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85
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
Jurnal Ekonomi Malaysia 46(1)(2012) 85 - 100
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter,
Perez, and Minsky
(Mekanisme Krisis Kewangan dalam Pertumbuhan dan Keruntuhan: Hammurabi, Schumpeter,
Perez, and Minsky)
Erik S. Reinert
Universiti Kebangsaan Malaysia
Tallinn University of Technology
ABSTRACT
This article provides a historical and theoretical overview of the mechanisms leading up to financial crises and
financial bubbles. It suggests that the potentially explosive growth of the financial sector at the expense of the real
economy fed by compound interest has – since before Ancient Mesopotamia under the rule of Hammurabi – represented
a real threat for such crises. A more modern and additional factor that builds up crises is Joseph Schumpeter’s
observation of the clustering of innovations. Carlota Perez has more recently developed Schumpeter’s vision into a
theory of techno-economic paradigms which – about midway in their trajectory – produce a build-up to financial
crises. The theories of Schumpeterian economist Hyman Minsky, which describe the mechanisms leading to the
collapse of financial bubbles, complete the overview. The article ends with recommendations to bring the West out of
the present crisis by –once again – putting the real economy, rather than the financial economy, in the driver’s seat of
capitalism.
Keywords: Carlota Perez; financial crises; Hammurabi; Hyman Minsky; innovations; John Maynard Keynes; Joseph
Schumpeter
ABSTRAK
Artikel ini memberikan gambaran secara keseluruhan dari sudut sejarah dan teori mengenai mekanisme yang
membawa kepada krisis kewangan dan bebuih kewangan. Ia menyarankan bahawa potensi pertumbuhan yang
sangat tinggi dalam sektor kewangan yang mengorbankan situasi ekonomi sebenar melalui penggunaan faedah
kompaun - sejak sebelum Mesopotamia Purba di bawah pemerintahan Hammurabi –merupakan suatu ancaman
sebenar terhadap krisis berkenaan. Suatu faktor tambahan dan lebih moden yang membentuk krisis adalah berkaitan
pandangan Joseph Schumpeter mengenai pengkelompokan inovasi. Carlota Perez baru-baru ini telah
mengembangkan pandangan Schumpeter tersebut menjadi sebuah teori paradigma tekno-ekonomi yang mana –
masih dipertengahan usaha mereka–telah menyumbang kepada berlakunya krisis kewangan. Teori-teori ekonomi
Hyman Minsky Schumpeterian, yang menerangkan mekanisme yang membawa kepada runtuhnya bebuih kewangan,
telah melengkapkan pandangan ini. Artikel ini diakhiri dengan cadangan untuk membawa Barat keluar dari krisis
yang berlaku – sekali lagi – dengan menjadikan ekonomi benar sebagai peneraju kepada kapitalisme, dan bukannya
ekonomi kewangan.
Kata kunci: Carlota Perez; krisis kewangan; Hammurabi; Hyman Minsky; inovasi; John Maynard Keynes; Joseph
Schumpeter
INTRODUCTION
Financial crises occur when the relationship between the
real economy (the total production of goods and services)
and the financial economy (money in the widest sense)
comes out of balance in such a way that the financial
economy no longer primarily supports the real economy,
but takes on an independent life of its own in such a way
as to damage the real economy. Modern economics
(neoclassical economics, standard textbook economics,
mainstream economics) accepts such an imbalance
between the real economy and the monetary sphere when
it comes to inflation and deflation, but not when it comes
to financial crises. This is in sharp contrast to other kinds
of economics – the experienced-base type of economics
referred to as ‘The Other Canon’ – that traditionally have
understood and still understand crises, but have been
marginalized.
Financial crises represent imbalances which – in
contrast to inflation and deflation – are not immediately
visible in the consumer price index as rising or falling
prices, but rather in the form of asset inflation and debt
86 Jurnal Ekonomi Malaysia 46(1)
deflation, which have very important impacts on income
distribution. The assets, in which massive incomes from
the financial sector are invested, will experience an asset
inflation.On the other hand, the falling levels of prices
and wages that result from the crises will result in debt
deflation, a continually rising real quantity of outstanding
debt.
The transfer of income and assets from the real
economy to the financial economy is the most important
long-run effect of a financial crisis. If these imbalances
are not addressed by making big investments in the real
economy, any recovery – in that case by definition weak
– will be driven by demand from the financial sector and
the losses in the real economy may be permanent. This is
now occurring in the US and in Europe, where the EU’s
‘internal devaluations’ in the Baltic in some places have
reduced real wages by up to 50 per cent, while at the same
time unemployment is alarmingly high.
If the financial imbalances in the EU periphery had
been addressed by a traditional formula of debt
cancellation and devaluation – which was successfully
done in Argentina about ten years ago – this would have
penalized the financial economy, but in the long run
supported the wage level. In the case of the Baltic
countries, this would have meant letting the (mostly
foreign) banks and the financial (real estate) side of the
economy take the losses, while saving the production
economy. Instead, Europe made the decision to ‘save’
the financial economy in the short run, which is likely to
permanently destroy the wage level. This is why Martin
Wolf of the Financial Times is of the opinion that a
possible recovery will be a ‘yacht and mansion’ recovery.
This article argues that the way the problems of the
financial crisis are being solved – under the general
heading of austerity – will lead to a permanent domination
of the economy by the financial sector at the expense of
the real economy, citing examples of similar developments
in Latin America in the 1970s and in the former Soviet
sphere in the 1990s.
FINANCIAL CRISES WERE UNDERSTOOD
FROM LEFT TO RIGHT – BUT UNLEARNED ALL
ALONG THE POLITICAL AXIS
The interesting thing is that once upon a time financial
crises were a well known and well understood
phenomenon along the whole political axis. Karl Marx
wrote about them (volume 3 of Das Kapital), and Lenin
said that control of the financial economy represented
the last stage of capitalism. In the theories of the Austrian
social democrat Rudolf Hilferding, financial crises were
once a social democratic strongpoint. Joseph Alois
Schumpeter and John Maynard Keynes – possibly the
most important theoreticians on financial crises – were
politically conservative, and the most important
Norwegian representative, Torkel Aschehoug, was head
of the conservative party. Even though the present loss
in the real economy in favor of the financial sector ought
to be extremely important for any government, it is still
barely visible on the political agenda. Contemporary
economics – compared to earlier times – has important
blind spots regarding the role of the financial sector, and
these blind spots also transfer to the perspective of
politicians.
