Category Archive: Analysis

  1. Investment and Decarbonization: Rating Green Finance

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    The Biden administration has committed the United States to cutting its carbon emissions in half by 2030 and achieving net zero emissions by 2050. The International Renewable Energy Agency (IRENA) estimates that the global transition to a low-carbon future will require $131 trillion in infrastructure investment by 2050.1 With the US share of global GDP and carbon emissions around 16 percent, a back-of-the-envelope calculation puts its gross financing needs at roughly $21 trillion—or 100 percent of GDP over the next three decades. In other words: approximately 3.3 percent of GDP per annum in investment has to be financed to achieve Biden’s commitments. But the climate-related financing promised by Biden’s twin infrastructure bills amounts to no more than $100 billion, or 0.5 percent of GDP per year over the next eight years.2 How is the rest going to be financed?

    In what follows, we propose that Congress should create a standalone public ratings agency that is insulated from both public and private institutions involved in green finance. The agency would be mandated to assess the economic viability and contribution towards decarbonization of project proposals. Their ratings would serve as a public signal for the state, investors, cities, and firms to back, fund, and undertake projects that are both viable and contribute significantly to decarbonization and resilience against climate change. Once there are reliable ratings, the United States can backstop private financing of green projects at scale, while conserving politically expensive tax dollars and maintaining financial stability. This strategy would unlock trillions of dollars in funding for green projects—going a long way towards closing the existing funding gap of $600 billion a year. Whatever institutional configuration emerges to fund the energy transition in the United States, an independent public ratings agency must be a pillar of green finance.

    Funding and building

    At the most fundamental level of analysis, we must distinguish between the financing and undertaking of green projects. A public authority may undertake a green project and finance it directly from tax revenue through a budget appropriation. Or it may finance it by borrowing the funds from private investors by issuing bonds and paying off the debt over time. Similarly, a private firm may undertake a green project and finance it directly from retained earnings, or through government subsidies, as envisioned in the “cash for clunkers” program. Or it may finance the project by raising funds from investors by issuing debt or equity. We thus have a basic typology of financing possibilities.

    Typology of green projects
    Public undertaking Private undertaking
    Public funding US creates a smart grid financed with tax revenue Car companies replace existing car fleet with EVs financed by federal subsidies.
    Private funding New York City builds a seawall by issuing municipal bonds. GM expands EV production capacity financed by issuing corporate bonds.

    Given the scale of the financing needs for true decarbonization, “all of the above” is the right solution to the problem of green finance. Different models of undertaking and funding are appropriate for different projects. Projects that are socially and privately rational can be undertaken by private actors and funded by private investors. Projects that have high social net present value but are difficult to monetize require either direct public investment or public subsidies for private undertaking. In either case, they can be financed directly by tax dollars or by issuing debt to private investors to be paid off with future tax revenue.

    Direct financing of public investment makes sense when the payoff from the investment is clear but only realized with a great time lag. Investments in childcare, education, and public health increase social welfare and even growth rates, but are unlikely to translate into higher revenues for fiscal authorities for decades. Replacing lead pipes, for example, will reduce health insults for children and make them into more productive adults, but the economic benefits of a generational increase in health outcomes will only show up in tax receipts decades in the future. Direct financing of public investment also makes sense when the goal is resilience, as in the case of seawalls. In fiscal terms, the investment pays off by preventing a future fall-off in revenue—seawalls prevent the collapse of property tax revenue, as storm risk and rising sea levels lower house prices. Many green projects have such properties. Many others—like smart grids, retrofitting the housing stock, public transportation, and clean energy—do not. For these, debt financing is more appropriate.

    Debt finance is highly attractive at the present moment for a number of reasons. First, the real interest rate on US debt is negative. Direct funding is therefore equivalent to leaving money on the table. Even if interest rates were to rise, as long as they remain below the rate of growth of the economy, debt-financed public investment pays for itself because future revenues increase faster than debt service obligations.3 It is also more effective than directly-funded public investment in stimulating economic activity.4

    Second, given the shortage of safe assets in the global financial system, US debt issuance tempers the risk of financial instability.5 Third, debt finance allows the US to bring the supermassive risk-bearing capacity of patient intermediaries—US pension funds and insurance companies alone reported $38 trillion in financial assets as of the last quarter of 2020—to bear on the problem of financing green projects. Given the high upfront costs of green investments, it makes sense to finance them with longer maturity bonds. Given their appetite for investment in fixed-income securities with long-term maturities that match their long-term liabilities, prime high-duration green bonds will be especially attractive to patient intermediaries.

    Risk

    The distinction between fiscal capacity and risk-bearing capacity is crucial to our argument. Fiscal capacity is the capacity of the state to collect taxes without destabilizing the economy. The median high income country raises 40 percent of GDP in tax revenue; for middle income countries, it is 28 percent; for low income countries, just 18 percent. Due to its high degree of institutional development and the fact that it has a larger economic size than any other country in the world, the United States in theory has immense fiscal capacity. In practice, it is subject to hard-to-evade political constraints and further limited by moral-intellectual commitments to fiscal discipline. However much these constraints may be bending in the current conjuncture, they are still evident in the Biden’s administration’s refusal to debt-finance the $4 trillion in public investment it has put before Congress.

    The risk-bearing capacity of a state is the capacity to absorb losses—to stomach the risk that the future may turn out worse than expected. The US advantage in risk-bearing capacity is considerably larger than its fiscal capacity, due to the structure of global financial intermediation.

    By a very large margin, the United States is the largest provider of safe assets in the global financial system: the dollar is the principal third-party currency of global trade invoicing; American banks dominate the global banking system; American investors are the dominant source of global FDI, and so on. The pattern of the US global investment position is such that it provides insurance to the rest of the world on which it earns a premium—risk assets featuring high returns predominate in the US portfolio of foreign assets, and safe assets featuring low returns predominate in the rest of the world’s portfolio of US assets.6 In times of market stress, global investors flee to the safety of US Treasuries—the effective definition of safe assets—and the dollar strengthens. The pattern is so marked that when Standard & Poor’s downgraded US debt from AAA to AA+ in 2011, US Treasuries actually rose in value. The compensation that investors demanded for holding US Treasuries fell despite the credit rating downgrade—where else could investors run? These structural features uniquely position the United States as the insurer of last resort.

    US guarantees immediately turn any asset it backstops into a safe asset that commands the lowest compensation for investors. A particularly striking instance of this phenomena occurred at the height of the financial crisis. During the brutal week of the Lehman bankruptcy, the core of the secured funding flywheel tottered, but did not come to a sudden stop. Instead, it continued to spin rapidly, as cash investors lent trillions of dollars to dealers overnight not just against Treasuries but also agency residential mortgage-backed securities (RMBS)—obligations of Fannie and Freddie assumed to be backed by the US government.7 The remarkable episode not only revealed that the toxicity was confined to private-label RMBS, but also made plain the power of the United States as the guarantor of the global financial order.

    For our purposes, the moral of the story is that US guarantees are so powerful that they can turn the debt obligations of US states, cities, and firms undertaking green projects into de facto AAA-rated safe assets and, in doing so, dramatically lower the financing costs for such projects. Our basic proposition is that you get an astronomically larger bang for your buck with public backstops: issuing guarantees is a virtually free, highly efficient mechanism to mine the unparalleled risk-bearing capacity of the US state and intermediaries in service of the energy transition. But the United States cannot simply guarantee the obligations of states, cities and firms undertaking green projects without making sure that it is backing only high-quality projects. This is the principal reason why we need a public ratings agency for green finance.

    Cities and states

    Local governments are at the frontlines of the climate crisis. From retrofitting the housing stock to mass transit, from electrification to seawalls—most of the work required for decarbonization will be undertaken at the level of the city and the state. But these governments face high financing costs. Despite the extraordinary compression of risk premia across the board, BBB-rated municipal bonds still command a premium of 1.2 percent per year over their duration-matched AAA-rated equivalents.8 This translates to roughly $150 billion in additional interest payments for every trillion dollars in state and local financing.9 A scheme where the US guaranteed prime municipal debt for green projects will save cities and states hundreds of billions of dollars.

    Since the global financial crisis, cities and states have been living in grinding austerity. After growing rapidly until the financial crisis, municipal debt simply stopped growing in absolute terms: municipal debt hit $3.2 trillion at the end of 2010—exactly where it stood at the end of 2020. If cities and states are to undertake the projects that comprise the energy transition, they need both dramatically more funding and much lower financing costs. But in order to make guarantees work, we need a public ratings agency that can credibly ascertain which projects are economically viable, financially sound, and contribute significantly to decarbonization. The full faith and backing of the US should backstop only prime municipal debt—in the full sense of the term.

    Controlling the boom

    So far we have talked about public investment. But many green projects can and should be undertaken by private entities. For instance, electric vehicles have to be manufactured at scale by car manufacturers; solar panels and wind turbines have to be manufactured, installed and operated by profit-seeking firms. Many such green projects (electric vehicles, and certain solar and wind projects) may already be attractive to firms and will require little encouragement by the government. However, many will not. In such cases, the standard modus operandi is to provide public subsidies and tax credits to encourage private activity.10 The same activity can be encouraged by providing public backstops that lower financing costs—while complementary to subsidies and tax credits, our proposal is virtually free.

    Despite being virtually free, such support would yield large gains for qualifying bond-issuing firms. The BAA10Y corporate spread over Treasuries stands at 1.97 percent and has averaged 2.36 percent since 1986. Under a scheme where the US guaranteed prime corporate debt for green projects, and given the prevailing yields on Treasuries, qualifying bond-issuers would save $216-263bn in interest rate payments for every trillion in financing. Using the average level Treasury yields since 1986, they would save $263-344bn instead.11 Through the monetary cycle, qualifying firms’ financing costs will be drastically reduced without consuming any direct subsidies or tax expenditures.

    But again: such a scheme could only work if there were a public ratings agency to ensure ratings are reliable and not manipulated. The most attractive feature of a public backstop is that it costs taxpayers virtually nothing—as long as the backstops do not generate large losses for the Treasury’s balance sheet. In order to ensure that they do not, we must be vigilant against a boom-bust cycle in green finance.

    At present, the business of project assessment and ratings classification for green finance is in private hands, led by BlackRock. This is a recipe for trouble because private credit ratings are coupled to the financial cycle. For instance, during the mid-2000s, deterioration of rating standards played a crucial role in amplifying the financial boom.12 There are already warnings of the coming catastrophe. Tariq Fancy, the former head of sustainability of BlackRock called the asset manager’s ESG scheme “little more than marketing hype, PR spin and disingenuous promises.”13 We can be virtually certain that, were green ratings left to “independent” ratings agencies or financial intermediaries, they would also become decoupled from fundamentals as the green boom gets underway. This is the default scenario. A public ratings agency for green finance is necessary to ensure that such a catastrophe does not obtain.

    The scenario of the green boom getting out of hand is far from outlandish. Given the scale of the undertaking, it would be hard for economic policymakers to distinguish a healthy economic boom from a dangerous financial boom. In fact, we will only know for sure that the boom got out of hand if and when the bubble bursts. If it did, we would find a major misallocation of resources only after the fact—but the timescale of decarbonzation does not allow for the boom, crash, reform cycle. It calls for macroprudential authorities to be on the watch for the green boom getting out of hand. It also calls for good institutional design in green finance.

