployed receive little in welfare payments, and a system to retrain, re-educate, house and look after the unemployed was almost non-existent before the 1990s. While manufacturing jobs declined by 2.2 million between 1998 and 2004, those registered for ‘social welfare’ rose by only 700,000 to 5.1 million.

The number of homeless people rose from less than 1,000 in the mid-1980s to 25,000 by mid-2002. The homeless erected small cities of tents around the main cities, made from blue tarpaulins taken from building sites. Osaka Castle Park and the ancient capital Kyoto both saw makeshift communities grow up, known generically as ‘blue homes’. They contained a high number of ex-construction workers.

Despite Japan’s problems, political and economic change looks as far away as ever. The Liberal Democratic Party has ruled the country since the end of the Second World War apart from a short time in the early 1990s. The success of technocratic government in the 1950s and 1960s continues to leave a mark. The reign of the LDP was a legacy of the Cold War, which ended at a similar date as the bubble economy collapse in 1990. As a creation of post-war politics, the LDP has lost its raison d’être, and undermined the economic prosperity that accompanied it. Japan’s role as an Eastern pole of US foreign policy is largely symbolic. Yet the LDP continues to hold power.

Slowly, Japanese public opinion has become more critical. Politicians have changed too. Prime minister Junichiro Koizumi privatised the vast savings of the Post Office, which had been used for decades to finance local projects to buy votes for the LDP, and the style of Koizumi himself was a radical departure from faceless politicians of the past. But this is really only a minor adjustment considering the extent of the damage done to Japan’s standing since 1990. The real process of adjustment has not made much headway yet in Japan.

If Sweden and Finland are held up as examples of how best to deal with a financial crisis in a modern economy, Japan seems determined to show how not to do it. Some of the criticism has become less strident since the West experienced its own problems. It has become obvious that radical change is much harder to initiate than it first appears. While the West preached to Japan that it must allow banks to close during the 1990s, the same countries making these suggestions (principally America) have conspicuously failed to move swiftly to close any of their own failing banks.

Recovery in both Scandinavia and Asia required world growth to help their economies. This background of global growth will be missing for America and Europe over the next two years, meaning the boost from exports is likely to be much weaker. Recovery will probably have to come from within the countries themselves. This may make the period of recovery much longer than it was for either Scandinavia or even Thailand.

Costs of crisis compound problems – the demographic decline of Japan is perhaps the biggest difficulty facing the nation. Falling population erodes the vitality needed to reform. Unfortunately, the demographic profiles of Germany and Italy are almost certain to follow the same pattern of decline of Japan. Indonesia’s expanding population may have been a factor in its relative success in adapting to a post-crisis world; a rising number of mouths to feed means rising demand. America is better placed in population growth than any other Western country, so its recovery may be partly down to old-fashioned population growth.

Where’s the good in bubbles and busts?

With the undoubted costs – financial, social and political – that follow busts and financial panics you may think it churlish to look for gains. How can something so destructive produce benefits?

This episode is not over, so we cannot be sure of the benefits that will emerge this time, but there is plenty of evidence of gains from past crises. The ‘railway mania’ of 1844 and 1845 collapsed in 1846. In its wake it:

‘left as a legacy a vast mass of railway securities, many of which were held by investors far distant from the area of operation. Thus, as investor confidence returned in the early 1850s, railway securities again came to play the major role in linking trading in the London and provincial markets. This was further enhanced by a series of alliances and amalgamations which created a small number of highly capitalised railway companies whose securities offered a secure and predictable rate of return. They appealed to investors from all parts of the country.’

So, modern capitalism was born out of crisis.⁶

Despite the pain of the current episode, modern capitalism has produced a panoply of benefits that populations would be unwise to reject; large-scale enterprises that are much more productive, and much less environmentally damaging, than local small-scale manufacturing, insurance for all manner of eventualities, travel, challenges to existing elites and distribution of benefits across society and the globe. Often the advances and benefits follow from financial crises.

The advances in nineteenth century communications technology had certainly contributed to the banking panics of the 1840s, 1860s and 1890s (railways, telegraph, newspapers). The advances also brought social mobility, world news, instant communications and alleviation of distress. They were associated with later social advances and medical advances.

Financial crises are also often followed by a period in which technological advances, frequently associated with the preceding bubble, become embedded in society. Railways, telegraph and newspapers all expanded their reach after nineteenth century crises, as well as contributing to the preceding bubble.