Earlier terminologies, which understood and
described the mechanisms of crises, are now largely
lacking. Lately, some economists, particularly in the US,
have ‘rediscovered’ some of the old theories, such as
Irving Fisher’s ‘debt deflation’. However, as this paper
argues, many more basic mechanisms and insights should
also be rediscovered.
To understand financial crises, terminology
distinguishing between the financial economy (what
Schumpeter called ‘die Rechenpfennige’, the ‘accounting
units’) and the real economy (the production of goods
and services, Schumpeter’s Güterwelt) is necessary (See
Figure 1). The family tree of today’s mainstream
economics, originating in the late 1700s with Quesnay
and the Physiocrats, and continuing with the English
economics of David Ricardo (1817), did not consider
monetary or financial sectors and are therefore generally
blind to financial crises, abstaining from studying the
relationship between the financial sector and the real
economy. In the alternative tradition, The Other Canon in
my terminology, this difference has always been important.
Starting with the Anti-Physiocrats, who tried to stop the
free trade and resulting speculation leading up to the
French Revolution, The Other Canon type of economics
– where distinguishing between the financial economy
and the real economy is a key feature – dominated after
the 1848 revolutions. However, as this historical and fact-
based economic theory virtually died out after World War
II, with it the crisis theories also disappeared along the
whole political axis. Under the assumption of perfect
competition and in the absence of any conflicts between
the financial sector and the real economy, neoclassical
FIGURE 1. The Real Economy and the Financial Economy as
Different Spheres
The Circular Flow of Economics
The real economy
“Güterwelt” Financial economy
“Rechenpfennige”
“Black Box”
Production of
goods and
services
Money capital
87
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
economics models the market economy as a machine
where friction is absent: a machine creating automatic
harmony. The theories, handed down from Ricardo, do
not contain the categories to make possible the
understanding of crises. As Thomas Kuhn puts it: ‘A
paradigm can, for that matter, even insulate the community
from those socially important problems that are not
reducible to the puzzle form, because they cannot be
stated in terms of the conceptual and instrumental tools
that the paradigm supplies’. This is precisely what
happened to the neo-classical paradigm in economics.
THE HAMMURABI EFFECT AND ‘DEBT
DEFLATION’
The simplest model for understanding imbalances
between the real economy and the financial economy
originated in Mesopotamia under Hammurabi (2030-1995
BC). Claiming that the roots of civilization were found
here is indeed more than an empty phrase.
Hammurabi’s economists calculated that due to
compound interest, the financial economy would increase
far more than the real economy would be able to absorb.
Following normal bookkeeping principles the assets of
the financial economy would have their counterparts as
liabilities, debt, in the real economy. English economist
Richard Price (1769) expressed the force of compound
interest, the force that accumulates assets in the financial
sector and corresponding debt in the real economy, as
follows:
A shilling invested at 6% interest at the birth of Christ would ...
have increased to an amount (gold) larger than could be contained
in the whole solar system, if this is constructed as a sphere with
the diameter of Saturn’s bane around the sun.
As someone must obviously have invested 1 shilling
at the time of the birth of Christ, this means that any
system permitting compound interest must necessarily
break down at intervals: the real economy would drown
in debt and people would be reduced to debt peonage.
Hammurabi and his advisors took the consequences of
this, and with irregular intervals (If the time of debt
cancellation was known beforehand, people would
speculate in the expected event)cancelled all debt (except
short run commercial debt) to avoid the death of the real
economy due to ever increasing debt. In the Old
Testament we still find references to this system. The
years when debts were cancelled were referred to as the
Jubilee Years.
Money and gold are conceptually different from the
goods and services that can be acquired with the
purchasing power they represent. History is filled with
warnings against what has been called chrysohedonism,
confusing money with what money can buy. The legend
of King Midas relates how he was granted his wish that
whatever he touched should be turned into gold, only
later to discovered that this was a curse because even his
food turned into gold. This is a brilliant example of the
danger of confusing riches of money and gold with riches
of ‘goods and services’. Without the Jubilee Years, the
financial sector would end up as a King Midas, with loads
of money and gold, but with a real economy extremely
weakened – or dead – because of the burden of debt.
This is the track we are on now.
The Bible (Matthew 25, 14-30) tells us that coins,or
‘talents’, should not be buried, but invested. In the mid-
1300s, early money theorist Nicolas Oresme complained
about too much money ending in treasure chests instead
of being productively invested. This is not why we created
money, he wrote. Around 1600, Francis Bacon wrote that
money is like manure, only useful when spread.
Throughout the whole history of civilization, we find as a
red thread that the ‘financial sector’ is only useful when
invested in the real economy.
The Muslim prohibition against interest, referred to
as riba, and the Christian prohibition against charging
interest up until the 1600s must be seen in this perspective.
Amassing fortunes without lifting a finger was seen as
qualitatively different fromearning money by ‘honest
work’, commerce and production. When Western
Christianity in the early 1600s started to allow collecting
interest, this was with a view – as Francis Bacon’s – of
the importance of innovation. Innovationsrequired risk
capital, and the acceptance of lending out capital against
interest seems to have coincided with the discovery of
the role of innovations. Western economists at the time
argued that interest was necessary because of the huge
amount of capital that was often needed in order to finance
new ventures. Capital became, in the words of Keynes, ‘a
bridge in time’, as something financed today may last for
a very long time.
Here it is important to understand Schumpeter’s
theory of capital: if nothing new happens in the world
(innovations) capital is theoretically without value. If we
again look to the bookkeeping perspective – which is
absolutely necessary to understand financial crises – all
investments in a world without innovations could be
covered by depreciation. The innovations give value to
capital. Capital in itself is sterile (cf. the examples of King
Midasand that of the buried talents (Matthew 25, 14-30)
refrred to above.
Financial crises occur when the financial sector stops
functioning as a bridge in time for the real economy and
starts earning money on itself through the use of pyramid-
scheme type constructions. We shall discuss this in the
section on Hyman Minsky. In the inter-war period German
discourse sharply distinguished between schaffendes-
Kapital (capital employed in the creation of goods and
services) and raffendesKapital (capital that only
accumulates more capital without creating anything).
Today, American economist Bill Lazonick differentiates
between wealth creation and wealth extraction. In his
Treatise on Money (1931), Keynes sees depression
88 Jurnal Ekonomi Malaysia 46(1)
approaching when money goes from being in industrial
circulation to being in financial circulation. Some years
later, in 1936, another conservative Englishman, later
prime minister, Harold Macmillan, complained that his own
party was dominated by casino capitalism.