    Institutions and investment

    Public investment in the United States has fallen by half from 7 percent of GDP under JFK in the early-1960s to 3.5 percent in recent years. State and local government investment in fixed assets has fallen by a third from 3.0 percent of GDP in the late-1960s to 2.0 percent, while federal investment has fallen by more than two-thirds from 4.4 percent of GDP in the early-1960s to 1.5 percent.14 Treasury Secretary Janet Yellen suggested recently that the public investment gap explains the vanishing of broad-based growth:

    For the past 40 years, the federal government has gradually shrunk its investment in public goods: schools, infrastructure, and research into new technologies. This slow decline has undermined broad-based growth. It has weighed-down productivity and curtailed our ability to respond to our nation’s most pressing challenges, including the threat of climate change.15

    The investment dearth has prompted a variety of new proposals, each reflecting a strand of the new expansionary consensus. Prominently, Robert Hockett and Saule Omarova’s National Investment Authority (NIA) proposes to close the public investment gap by using the risk-bearing capacity of the US state to mobilize private finance to fund the energy transition. The NIA would function as a modern finance version of the New Deal-era Reconstruction Finance Corporation. This is an ambitious agenda to “lever private investment in public goods through federal grants, loans, guarantees, securitization, and large-scale private equity-style asset management.” The NIA would “directly allocate both public and private capital to clean infrastructure projects” by actively participating in financial markets “not only as a lender, guarantor, and market-maker but also as an active asset manager and venture capital investor.”16 We share this approach of leveraging the public balance sheet to underwrite private financing of public investment in green projects. As of writing, enthusiasm for a full-scale NIA is tepid on Capitol Hill, for the obvious reason that such an entity would be the dominant actor in the economic and financial system, and therefore threaten the revenues and power of private financial institutions. No political bloc currently exists to counterbalance this opposition, and Congress is instead considering institutions with more modest dimensions: in the House, the Committee on Energy and Commerce has proposed a bank capitalized with $100 billion, and Ed Markey has similarly introduced a $100 billion National Climate Bank Act in the Senate.

    We support these initiatives. But there is reason to believe that the ratings agency we propose should not be folded into the climate bank or any other green finance institution at all. In addition to keeping green asset ratings out of the hands of interested private entities, we must also insulate the ratings function from the public climate finance institutions already under construction.

    Banks in India and China are sitting on a vast pool of bad debt as a result of state planners directing investment into coal and real estate in a publicly driven boom-bust cycle.17 More than half of the financial system in each country consists of state-run banks that went on a lending spree, extending credit to crony capitalists, ultimately resulting in a massive misallocation of resources. The economic costs of such investment cycles are not confined to the misallocation: high ratios of nonperforming loans reduce the risk-bearing capacity of the banks, who in turn limit lending, which acts as a major headwind for economic growth. Raghuram Rajan, the governor of the Reserve Bank of India, was fired for trying to solve the problem of clogged public bank balance sheets in India.18

    The problem here is not merely a banking problem or a crony capitalism problem. Where private bureaucracies are motivated by profits, public bureaucracies are interested in their own power. In the case of a climate bank, that may manifest at minimum as a desire to scale the assets under its control, creating systematic pressure for a deterioration in ratings quality. This procyclical tendency again risks creating a boom-bust cycle for the same reason that planned economies exhibit investment cycles. A boom-bust dynamic would destroy the moral economy of the energy transition. That is, a series of scandals around green-washing boondoggles, whether public or private, would undermine the legitimacy of the green project. We need tighter control over the high-pressure green economy—it cannot be plagued with cyclical excess.

    Good institutional design, consistent with the philosophy behind some provisions already in the National Climate Bank bill19, requires that the ratings agency should be staffed by public servants forbidden from working for private financial institutions for, say, five years after they leave public service. It calls for a board of governors to supervise the agency, preferably appointed for life or for legally fixed terms of, say, ten years. The operating costs of the agency should be no more than a few hundred million dollars a year, paid for by revenues that are completely insulated from all cyclical factors.

    Our proposal would save firms, cities, and states hundreds of billions of dollars at a minuscule cost to US taxpayers. It would go a long way towards ensuring financial stability as a green boom gets underway by restraining it from turning into a dangerous financial boom. It would prevent waste, cronyism, and a misallocation of national resources. Most importantly, it would move us a long way towards closing the glaring funding gap—the central problem of green finance.

    1. World Energy Transitions Outlook, IRENA, March 2021. Gross instead of net is the relevant concept. The latter is obtained by deducting savings from lower expected investments in fossil energy and so on—savings that are not automatically available for funding for green projects.  ↩
    2. Alicia Parlapiano. “Biden’s $4 Trillion Economic Plan, in One Chart.” New York Times. April 28, 2021. ↩
    3. DeLong, J. Bradford, and Lawrence H. Summers. “Fiscal Policy in a Depressed Economy.” Brookings Papers on Economic Activity (2012): 233-297. ↩
    4. Abiad, Abdul, and Petia Topalova. “The Macroeconomic Effects of Public Investment: Evidence from Advanced Economies.” Journal of Macroeconomics 50, no. C (2016): 224-240. ↩
    5. Caballero, Ricardo J., Emmanuel Farhi, and Pierre-Olivier Gourinchas. “The Safe Assets Shortage Conundrum.” Journal of Economic Perspectives 31, no. 3 (2017): 29-46. ↩
    6. “Real Interest Rates, Imbalances and the Curse of Regional Safe Asset Providers at the Zero Lower bound.” No. w22618. National Bureau of Economic Research, 2016. ↩
    7. Copeland, Adam, Antoine Martin, and Michael Walker. “Repo Runs: Evidence from the Tri‐Party Repo Market.” The Journal of Finance 69, no. 6 (2014): 2343-2380. ↩
    8. FINRA; authors’ computations. Estimate based on fixed-rate, semi-annual coupon bonds with proceeds going towards general purpose/public improvement and paid for by regular tax revenue. ↩
    9. Ballpark based on borrowing one trillion dollars for 10 years. The yield on low-duration AAA-rated muni bonds is 1.3 percent, that on high-duration AAA-rated muni bonds is 2.3 percent. The BBB premium of 1.2 percent over these base rates translates to $142-155bn in additional interest payments at the end of 10 years. ↩
    10. Senator Wyden’s Clean Energy for America Act provides for tax credits for green investments in energy, buildings and cars.  ↩
    11. FRED; authors’ computations based on borrowing $1tn for 10 years. ↩
    12. Diomande, M. Ahmed, James S. Heintz, and Robert N. Pollin. “Why US Financial Markets Need a Public Credit Rating Agency.” The Economists’ Voice 6, no. 6 (2009). ↩
    13. “Former BlackRock Executive Blows the Whistle on Greenwashing.” Bloomberg. March 23, 2021. ↩
    14. FRED, Federal Reserve Bank of St. Louis: https://fred.stlouisfed.org/graph/?g=DPew. ↩
    15. “Statement by Secretary of the Treasury Janet L. Yellen on the President’s Jobs Plan.” April 1, 2021. United States Treasury.  ↩
    16. Robert Hockett and Saule Omarova. “Private Wealth and Public Goods: A Case for a National Investment Authority.” Cornell Law Faculty Publications, Spring 2018. ↩
    17. Ren et al. “China Overinvested in Coal Power: Here’s Why.” Vox-EU, March 2019.  ↩
    18. Keynote address by Mr N S Vishwanathan, Deputy Governor of the Reserve Bank of India, at the National Conference of the Associated Chambers of Commerce and Industry of India on “Risk Management: Key to Asset Quality.” New Delhi, August 30, 2016. ↩
    19. National Climate Bank Act (S.283), United States Congress. ↩

  2. Reconstruction Finance

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    Like the world system as a whole, segregated cities in the United States have their own finance driven core-periphery dynamics.1 The world economy is structured by countries with competitive export sectors and trade surpluses, like Germany and China, who exhibit underconsumption and excess savings; the US’s debt-fueled economy receives these savings through its domination of global financial markets. The dynamic strengthens the power of global finance at the expense of wages and living standards. And within the US, the allocation of credit and investment has exacerbated racial disparities and altered the municipal geography of debt. At the level of the city and the financial system, these developments warrant a powerful political response. But what form can that response take?

    Global underconsumption and a structurally-weakened working class are problems likely to persist as the twenty-first century marches on. Altering the shape of our global economy will require building new institutions capable of funneling excess savings into productive investment. This is not something that can be done with a temporary increase in spending—no matter how large. Moreover, as commentators stressed in the wake of the Black Lives Matter uprisings of 2020, such investment must be democratically managed. Can the tensions and energies created on the local scale be harnessed to address larger macroeconomic imbalances? The history of the New Deal’s Reconstruction Finance Corporation offers a starting point with which to think through these dynamics.

    The Reconstruction Finance Corporation as tribune

    On the morning of April 24, 1933, five thousand Chicago schoolteachers stormed the lobbies of the five largest financial institutions in the Loop. The Chicago School Board was ten months behind on their salaries, amounting to $30 million owed. Earlier that day, the teachers had marched to the Governor Henry Horner’s mansion to demand pay, but when Horner appeared, he explained that the municipal government’s vaults were empty—“the only way that we can get money is through taxes”—and receipts were already two years overdue. The teachers turned to the monetary control centers instead.2

    At City National Bank they demanded to understand why chairman Charles Dawes hadn’t lent the city money, despite the fact that his bank had just received a $90 million loan from the government via the newly formed Reconstruction Finance Corporation (RFC), a government-sponsored enterprise whose express mission was to loosen credit conditions for the wider economy by lending to banks. Dawes had impressive financial credentials: in 1925, he won the Nobel Peace Prize for organizing an international flow of money from US coffers to save the Germans and the French after the indemnities imposed by the Treaty of Versailles proved unworkable, the so-called “Dawes Plan.” Now, his bank flush with loan money from the state, the teachers demanded to know what was keeping him from saving Chicago’s finances. Reluctant to lend to a city two years behind on tax receipts in the middle of the Great Depression, Dawes refused to discuss the matter. In the lobby of the Continental-Illinois National Bank, the protesters pressured the bank president to seek an RFC loan so that he could lend to the city directly, but they were again turned down. The crowd grew agitated, but the police did not disperse it—their paychecks were in arrears too. “Outside their doors a revolt is brewing,” Senator J. Hamilton Lewis of Illinois said of the Chicago situation. “We are on the eve of a revolution unless we use a little common sense.”

    The crisis continued through the summer until, on August 25th, it was over: Congress had passed legislation allowing the RFC to lend directly to the Chicago School Board, bypassing the private banks.3 In this moment, the RFC became a direct link between the abstractions of finance and the concrete demands from those in the street.4

    Inventing a tradition — war

    The origins of the RFC go back to America’s chaotic entry into World War I, when rampant inflation, weakened transportation networks, and tightening corporate financing constraints necessitated state action. Woodrow Wilson charged Treasury Secretary William Gibbs McAdoo and his protégé Bernard Baruch with handling the situation, and Congress summoned into existence a series of administrative agencies for the task.

    The US Shipping Board coordinated the construction and refitting of America’s merchant marine for war. In a public-private partnership, the Shipping Board tripled the number of vessels flying the American flag, pushing America’s share of the world fleet up to 22 percent. Though these vessels did not sail until after Versailles, they formed the backbone of American naval and commercial power in the 1920s. The US Railroad Administration nationalized the sector, which was suffering from “excess capacity” and lack of investment. Squeezed between antitrust laws which resulted in product duplication and redundancy on the one hand, and the alliance of populist consumers and regulators aimed at blocking rate hikes on the other, the industry had been unprofitable for some time. The Railroad Administration consolidated lines, suspended antitrust laws, and put up the capital necessary to modernize the system. Perhaps most impressive, the War Industries Board coordinated production, fixed prices, purchased supplies for the Allies, reformatted factories to operate on a war footing, and dictated to corporate management production levels and the sourcing of raw materials.