Democracy itself has been extended by financial crises. After a particularly spectacular banking panic in 1866, a crisis that began with the collapse of the discount house Overend and Gurney and spread to many international banks, the British government under Disraeli introduced the 1867 Reform Bill. The act that followed enfranchised all male householders in Britain for the first time, doubling the franchise to one million men. The bill had been developing for many years, and had been suggested by Disraeli himself several years previously, but the bank crisis of 1866, and the public discontent that followed, prompted the actual introduction and passage of this important democratic advance.

The 1930s are usually written off as an economic wasteland, culminating in the outbreak of the Second World War. In fact, after 1934, growth improved until 1937, when the ‘Roosevelt recession’ hit. Unemployment remained high, but the condition of the unemployed did improve – it had to. National income and personal disposable income rose sharply from 1934 onwards, starting roughly three years after the banking crisis. Inflation remained subdued till the outbreak of war. America was more prosperous – as a whole – at the end of the decade than at the beginning, despite difficulties along the way. The same can be said about Britain, which was suffering added problems from challenges to its imperial dominance, in Europe and in the most important colony of all, India. But even in Britain, the condition of the working class improved through the decade.

Change in the US came with shifts in the role of government with the election in 1932 of Franklin D. Roosevelt. In the shadow of the Great Depression, the Democrat Roosevelt drew on support from the poor, unionised workers, ethnic minorities, urban elites and the Southern white population to gain a mandate for social change. For some, especially the black population, social change would take a long time coming and depression set back their progress. For others, it provided a levelling effect.

In his inaugural address in 1933, Roosevelt laid out a programme for change that rejected the political elite – and the bankers – of the past:

‘Recognition of the falsity of material wealth as the standard of success goes hand in hand with the abandonment of the false belief that public office and high political position are to be valued only by the standards of pride of place and personal profit; and there must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and selfish wrongdoing… in our progress toward a resumption of work we require two safeguards against a return of the evils of the old order; there must be a strict supervision of all banking and credits and investments; there must be an end to speculation with other people’s money, and there must be provision for an adequate but sound currency.’

This sounds familiar.

Roosevelt introduced a social security system. He also created the basis of a financial system that has lasted almost to the present day. The mortgage agencies were created in the 1930s, as was the SEC and the Federal Deposit Insurance Corporation (FDIC), and the Glass–Steagall Act was introduced. All these were significant advances. Most importantly for many people, Roosevelt also ended prohibition. Private sector development was not idle either. The Empire State Building, the Chrysler Building and Rockefeller Center were all completed in the 1930s.

Radio contributed to the boom in the 1920s, spreading the influence of instalment loans and share ownership as much as newspapers. Newspapers, telegraph and railways preceded a series of financial crises in the nineteenth century, yet survived the busts to become the most important communications media for the next fifty years. Radio was itself the cause of a rise in advertising of all manner of goods and services in the 1920s. During the depression that followed, the radio became the preferred means of communicating the news and took on a national unifying role in the US and the UK. The first Christmas message broadcast by a British monarch took place in 1932, not long after the Great Crash, and embodied a new ethos of collective effort.⁷ Our own crisis grew from the communications technology revolution, and yet its benefits will probably grow for many years in the future.

Radio was a beneficiary of the depression, spreading much further as a result of the 1930s financial crisis. By the middle of the decade almost every household in America and Britain possessed a wireless. In fact, the continued success of radio was a direct result of the depression, with the cost savings of radio sets compared with other forms of entertainment encouraging many new purchases.

In 1930 the wealthiest areas had the highest and the poorest areas had the lowest concentration of radio ownership.⁸

‘By 1936, despite the depression, all areas of the United States had made great strides in radio ownership. By then, 74 per cent of the nation’s home contained a radio, and all areas of the country had seen their rates grow by at least 10 per cent… Growth in radio ownership between 1930 and 1936 was highest in the South… Radio was as close to depression-proof as any industry in the economy.’

The south, of course, was the poorest part of the country.

The benefits of radio were in entertainment, but it also brought wider access to national news, sport, a certain amount of education and, above all, music. All these benefits were free, after the initial purchase. American record companies produced 100 million records in the mid-1920s. By the early 1930s, only six million were being sold; the cost advantage of radio almost killed the record market. Radio advertising revenues continued to grow throughout the 1930s. The higher proportion of the population with access to radio brought support for the medium from business. The spread of radio raised interest in jazz, as well as classical music, during the 1930s.