Even if Lenin, as above mentioned, concluded that
financial capital taking command over the system would
mark the final stage of capitalism (it would presumable
collapse for lack of demand, as we presently witness in
Greece), skepticism towards the financial sector – the
whole banking system – has been great also among
conservatives. Thomas Jefferson, the most conservative
of the US founding fathers, was also the one most critical
towards banking and finance. To be conservative (rightist)
for Norwegian economist TorkelAschehoug meant that
he wanted to protect the real economy from devastating
speculations; to be a neo-liberalist (rightist) now means
to believe that the market cannot be wrong. In terms of
understanding financial crises, conservatives and
neoliberal find themselves in strong disagreement. For
conservative think-tanks to act as claques for the financial
sector is a completely new phenomenon. Neoclassical
economics and neo-liberalism have replaced the
conservative voices that have traditionally acted as a
bulwark against the excesses of the financial and
speculation economies. This will most likely make the
present crisis both deeper and longer lasting.
Conclusion: History has shown that to have a system
permitting compound interest makes financial crises a
certainty. Historian Reinholdt Mueller at the University
of Venice describes how the Venetian State in the 1200s
had to step in and save the whole financial system only a
few years after the first financial center had been
established. Capitalism had to be saved by the state right
at the start! Since then financial crises have been frequent
in capitalism, and – as illustrated in Figure 2 – are easy to
find by checking the quantity of books published about
economics and when. The first international financial
crisis in 1720 - which simultaneously hit the large financial
centers Paris, London, and Amsterdam – shows the same
pattern as today’s crisis.
The book This time is different. Eight Centuries of
Financial Folly, by Carmen Reinhart and Kenneth
Rogoff, gives us an historical perspective on financial
crises. However, the book contains more data than it
contains theory and analysis.
A symbol-filled illustration from one of the many
books published in 1720 – Figure 3 – shows a typical trait
of a financial crisis: a stock exchange project artificially
kept up by speculators. These are named ‘wind merchants’
because they buy and sell merchandise which can only
be bought and sold in a fantasy world, not in the real
economy.
HYMAN MINSKY
In contrast to Hammurabi’s model with two sectors, the
real economy and the financial sector, the American
Schumpeterian economist Hyman Minsky (1919-1996)
had other sectors: households and non-financial
activities, as well as financial intermediaries and
government. Recently, US economists have contributed
a more precise definition of what we can call the enlarged
financial sector: Finance, Insurance, and Real Estate: the
FIRE sector.
FIGURE 2. Number of Economics Books Published (1715-1723)
Source: Own calculations from the holdings of Kress Library, Harvard University
250
200
150
100
50
0
1715 1716 1717 1718 172117201719 1722 1723
Year
Number of economics books
published
89
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
Hyman Minsky built his theories on earlier insights
from Thorstein Veblen, John Maynard Keynes and Joseph
Schumpeter. A leitmotif in his carrier was that ‘it’ (i.e.
another financial crisis like the one in the 1930s) ‘can
happen again’. Minsky’s two important books were John
Maynard Keynes (1975) and Stabilizing an Unstable
Economy (1986). Both were, because of the financial crisis,
republished in 2008.
Like Schumpeter, Minsky says that innovations in
the financial sector differ from innovations in the rest of
the economy and that economies that have financial
innovations (which are both useful and necessary) will
necessarily have crises because financial innovations
make debts grow faster than the ability to repay these
debts (cf. Hammurabi). In other words the capacity of the
financial sector to generate funds through new
innovations exceeds the ability of the real economy to
absorb these funds in a profitable way, and such crises
move income and wealth to a class of rentiers whose
tendency to spend is lower than in the real economy (cf.
Martin Wolf’s yacht and mansion recovery). This way
the demand that is needed to help the countries out of
the crisis is not created. A typical example is demonstrated
by contemporary US economy. Real wages are roughly at
the level they were in the mid-1970s, which means that
most fruits of economic growth since that time has gone
to the FIRE sector. Any stimulation packages will not work
well unless the balance between the FIRE sector and the
real economy is adjusted.
One of Minsky’s important contributions was the
understanding of the ‘destabilizing stability’, a point we
see clearly already in Torkel Aschehoug’s writings: As
the good times seem to go on, the banks will take
increasingly greater risks. Finally,banks will finance
projects so speculative that they will not even be able to
serve the interest on the debt. Minsky called such loans
Ponzi schemes, and the subprime crisis matched this
description perfectly. Loans were granted to home owners
who could not even pay the interest on the loans. This
creates a bubble in the economy – an imbalance between
the financial economy and the real economy – which is
bound to burst. Understanding Minsky’s model it was
fairly clear that the Terra scandal – a scandal that virtually
bankrupted several Norwegian municipalities – might be
the start of a serious financial crisis (e.g. my article in
newspaper Dagbladet, November 26, 2007).
As Minsky wrote in 1964, ‘At present real estate
assets seem to be a more important source of financial
distress than stock exchange assets... real estate assets
are collateral for an extensive amount of debt, both of
households and of business firms, owned by financial
institutions... If the price of real estate should fall very
sharply, not only will the net worth of households and
business firms be affected, but also defaults,
repossessions, and losses by financial intermediaries
would occur.’
This 1964 paragraph is still an adequate description
of what happened during the last financial crisis. It is
important to note that in this perspective financial crises
are no ‘black swan’ – something happening surprisingly
and very seldom. Such crises are endogenous to the
technological selection mechanisms of the capitalist
system, forming an integral part of the relationship
between the innovation cycles in the real economy and
the innovations in the financial sector.
Minsky’s idea was that anyone can create money,
the only problem is to get that money accepted. Minsky
imagined a hierarchy – a pyramid – of different kinds of
money, organized by solidity and confidence. Before the
last financial crisis there were financial innovations that
– probably literally – no one understood, like mortgage-
based securities (MBS), collateralized debt obligations
(CDO), and credit default swaps (CDS). These financial
innovations, securitization, created a systemic risk, as
they created a debt significantlygreater than the system’s
capacity to repay. When the confidence in the less secure
financial instruments collapses during crises, people tend
to seek the more secure ones, such as cash and gold
(which Keynes called ‘a barbaric relic’).