    Sitting above this raft of agencies was the War Finance Corporation. Capitalized by Congress at half a billion dollars, its purpose was to act as an omni-competent executive agency directing credit in the economy to win the war. It helped capitalize the Shipping Board and the Railroad Administration and was a key part of making their adventures possible, but it also lent to public utilities, banks, construction companies, and exporters.5

    The men who ran these operations, McAdoo and Baruch, were both Southerners, and this is crucial for interpreting their time in government. The Civil War had liberated nearly four million men, women and children from bondage, simultaneously erasing $3 billion worth of slave capital—three times the size of the entire US industrial capital stock—and transforming the South into an economic backwater. Within this historical context, the ideology of McAdoo and Baruch can be described as a post-populist New Southern nationalism. They were not Redeemers or partisans of the Lost Cause, but capitalists on the make, whose experiences in business keyed them in to the importance of credit. They believed the best way to redevelop the South was to go North, to establish a reputation and connections on which they could capitalize upon returning home. For instance, McAdoo was the moving force behind the Hudson Tubes, a massive construction project completed in 1908 that connects New York and New Jersey. Both were high profile corporate lawyers, in an age when corporations were just coming into their own as the dominant force of American capitalism. Since the Civil War, the commanding heights were located in New York, center of the Eastern financial establishment.

    Like the earlier populists, McAdoo and Baruch wanted to expand the American credit system’s geography of inclusion, breaking down its core-periphery structure into a uniformly nationalized economic space. Wilson’s progressive economics alienated many Eastern elites, so he looked elsewhere for capitalists he could claim as supporters. As Wilson’s Treasury secretary, McAdoo vigorously directed credit to the South and West. The federated structure of America’s central bank, for instance, partly reflects these priorities. When the war in Europe broke out, McAdoo and Baruch were well prepared ideologically to take the reins of the national economy, with command-and-control powers the US had never dreamt of before.

    Fearing the potential dislocations of the transition to peacetime, Congress repurposed the wartime institutions to smooth reconversion at the end of the war. The Shipping Board handed the private sector a windfall by selling off the merchant marine and using the subsequent revenues to subsidize exports. The War Finance Corporation (WFC) proved more flexible—it also became an export machine, and in 1921 Congress added to its portfolio with the Agricultural Credits Act. The WFC was endowed with extra capital and moved into the business of making subsidized loans to agriculture. Gradually, as the exceptional frame of wartime emergency faded and Harding’s “Return to Normalcy” took hold of the 1920s, these functions were wound down and transferred to other institutions. Shrinking the WFC’s balance sheet to zero took until 1930, and by then the world of national capital was scrambling yet again.

    Reviving a tradition — depression

    In the wake of Black Tuesday, private investment fell off a cliff. Hebert Hoover tried to organize another pool of capital funded and controlled entirely by private banks, to play the role of the WFC: all-purpose director of credit in the economy. The 1931 National Credit Corporation (NCC) successfully collected $500 million in subscriptions, but lent out barely $10 million in low interest loans to troubled banks. After two years of depression, private capital no longer had the will to confront the radical uncertainty of the events surrounding it. Civil society voluntarism had been a failure—the solution would require the general will of a democratic developmental state to break the financial deadlock. Eugene Meyer, Chairman of the Federal Reserve and former-Chair of the WFC, urged Hoover to admit his NCC had been a failure and to revive the old model. In December he did just that, and the Reconstruction Finance Corporation was born. Hiring the existing WFC staff and occupying its thirty-three offices, the RFC had a readymade team waiting for them when the doors opened in January of 1932. In order to accept loan applications, they simply flipped the signs in their windows to “open.”

    After being capitalized by the public, the RFC was a completely independent institution: no oversight from Congress, the President, or the director of the budget was built into its founding legislation. It didn’t even have to reveal the names of borrowers or the amounts lent out. It could borrow money in its own name from capital markets too—so in theory it never needed another appropriation from Congress. It could live indefinitely off the profits from its lending operations.

    The RFC was enormously successful at its appointed task. By the end of 1932 it had authorized $1.6 billion in loans, almost all of it going to banks and the railroads. But that appointed task was flawed. Hoover et al. believed that the Great Depression was caused by a lack of credit—that it was banks’ unwillingness to lend that had caused the fall in investment. But the RFC money taken by the banks didn’t find its way into real fixed investments; the banks were simply lending it back to the federal government at higher interest rates.

    Radicalizing a tradition — New Deal

    FDR wanted to try a different strategy. But like Wilson before him, FDR had scared off the financiers and industrialists in the core of American capitalism; one look at the collective bargaining clauses of the NIRA and they had bolted. And like Wilson before him, FDR looked to capitalists in the periphery to stabilize his coalition. FDR’s new RFC Chairman Jesse Jones was from Texas, and strongly supported the new strategy: bending Eastern capital to the public will in Washington and using it to develop the rest of the nation. The Emergency Banking Act of 1933 authorized the RFC to buy preferred stock in banks, providing not just liquidity and temporary loans, but recapitalizing them. By the end of 1935, the RFC owned stock in half of all banks, and owned one-third of all bank capital in the US.

    The RFC was a great client to lend to—with the implicit backing of the federal government and a massive portfolio, banks were eager to offer money to the RFC. Its securities were perfectly safe in a storm and offered a high return. The RFC took that money and used it to bankroll the New Deal.

    By early 1936, a mere three years after having taken over the RFC, Jones reported to FDR that the RFC had authorized more than $8 billion in loans, received repayments totaling $3.2 billion, and had earned more than $294 million in interest.6 (By comparison, total New Deal emergency relief spending in the ten years after 1933 amounted to $40 billion.7)

    Its customers included the usual suspects of banks, construction companies, and railroads, but also farmers, corporations, federal land banks, cooperatives, insurance companies, livestock credit corporations, and school districts. It built bridges. It built roads. It built the TVA and it built hospitals. It couldn’t and didn’t fund everything by itself, and was usually a minority stakeholder in the projects it capitalized. But the provision of patient, public capital proved sufficient in every case for putting a floor beneath the radical uncertainty of the investment process, drawing private capital back into fixed investment. It was an astonishingly powerful and flexible executive agency. By 1935 it had made 40,000 loans to unique individuals, blanketing every single Congressional district in the nation. A list of recipients of RFC money simply replicates the entire New Deal alphabet soup: FERA, CWA, FHLB, EHFA, DLC, HOLC, FCA, RACC, FICB, FLB, FFLC, FFMC, FHA, REA, RMC, EIB, CCC, NRA, FNMA, and the AAA all received RFC money. The RFC purchased $700 million worth of bonds from Harold Ickes’ PWA, and when the WPA came online in 1935 the RFC lent it $1 billion to start work immediately. When the Federal Deposit Insurance Corporation was created, many banks were not qualified to join—their capital structures were too weak and they would surely fail. This was hardly a circumstance in which the government should have provided insurance, but it was difficult to tell which banks were insolvent and which were merely illiquid, and events were moving fast. The RFC stepped in, lending to and recapitalizing every last financial institution in the country so the new FDIC could be truly universal, promising to sort out the insolvent banks later. In response to the economic downturn of 1937-8, the RFC moved into industrial policy, providing working capital directly to corporations. It wasn’t just providing liquidity—it was socializing investment.

    During the war it transformed yet again, using its control of the commanding heights of American capital to help plan the war, much like the WFC had twenty years before. The Fed also helped finance the war by keeping interest rates pegged at a low level. When the Office of Price Administration was dissolved after the war, there was an inflationary spike, but it was the RFC that suffered—the Fed retained control of the money supply, while the RFC’s investment-juicing functions were now seen as extraneous in an economy characterized more by abundance, full employment and full capacity than Depression. After grumblings about favoritism and insider dealing, the RFC was directed to transfer its functions to other departments—for instance, the new post-war Small Business Administration—and to cease issuing new loans. Like the WFC before it, the RFC’s balance sheet tapered off for the better part of a decade. Its memory lived on in state development banks elsewhere—Marshall Plan funds set up the Kreditanstalt für Wiederaufbau in American occupied Germany, for instance. (KfW is now at the cutting edge of green energy.) But by the time Americans began complaining in the late 1950s about the dearth of fixed investment compared to Europe in the heyday of its trente glorieuses, the RFC was already approaching non-existence.

    Democracy in America?

    We no longer live in a world of capital scarcity, if we ever did.8 The excess savings in the world economy should be rerouted from indebted consumer demand in the US, and channeled instead into a new Reconstruction Finance Corporation.9 The capital should come from the return the Federal Reserve makes on its portfolio managing the dollar empire. In 2015, the Fed remitted $97 billion in profits to the US Treasury; compare that to the $88 billion made by the most profitable company in the world, Saudi Aramco. Right now, that money is treated like tax money—the Treasury reduces the federal debt by that amount, diminishing the quantity of safe assets in the world. Instead, that massive income stream should be rerouted to a neo-RFC, which could leverage it by issuing its own debt, soaking up excess savings and directing it into useful investment projects around the country. There are many such projects: ask cities and states, construction workers, environmentalists, healthcare workers—or Chicago schoolteachers. Even some on the populist right are clamoring for industrial policy today—why not one directed by a neo-RFC?10

    A new RFC would also allow us to cope with the failures of American democracy. Without a thick set of civil society associations capable of channeling the energy of mass movements, what kind of historical agent can reorder American capital? History suggests we should look to the periphery. The democratic developmentalist state project in America has often been national in sovereignty but local in leadership and governance.11 In the past, that meant the South-West. Today, the hierarchy of American economic space is oriented around a municipal axis—urban core, ghetto, suburb, exurb, rural.12 The demand to defund the police, mainstreamed by the uprisings of last year, is paired with a demand for funding for more infrastructure and social services, which will have to happen at the state and municipal level.

    In the wake of the pandemic, the Fed announced the creation of a Municipal Lending Facility, which made the prospect of direct lending to cities a reality. Even if the specific terms which cities have been offered are poor, and consequently the number of loans authorized has been trivial, it is a powerful precedent. A neo-RFC should take it up, becoming a new bulwark for states and cities against the market. It makes intuitive sense to people—who have seen the monetary floodgates opened twice in a generation—that if you can print money for them you can print it for us. Advancing the democratic project today means not taking the absence of mass politics as a given; it means building institutions capable of coordinating our collective life. If reconstruction finance were readily available, every mayor and city council could become a democratic mediating link to the real abstractions of monetary sovereignty. The Fed can link up with local democratic politics precisely because it is a federal institution. There are thirty-six local offices scattered all across the Union, including one in Minneapolis, only a short walk from where the rebellion began last May.

    1. Destin Jenkins, The Bonds of Inequality (Chicago, 2021). Robert Manduca, “Income Inequality and the Persistence of Racial Economic Disparities,” Sociological Science (2018) 5:182-205, and “The Contribution of National Income Inequality to Regional Economic Divergence,” Social Forces (2019) 98 (2): 578-621; Reardon & Bischoff, “Income inequality and income segregation,” American Journal of Sociology (2011) 116(4) and “The Continuing Increase in Income Segregation, 2007-2012,” (2016); Reardon, Bischoff, Owens, & Townsend, “Has Income Segregation Really Increased? Bias and Bias Correction in Sample-Based Segregation Estimates,” Demography (2018) 55(6), 2129–2160. ↩
    2. “5,000 Chicago Teachers Storm Five Banks; Dawes Heckled as He Argues With Crowd,” by The Associated Press. New York Times (1923-Current file); Apr 25, 1933; ProQuest Historical Newspapers: The New York Times pg. 1. ↩
    3. “14,000 Teachers to Get Millions in Chicago Pay,” by The Associated Press. New York Times (1923-Current file); Aug 26, 1934; ProQuest Historical Newspapers: The New York Times pg. N6 ↩
    4. The RFC is wildly under-historicized. The main references on the subject remain James Stuart Olson, Saving Capitalism: The Reconstruction Finance Corporation and the New Deal, 1933-1940 (Princeton, 1988) and Jordan A. Schwarz, The New Dealers: Power Politics in the Age of Roosevelt (Knopf, 1993). ↩
    5. On capitalization see Jonathan Levy, “Capital as Process and the History of Capitalism,” Business History Review, 91(3), 483-510. ↩
    6. Olson, Saving Capitalism, 43. ↩
    7. James T. Sparrow, Warfare State: World War II Americans and the Age of Big Government (Oxford, 2012), 6. ↩
    8. The literature on secular and supra-secular stagnation suggests that we will be in or near a liquidity trap for the foreseeable future. ↩
    9. Atif Mian, Ludwig Straub, and Amir Sufi. Working Paper. “Indebted Demand.” ↩
    10. Arthur Herman, “America Needs an Industrial Policy,” American Affairs Winter 2019 / Volume III, Number 4. ↩
    11. Tocqueville, Democracy in America; Gary Gerstle, Liberty and Coercion: The Paradox of American Government from the Founding to the Present (Princeton, 2017); Stefan Link and Noam Maggor, “The United States As A Developing Nation: Revisiting The Peculiarities Of American History,” Past & Present 246/1 (2020), 269–306. ↩
    12. Manduca (2019). ↩

  3. Risks and Crises

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    “The Most Significant Economic Crisis of the Era is the One that Has Not Happened.”
    Hyman Minsky, 1982

    The Importance of Being a Risk Manager

    In “It’s a Wonderful Life (1945),” Jimmy Stewart struggles to convert his well-functioning loans into cash. The absence of convertibility, known as liquidity risk in modern finance, impaires his ability to pay depositors. Like any traditional financial intermediary, Stewart seeks to transform short-term debts (deposits) into long-term assets (loans). According to traditional macroeconomic accounts, a run on the bank could be prevented if Stewart had borrowed money from the Fed and used the bank’s assets as collateral. British journalist Walter Bagehot argued that the Fed acts as a “lender of last resort,” injecting liquidity into the banking system. As long as the bank was perceived solvent, its access to the Fed’s credit facilities would be almost guaranteed. For a long time, Bagehot’s rule, “lend freely, against good collateral, but at a high rate,” restored the Fed’s control over the money market and helped end banking panics and systemic banking crises.