The banking crash in Scandinavia in 1990 introduced many benefits; some rather surprising. One remarkable outcome was that the nationalised banks were eventually sold back to the private sector for a profit – meaning that what had looked like a cost to the taxpayer was greatly reduced. The initial cost was put at 2 per cent of GDP for Norway, and as high as 9 per cent of GDP for Finland. The end cost was much lower – for Finland it was 5.3 per cent of GDP, for Sweden only 0.2 per cent of GDP and for Norway a net gain of 0.4 per cent of GDP.

The crisis also introduced tax changes and improvements in efficiency, especially in Finland, that led to long-term gains. By the early twenty-first century, Finland had moved from the least developed Nordic country to the most developed. It was ranked number one in the World Economic Forum competitive index repeatedly. It was the top ranked country for higher education in the OECD. Finland achieved the highest score in information technology and the knowledge economy in 1995 and 2006.⁹

The main cause for all these accolades was the extraordinary success of Nokia, which grew from a local conglomerate to international industry leader following the crash of the early 1990s. The banking collapse caused Nokia to focus on its telecommunications business and sell off its domestic businesses, such as rubber and cables. Within four years it had become the largest mobile phone manufacturer in the world. It became the leading instigator of the digital GSM technology, which allowed roaming and SMS messaging for the first time on a large scale. Nokia, and GSM, laid the foundations for the worldwide boom in mobile telephones; without the Scandinavian banking crisis, the competitive advances made by Nokia might not have occurred, or would have been delayed.

Finland itself was transformed, from a country largely dependent on natural resources – especially wood – into one of the high-technology centres of the globe. From 1996, the Finnish economy grew at an annual rate of 5.1 per cent – very high for a developed economy – driven by Nokia and the associated information technology sector. Similarly, Thailand concentrated its export energies on the high-technology sector in the aftermath of the Asian crisis, to its lasting benefit.

A complex of crises: 1970 to 2009

The current financial crisis is undoubtedly the most costly yet. It dwarfs the cost of the last American banking crisis, involving Savings and Loans banks in the late 1980s, even when adjusted for inflation. Yet, every financial crisis in a developed country seems to be the worst ever. Episodes are unlikely to be described as ‘crises’ unless they are the worst ever – in their time. Anything less can be dealt with using tools tried and honed in previous episodes.

Part of the reason for the shock of today’s crisis is because the developed West is among the countries affected. The West, in particular, has become unused to financial disruption first hand. Compared with the rest of the world, the West has not had a fair share of financial disasters.

Our impression is that such crises are relatively rare: ‘Black Swan’ events that occur only once a generation. So rare that they catch regulators, central bankers, politicians and commercial bankers by surprise.

But this is not true. The IMF database on banking, currency and sovereign debt crises shows that between 1971 and 2008, there was just two years (1974 and 2006) when there was not a financial crisis of some sort in at least one country. For most of that time there were financial crises in several countries at one time.

The impression of the rarity of crises leads to other misconceptions. The Great Crash of 1929 did not end a decade of carefree partying. The banking crisis of the early 1930s that immediately preceded the depression was far from unique. The early 1920s were affected by a large number of panics, across a range of countries. In fact, between 1900 and 1971 the greatest number of countries affected by banking crises occurred in 1922, not the 1930s, caused by delayed after-effects of the Great War. Countries afflicted included the Netherlands, Italy, Sweden, Denmark and Norway. The Nordic countries suffered crises lasting half of the 1920s.

Rather than a single cataclysmic event following the crash, it is more accurate to think of a periodic series of crises through the 1920s, culminating in a final and more damaging crisis in the early 1930s. None of the earlier crises affected America, so it ignored the disruption elsewhere.

Similarly, the banking crises of the nineteenth century clustered around various dates, peaking in the 1840s, followed by a lull, then another series of crises between 1860 and 1880, with the final panics of the century in the 1890s. The crisis of today is actually the culmination of a rolling financial crisis that began in the mid-1970s; perhaps it is not even the culmination.

The current series closely matched the introduction of neo-liberal market policies, spreading from Britain and the US across the world. And as they spread, so the number of countries affected by crises rose. Some would point to this association between financial crisis and market systems and assume they would not have happened had neo-liberalism been thwarted. The French and some German politicians seem to hold this idea, and are not afraid to voice it.

A more challenging notion is that financial crises are an integral part of a system that brought greater freedom and greater wealth to more people than could have been possible otherwise. The assessment of costs and benefits must therefore assess how the social costs of neo-liberalism stack up against the undoubted benefits it has brought.