My Chilean colleague Gabriel Palma (University of
Cambridge) has quantified the increasing imbalance
between the real economy and the financial economy in a
paper. Figure 2 of this paper shows the increase in the
balance between financial assets and GDP in the period
2002 to 2007, before the financial crisis. Here Schumpeter’s
and Minsky’s point is clearly illustrated: financial assets
FIGURE 3. Speculative Stock Exchange Projects That Cannot
Keep in the Air without Artificial Help
Source: Het grootetafereel der dwaasheid (‘The Great Mirror of
Folly’), Amsterdam 1720.
90 Jurnal Ekonomi Malaysia 46(1)
increased heavily compared to the size of GDP. In a country
like Spain financial assets as a percentage of GDP increased
from a little over 300% to more than 550% from 2002 to
2007.
Palma’s Figure 3 shows growth in GDP and growth in
the debts of households and non-financial business firms
in the US from 1950 to 2007. He shows that debt growth
and economic growth more or less kept pace until 1982,
after which point debt grew at a rate of 3.8% annually,
while GDP grew at a rate of 3.4%. In the period between
1982 and 1987, debt grew at a rate of 4.7% annually, while
GDP grew at a rate of 3.4%. In the period between 1988
and 2007, debt grew at a rate of 0.5% annually, while GDP
only grew at a rate of2.8%. This could not possibly go on
for long.
The moment when the market realizes that the
financial economy is a non-sustainable pyramid game is
now often called ‘The Minsky Moment’. Another name
is ‘The Wile E. Coyote Moment’ after the cartoon figure
who has rushed over the edge of an American canyon
and – in the moment he starts falling – realizes what has
happened.
CARLOTA PEREZ: FINANCIAL CRISES AND
TECHNOLOGICAL CHANGE
In his three-volume Social-Oeconomik (1905-1908),
Norwegian economist TorkelAschehoug points out the
fact that financial crises have their origins in technological
changes. Venezuelan scholar Carlota Perez has developed
this reasoning in a way, which in my view, is convincing
in her 2003 book Technological Revolutions and
Financial Capital: The Dynamics of Bubbles and Golden
Ages. As Perez herself points out in the introduction, The
Other Canon conference in Oslo in 1998, referred to in
footnote 1, was important for the development of the
theory. Her theories build on the works of Russian
economist Nicolay Kontratief (1892-1938) and Joseph
Schumpeter (1883-1950).
A main point in her theory is that technological
revolutions create new firms with high stock exchange
value. Through several hundred years, technological
revolutions have created financial bubbles, such as the
canal bubble the railroad bubble and, lastly, the IT bubble,
which burst in 2000. Such bubbles that are a result of a
new and revolutionary technology are useful, they seem
to be a necessary part of the dynamics of capitalism, and
serve to upgrade the whole production system of the real
economy.
But what we saw after the burst of theIT bubble was
bubbles that did nothing for the real economy, but, on
the contrary, weaken it. Figure 4 shows that before the IT
bubble burst, 60% of new companies on the US stock
exchanges were (IPO = Initial Public Offering)
technological companies (ICT = Information and
Communication Technology), while only 10% were
companies from the financial sector. In 2003 the roles were
changed: 60% of all new companies on the stock exchange
were financial ones, while only 10% were from the IT
field.To Perez, the rational increase in stock prices of
companies with new and revolutionary technologies will
spread irrationally to hopeless projects and to pyramid
schemes in the financial sector (see Figure 3 and Figure
5). In times when capitalism functions well, the financial
FIGURE 4. Technology Bubble (‘Useful Bubble’) vs. Finance Bubble (‘Useless Bubble’)
Source: Carlota Perez
70%
60%
50%
40%
30%
20%
10%
0%
Percent of total initial public offerings
Major Technology
Bubble
Common financial
Bubble
Finance IPOS
Information and
communications
technology IPOs
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
ICT and finance IPOs as percent of total in US stock markets 1993-2007
91
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
sector and the real economy live in a kind of symbiosis -
they support each other. In times of crisis, the financial
sector becomes a parasite weakening the real economy.
What was rational (investing in new technology) gradually
becomes irrational (investing in pyramid games).
An early contribution to this literature was the book
‘Extraordinary Popular Delusions and the Madness of
Crowds’ by Charles Mackay, published in 1841. The
former head of the Federal Reserve, Alan Greenspan,
described this phenomenon as ‘irrational exuberance’.
Figure 5 shows how a cartoon author (Dilbert 1999)
understood the irrationality of the stock exchange bubble
a year before the burst of the bubble. Note the similarity
of this to the idea behind the drawing in Figure3.
Defending capitalism as being ‘rational’ has been a
serious hindrance for the economics profession’s
understanding of financial crises. The present Chairman
of the Federal Reserve, Ben Bernanke, wrote a book about
the 1929 crisis and the Great Depression. There he
mentions Hyman Minsky once, but just in order to dismiss
him because Minsky ‘had to depart from the theory of
rational economic behavior’. To be a ‘mainstream’
economist the last 30-40 years has meant not to accept
mechanisms that doubtlessly are very important in a
financial crisis because they were in conflict with the
fundamental assumptions of standard economic theory.
In this way even the people with the main responsibility
for handling the crisis have been isolated from the most
relevant theory of crisis.
It is quite clear that for a single individual earning
money in the financial sector, without at the same time
creating real economy values, the speculative build-up
towards a financial crisis is rational. The important thing
is to be close enough to the door to get out before the
rest when ‘the Minsky Moment’ strikes. That this should
be rational from the viewpoint of society is something
completely different. Here the markets fail and regulations
are needed. During Clinton’s presidency, and with Ayn
Rand pupil Alan Greenspan at the Head the Federal
Reserve, the very wise and well-built institutional defenses
against financial crises that had been erected after the
crisis of 1929 (Glass-Steagall Act) were removed. The main
argument for dismantling the defenses was that there were
no crises, so the defenses were not needed. The obvious
fact is that the regulations that were removed were indeed
the very reasons that there had been no crises.
The tulip bubble in Holland in 1636-1637 was also a
bubble, where the tulip bulbs from far countries – this
FIGURE 5. Finance Capital Goes Berserk during a Techno-Economic Paradigm Shift
Source: Dilbert cartoons, 1999 (the year before the stock market collapse)
92 Jurnal Ekonomi Malaysia 46(1)
was indeed an innovation – played the role of ‘new
technology’ (see Figure 6).