    This control evaporated on September 15, 2008, with the Lehman Brothers’ collapse. On that day, an enormous spike in interbank lending rates was caused not by a run on a bank, but by the failure of an illiquid securities dealer. This new generation of financial intermediaries were scarcely related to traditional counterparties—their lending model was riskier, and they did not accept deposits. Instead, these intermediaries synchronized their actions with central banks’ interest rate policies, buying more loans if monetary conditions were expansive and asking borrowers to repay loans if these conditions were contractive. They financed their operations in the wholesale money market, and most of their lending activities were to capital market investors rather than potential homeowners. When Lehman Brothers failed, domestic and foreign banks could no longer borrow in the money markets to pay creditors. The Fed soon realized that its lender of last resort activities were incapable of influencing the financial market. The crisis of 2008-09 called for measures beyond Bagehot’s principle. It revealed not only how partial our understanding of the contemporary financial system is, but how inadequate the tools we have available are for managing it.

    Re-Conceptualizing the Contemporary Financial System

    Prior to the financial crisis, the emerging hybrid system of shadow banking went largely unmonitored. Shadow banking is a market-based credit system in which market-making activities replace traditional intermediation. A shadow banker acts more like a dealer who trades in new or outstanding securities to provide liquidity and set prices. In this system, short-term liquidity, raised in the wholesale money market, funds long-term capital market assets. The payment system reinforces this hybridity between the capital market and the money market. Investors use capital market assets as collateral to raise funds and make payments. Therefore, the integrity of the payment system depends on the collateral acceptability in securities lending. Since the crisis, collateral has been criticized for rendering financial institutions vulnerable to firesales and loss of asset value. The Fed did not save Lehman Brothers, a securities dealer, because the alternative was likely to have encouraged others to make toxic loans too. Like in Voltaire’s Candide, the head of a general was cut off to discourage the others.

    The crisis also revealed the vulnerabilities of contemporary risk management. Modern risk management practices depend largely on hedging derivatives. Hedging is somewhat analogous to taking out an insurance policy; at its heart are derivatives dealers who act as counterparties and set prices. Derivatives, including options, swaps, futures, and forward contracts, reduce the risk of adverse price movements in underlying assets. The crisis exposed their fragile nature—dealers’ willingness to bear risk decreased following losses on their portfolios. These concerns left many firms frozen out of the market, forcing them to terminate or reduce their hedging programs. Rationing of hedging activity increased firms’ reliance on lines of credit. As liquidity was scarce, over-reliance on credit lines further strained firms’ risk management. In the meantime, rising hedging costs prevented them from hedging further. Derivatives dealers were essential players in setting these costs. During the crisis, dealers found it more expensive to finance their balance sheet activities. In return, they increased the fees. As a result of this cycle, firms were less and less able to use derivatives for managing risks.

    Most financial economists analyze risk management through cash flow patterns. The timing of cash flow is critical because the value of most derivatives is adjusted daily to reflect their market value (they are mark-to-market). This requires a daily cash settlement process for all gains and losses to ensure that margin (collateral) requirements are being met. If the current market value causes the margin account to fall below its required level, the trader will be faced with a margin call. If the value of the derivatives falls at the end of the day, the margin account of the investors who have long positions in derivatives will be decreased. Conversely, an increase in value results in an increase in the investors’ margin account who hold the long positions. All of these activities involve cash flow.

    But in order to properly conceptualize the functioning of contemporary risk management practices, we need to follow in Hyman Minsky’s footsteps and look at business cycles. The standard macroeconomic framing begins from the position of a representative risk-averse investor. Because the investor is risk-averse, they neither buy nor sell in equilibrium, and consequently, there is no need to consider hedging and the resulting cash flow arrangements. By contrast, Minsky developed a taxonomy to rank corporate debt quality: hedge finance, speculative finance, and Ponzi finance. Hedge finance is associated with the quality of the debt in the economy. It occurs when the cash from a firm’s operating activities is larger than the cash needed for its scheduled debt-servicing payments. A speculative firm’s income is sufficient to pay the interest, but it should borrow to pay the principal. A firm is Ponzi if its income is smaller than the amount needed to pay all interest on the due dates. The Ponzi firm must either increase its leverage or liquidate some of its assets to pay interest on time. Within this scheme, hedge finance represents the greatest degree of financial stability.

    Minsky’s categorization scheme emphasizes the inherent instability of credit. In periods of economic euphoria, the quantity of debt increases because the lenders and investors become less risk-averse and more willing to make loans that had previously seemed too risky. During economic slowdowns, overall corporate profits decline, and many firms experience lower revenues. This opens the way for a “mania,” in which some in the hedge finance group move into speculative finance, and some firms that had been in speculative finance move into Ponzi finance.

    Regulatory Responses to the Crisis: Identifying and Managing Risk

    But why should a central banker worry about the market for hedging? After all, finance is inherently about embracing risk. In a financial crisis, however, these risks become systemic. Systemic risk is the possibility that an event at the company level could trigger the collapse of an entire industry or economy. Post-2008 regulatory efforts are therefore aimed at identifying systemic risk before it unravels.

    The desire to identify the origins, and nature, of risks, is as old as finance itself. In his widely cited article, Fischer Black distinguished between the risks of complex instruments and the trades that reduce those risks—the “hedges.” But less widely cited is his conviction that financial models, such as the capital asset pricing model (CAPM), are frequently not equipped to separate these risks.

    The same argument could be made for identifying systemic risk. To monitor systemic risk, the Fed and other regulators use central clearing, capital standards, and stress-testing. However, these practices are imperfect diagnostic tools. Indeed, clearinghouses may have become the single most significant weakness of the new financial architecture. In order to reduce credit risk and monitor systemic risk, clearinghouses ensure swaps by serving as a buyer to every seller and a seller to every buyer. However, they generally require a high degree of standardization, a process that remains poorly defined in practice. Done correctly, the focus on clearing standardized products will reduce risk; done incorrectly, it may concentrate risks and make them systemic. Standardization can undermine effective risk management if it constrains the ability of investors to modify derivatives to reflect their particular activities.

    Regulators also require the banks, including the dealer banks, to hold more capital. A capital requirement is the amount of capital a bank or another financial institution has to have according to its financial regulator. To capture capital requirement, most macroeconomic models abstract from liquidity to focus on solvency. Solvency risk is the risk that the business cannot meet its financial obligations for full value even after disposal of its capital. The models assert that as long as the assets are worth more than liabilities, firms should survive. The abstraction from liquidity risk means that by design, macroeconomic models cannot capture “cash flow mismatch,” which is at the heart of financial theories of risk management. This mismatch arises when the cash flows needed to settle liabilities are not equal to the timing of the assets’ cash flows.

    The other tool that the Fed uses to monitor systemic risk regularly is macroprudential stress-testing. The Comprehensive Capital Analysis and Review (CCAR) is an annual exercise by the Fed to assess whether the largest bank holding companies have enough capital to continue operations during financial stress. The test also evaluates whether banks can account for their unique risks. However, regulatory stress testing practice is an imperfect tool. Most importantly, these tests abstract away from over-the-counter derivatives—minimally regulated financial contracts among dealer banks— that might contribute to systemic risk. Alternatively, the testing frameworks may not capture network interconnections until it is too late.

    The experience of the 2008 financial crisis has revealed the ways in which our current financial infrastructure departs from our theorization of it in textbooks. It also reveals that the analytical and diagnostic tools available to us are inadequate to identifying systemic risk. The Fed’s current tools reflect its activities as the “financial regulator.” But at present, the Fed lacks tools based on its role as lender of last resort, which would enable it to manage the risk rather than imperfectly monitor it. In the following sections, I examine the importance, and economics, of derivatives dealers in managing financial markets’ risks, and propose a tool that extends the Fed’s credit facilities to derivatives dealers during a crisis.

    Derivatives Dealers: The Risk Managers of First and Last Resort

    Over the course of 17 years, Bernie Madoff defrauded thousands of investors out of tens of billions of dollars. In a Shakespearean twist, the SEC started to investigate Madoff in 2009 after his sons told the authorities that their father had confessed that his asset management was a massive Ponzi scheme. Madoff pleaded guilty to 11 federal felony counts, including securities fraud and money laundering.

    Bernie Madoff paints a dire portrait of the market making in securities. In world of shadow banking, derivatives dealers are the risk managers of first resort. They make the market in hedging derivatives and determine the hedging costs. Like every other dealer, their capacity to trade depends on their ability to access funding liquidity. Unlike most other dealers, there is no room for them in the Fed’s rescue packages during a financial crisis.

    Derivatives dealers are at the heart of the financial risk supply chain for two reasons: they determine the cost of hedging, and they act as counterparties to firms’ hedging programs. Hedgers use financial derivatives briefly (until an opportunity for a similar reverse transaction arises) or in the long term. In identifying an efficient hedging instrument, they consider liquidity, cost, and correlation to market movements of original risk. Derivatives connect the firms’ ability and willingness to manage risk with the derivatives dealers’ financial condition. In particular, dealers’ continuous access to liquidity enables them to act as counterparties. As intermediaries in risk, dealers use their balance sheets and transfer the risks from risk-averse investors to those with flexible risk appetite, looking for higher returns. In the absence of this intervention, risk-averse investors would neither be willing nor able to manage these risks.

    This approach towards risk management concentrates risks in the balance sheets of the derivatives dealers. The derivative dealers’ job is to transfer them to the system’s ultimate risk holders. In a typical market-based financial system, investment banks purchase capital market assets, such as mortgage-backed securities (MBS). These hedgers are typically risk-averse and use financial derivatives such as Interest Rate Swaps (IRS), Foreign exchange Swaps (FXS), and Credit Default Swaps (CDS). These derivatives’ primary purpose is to price, or even sell, risks separately and isolate the sources of risk from the underlying assets. Asset managers, who look for higher returns and therefore have a more flexible risk tolerance, hold these derivatives. It is derivatives dealers’ job to make the market in instruments such as CDS, FXS, and IRS. In the process, they provide liquidity and set the price of risk. They also determine the risk-premium for the underlying assets. Crucially, by acting as intermediaries, derivatives dealers tend to absorb the unwanted risks in their own balance sheets.

