The Finance Curse. Nicholas Shaxson
real world.7 And for a long time it didn’t take off. Political centralization was in vogue, so nobody cared much for theories about local politics, and the media usually brought up local government only in the context of desegregation, incompetence, or corruption. The story might well have ended there—and for Tiebout it did: he died of a heart attack in January 1968, aged forty-three.
When the world finally started to wake up to Tiebout’s paper, the year after his death, it would kick off a debate about one of the most important questions in the modern global economy: What happens when rich people, banks, multinational firms, or profits shift across borders in response to different incentives like corporate tax cuts, financial deregulation, and so on? When states “compete” by offering incentives like corporate tax cuts, is this a good thing, or the recipe for an unhealthy race to the bottom, as states scramble to offer ever-bigger incentives? In this debate, Tiebout’s ideas would be magnified and distorted, then wielded to support arguments that this kind of “competition” is a good thing. And these arguments, in turn, would serve as the ideological underpinning for a wide range of harmful policies that generate the finance curse. Which is not what the leftist Charles Tiebout would have wanted at all.
History shows that inequality usually gets properly upended only after large, violent shocks.8 For Tiebout’s generation, it was World War II that provided the shock. The financial crisis and Great Depression of the 1930s had discredited the old certainties of free trade, financial deregulation, and laissez-faire economics that had given the market saboteurs like Rockefeller and the Vesteys such freedom to operate. Workers who had spilled their blood on the battlefields of France were in no mood to pander to moneyed elites anymore; they wanted their countries to give something back to them. The end of the war in 1945 provided a unique political opening to put into practice the progressive, revolutionary ideas of the British economist and polymath John Maynard Keynes.
Keynes knew that finance had its uses, but he knew that it could also be dangerous, especially when it was allowed to slosh around the world at will, unchecked by democratic controls. If your economy is open to tides of global hot money—rootless money not tied to any particular real project or nation, that is—then it is harder to pursue desirable policies like full employment. This is because if you try, for instance, to boost industry by lowering interest rates in a country that is open to flows of financial capital, then money will simply sluice out, looking for better returns elsewhere. Capital will become scarcer; the value of the currency will tend to fall; and interest rates will be forced up again. If governments wanted to act in the interests of their citizens, Keynes knew, there was no alternative but to curb those wild, speculative flows. “Let goods be homespun whenever it is reasonably and conveniently possible,” he famously said. “Above all, let finance be primarily national.” Keynes carefully distinguished between cross-border trade, which was often beneficial, and speculative cross-border finance, which he knew was far more dangerous. It wasn’t just governments at risk; the great crash of 1929 had exposed how cross-border speculative flows could wreak havoc with the private sector too. “Experience is accumulating,” he added, “that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.” If distant foreign financiers control your business, he was saying, the damage is likely to outweigh whatever profits might emerge.
Keynes’s ideas about the dangers of cross-border finance carried such intellectual force that by the time World War II got under way they had become mainstream wisdom. Governments and general public opinion accepted that if countries were to avoid a repeat of the economic and military horrors that had occurred in recent years, they were going to have to transform the global financial system. So in 1944, under the intellectual guidance of Keynes and in the dominating presence of his US counterpart Harry Dexter White, the world’s most advanced countries got together at Bretton Woods in New Hampshire and hammered out an agreement to set up a global system of negotiated cooperation, to curb flows of financial capital across borders and to protect countries from these destabilizing tides of hot money. The system had a shaky start: from 1945 to 1947 Wall Street interests forced through a brief financial liberalization, which caused huge waves of capital flight from war-shattered Europe, as rich Europeans sent their wealth overseas to escape having to pay for reconstruction. But fears of a communist takeover in Europe soon focused policy makers’ minds, and the system was at last given teeth.
Bretton Woods was a remarkable arrangement and almost unimaginable today. Cross-border finance was heavily constrained, while trade remained fairly free. So cross-border financial flows were permitted if they were to finance trade, real investment, or other accepted priorities, but cross-border speculation was discouraged. A vast administrative cooperative machinery was set up to make the system work, to prevent destabilizing flows of hot money, and to open space for war-shattered democratic societies to put in place progressive policies. In his book Moneyland, the British writer Oliver Bullough uses the image of an oil tanker as a metaphor for the system. If it has just one huge tank, the oil may sluice back and forth in ever-greater waves until it knocks the vessel over. But if divided into many smaller, separate compartments—each compartment being analogous to a country in the Bretton Woods system—the oil could shift about a bit inside each compartment “but would not be able to achieve enough momentum to damage the integrity of the entire vessel.”9
One of the overall aims of this giant global safety mechanism was, as US Treasury secretary Henry Morgenthau famously declared, to “drive the usurious moneylenders from the temple of international finance.” Another related goal was to keep Europe growing and keep communist influences out. Curbing finance was then—and should be today—treated as a matter of national security.
The Bretton Woods system was leaky and troublesome, but it held together for roughly a quarter century after World War II. With finance bottled up in its national compartments, governments felt free to act in their countries’ best interests, without fear that all the money would flee overseas. Taxes for the wealthy were high, sometimes very high: average top income tax rates fluctuated around 70–80 percent in the United States between the 1950s and 1970s (and in Britain, having reached 99.25 percent during the war, stood at 97.5 percent for most of the 1950s, falling to 80 percent only in 1959). Domestic financial regulations were amazingly robust too: the New Deal in the United States, combined with vibrant anti-monopoly laws, split up mega-banks and hedged bankers with all kinds of restrictions. Massive government-led technological developments during the war were also unleashing waves of industrialization, and governments continued to invest aggressively in research considered too risky for the private sector.10 Health services and government-funded welfare provision blossomed across the Western world; labor unions were mighty; and developing countries successfully nurtured infant industries behind trade barriers. It is hard to imagine now, but investment bankers weren’t paid outrageously more than teachers.11
Amid all this massive, coordinated government intervention and in some cases astonishingly high tax rates, economic growth in both rich and poor countries was collectively higher—much higher—during this period than in any other age of human history, before or since. Western economies grew at an average 5.5 percent a year during 1950–73: astonishing by modern standards. Trade flourished, even as speculative capital flows were repressed. The era is now often known as the Golden Age of Capitalism.12 As growth powered ahead, economic inequalities fell, inflation was tamed, debts shrank, and financial crises were small and infrequent. The history books are full of references to France’s trente glorieuses (glorious thirty), Italy’s miracolo economico (economic miracle), Germany’s and Austria’s Wirtschaftswunder (economic wonder), and plenty of others. “Most of our people have never had it so good,” purred British prime minister Harold Macmillan in 1957. “Go round the country, go to the industrial towns, go to the farms and you will see a state of prosperity such as we have never had in my lifetime—nor indeed in the history of this country.”13 Growth in developing countries picked up too. This was the American dream on a global scale. Rebuilding after the destruction of war was a part of the story, to be sure, as was a large shift of women out of unpaid work at home into the paid workforce, but controlling global financial flows was an essential ingredient, preventing crises and speculative attacks on countries that