SAVE THE FINANCIAL ECONOMY OR SAVE
THE REAL ECONOMY?
Joseph Schumpeter was of the opinion that governments
should not intervene in a financial crisis, as such a salvage
operation would strengthen the very forces which had
created the crisis in the first place. The crisis should burn
out by itself. Today, we see the wisdom of that. But the
crisis became so serious that governments had to do
something, as Keynes suggested. But we see that
Schumpeter’s intuition on one level was correct: it is hard
to do this without encouraging new speculative bubbles.
The huge financial packages that were made to save the
real economy by saving the banks, effectively failed to
reach the real economy in many countries. At the moment
(2012), both banks and large corporations are left with
huge cash balances, while lacking demand and
consequently lagging investments are preventing a
healthy recovery.
Financial crises both create and are results of
imbalances. During the Bretton Woods-discussions,
Keynes suggested a ‘tax on imbalances’. As the world’s
imports must equal its exports, Keynes suggested an
international tax on export surpluses over a certain amount.
This would avoid international imbalances and prevent
some nations from savings glut – oversaving– while others
built up enormous debts. It would also serve as an
incentive for nations not to keep their exchange rates
artificially low, as China has been doing. The suggestion
was blocked, mainly by the US, but if Keynes had had his
will, the United States would today have been saved from
their own irresponsibility, saved from building up such
enormous debts to the rest of the world as they have
done.
Classical crisis theories operate with the terms
‘overproduction’ and ‘underconsumption’. An important
part of today’s financial crisis is the Global Savings Glut
(GSG). ‘Real’ saving may be said to occur when it is
matched by a dis-saving, in the form of investment or
consumption, as a bookkeeping counterpart In the
absence of investment or consumption, without a dis-
saving, saving becomes unproductive hoarding. The
Quantitative Easing – the creation of huge amounts of
money – on both sides of the Atlantic, matched with
austerity policies simultaneously reducing demand, are
creating the conditions that the Bible (idle ‘Talents’),
the Midas legend, Oresme and Lenin all warned against.
These all represent a wisdom which cannot seemingly be
captured by today’s mainstream economics, apparently
unable to perceive the financial economy as being
something other than the mirror image of the real
economy.
The lack of balance between the financial economy
and the real economy can only be solved by one party –
or both – being adjusted. One can choose to protect the
inflated financial sector, or protect the real economy. Often,
as during the Asia crisis, production units are left to go
broke to save the banks. The Argentine crisis at the end
of the 1990s ended up reducing real wages by more than
40%.The EU’s handling of the crisis shows us the choices.
The deficits in the PIIG countries (Portugal, Italia, Ireland,
and Greece) would traditionally have been solved by the
countries devaluating, so the local production systems
would restore their competitiveness. At the same time the
debt, traditionally often in local currency, would be
reduced, leading to a loss for foreign creditors.
The alternative to this is what is called internal
devaluation. This means that wages are pressed
downwards, without touching the exchange rate, while,
at the same time even, larger loans are taken up, to service
the debt. This will let the real economy take the whole
loss, while downward spirals of lessened buying power
and lessened national production start.
The Estonian example shows that these are
mechanisms that can also be initiated without the country
in question being in debt. The country has had an internal
devaluation reducing wages by more than 20%. Wages
have fallen for 9 quarters in a row and unemployment is
high. What gives food for thought is that such internal
devaluations now seem to also be the model for the larger
countries in the EC periphery. It seems likely that the
downward adjustment of people’s buying power – the
buying power of whole nations – may be permanent.
Traditionally it has been possible to differentiate
between two models for economic adjustments, the
European model and the American one. The European
model had adjusted exchange rates. In the US, the whole
country of course has the same currency. When one of
the states has an economic crisis, like Michigan with its
car industry, the adjustment mechanism is that people
move to other states. By not giving up the Euro to let
countries in crisis devaluate, Europe has in effect chosen
FIGURE 6. The Anatomy of a Bubble. The Tulip Bubble in
1636-37
Tulip price index
1636-37 Feb 3
Feb 5
Feb 9
Dec 12
Nov 25 Dec 1
May 1
Nov 12
200
150
100
50
93
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
the American model. Greeks will have to move to Germany,
even though neither Greeks nor Germans see this as an
optimal solution. Europe is probably not prepared for the
demographic movements which will be the result of the
ongoing crisis.
THE GROWTH OF THE FIRE SECTOR
DISPLACES THE REAL ECONOMY
We have earlier referred to Gabriel Palma’s article, which
shows the disproportionate growth in the financial
economy over the real economy. This is a phenomenon
that has already started in the 1970s in the economic
periphery of the world. The period from 1950 to 1973
registered the highest economic growth ever in the world,
but after 1973 there was a change in political economic
ideology that (consciously) led to a market and free trade
shock which again led to the FIRE sector taking over a
larger part of the total value of GDP at the expense of
wages and the income of the self-employed. Figure 7
shows the changes in GDP growth rates in certain
countries in the Second (ex communist) World and the
Third World.
Asia in general, but particularly China and India,
avoided this development because of what can be called
ideological inertia. While shock therapy and free market
logic became the fashion in the rest of the world, China
and India stuck to the same conscious industrial strategy
they had followed since the end of the 1940s. The markets
opened, but slowly.
THE FIRE SECTOR TAKES OVER: THE THIRD
WORLD
From the mid-1970s Latin America and Africa were the
victims of a so-called structural adjustment policy. In
several of these countries, real wages were more than
halved in a very short time. We shall take Peru as an
example. The structural changes led to a rapid fall in
wages, as a very quick opening up for free trade killed the
industry and weakened the unions.
Real wages were more than halved, but, on the other
hand, exports increased rapidly (see Figure 8).
The interesting thing here is that by looking solely
at GDP, things do not seem too bad in Peru.
However,Figure8 shows that the apparent export success
was combined with real wages being reduced by more
than 50 per cent. To Peruvians, globalization meant
maximizing foreign trade while cutting the standard of
living dramatically. This development would necessarily
dramatically change the composition of this GDP: the FIRE
sector has taken over an ever larger percentage of GDP
(Figure 9).
The data from Peru’s central bank show that in 1972,
wages represented 51.2% of GDP, and the income of self-
employed 26.5%, total 77.7%. Figure 9 shows how this
percentage fell with deindustrialization. In 1990, the last
year Peru’s central bank produced such statistics, the
wage portion of GDP was almost halved, while the portion
representing the self-employed had fallen to 15.9%. In
total wages and income of the self-employed had fallen
by 45% from 77.7% of GDP to 42.4%.