    During a credit crunch, derivatives dealers’ access to funding is limited, making it costly to finance inventories. At the same time, their cash inflow is usually interrupted, and their cash outflow comes to exceed it. There are two ways in which they can respond: either they stop acting as intermediaries, or they manage their cash flow by increasing “insurance” premiums, pushing up hedging costs exactly when risk management is most needed. Both of these ultimately transmit the effects to the rest of the financial market. Higher risk premiums which lower the value of underlying assets could lead to a system-wide credit contraction. In the money market, a sudden disruption in the derivatives market would raise the risk premium, impair collateral prices, and increase funding costs.

    The increase in risk premium also disrupts the payment system. Derivatives are “mark-to-market,” so if asset prices fall, investors make regular payments to the derivative dealers who transfer them to ultimate risk holders. A system-wide credit contraction might make it very difficult for some investors to make those payments. This faulty circuit continues even if the Fed injects an unprecedented level of liquidity into the system and pursues significant asset purchasing programs. The under-examined hybridity between the market for assets and the market for risks make derivatives markets the Fed’s concern. There will not be a stable capital valuation in the absence of a continuous risk transfer. In other words, the transfer of collateral, used as the mean of payments, depends on the conditions of both the money market and derivatives dealers.

    Understanding Financial Assets as Collateral

    Maintaining the integrity of the payment system is one of the oldest responsibilities of central bankers. In order to do this effectively, we should recognize financial assets for what they actually do, rather than what economists think they ought to do. Most macroeconomists categorize financial assets primarily as storers of value. But in modern finance, investors want to hold financial assets that can be traded without excessive loss. In other words, they use financial assets as “collaterals” to access credit. Wall Street treats financial assets not as long-term investment vehicles but as short-term trading instruments.

    Contemporary financial assets also serve new economic functions. Contrary to the present and fundamental value doctrines, a financial asset today is not valuable in and of itself. Just like any form of money, it is valuable because it passes on. Contemporary financial assets are therefore the backbone of a well-functioning payment system.

    The critical point is that in market-based finance, the collateral’s market value plays a crucial role in financial stability. This market value is determined by the value of the asset and the price of underlying risks. The Fed has already embraced its dealer of last resort role partially to support the cost of diverse assets such as asset-backed securities, commercial papers, and municipal bonds. However, it has not yet offered any support for backstopping the price of derivatives. In other words, while the Fed has provided support for most non-bank intermediaries, it overlooked the liquidity conditions in the derivatives market. The point of such intervention is not so much to eliminate the risk from the market. Instead, the goal is to prevent a liquidity spiral from destabilizing the price of assets and, consequently, undermining their use as collateral in the market-based credit.

    In 2008, AIG was the world’s largest insurance company and a bank owner. Its insurance business and bank subsidiary made it one of the largest derivatives dealers. It had written billions of dollars of credit default swaps (CDSs), which guaranteed buyers in case some of the bonds they owned went into default. The goal was to ensure that the owner of the swap would be paid whole. Some investors who owned the bonds of Lehman had bought the CDSs to minimize the loss if Lehman defaulted on its bonds. The day after Lehman failed, the Fed lent $85 billion to AIG, stabilizing it and containing the crisis. However, this decision was due to the company’s importance in markets for municipal bonds, commercial papers, and money market mutual funds. If it us unwilling to do the same for derivatives dealers, it may not be able to alleviate near-term risks generated from the systemic losses on derivatives.

    After the COVID-19 pandemic, the Fed extended credit facilities to critical financial intermediaries, but excluded market makers in risk. But in a financialized economy, the business cycle is nothing more than extreme corrections to the price of capital. Before a crash, investors’ risk tolerance becomes flexible—they ignore the possibility for market corrections or rapid changes in an asset’s market price after the establishment of an equilibrium price. As a result of this bias, investors’ expectations of asset prices form more slowly than actual changes in asset prices. Hedging would save these biased investors, and if done appropriately, they could help stabilize the business cycle. However, the Fed has no formal tool that enables it to support derivatives dealers in providing hedging services. It cannot act as the “ultimate” risk manager in the system.

    The Dealer Option: Connecting the Fed with the Ultimate Risk Managers

    Charles Kindleberger argued that financial crises cannot be stopped, but only contained. The dealer option proposed in this paper would enable the Fed to control the supply chain of risk. It extends credit facilities to a specific type of financial intermediaries: options dealers. This extension does not include financial speculators of various stripes and nonfinancial corporations—the so-called “end-users” of derivatives—seeking to hedge commercial risks. The options dealers’ importance comes from their paradoxical effects on financial stability. Since Dodd-Frank increased firms’ capital cost in favor of risk mitigation techniques like hedging, these companies are crucial to policy because they buy protection from options dealers in centrally cleared markets.

    The problem is that options dealers’ role as counterparty to hedging firms could create fragility and magnify the market risk. In equilibrium, the risk is transferred through the option supply chain to dealers, who are left with the ultimate task to manage their risk exposure using dynamic hedging techniques. The dynamic nature of these activities means options dealers contribute to daily volatility when they balance their exposures. During a crisis, these actions lead to increasing market fragility. The “dealer option” empowers the Fed to become the lender of last resort to the financial system’s ultimate risk managers. This instrument extends many benefits that banks receive by having an account at the Fed to these dealers. Some of these benefits include having access to reserves, receiving interest on reserves, and in very desperate times, access to the Fed’s liquidity facilities. The goal is to strike a balance between the fragility and stability they impose on the market.

    Containing liquidity risk is at the heart of the dealer option. The daily cash flow that the options contracts generate could contribute to asset fire sales during a crisis—options contracts are subject to mark-to-market rules, and fluctuations in the value of assets that dealers hold generate daily cash flows. If dealers do not have enough liquidity to make daily payments, known as margin calls, they will sell the underlying assets. Asset fire sales might also arise because most market makers have an institutional mandate to hedge their positions by the end of the trading day. Depending on the price changes, the hedging activities require dealers to buy or sell the underlying asset. Most dealers hedge by selling shares of the underlying asset if the underlying asset’s value drops, potentially giving rise to firesale momentum. Limited market liquidity during a crisis means that the possibility of firesale is larger when dealers do not have enough liquidity to meet their cash flow requirements. The dealer option could stop this cycle. In this structure, the Fed’s function to provide backstops for derivatives dealers can reduce firesales’ risk and contain market fragility during a credit crunch.

    The tool is based on Morgan Ricks, John Crawford, and Lev Menand’s Public Option proposal, Perry Mehrling’s Money View framework, and Katharina Pistor’s Legal Theory of Finance (LTF). The public option suggests opening the Fed’s balance sheet to non-banks and the public. On the other hand, the Money View emphasizes the importance of managing the timing of cash flows and calls any mismatches liquidity risk. Like the Finance view of the world, the Money View asserts that the goal is to meet “survival constraints” at all times.

    The LTF builds on the Money View through four essential premises: first, financial markets are a rule-bound system; The more an entity solidifies its position within the marketplace, the higher the government’s level of responsibility. Second, there is an essential hybridity between states and markets; in a financial crisis, only Fed’s balance sheet—with its unlimited access to high-powered money—can guarantee full convertibility from financial assets into currency. Third, the law is what makes enforcement of financial instruments possible. On the other hand, these enforcements also have the capacity to bring the financial system down. Finally, LTF law is elastic, meaning that legal constraints can be relaxed or tightened depending on the economy’s health.

    Calling the Fed to intervene in the derivatives market, the “dealer option” emphasizes the financial system’s hybridity. The law does not currently require central banks to offer convertibility to most assets. In most cases, they are explicitly barred from doing so. Legal restrictions like this could be preventing effective policy options from restoring financial stability. The dealer option would defy such restrictions and allow derivatives dealers to have an account at the Fed. The Fed’s traditional indirect backstopping channel has proven to be inadequate during most financial crises. Banks tend to reduce or sometimes cease their liquidity provision during a crisis. Accounting for such shifts in banks’ business models, the dealer option allows the Fed to directly backstop the leading players in the supply chain of risk. Importantly, these benefits would only be accessible for derivatives dealers once a recession is looming or already in full effect, when unconventional monetary policy tools are used.

    Whether a lender of last resort should provide liquidity to forestall panic has been debated for more than two hundred years. Those who oppose the provision of liquidity from a lender of last resort argue that the knowledge that such credits will be available encourages speculation. Those who want a lender of last resort worry more about coping with the current crisis and reducing the likelihood that a liquidity crisis will cascade into a solvency crisis and trigger a severe recession. After the 2008 crisis, the use of derivatives for hedging has greatly increased due to the growing emphasis on risk management. Solvency II, Dodd-Frank, and the EMIR Risk Mitigation Regulation increased the cost of capital in favor of risk mitigation techniques, including hedging and reducing counterparty risk. The risk is transferred over the option supply chain to market makers, who are left with the ultimate task to manage their risk exposure. The dealer option offers liquidity to these dealers during a crisis when the imbalances are huge. Currently, there is no lender of last resort for the market for risk because there is neither a consensus about the systemic importance of shadow banking nor any model adequately equipped to distinguish between hedge finance, speculative finance, and Ponzi finance.

    Shadow banking has three foundations: liquid assets, global dollar funding, and risk management. So far, the Fed has left the last foundation unattended. In order to design tools that fill the void between risk management and crisis prevention, we must understand the financial ecosystem as it really is, and not as we want it to be.

    References
    [1] Aliber, Robert Z., and Kindleberger, C., 2011. Manias, panics, and crashes: a history of financial crises. New York: Palgrave Macmillan
    [2] Barbon, A., and Buraschi, A., 2020. Gamma Fragility. The University of St.Gallen, School of Finance Research Paper No. 2020/05.
    [3] Black, F., 1982. General Equilibrium and Business Cycles. NBER Working Paper No. w0950.
    [4] Black, F., 1989. Equilibrium Exchange Rate Hedging. NBER Working Paper No. w2947.
    [5] Canadian Derivatives Institute., 2018. Corporate Hedging During the Financial Crisis. Working paper; WP 18-04.
    [6] Gary, G., and Metrick, A., 2012. Securitized banking and the run on repo. Journal of Financial Economics, Volume 104, Issue 3, Pages 425-451, ISSN 0304-405X,
    [7] Mehrling, P., 2011. The New Lombard Street: How the Fed Became the Dealer of Last Resort. Princeton; Oxford: Princeton University Press.
    [8] Mehrling, P., 2011. Fischer Black and the Revolutionary Idea of Finance. Wiley Publications; ISBN: 978-1-118-20356-9
    [9] Mehrling, P., 2012. Three Principles for Market-Based Credit Regulation, American Economic Review, American Economic Association, vol. 102(3), pages 107-112, May.
    [10] Mian, A, and Sufi, A., 2010. The Great Recession: Lessons from Microeconomic Data. American Economic Review, 100 (2): 51-56.
    [11] Pistor, K. 2013a. Law in Finance, Journal of Comparative Economics, Elsevier, vol. 41(2), pages 311-314.
    [12] Pistor, K. 2013b. A Legal Theory of Finance, Journal of Comparative Economics, Elsevier, vol. 41(2), pages 315-330.
    [13] Ricks, M., Crawford, J and Menand, L. 2018. A Public Option for Bank Accounts (Or Central Banking for All), Vanderbilt Law Research Paper 18-33; UC Hastings Research Paper No. 287.
    [14] Saeidinezhad, E., 2020. When it Comes to Market Liquidity, What if Private Dealing System is Not “The Only Game in Town” Anymore? (Part I). Available at: http://elhamsaeidinezhad.com
    [15] Saeidinezhad, E., 2020. When it Comes to Market Liquidity, What if Private Dealing System is Not “The Only Game in Town” Anymore? (Part II). Available at: http://elhamsaeidinezhad.com
    15
    [16] Scholes, M. S., 1995. Fischer Black. Journal of Finance, American Finance Association, vol. 50(5), pages 1359-1370, December.
    [17] Schwarcz, S., 2008. Identifying and Managing Systemic Risk: An Assessment of Our Progress. Harvard Business Law Review.
    [18] Stigum, M., 2007. Stigum’s Money Market. McGraw-Hill Professional Publishing
    [19] Wayne, G and Kothar, S. P., 2003. How Much Do Firms Hedge With Derivatives? Journal of Financial Economics 70 (2003) 423–461

  4. Democracy or the Market

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    The problem of democratic representation has always turned on the question of the “have-nots”—that is, not only those without wealth and property, but also those marginalized on the basis of race, ethnicity, gender, origin, religion and education. Even in a world of full-fledged democratic rights, the democratic game tends to break in favor of the “haves.” They enjoy an easy affinity with political elites who are not so different from them, and they experience democratic politics as a hospitable and responsive place. When in doubt, they can back-channel, mobilize proxies and networks, and exchange cultural influence and economic power for political voice, cloaked in the comfort that what’s in their interest is in everyone’s interest. None of this means the powerful always get their way. But it means they operate on the assumption that their way is likely to prevail.