These benefits include the transformation of communications and computing power, the expansion of world trade, the fall of the communist bloc in Europe, the inclusion of Eastern Europe in the European Union. Perhaps the greatest achievement has been bringing China into the world trade system. The wealth this has brought to millions of previously impoverished Chinese is so immense it outweighs many, perhaps over time even all, of the negative aspects of neo-liberalism. Without these ideas, paramount leader Deng Xiaoping would probably not have declared in 1978 that ‘to be rich is glorious’. China has a long way to go when it comes to freedom for individuals. But there is no doubt it is a much healthier and freer society than it was; though with some lapses, such as the Tiananmen Square massacre.

It is difficult to argue against the obvious links between the Japanese, Asian and Western crises that marked a decade of disruptive finance from 1990 onwards, and which led directly to the current crisis.

The transfer of crises from one region to another required a globalised world, employing sophisticated communications, investment and trade; these benefits were required to create the crisis we have. There is no-one in the West who has not benefited from these trade and technological developments, either through cheaper electronic goods, or cheaper clothes, or the resulting freeing of cash to spend on travel, or leisure.

All our new technologies of communication – from telegraph and telephone to the internet – offered novel means of transcending time and space. It is no coincidence that transcendence of time and space is also the purpose of banks. Banks distribute credit across time and space, and manage the considerable risks associated with that. New communication technologies expand horizons and both stimulate and require expanded credit to fund the exploitation of these new horizons. When we consider the costs of the provision of credit in the past decade, we should perhaps also remember that without these costs, there might have been no longer-term benefits either.

The internet: too early to tell

What kind of future can we expect? For the moment it looks unrelentingly grim. In the UK, unemployment is rising, government debt is rocketing, mainstream parties have lost public confidence and even parliament has been tainted by the abuse by MPs of expenses; a scandal that is unlikely to have had such an impact without the distress of the financial crisis. Worryingly, extremist parties are making electoral inroads.

Perhaps of greater concern is that the world has become globalised. Britain and the US cannot rely on the growth of other countries while they rebuild their economies; these were the economies, particularly America, which generated the growth for the entire world. Transformation through exports, which was the route followed by the Asian victims, Finland, Sweden and attempted by Japan, looks destined to fail.

At least it may fail if the only exports were those relying on existing markets. Finland proved it was possible to create new markets and shape them to its own advantage.

Information technology and globalisation formed the direct background of not one but two bubbles, the dot-com bubble of 1999–2001 and the housing bubble of 2003–2006, and was one of the causes of the crises in Japan, Thailand and Scandinavia. In between the end of 2001 and the end of the housing bubble, the internet had undergone the sort of growth that even its fanatical supporters in the late 1990s would have found surprising. In the process, it nearly wiped out the recorded music industry, challenged the film and software industries and created new economies in the virtual world Second Life. Social networking websites and blogging were embryonic and Google was just emerging from its birth as the experiment of two students.

A bubble may be rational and the disruption of the bust itself may be part of the long-term adjustment to technology, trade or social conditions. When Greenspan looked at the internet he looked at it in classical terms of improving efficiency, speeding processes, oiling the wheels of commerce and global trade. It is all these things, yet the economics of the internet fail when measured only by economic efficiency. Social sites do not work because they are efficient. Rather they become efficient – meaning profitable – through their social success. The metrics of measuring many of the newer successful online businesses are entirely different from those used to measure old industries.

If this sounds like a return of the dot-com optimism, then it is tempered with a demand for the bottom line, and informed by the fickleness of success in the still-new medium. There are perhaps only three lasting online brands so far; Amazon, eBay and Google. Their success is not driven by marketing in the conventional sense, but by use and word of mouth. At heart, all three are a modest collection of algorithms operating over a large number of servers. All three are based on marketplaces. Of the three, by far the most powerful is Google, whose marketplace is pure information. Without Google, that information would not be found, or, in many cases, would not exist at all, an attribute not shared by the other two companies.

I remain optimistic that economic recovery is tied to and likely to emerge from the connectedness we have created in the internet. The need to control, understand and manipulate that connectedness will lead to opportunities we did not think we needed. Communications technologies take many decades to fulfil their potential.

Many of the benefits of communication technologies are also unexpected. No-one could have predicted that the printing press would have a direct influence on the discovery of America through the huge popularity of printed editions of Ptolemy’s Geography. It is likely that some New World remains to be discovered and the crises of the past twenty years are a symptom of the journey towards it.