FIGURE 7. Economic Growth Falls Drastically, Except in Asia
Source: Rainer Kattel, Tallinn University of Technology
5
4
3
2
1
0
–1
–2
1820-1870 1870-1913 1913-1950 1950-1973 1973-2001
Africa
Asia (Japan
excluded)
Latin America
Eastern Europe
Former USSR
94 Jurnal Ekonomi Malaysia 46(1)
0
1
2
3
4
5
6
7
I spent much time in Peru during the time in which
wages were halved and saw poverty increase dramatically.
My wife commented that the same children outside the
Lima supermarket, who had usually begged for sweets,
now begged for canned milk and other food. To me, it has
always remained a mystery that this development was
not regarded as interesting and why such a dramatic theme
has not shown up on an academic or a political agenda.
With Europe’s internal devaluations, these same
dramatic mechanisms have started in Europe. We get a
permanent fall in wages and self-employed income as part
of GDP and in absolute numbers. In the short run, this can
look good for industry, as wage costs fall. However,
industry as a whole will suffer, as demand contracts
dramatically. In Peru, the halving of wages led to a brutal
closing down of newspapers (before the age of internet).
High wages are in many ways very important for
development because not only do markets grow through
higher demand,the rising cost of labor compared to the
cost of capital is a major force driving technological
development. With the wage reductions Europe now
experiences, we risk Hyman Minsky’s ‘financial fragility’
creating a ‘technological fragility’: Cheap labor is a
deterrent for investments in new technology.
FIGURE 8. Peru: Deindustrialization, Falling Wages and Increasing Raw Materials Exports
Source: (Reinert 2007:162)
FIGURE 9. Composition of GDP in Peru: The FIRE Sector Takes Over
Source: Banco Central de ReservadelPerú. These data have not been published after 1990
Peru 1950-1990, Composition of GDP
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1950 1950 1950 1950 1950 1950 1950 1950 1950
WAGES
SELF-
EMPLOYED
MUNICIPAL
TAX
PROFITS
100%
75%
50%
25%
0%
–25%
–50%
–75%
–100%
1960 1970 1980 1990 2000
7
6
5
4
3
2
1
0
White collar wages
Blue collar wages
Export
95
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
THE FIRE SECTOR TAKES OVER: THE SECOND
WORLD
In 2000, I was invited to a conference in Parliament in
Mongolia’s capital, Ulaanbaatar, and was asked to prepare
a report on the economic development of the country.
Again, I found the same pattern as in Latin America: real
wages were more than halved. The real interest level was
35%, which made it virtually impossible to start any
production, while there was much gain in moving money
into the country. This money was not invested in the real
economy. I was told that the high real interest was
necessary to avoid a financial crisis.
Figure10 shows the fall in production in a typical ex-
Soviet republic, Latvia. Production was more than halved,
but when this graph was made, in 1994, everybody
believed growth would return rapidly. Time has shown,
though, that most of the growth in the Baltic has actually
consisted of housing bubbles. Growth after 1994
demonstrates the same pattern as in Latin America: the
wage part has fallen.
Russia also shows a similar type of development
(Figure 11). Real wages were halved, but as Russian GDP
now gets closer to the 1989 level, income distribution is
totally different. Particularly interesting is the observation
that a strong overvaluation of the Ruble in the mid-1990s
FIGURE 10. The Latvian Economic Collapse after the Fall of the Iron Curtain
Source: Latvian Ministry of the Economy 1994
FIGURE 11. Russia: Halving of Production and Wages
Source: Reinert&Kattel 2010
0
20
40
60
80
100
120
50
70
90
110
130
150
170
190
210
01/92
07/92
01/93
07/93
01/94
07/94
01/95
07/95
01/96
07/96
01/97
07/97
01/98
07/98
01/99
07/99
01/00
07/00
01/01
07/01
Exchange rate (right axis), real wages and production, 1992-2001
Index of Industrial
Production, seaso
nally
adjusted, 2000 =
100
Index of
agricultural
production, seaso
nally
adjusted, 2000 =
100
Real average
monthly accrued
wages (based on
CPI), seasonally
adjusted, 2000 =
100
Real exchange
rate (against
US), DEC 95= 100
6000
5000
4000
3000
2000
1000
1990 1985 1990 1995 2000 2005 2010
At Constant 1993 Prices mln. LVL
LATVIA ECONOMIC DEVELOPMENT SOENARIOUS
Gross Domentic Product
17.3%
annual
increase
10.9%
annual
increase
8.1%
annual
increase
GDP actual curve
GDP hypotethetical
curve
Soenariofor the
year 2000
Soenario for the
year 2005
Soenario for the
year 2010
Index of Industrial
Production, seasonally
adjusted, 2000 = 100
Index of Agricultural
Production, seasonally
adjusted, 2000 = 100
Real average monthly
accrued wages (based
on CPI), seasonally
adjusted, 2000 = 100
Real exchange rate
(against US), DEC 95 = 100
96 Jurnal Ekonomi Malaysia 46(1)
is closely connected to the fall in production and in real
wages.
It is worth noting that democracy arrived in Russia
at the same time as real wages were halved. The ‘oligarchs’
who had the economic power earned their money in the
financial sector, while the real economy plummeted. A
revaluation of the Ruble made it easy to transfer the
oligarch’s booty from financial speculations abroad at a
very high value in dollars or pounds. But this reevaluation
at the same time weakened the production economy even
more, as Russian produced goods became very expensive
and imports became cheaper. As in many other instances,
the financial sector and the real economy have opposing
interests.
THE FIRE SECTOR TAKES OVER:
THE FIRST WORLD
The finance sector’s dominance over a significant portion
of GDP started in Latin America in the 1970s, hit the earlier
Soviet sphere in the 1990s, and is now badly affecting US
and Europe. The destructive effect of overrated currencies
is a common element for them all. The Euro, as a straight
jacket, sets off the same mechanisms in Greece and Spain
now as they did in Russia in the 1990s (see Figure 11), but
through internal devaluations.