    Before democratization, which in both Europe and the United States did not reach its full expression until the turn of the twentieth century, those without power were politically excluded by fiat. Even when some “have-nots” overcame formal exclusion, they had to further overcome efforts, both brazen and subtle, to impede the exercise of their political rights; if they managed to bridge the distance between rights-in-name and rights-in-fact, they still had to muster meaningful representation in a game that was not built for them. The achievement of both rights and representation for the powerless is difficult, rare and fragile—not least because formal rights, once achieved, can be used as a pretense for rendering representation practically meaningless. In this case, democracy becomes form without substance.

    Three kinds of institutions were crucial drivers of the fitful, contested, imperfect construction of democratic rights and representation of the powerless between the 1850s and the 1920s: socialist and social democratic culture, mass political parties, and labor movements. Where the three converged, the result was a unique historical organization—the labor-allied mass party of the socialist and social democratic left.

    One does not have to romanticize social democratic parties or gloss over their failures to recognize that they, or something like them, are necessary for democracy. Indeed, there was once a well-established twentieth-century pattern in which tough economic times favored the fortunes of the social democratic left. The assumption that social democratic parties were forces of protection from the vagaries of markets, and understood as such by electorates, was once so taken-for-granted that an electoral left turn came to be understood by social scientists as a law of modern democracy.

    But in the 1990s—the era of the—“third way,” this law began to falter, and now appears to be in catastrophic collapse. The 2008 financial crisis did not convincingly reinvigorate the electoral fortunes of the social democratic center-left; it accelerated voters’ rush into the embrace of radical far-right parties, many of which took shape in the third-way era. (The UK Independence Party was founded in 1993, moving in a more xenophobic direction in 2006 under Nigel Farage; in Sweden, where the social democratic party embraced so-called Third Road politics in the 1980s, the far-right Sweden Democrats emerged in 1988.) The fates of parties, per se, are not necessarily important; but the fate of representative democracy itself is. Historically speaking, social democratic parties occupy the space in democratic systems that has the potential to make the difference between mere rights and actual representation. But simply occupying that space isn’t enough—it matters how these parties work, the agendas and policies they promote, and how and for whom (or what) they speak.

    Indeed, language is the coin of the political realm. And so it is note- worthy that, in the interview published here, former Prime Minister of Spain Felipe González describes politics as akin to “an iceberg, with democracy on the surface and democratic forces operating underneath.” Coming from a social democratic politician, González’s remarks can be read as a comment on the fragility of the representation of the “have-nots”—that it is never fully achieved. From the vantage point of the present, his remarks also suggest that there may have been something about third wayism that ultimately eviscerated center-left parties’ capacity to represent. Indeed, despite claims to the contrary, it now appears clear that third wayism’s particular variety of representation was not what center-left constituencies had in mind.

    To think about this we have to remind ourselves that parties represent more than just constituents; they also make truth claims about how the world works. Claims about the economic world are especially critical for the representation of poor and working people. Accordingly, center-left parties always concerned themselves with the production and recruitment of economic experts. Before the 1920s, these experts were largely in-house and journalism-centered, but the tumultuous interwar years ushered in two significant changes: on the one hand, rebellious, younger-generation ranks of still-developing economics professions embraced more pro-labor, pro-deficit-spending ways of thinking; and on the other hand, socialist, labor, and social democratic parties increasingly became viable parties of government, growing their ranks and connections to university-educated elites in the process. The result was the forging of a critical tie between center-left parties and increasingly “Keynesian” economics professionals.

    This tie was expressed in and sustained by a dominant profession- al ethic among mainstream economists that prioritized strategically sensitive policy advice—that is, a commitment to adapting economic analysis to the social democratic imperative of responding to constituencies including, critically, organized labor. With one foot in the academy and the other in center-left parties, economist theoreticians of the 1960s developed a unique understanding of their political function: to ground economic advice in a sensitivity to democratic demands.

    But ties to economics professions meant that center-left parties’ understanding of the economic world was very sensitive to mainstream economists’ understanding. And so, as economics professions internationalized, became increasingly integrated into the growing world of transnational financial and monetary institutions, and embraced a vision of the world rooted in untethered markets, the economic truth claims—and thus the representative capacity—of center-left politics were transformed for reasons that had little, if anything, to do with electoral “demand.”

    This transformation helps to explain a hallmark of third way center-leftism: a shift from the representation of people to the representation of markets, understood not as a means to human ends, but rather as territorially, politically and socially untethered forces governed by natural laws. We find hints of this way of seeing things in third-way preoccupations with the irresistible forward march of globalization and “modernization.” In continental Europe, third-wayers sometimes conflated market demands with the exigencies of European integra- tion—which, having originated as a pacification project aiming to construct a “community of law,” became increasingly about mar- ket-making (trade liberalization, free movement of workers, labor market reform, monetary integration) from the mid-1980s onward. No matter the euphemism, the basic logic was the same: democratic constituencies would have to adapt to the demands of markets, not vice versa. Yet socialist and social democratic parties’ embrace of market imperatives entailed an intractable dilemma, because the interests of markets tend not to coincide with the interests of the powerless.

    Efforts to rhetorically navigate this irreconcilability was, inevitably, another hallmark of third wayism, fueling the production of memorable but elusive catchphrases. Third wayism, in the words of Tony Blair and Gerhard Schroeder, stood for “[f]airness and social justice, liberty and equality of opportunity, solidarity and responsibility” while accepting “[m]odernization” of a specific sort: “The essential function of markets must be complemented and improved by political action, not hampered by it.” Still, third wayers insisted there was a line they wouldn’t cross: “We support a market economy, not a market society.” Interestingly, González uses this very phrasing, even now: “This is what I believe in: a market economy and not a market society. Because human beings are not merchandise, and for that reason we need regulations and constraints.” The difficulty, of course, is that in a worldview in which markets can only be helped and never hindered, the line between market economy and market society becomes impossible to uncover—much less put to work as a practical principle of government.

    Despite the particular trajectory of the Spanish Socialist Workers’ Party (PSOE)—unlike other social democratic parties, it skipped over the intermediate, Keynesian phase found elsewhere, and its commitments in the 1980s centered on the construction (not “reform”) of social welfare institutions—González’ comments echo the constitutive ambiguities of third wayism.

    Traces can also be found in the interview with Italian Prime Minister Giuliano Amato. He is clear from the outset that his politics are explicitly class politics—a theme that’s missing from González’s political self-description. He notes: “The political culture when I entered the Socialist Party was one which stressed the protection and expansion of social rights.” But present in Amato’s remarks, also, are questions third wayers never really answered: where do we draw the line between a market economy and a market society? Who should draw this line, according to what principles, in the context of a meaningfully representative democracy? When Amato recounts that “little by little, we’ve reduced public expenditure beyond the point which enabled the continuation of social rights, to the point where it has deteriorated them,” he highlights the enduring consequences of third wayism’s failure to address those questions.

    Amato insists that third wayers, at the time, could not have known what was coming. In his words: “At the time, we could not understand the consequences of what we were doing. We could not see the moment in which the loss became greater than the benefits. And the people who lost from these developments went elsewhere.” But if democratic politics are to survive, the question we need to answer is what made the writing on the wall so difficult to see. Doing so requires that we reject the notion that parties and politicians simply react to the world as it is. The reasons for the rise of market-centric third wayism were as much internal to parties as they were external. To be sure, the period since the 1960s saw large scale transformations in the structure of the global economy, including the decline of domestic manufacturing in the West and the rise of multinationals and global finance. But these were not inexorable market processes; they were enabled by deregulatory and liberalizing policies that third wayism, on the basis of a belief in markets, embraced—and, in so doing, helped to make their belief a reality.

    Can we chalk the third way turn up to “ideology,” then? This, too, is overly simplistic. When we peer inside center-left networks, we see that beliefs are never pure principle; they are inextricable from the complexities of factional intrigue, power-seeking and contestation over the meaning and interpretation of events. Third wayism was not born as spontaneous consensus, but rather through a series of factional victories—American New Democrats over New Deal liberals; Third Road Swedish and (later) New Middle German Social Democrats over traditionalist foes; New Labour “modernizers” over the “old” Labour Left.

    This collection of interviews helps us grasp the making of third wayism and its consequences by shedding light on these processes. They press us to reflect on the present and future of democratic representation, as the space once occupied by socialist and social democratic parties has been vacated in the name of markets—leaving the “have-nots” with little democratic terrain on which to stand. Finally, they speak to the necessity of building parties that are capable of formulating economic truth in a way that expresses, rather than suppresses, the needs, experiences, and demands of the people they claim to represent.

  5. Revolution, Reform, and Resignation

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    This text is co-published with the Boston Review, and is an excerpt from the PW Volumes publication Market Economy, Market Society: Interviews and Essays on the Decline of European Social Democracy.

    Some time in 1991 I was invited to give a talk to the Andalusian Confederation of the Spanish Socialist Worker’s Party (PSOE). Afterwards, the secretary of the confederation walked me back to my hotel. I asked him why there was a widespread atmosphere of demoralization within the party. Nos hicieron hablar un idioma que no era el nuestro, he answered: “They made us speak a language that was not ours.”

    Note that the secretary did not evoke the industrial restructuring of the 1980s, which significantly reduced the Party’s industrial working class base. He did not refer to the emergence of television, which reduced the importance of the party machine in mobilizing that base. He did not point to cultural transformations in Spanish society, which rendered new ideological dimensions politically salient. Instead, he identified the root of the party’s transformation in the language by which party leaders were expected to address their supporters, publicly interpret the world, and justify their policies. What was this language that was not “ours”?

    To answer this question we have to go back in time and to venture beyond Spain. The two keywords of the socialist movements that were born in Europe in the second half of the nineteenth century were “working class” and “social revolution,” where the latter was expected to realize the “ultimate goal” of abolishing the class system. Yet when socialist parties entered into electoral competition and, for the first time, gained parliamentary power in the aftermath of World War I, “ultimate goals” were not sufficient to mobilize electoral support or to govern. As political leaders, they had to offer a program of immediate improvements to the life conditions of the public. Moreover, Socialists learned to dilute or obscure the language of class in order to win elections. While communists continued to adhere to “class contra class” strategy, socialists formed coalitions and fronts aimed at appealing to “the people.”

    Thus was born reformism: the strategy of proceeding towards socialism by steps, and through electoral expression of popular support. The Social Democratic view of the world was one in which there was no choice between reform and revolution. There was nothing strange about French Socialist Jean Jaurès’s argument that “Precisely because it is a party of revolution… the Socialist Party is the most actively reformist.”1 He further notes:

    I do not believe, either, that there will necessarily be an abrupt leap, the crossing of the abyss; perhaps we shall be aware of having entered the zone of the Socialistic State as navigators are aware of having crossed the line of a hemisphere—not that they have been able to see as they crossed a cord stretched over the ocean warning them of their passage, but that little by little they have been led into a new hemisphere by the progress of their ship.2

    But even if reaching socialism would be imperceptible, socialism remained the goal. “Revolution” would be accomplished by accumulating reforms.

