Part 2 of Andrew Sheng recent speech

The Crisis of Economic Thought


            There is a common thread linking all post-mortem studies of the current crisis – that we lack a system-wide view, culminating in the new term “macro-prudential supervision”, as if such a new cliché would help all financial regulators.  Any single-dimensional solution obviously forgets that the problem with financial markets is that they are highly complex, concentrated, inter-connected, inter-dependent, interactive with complex feedback mechanisms and the distinctive feature is that all players are gaming the system[1].  Such gaming may lead, as we all know through the work of political scientist Mancur Olsen, into a “race to the bottom” or a collective “Tragedy of the Commons”, where individual greed without the ability to arrive at collective public good solution, leads to the destruction of the common good.   Unless G20 is able to come up with solutions to break this vicious circle, we may end up with the “beggar-thy-neighbour” policies of the Great Depression. 


            As early as 1982, University of California physicist and system scientist Frithof Capra had argued that current problems are “systemic problems, which means that they are closely interconnected and interdependent.  They cannot be understood within the fragmented methodology characteristic of our academic disciplines and government agencies….a resolution can be found only if the structure of the web itself is changed, and this will involve profound transformations of our social institutions, values and ideas. As we examine the sources of our cultural crisis, it will become apparent that most of our leading thinkers use outdated conceptual models and irrelevant variables[2].


            Basically, Capra argues that the present Cartesian, logical, linear, Newtonian approach to analysis leads to a “mechanistic conception of the world” that “has led to the well-known fragmentation in our academic disciplines and government agencies and has served as a rationale for treating the natural environment as if it consisted of separate parts, to be exploited by different interest groups (my italics).”


            More recently, Capra and Henderson has caricatured economists as those who measure development “to a single economic dimension, usually measured in terms of per capita GDP    unlimited quantitative growth [on a finite planet], as promoted so vigorously by economists and politicians, is unsustainable …   Qualitative economic growth, by contrast, can be sustainable if it involves a dynamic balance between growth, decline, and recycling, and if it also includes development in terms of learning and maturing[3].”


            GDP fever is at the root of many current problems in emerging markets because GDP statistically adds up all measurable monetary values, but ignores non-measured externalities.  Hence, growth for growth’s sake has become quantitative exploitation of natural resources without considering ecology, global warming and the quality of life.   Many Asians are wakening up to the reality that the price of rapid GDP growth has been achieved at tremendous deterioration of their quality of life, growing social inequality and tremendous health concerns.  Short-term prosperity has been bought at long-term social unsustainability in exchange for financial assets that may be devalued in the long-term.


            Capra and Henderson argue that the central challenge of our economic and ecological crisis is: “How can we transform the global economy from a system striving for unlimited quantitative growth, which is manifestly unsustainable, to one that is ecologically sound without generating human hardship through more unemployment?”   In Mahatma Gandhi words, for which I am grateful to Mrs. Lall for reminding me last February:  “Earth provides enough to satisfy every man’s need, but not every man’s greed”.


Crisis of Global Governance


            Before I proceed to what G20 could be doing, allow me to ponder on the current crisis of governance.   In hindsight, the combination of the culture of growth for growth’s sake, greed and network concentration has resulted in a networked world that is dominated by 20-25 large complex financial institutions (LCFIs), which account for more than half of global financial turnover, concentrated in a handful of financial centres.   Their power overwhelms governments and markets because the assets they command are larger than national economies and their alumni are spread throughout fund managers and national and global bureaucracies.  They have become a financial version of the Asian Global Supply Chain or what I call the Financial Engineering Food Chain.  Their version of financial innovation has been characterized by UK FSA Chairman Lord Turner as of “little social value” and in hindsight, the high profits of the financial sector has been achieved through growing (and hidden) leverage, in a classic case of moral hazard – private gain at social cost. 


            As a global citizen, I am frankly appalled by the fact that what was blamed on subprime borrowers in 2007 responsible for losses of around US$150 billion has ballooned to a rescue package that the US Government has spent, lent or committed to the rescue of financial institutions of US$13.2 trillion as of 19 June 2009[4].   The Federal Reserve Bank’s analysis of the US commercial banks profits from 1999 to 2008 is eye opening[5]. In 2008, the ten largest US banks increased their concentration from 35.6% of net consolidated assets of the US banking system in 1999 to 53.9%, growing their asset size by 3.2 times compared with 2.1 times for the banking system as a whole.  Last year, when the banking system suffered hugely on profits and investors had to bail out many banks by injecting substantial capital, the amount of salaries and benefits for the top ten banks declined from 1.59% of net consolidated assets in 1999 to 1.27% in 2008[6], but in absolute terms increased 2.4 times over the same period from US$30.8 billion to US$74.9 billion.  Note that cash dividends to shareholders declined from 0.79% to 0.28% of net consolidated assets during the same period, but increased marginally from $15.3 billion to $17.5 billion. 