Carlota Perez sees these as cyclical movements:
during financial crises, income is badly distributed; while
FIGURE 12. Part of Total Income in US Earned by the Top 1% of the Tax Payers
FIGURE 13. The Financial Sector as Part of US GDP
Share of top 1% ofincome earners (above $398.900 in 2007)
U.S. 1913-2007
25%
20%
15%
10%
5%
0%
Share of total income
1913
1916
1919
1922
1925
1928
1931
1934
1937
1940
1943
1946
1949
1952
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
97
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
in times when technological development hits the real
economy, income distribution improves (see Figure12).
Before the financial crises of 1928 and 2006, the wealthiest
1% of the tax payers possessed about 25% of the US’
total personal income. In times when technology and the
real economy are seen as important, this number falls to
about 10%. This will not happen without strong political
pressure, as with Roosevelt and his economists’ New
Deal in the 1930s. The kind of political pressure that was
built up during the crisis of the 1930s so far seems to be
missing in today’s crisis.
Figure 13 shows that the financial sector’s portion of
the GDP in the US is under 10%, while Figure14 shows
that the financial sector of the US has at times constituted
45% of the total income of the US.
documentary film TheInside Job. Another documentary
movie on the crisis, When Bubbles Burst (2012), bases its
understanding on the traditions emphasized in this paper:
Schumpeter, Keynes, Veblen, Minsky and Perez.
The counterweight to this understanding is found in
German and American traditionsprior to World War II.
This tradition was cross-disciplinary and covered
economic theory and money theory, finance, law,
philosophy, and political science, all within the same
volumes. Examples are Georg Friedrich Knapp’s The State
Theory of Money (1905), Georg Simmel’s Philosophy of
Money (Philosophie des Geldes), and Karl Elster’s The
Soul of Money (Die Seele des Geldes). Schumpeter
contributed to this debate with an article from 1917 (‘Das
Sozialprodukt und die Rechenpfennige’, roughly
translated as ‘GDP and the Accounting Units’) and his
book Das Wesen des Geldes (The Nature of Money)
written in the late 1920s, but not published until 1970.
Schumpeter draws the line between financial economy
(the Rechenpfennige, accounting units) and the real
economy (the Güterwelt, ‘the world of goods and
services’), concepts that are integral to understanding
financial crises (Figure 1).
The old American institutional school of economics,
founded by Norwegian-American Thorstein Veblen, also
made important contributions to the study of business
cycles and crises. Veblen – who predicted the crisis of
1929, but died a couple of months before it started –
sharply differentiated between people in ‘industrial
activities’ (‘engineers’) and speculators who peripherally
contributed to production. He viewed speculators as the
last remnants of the pirates and robber barons of earlier
times. In his classic bestseller, The Theory of the Leisure
Class (1899), Veblen ridiculed what he deemed a
completely unproductive class, and its rituals, which he
compared to the rituals of primitive races.
The US institutional school literally produced massive
volumes on financial crises. Veblen’s student, Wesley
Clair Mitchell, wrotea huge volume on Business Cycles.
Joseph Schumpeter moved to the US and Harvard in the
early 1930s, and his Business Cycles fills two heavy
volumes. Mitchell’s student, Arthur F. Burns, was the
last representative of the old US institutional school to
head the Federal Reserve, from 1970 to 1978. His
presidency was dominated by a financial crisis – the so-
called oil crisis – and, under Burns’ chairmanship, this
crisis was solved by saving the real economy, production
and real wages, at the expense of the financial sector
(through inflation and negative real interest rates). The
negative real interest rate forced money out of banks and
into productive investments.
In his 1949 book, The Veil of Money, Cambridge
professor Cecil Pigou described the seesaw of sequential
domination of the financial economy with corresponding
crises and the real and productive economy: ‘During the
1920s and 1930s ... money, the passive veil, took on the
appearance of an evil genius; the garment became a
CONCLUSION: THE MENTALITY THAT
CREATED THE CRISIS, ITS CONSEQUENCES
AND POSSIBLE REMEDIES
The crisis was made possible by an economics profession
that no longer differentiates between the financial
economy and the real economy. Influential economists
even came to believe that the financial economy was the
real essence of the economy. Larry Summers’, one of
Obama’s main advisors, favorite expressions is ‘Financial
markets do not just oil the wheels of economic growth.
They are the wheels.’ Summers is then getting close to
what we have called chrysohedonism, to confuse money
itself with what money can buy. The financial economy
became more real than the real economy. Important
economists’ close connection and common vested
interests with the financial sector have become a theme
in the discussions about the financial crisis, e.g. in the
Financial industry share of domestic profits
50
45
40
35
30
25
20
15
10
5
0
2001-I
2001-IV
2002-III
2003-II
2004-I
2004-IV
2005-III
2006-II
2007-I
2007-IV
2008-III
2009-II
Figure 14. Financial Industry Share of Total Income in US
98 Jurnal Ekonomi Malaysia 46(1)
Nessus shirt; the wrapper a thing liable to explode.
Money, in short, after being little or nothing, was now
everything... Then with the Second World War, the tune
changed again. Manpower, equipment and organization
once more came into their own. The role of money
dwindled to insignificance.” This tradition of qualitative
understandingsof economics disappeared with the
mathematization of economics after World War II. The
fact that it had disappeared made the coming crisis so
much harder to see and the consequences so much harder
to understand and remedy.
In old traditions, money was seen as created and
regulated by society’s law and order (German: Das
Geldistein Geschöpf der Rechtsordnung). The business
cycles of capitalism were seen as needing continuous
adjustment, not only of the interest, but also of the
reserves of the banking sector in relation to its loans. My
1970s textbook from the University of St. Gallen in
Switzerland taught students how the economy must be
fine-tuned throughout the business cycles by increasing
or decreasing the reserve requirements regulating the
banking sector. Under the ideological influence of
neoliberalism, these adjustments were stopped. The
reserve requirements were set very low, while the
leveraging and the risks of the global financial system
became correspondingly higher. The Basle process is now
readjusting this somewhat. But the reserve requirements
are still low and do not have to be fully adhered to until
2019, so ‘we’ll manage to have a couple of financial crises
before that time’, as Martin Wolf says. Even if regulations
tighten a bit, it is very clear that the financial sector is still
directing capitalism. As long as this situation remains, it
is hard not to expect the crisis to go on, and deepen.
If we take a look at how the crisis that started in 1929
was solved, it is clear that several theoretically radical –
though often politically conservative – economists, not
only Keynes and Schumpeter, played an important part.
It could be said that Schumpeter delivered the theory
explaining the crisis, while Keynes delivered the cure.