    Following the success of the Swedish Social Democrats in the 1930s, and in the aftermath of World War II, the Keynesian welfare state institutionalized a compromise between organizations of workers and of capitalists across Western Europe. Gradually abandoning Marxism, social democrats accepted the tenet announced in the SPD’s Bad Godesberg program of 1959: markets when possible, the state when necessary. Social democrats were to administer capitalist societies with the goals of liberty, employment, and equality. And they did accomplish much: they strengthened political democracy, introduced a series of improvements to work conditions, reduced income inequality, expanded access to education and health, and provided a foundation of material security for most people, while promoting investment and growth.

    But because it left the property structure intact and allowed markets to allocate resources, the social democratic approach fueled the causes of inequality at the same time as it aimed to mitigate their effect. This contradiction reached its limits in the 1970s. As many old ills were overcome, new ones emerged. Indeed, the list of problems to be resolved by socialist programs in the mid-1970s was not any shorter than it had been at the turn of the twentieth century.

    The constraints of capitalist economy turned out to be inexorable, and political defeats meant that reforms could be reversed. In office in most Western European countries, social democratic governments desperately searched for responses that would preserve their commitment to “ultimate goals” in the face of the economic crisis. During the early 1970s, socialist parties developed new energy policies, workers’ management schemes, and structures of economic planning. But Callaghan’s defeat to Thatcher in 1979, and the departure of Communists from the Mitterand government in 1984, administered fatal blows. Mitterand’s turn to austerity was the final act of resignation in the face of domestic and international constraints. All that was left were successive ”third ways.”

    The evolution of social democracy until the advent of neoliberalism has been extensively documented. The capitulation of the left to the neoliberal offensive is more puzzling. It is hence revealing to get a glimpse of how social democratic leaders saw the future when they got the first whiff of the impending crisis of their long-term project. Fortunately, they were articulate about their fears, their hopes, and their plans. An exchange of letters among German Prime Chancellor Willy Brandt, Austrian Chancellor Bruno Kreisky, and Swedish Prime Minister Olof Palme on the eve of the first oil crisis of the 1970s offers insight.3

    Max Beckmann, Die Hölle (Hell): Die Strasse (The Street), 1919.

    The exchange among Brandt, Kreisky, and Palme included a series of letters and two in-person debates. It was initiated by Brandt on 17 February 1972 and ended with a conversation in Vienna on 25 May 1975. Brandt became the Prime Minister of Germany on 21 October 1969, won a reelection in 1972, and resigned on 6 May 1974. Kreisky became the Chancellor of Austria on 21 April 1970 and continued to serve until 24 May 1983. Palme came to office in Sweden on 14 October 1969, left after an electoral defeat on 8 October 1976, returned to office in 1982, and was assassinated in 1986. Hence, all the three were in office through most of the period of correspondence. The exchange took place after the collapse of the Bretton Woods system in 1971 and during the onset of the first oil crisis of the 1970s. Between October 1973 and March 1974 oil prices increased by about 300 percent. Unemployment in the OECD countries rose from an average 3.2 percent between 1960 and 1973 to 5.5 percent between 1974 and 1981; inflation rose during the same periods from 3.9 percent to 10.4 percent, and growth rate fell from 4.9 percent to 2.4 percent.4

    Brandt initiates the exchange with a call to discuss the fundamental values of democratic socialism. Quoting the Bad Godesberg Programme of 1959, he declares that the goal of social democrats is to create a society “in which all men could freely develop their personality and cooperate in the political, economic, and cultural life of humanity as members of the community.” This transformative orientation is immediately echoed by Palme: “social democracy is more than a party charged to administer the society. Our task is much more to transform it.” Kreisky even more explicitly refers to the ultimate goal: “Socialists… want to eliminate classes and justly divide the product of work of the society.”

    Echoing Jaurès, all the three reject the choice between reform and revolution. Brandt refers to it as an artificial distinction “because no one can seriously deny that all reforms tending to increase our sphere of liberty do not also contribute to a transformation of the system.” Palme rejects the idea of a violent revolution as “elitist,” claims that reformism is based on the support of social movements, and sees reformism as nothing but a “process to improve the system.” Kreisky is less certain about the cumulative effect of reforms and more specific about the reforms that would have transformative effects, but he also believes that “there is always a moment in which the quantity [of reforms] becomes transformed into quality.”

    All the three worry about the relation between long term goals and current policies. Resolutely democratic, they condition the progress of reforms on their popular support and they welcome the cooperation in reforms by other political forces. Yet whatever their commitment to long term goals, they are leaders of political parties, with the responsibility to win elections. They are acutely aware that people will condition their support on bread-and-butter issues, not on long-term goals. This is what preoccupies them. Palme writes: “It is the problems of everyday life which occupy men most.… The relation between the ideas and the practical questions must be explained.… It is not sufficient to say: We need to modify the system. All efforts in this direction must be attached to solving human problems.”

    And problems there were: income inequality and capital concentration were intensifying, unemployment was rising, natural resources were limited, and the environment was increasingly under threat. Kreisky worries that: “Sooner or later we will face the problem of how far we can guide ourselves by our principles in practical politics.” He worries about the rise of multinational corporations, environmental limits to growth, and the depreciation of manual work. The letters are forward looking: the three discuss structural reforms that would advance their fundamental values.

    On December 2 of 1973, they meet to discuss the consequences of the oil crisis. Brandt recognizes that it constitutes a decisive breakthrough for industrialized countries and will require serious efforts to cope with. The first bell of alarm is struck by Kreisky:

    There is something that seems very important to me, namely, our lack of foresight in matters of social policy. There has been a particularly dangerous development. It was believed that crises like the one in the early 1930s could not be repeated. Yet we now see how from one day to the next political events came to weigh on our economic situation. A threat of global proportions which, just a few months ago, would have been held to be impossible.… We suddenly see that we confront a situation the seriousness of which cannot be minimized.

    Palme spells out the difficulty:

    We told the people who were already enjoying a prosperous situation that things would be much better for their children and that we would be able to solve the outstanding problems.… [But the new situation] presents a much more difficult task to fulfill. Because from the moment there is no longer a constant surplus to be distributed, the question of distribution is appreciably more difficult to resolve.

    Brand echoes these concerns, noting that it is essential to prevent inequality from increasing as growth resumes. Eighteen months later, during another in person meeting on 25 May 1975, Kreisky makes the fiscal constraint even more explicit: “It is precisely now that reforms should be made. It is just a question which. If we strongly develop social policies, we will not be able to finance them.”

    They desperately search for a distinct social democratic response. “Social Democracy,” Kreisky emphasizes, “must find its own response to the crisis of modern industrial society.” Brandt rejects the accusation that “we have become a party confined to tactical maneuvers. The program of 1959 does not separate us in any way from the grand objectives of the German and international workers’ movement.” They agree that some reforms, those in the realm of social policies, have become much more difficult, but they emphasize that reforms which extend democracy to the economic realm by introducing employee co-management, as well as new energy and environmental policies and increased State intervention in the economy are not only still possible but necessary. While Palme reflects that “the time of simplistic belief in progress is irrevocably gone,” he searches for a new “third way” between “private capitalism” and “bureaucratic State capitalism of Stalinist variety,” offering a detailed eleven-point program of reforms. And Brandt admonishes that “the effort to reform the society must not cease.”

    The reforms did not cease. After Brandt resigned in 1974, Helmut Schmidt, who succeeded him, pursued demand stimulation policies, albeit paying increasing attention to fiscal constraints and reducing some public expenditures, until he was removed in 1982 by a vote of no confidence in favor of Helmut Kohl. Palme lost the election in 1976 but returned to office in 1982, restoring most cuts to social policies instituted by the interim government but emphasizing wage restraint and abandoning Keynesian policies. Kreisky won several elections and remained in office until 1983, continuing to expand social policies, particularly in education and health. While the shadow of fiscal and foreign exchange deficits tempered the reforms, the reformist zeal was not abandoned.

    Figure 1.

    As Figure 1 shows, electoral support for social democratic parties and the left as a whole in the OECD peaked in the early 1980s and continued to decline ever since.

    Explanations of the electoral decline of social democracy are many, but this is not what I aim to examine here. Parties bearing social democratic or socialist labels may do better or worse electorally; the deeper question is whether the content of their vision has changed. And in response to the shrinking of their traditional base of industrial workers, the rise of neoliberal ideology, the liberalization of capital flows and subsequent tightening of fiscal constraints, and the necessity to defend national currencies against financial speculation, the language of social democracy fundamentally changed. We get a sense of this language in Brandt, Kreisky, and Palme’s references to fiscal constraints generated by the oil crisis. We hear it, in the interview that follows, in Italian Prime Minister Giuliano Amato’s understanding of “the need to balance social rights with financial stability.” We heard it from Felipe González in 1999: “Capital markets charge themselves with reminding that they do not trust an economic policy that does not watch inflation or deficit.” I heard it personally from Brazilian President Fernando Henrique Cardoso, whom I asked what he found most constraining, to which he answered, ”the market.”

    These constraints are real. Felipe González once told me that the run on the peseta in 1986 cost Spain the equivalent of the national health budget in a few days. Slow growth, inflation, unemployment, large fiscal deficits, and balance of payments crises did not leave socialist governments with much room for maneuver. The Maastricht Treaty was to be a solution to these problems, but at the cost of tying the hands of social democrats behind their backs: with the limit of 3 percent on annual deficits and of 60 percent on the ratio of debt to GDP, Keynesian stimulation was nearly impossible and increased social expenditures tightly circumscribed. As the Right moved to the right, the Left moved even farther to the right, and the economic policies of center-Left and center-Right became almost indistinguishable. Social democrats embraced liberalization of capital flows, free trade, fiscal discipline, and labor market flexibility, abstained from counter-cyclical and industrial policies.

    For fifty years social democrats believed that equality promotes efficiency and growth: in the words of Swedish minister Bertil Ohlin, social expenditures “represent an investment in the most valuable productive instrument of all, the people itself.” Yet suddenly they adopted the neoliberal verbiage about “trade-offs,” between “equality and efficiency,” between “equality and growth.” The world became full of “dilemmas” and “trilemmas.” The English sociologist Anthony Giddens invented as many as five dilemmas—none of which is one, in a logical sense of the term. “The government can do only so much”—Social Democrats echoed the Right. “Responsibility,” a word from Thatcherite vocabulary, was shifted from the State to individual citizens. Giddens preached, “A prime motto for the new politics [is] no rights without responsibilities.” And in addition to this linguistic turn, social democrats ran out of ideas. In Joseph Stiglitz’s ambitiously entitled book chapter, “A New Capitalist Order,” he urges the same reforms of the postwar period: governments should maintain full employment and a stable economy, they should promote innovation, provide social protection and insurance, and prevent exploitation.

    The Hague Congress of the First International proclaimed that the “organization of the proletariat into a political party is necessary to insure the victory of social revolution and its ultimate goal: the abolishment of classes.” The first Swedish program specified that “Social Democracy differs from other parties in that it aspires to completely transform the economic organization of bourgeois society and bring about the social liberation of the working class.” Socialists were going to abolish exploitation, to eradicate the division of society into classes, to remove economic and political inequalities, to finish the wastefulness and anarchy of capitalist production, to eradicate all sources of injustice and prejudice. They were going to emancipate not only workers but humanity, to build a society based on cooperation, to rationally orient energies and resources toward satisfaction of human needs, to create social conditions for an unlimited development of personality.