            In other words, in the midst of the worst crisis of 2008, the employees in the top 10 banks took home 4.28 times more than shareholders did, when shareholders took most of the hit and the government guaranteed all the deposits.   Although I have not had access to the data, I would not be surprised that the same trend may be present in many of the non-US global banks.  To put it mildly, it was management that took a large chunk of gross profits, whereas the shareholders and the taxpayers bore the brunt of the risks and losses.  In free market economies, most failed firms would have employees being sacked, laid-off or facing much reduced salaries.  You tell me if this is equitable.


            But this was not supposed to be how the moral philosopher Adam Smith envisaged the benefits of the Invisible Hand working through the market for the greater public good.  If we were to construct a matrix of public/private sector type of governance (Table 1), we would see that there are four types.  Adam Smith’s ideal situation is Type 1, private sector for self-interest that is supported and kept in check by Type 4, a selfless public sector working solely for the public good.  But in the real world, we have seen enough examples of Type 3 Governance, where the public sector is working mostly for bureaucratic interests, resulting in at best unending turf wars, gaps and overlaps in delivery of public services and at worst, corruption.  Recently, we had an example of how frustrating it can become when the US Treasury Secretary had to tell his financial regulators at a stormy meeting that ‘enough is enough’ to end the turf wars and refusals to give up jurisdiction, including lobbying against the reform plans[7]. 


            The worst type of situation is when Type 3 is captured by Type 1, which means that the only way to check such behaviour is to have countervailing power through civil society  (Type 2) and appeal to the higher morality of public service (Type 4).


              Table 1:  Taxonomy of Private/Public Governance





1 – Private Greed for Self-Interest

2 – Private Action for Public Interest (civil society)


3 – Public Sector for Bureaucratic Interest

4 – Public Sector for Public Interest 


            Before discussing what G20 can do, we have to examine the issues confronting global governance.  The World Economic Forum, which is engaged on a “Global Redesign Initiative”, recognizes that the world has become much more complex and bottom-up, with a major power shift from North to South and from West to East.  There is greater recognition that one needs a holistic approach, with multi-stakeholder engagement and awareness that you cannot solve complex global issues without ecological and social sustainability. 


            As European social scientists and policy analysts Benner, Reinicke and Witte recognized, “we are faced with on the one end the persistence of greater power politics, unilateralism or ‘multilateralism á la carte’ (Richard Haass) and outright state failure, on the other end the emergence of new forms of governance along the public-private frontier.  International organizations are caught in the middle trying to reinvent themselves in a changing world[8].”   Global institutions face four operational and participatory asymmetries. The operational gaps are the jurisdictional gap between global public goods (and needs) and disexternalities that extend beyond the legal powers of nation-states; the temporal gap between need for timely action and long-term inter-generational sustainability solutions; the complexity of public policy issues that have profound economic, ecological, political and security effects on a cross-border basis; and the contradiction between market-reinforcing agreements (e.g. WTO) that concentrate power versus equitable standards, such as human rights, environmental and labour issues.


            The participatory gaps exist in the areas of growing income and wealth inequality arising from globalization; and also the demand from NGOs to be heard on global issues, with increasingly moral, financial and knowledge resources.


            In short, G20 must confront all these issues of global governance fairly and squarely to have any meaningful impact. 

[1] Andrew Sheng (2009), The first Network Crisis of the Twenty First Century: A Regulatory Post-Mortem, Economic and Political Weekly, India, Special Issue on Global Financial and Economic Crisis, March.

[2] Frithof Capra (1982), The Turning Point: Science, Society, and the Rising Culture, Simon and Schuster, Bantam Paperback, Chapter 1.  I am grateful to Dr Lim Mah Hui for pointing out this reference.  

[3] Frithof Capra and Hazel Henderson (2009), Qualitative Growth, The New Economy, Summer, available at

[4] Bloomberg Markets, August 2009, “Now’s It’s $13.2 Trillion”, p.13

[5] Federal Reserve Bulletin, Profits and Balance Sheet Development at U.S. Commercial Banks in 2008, Board of Governors of Federal Reserve System, Washington DC June 2009, pages A57-97.

[6] Fed, op.cit. Table A.1, page A87-90.   I am unclear whether share option values are included in salaries and compensation.

[7] Damian Paletta and Deborah Solomon, Geithner Vents at Regulators as Overhaul Stumbles, Wall Street Journal, 4 August 2009. 

[8] Thorsten Benner, Wolfgang H Reinicke and Jan Martin Witte, Multisectoral Networks in Global Governance: Towards a Pluralistic System of Accountability, Government and Opposition Ltd, 2004.


About kchew

an occasional culturalist
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