American economist Rexford Tugwell (1891-1979) was an
important adviser to Roosevelt and his New Deal. No
economists of that kind have any power today. There is
no conspiracy, but it seems clear that there exists a
powerful political group in the US with the goal to reverse
the New Deal reforms. The vested interests of this group
overlap with the interests of financial capital. If this group/
fraction is successful – as it seems to be – financial capital
will take over for a long time and the fall in real wages will
be permanent, in the developing world and in the
developed world.
The process of falling wages and an increasing FIRE
sector as a percentage of GDP described in this paper,
which started in the economic periphery in the 1970s,is
now found all over the world. The processes in the
periphery have been totally neglected and now, as the
Americans say, the chickens are coming home to roost.
The West itself is being overtaken by mistakes made long
ago and far away. The crisis theories presented in this
paper are based on observations of historical facts – what
I refer to as The Other Canon of Economics – and have
been marginalized by theories which tend to treat the
financial sector as a mere mirror image of the real economy.
Instead, in the Other Canon tradition, the financial sector
may abruptly change from being a faithful servant to the
real economy – living in symbiosis – to a parasitic monster
feeding on possibly permanent cuts in wages, production,
and human welfare, such as Greece is experiencing at the
moment. Capitalism needs purchasing power and to
remove so much purchasing power from the majority of
the population, as is now being done, will sooner or later
destroy capitalism as we have known it since World War
II. What we may be creating in its place is a kind of post-
industrial feudalism.
This artical is written from the point of view of an
oil-rich Norway. The financial crisis will probably force
Norway to reconsider the strategy behind the oil fund.
When visiting Oslo in 2008, Martin Wolf was already of
the opinion that the Norwegian oil fund was part of GSG,
The Global Savings Glut. Our first Nobel Prize winner in
economics, Ragnar Frisch, once wisely wrote something
which is not obviously understandable except in the
setting of a financial crisis, as experienced in the 1930s:
‘Savings from the point of view of an individual and from
the point of view of society as a whole are two entirely
different concepts. They ought to be distinguished by
using two different labels, not the same as now. This just
causes confusion. Society as a whole can only save
through productive investments’.
This is because financial savings in times of financial
crisis will easily lose much of their value. Norway’s first
reserve fund for a rainy day was established in 1904 and
invested in government bonds – which everybody
thought was the safest investment. Most of the
investments were lost during the crises following World
War I. Particularly during times of financial crisis,Ragnar
Frisch’s advice should be followed: More should be
invested in productive investments and less in financial
markets. When, sooner or later, the financial sector
receives ‘a haircut’ from nations defaulting on their debts,
while at the same time share prices fall because of
diminishing purchasing power (a result of falling wages),
part of the Norwegian oil fund will be lost. If the
mechanisms of financial crises are properly understood,
it is also easy to see that, in the long run, the oil fund
takes on the characteristics of ‘Monopoly’ money. There
are times when savings are counterproductive in all their
aspects and the wisest thing to do is to spend money
before it loses too much of its value.
The crisis in Europe will probably pass through the
same stages as the one in Argentina in the 1990s. Right
now we are at the stage of rigidly holding on to the
currency exchange rates, while wages are falling (in
Argentina this was an exchange rate at 1:1 with the dollar.)
Sooner or later the nations of the European periphery will
99
Mechanisms of Financial Crises in Growth and Collapse: Hammurabi, Schumpeter, Perez, and Minsky
have to do as the Argentines did, default and at the same
time devalue. When the crisis in Argentina was over, real
wages had fallen by 40%. The longer one waits, the worse
it gets, because the productive sectors of the crisis
economies are gradually destroyed over a period of time.
Markets dwindle and machines physically rust while the
best brains leave the crisis countries.
During the crisis of the 1930, selective protectionism
– so called Trade Wars – prevented a very uneven
outcome of the crisis among the developed countries.
This policy measure prevented a winner-takes-it-all
outcome where the developed world avoided being split
into one camp of winners and one camp of losing nations.
The Marshall Plan after World War II completed this work,
before Europe again could start growing under a
symmetrical free trade regime (among industrialized
countries at similar levels of development). Today the
mistaken idea that protectionism caused the crisis is
widespread and, instead of Trade Wars, the world is
embarking on Currency Wars. An important difference
between Trade Wars and Currency Wars is that while the
former primarily creates jobs, wages, and income in the
real economy, the latter primarily creates rents to the
financial sectors from bids and speculations. Trade Wars
aimed towards symmetrical industrial development are
infinitely superior to Currency Wars. This financial crisis
may represent a permanent blow to Western economies,
with Asia being the winner that takes it all.
The last period of big shifts in the economic ranking
between European states was the 1700s, when small city
states were forced to yield economic power to strong
nation-states. Venice and Amsterdam declined, while
England and France rose. Faced with a growing real
economy in Asia and, at home, a vicious circle of financial-
sector growth and productive-sector decline, the West
now has to choose between declining like Amsterdam –
relatively, but keeping a healthy productive sector – or
declining like Venice – declining absolutely, first losing
the productive sector and then the financial sector – in
order to become a museum. The former will requires the
resurrection of policy instruments which went out of
fashion in the 1970s and started the trend of falling real
wages: first in the Third World, then in the Second World,
and now in the First World: the West.
Capital – without possibility for investments – is
sterile. If the possibilities for investment are lacking,
amassing capital will be counterproductive and prolong
the crisis. The world economy is – as it was in 1929 – a
pyramid game or Ponzi scheme, which collapses under
increasing debt deflation if we do not maintain and
increase the speed of innovation in the real economy. In
the US, the GDP level from 1929 was not reached again
until mid-World War II. The US stock market did not regain
its 1929 level until the early 1950s. War is the ultimate
Keynesian machinery for investment and consumption
because it creates a situation where political and economic
worries about inflation disappear and enormous amounts
of money are invested and spent in the real economy.
The world does the opposite by over-saving, it dis-saves.
War is also an important driver for technological change,
because the state wants and demands products at the
limits of what is technologically possible, thus advancing
the frontier of knowledge.If these mechanisms are
properly understood, it is possible to invest more in the
real economy by declaring war against environment
pollution and old fashioned energy forms, while obtaining
the same economic boom that has always been the result
of conventional wars. Such massive investments in
renewable energy and green technology, in my view,
represent the only way out of the present crisis.
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Erik S. Reinert
Faculty of Economics and Management
UniversitiKebangsaan Malaysia
43600 UKM Bangi
MALAYSIA
