Charlie McCreevy, the European Union's commissioner for financial services, let the cat out of the bag this month when he confirmed the EU was "strengthening its existing regulatory contacts on financial services" with the United States, Japan, China, Russia and India. His officials are already drafting a new set of international rules on credit rating agencies with their U.S. counterparts.
Moreover, the EU is pushing for what McCreevy calls "well targeted and robust internal governance reforms" on the whole credit rating system. This would include statistical modeling, monitoring their quality and redrafting the way they are paid and financed to avoid conflicts of interest, and the imposition of "an appropriate corporate culture."
This sounds as dry as dishwater. It isn't. In the wake of the subprime mortgage disaster and Wall Street's financial crisis, a new era of regulation is upon us. And this time, it will be global rather than national in scope.
It has been a pretty good 30 years since Margaret Thatcher in Britain and Ronald Reagan in the United States began campaigning for an end to the previous era of social democratic and moderately left-wing governance that had prevailed since the end of World War II. This was the era that brought about Europe's welfare states and America's "great society," with high taxation, powerful labor unions and a highly intrusive government role in strategic planning for the economy.
That era ended with Thatcher and Reagan. Taxes fell. Free trade pacts were agreed and tariffs slashed. Government-owned enterprises were privatized. Union membership declined sharply. Inflation was tamed. Innovation and entrepreneurs were encouraged, and successful risk-takers were not just allowed to keep most of their rewards but were hailed and praised as role models.
Globalization was promoted and accelerated, and currency controls were slashed. The Soviet Union collapsed. China thrived under its own form of statist capitalism. More people emerged from poverty into the new global middle class than ever before in history.
Thatcher's Britain stopped declining and steadily overtook the economies of Italy and France and found last year that it had a higher GDP per head than either Japan or Germany. And the U.S. economy is now about one and a half times larger, allowing for inflation, than it was when Reagan was elected.
The 30-year era of free trade and free markets is now ending. The immediate cause of its demise has been the financial crisis and the demand for more regulation of the financial markets.
The underlying causes are even more potent. The first is demographics. Led by Europe and Japan, the world's population is aging fast. In 1998 for the first time, the number of people over 60 in the developed world exceeded those below the age of 15. In about 30 years from now (on current trends), that majority of the elderly will apply to the whole human population.
That means that pensions and health costs for the elderly are going to grow very sharply, and that will mean more taxes and an ever greater role for the state in collecting and redistributing income.
The second underlying cause is that the losers from the globalization process are winning the political battle over the far greater number of beneficiaries. Well-organized and vocal opponents of free trade in the G8 countries have managed to delay and weaken and virtually sabotage the Doha Round of the world trade talks. Even the most obviously benign and useful bilateral free trade agreements, like the one with Colombia, are blocked in the U.S. Congress. In the EU, the world food crisis has provided the French and their allies with the perfect cover to block any further attempts to reform the dreadful Common Agricultural Policy.
The third underlying cause is climate change. Globalization has produced so many more consumers of oil and food and water that the biosphere is straining to cope. The fact that both U.S. presidential candidates support a cap-and-trade system to tackle climate change means that a Kyoto 2 is now very nearly inevitable. This again will mean more regulation, more taxation and not just greater power for government but a much more prominent role in setting industrial strategy.
Shortages of food and water and other resource constraints are likely to have a similar effect. The era of big government is back.
Maybe this is no bad thing. The excesses of the Reagan-Thatcher era, from the ridiculous pay of financial manipulators and hedge fund hustlers to the erosion of the manufacturing industry in the United States and Europe, have exacted a toll in public opinion. The Anglo-Saxon economic model looks rather less impressive today than it did in the Clinton-Blair years. A free market does not yet seem to be much use in tackling the demographic challenge or climate change.
Maybe it was inevitable. There does seem to be a 30-year cycle in operation. We have had 30 years of free market monetarism led by economist Milton Friedman and central banker Alan Greenspan. That was preceded by 30 years of welfare statism led by economist Lord Keynes and accommodating central bankers. And that was preceded by 30 years of orthodox economics led by the Bank of England's Montagu Norman and the Smoot-Hawley Tariff Act that brought us protectionism and the Great Depression.
The next stage is upon us. There will be more powers to the states, and probably more international regulation and governance, more managed trade and more government intrusion. If we are lucky, this coming era may even resolve the challenges of climate change and the looming pension and healthcare crises. But sometime around the year 2040, the conventional wisdom will change and the cycle will turn again.