    These turned out not to be feasible goals. But the vision of transforming the society survived for nearly one hundred years, even when it was imperative to cope with immediate crises, even when some ideas—most prominently nationalization of the means of production—revealed themselves to be mistaken, and even when Social Democrats experienced political defeats. This is what faded at the end of the 1970s. Referring to the reforms of the 1980s, Giuliano Amato reflects, “Little by little, we’ve reduced public expenditure beyond the point which enabled the continuation of social rights, to the point where it has deteriorated them.” Commenting on the experience of his government, González is also nostalgic: “What worries me is that to some degree social democracy died of success. It died because it couldn’t understand that the society that it had helped create was not the society which existed when it started.”

    The title of the Brandt, Kreisky, Palme exchange was Social Democracy and the Future. But this may have been the last time when social democrats struggled to maintain a transformative perspective while coping with an immediate crisis. Perhaps social democrats have transformed as much as they could have; perhaps they have succeeded in making some of their reforms irreversible. Nothing in this essay is intended to question their achievements. But any vision of a common future to which they would orient their societies faded under the onslaught of the immediate obstacles. What was no longer “ours” for the Andalucian secretary was a language that does not extend beyond a program for the next election, a language that does not guide the society toward some goals. And this is what we must regain.

    1. Fiechter, Jean-Jacques. 1965. Le socialisme français: de l ́affaire Dreyfus a la Grande Guerre. Geneve: Librairie Droz. p. 163. ↩
    2. Ensor, R.C.K. 1908. Modern Socialism as Set Forth by the Socialists in Their Speeches, Writings, and Programmes. New York: Charles Scribnerís Sons. p. 171 ↩
    3. Brandt, Willy, Bruno Kreisky, and Olof Palme. 1976. La social-démocratie et l’avenir. Paris: Gallimard. ↩
    4. Bruno, Michael, and Jeffrey Sachs. 1985. Economics of Worldwide Stagflation. Cambridge, MA.: Harvard University Press. Table 1. ↩

  6. François Mitterrand’s Austerity Turn

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    The history of French socialism is filled with famous and heroic dates: 1789; 1848; 1871 1936; 1968. But less well remembered is another date of great significance: 1981. It was in May of that year that the French left achieved its greatest electoral triumph of the postwar era, with the election of Socialist Party (PS) leader François Mitterrand as President of the Republic. That victory, which came after a quarter century of uninterrupted conservative rule, raised hopes for a new departure in French politics. Mitterrand’s election manifesto, the 110 Propositions for France, embodied the sweeping reform agenda he had promised since ascending to the leadership of the PS a decade earlier, when he memorably capped his speech at the Party’s 1971 Congress with a thunderous call for a “rupture” with capitalism. As head of the PS, Mitterrand’s decision to pursue an electoral agreement with his long-time his rivals from the Communist Party (PCF), which resulted in the 1972 “Common Program,” was both a milestone for the postwar French left, and an important step in his own rise to the Élysée Palace.

    Mitterrand’s election in the spring of 1981, and the subsequent triumph of the left in parliamentary elections which followed immediately afterwards, led to the formation of a government under Prime Minister Pierre Mauroy that was more radical than any France had seen since Léon Blum’s Popular Front in 1936. For the first time since the start of the Cold War, Mauroy’s cabinet included four communist ministers. Once installed in office, the new government moved quickly to make on the left’s campaign promises, introducing a dizzying array of reforms in the weeks and months that followed. Among these were an extensive series of nationalizations, which put dozens of major firms and numerous strategic industries (including the entire banking sector) in the hands of the state; a 40 percent increase in the minimum wage; a reduction in the legal workweek to thirty-nine hours (with the promise of additional reductions to follow); a host of new powers and protections for French trade unions; welfare state expansion; the creation of thousands of additional public sector jobs; plus abolition of the death penalty, and reform of the legal code and education system.

    In many ways, this reform agenda was indicative of the leftward turn of European social democracy during the 1970s. In the face of growing economic difficulties and widespread labor militancy across the region, left parties and trade unions throughout Western Europe adopted increasingly ambitious reform plans. In France, where the crisis was particularly acute, that radicalization was the backdrop to Mitterrand’s rise during the 1970s, and continued to shape the outlook of his administration during its first year in office. In this initial, reformist phase, the government pursued an economic program which, though it may not quite have constituted the promised “French road to socialism” was at least a kind of augmented Keynesianism, in which wage and employment growth was prioritized, disposable income rose sharply, and the tools of state-led economic development that had long been central to French capitalism were turned toward a left-wing, pro-labor policy agenda.

    Within a year, however, the government’s efforts to find a reformist route out of the crisis began to collapse. In the face of growing economic problems, and significant pressures on the franc, Mitterrand put his economic agenda on pause. In June 1982, the government announced a spending and wage freeze, and moved to devalue the French franc (which, under the terms of then-existing European Monetary System, was pegged to the German Deutschmark). The following spring, Mitterrand effectively turned this pause into a U-Turn. Facing calls from both foreign officials and leading voices within his own government for more drastic action to restore monetary stability, he relented. Despite objections from left-wingers in the cabinet, the President announced a further devaluation of the franc, along with more drastic austerity measures. For Mitterrand, this course reversal marked a new phase of his Presidency: by the end of 1984, the communist ministers were gone, and price stability, not employment, had been officially declared the government’s top economic priority.

    The fallout from these events continues to shape French politics today. Mitterrand’s austerity turn embarked France on a now almost four-decade-long process of economic restructuring. Liberalizing reforms have been introduced by governments of both the right and the left. For the PS, the consequences have been dire. The political costs of this rightward drift can be seen in the electoral fall the party suffered in 2017. For the rest of the left, however, the impact has been even more catastrophic: for the Communist Party (PCF), long the dominant force in the left and labor movement, Mitterrand’s election and subsequent U-Turn contributed to a long-term drop in membership and electoral support. The traditionally communist-led union confederation (the General Confederation of Labor, or CGT by its French initials), shrunk by more than half during the 1980s, and by the mid-1990s it had severed its links to the PCF. Conversely, the far right, which achieved its first electoral breakthrough in the 1984 European elections that followed on the heels of Mitterrand’s austerity turn, has managed to grow rapidly, in part by winning over voters in de-industrialized regions and working class communities that once were bastions of the socialist left. Today, far right leader Marine Le Pen has emerged as the leading opponent of incumbent President Emmanuel Macron and his primary competitor in the 2022 presidential election.

    The interviews published here offer a unique perspective on the early years of Mitterrand’s Presidency, from three observers who witnessed them first hand. They include Anicet Le Pors, former PCF Senator and Minister of Civil Service and Administrative Reform in Mitterrand’s first cabinet; François Morin, Professor Emeritus of Economics at the University of Toulouse-I-Capitol, and previously an adviser to Mitterrand’s first Prime Minister, Pierre Mauroy, and Roger Martelli, a former member of the leadership of the French Communist Party, and now co-editor of the magazine Regards. What these interviews provide is not a full picture or detailed recounting of the period 1981–1983, but a fascinating picture of the trajectory of French socialism in the second half of the twentieth century.

    The French left of this period was shaped by the tumultuous politics of the postwar decades: those decades began with high hopes, following France’s liberation from Nazi rule, which soon gave way in the face of growing Cold War divisions. Throughout the 1950’s, those divisions split labor and the left in France between a large and powerful, but politically isolated communist movement, and a smaller group of moderate parliamentary socialists, who competed with one another to secure positions in the unstable coalitions that governed the Fourth Republic. More than just a political party, the communists controlled what Roger Martelli rightly calls a “galaxy of organizations” including France’s biggest labor confederation, the CGT. In size and support, it far surpassed its counterparts on the moderate socialist left. But, in the context of the Cold War, its support for the Soviet Union made it an anathema in French politics, ensuring its total exclusion from national office.

    In the 1950s, the political crisis that resulted from France’s bloody, and ultimately unsuccessful, colonial wars in Indochina and Algeria, brought these tensions to a head, precipitating a coup which returned General de Gaulle to power in 1958. That coup led to the death of the Fourth Republic and the rise of a Fifth, with authority now vested in a strong President. During the 1960s, de Gaulle’s stranglehold over the Presidency and the dominance of his brand of conservative nationalism over French politics kept the left in a position of permanent opposition. But the very success of the Gaullists in these years also set the stage for the unprecedented explosion of strikes and protests that marked the month of May 1968. Despite the defeat of that movement, and the crushing defeat de Gaulle handed the left in elections held latter that June, the legacy of 1968 would continue to influence the direction of French politics: in the 1970s, its impact was felt in a series of major reforms to institutions like the welfare state, and in the enormous wage concessions won by French workers.

    These developments were compounded by the emergence of growing economic difficulties in France in the decade before Mitterrand’s election. In the 1970s, French capitalism was plagued by rising unemployment and inflation. Falling growth rates, reflecting the declining competitiveness of French manufacturing industries, and the onset of rising joblessness signaled the end of the postwar trente glorieuses, the three decades of rapid economic expansion and full employment after WWII. In response, conservative governments of the 1970s alternated between austerity and expansionary economic policies, while attempting to use the traditional tools of France’s state-led development model to restore the economy to health. This model had involved government directing economic development by means of “indicative planning” and support for priority industries and firms (known as “national champions”). While state-led development forged close ties between business and officials in the powerful national state, it largely excluded organized labor. Since the communists controlled the largest trade union confederation, government officials sought to limit the power and autonomy of labor, by making unions dependent on the state for recognition, financing and the extension of collective bargaining coverage.

    The upshot was that France developed few of the institutions we associate with postwar social democracy elsewhere in Europe. It lacked the centralized trade unions, and encompassing wage bargaining systems that characterized Scandinavia, for instance. Instead, questions that elsewhere were settled through collective negotiation were determined by state officials. Meanwhile, the combination of full employment and widespread tensions between labor, on the one hand, and big business and state officials, on the other, pushed French trade unions toward greater militancy, particularly in manufacturing industries where the communist-led CGT was strong. The flip side of this industrial militancy was the competition between the unions, who were forced to compete for members and influence in the same industries, due to the absence of the closed shop. As a consequence, high strike rates went hand-in-hand with the organizational fragmentation of labor, with the trade unions sharply divided along confederal lines.

    During the trente glorieuses, these arrangements produced considerable levels of shopfloor conflict, and constant stop-go dynamics in the economy, which fluctuated between periods of rapid (but inflationary) growth and government-engineered slowdowns intended to curtail inflation. Mitterrand’s election in 1981 marked both a continuation and a break with this pattern. On the one hand, the new government continued to expand the scope of state intervention via large-scale nationalizations and the extension of additional subsidies to business, as well as the further growth of the welfare state to buffer workers from the threat of joblessness. On the other hand, his Socialist Party was committed to bringing social democracy to France: for example, the new legal rights instituted by the government’s Auroux Laws enshrined many of the trade unions rights and protections labor enjoyed in other parts of Western Europe.

    The three interviews published here highlight the evolution of the French left after 1968, and specifically the changing relationship between the communist and socialist parties. Traditionally, that relationship had been marked by suspicion and hostility on both sides. In the years after WWII, when the PCF’s dominance over the French left and labor movement was at its height, relations with the socialist left were particularly strained. But from the mid-1960s on, that began to change. While suspicions remained as deeply rooted as ever on both sides, it became increasingly clear that neither the PCF nor the moderate non-communist left could challenge de Gaulle alone. Only a union between the two currents could win an electoral majority.

    This convergence also reflected a change in the balance between the communist and non-communist left. In the aftermath of May 1968, French socialism’s leftward turn helped set the stage for a rapid increase in the size and influence of the non-communist left. In the labor movement, these changes were reflected in the rise of the CFDT (French Democratic Confederation of Labor) as a left-wing competitor to the communist-led CGT. In the political arena, this process was given a major boost by the amalgamation of the reformist left into a unified Socialist Party in 1969. Joined by Mitterrand two years later, the newly-formed PS became the vehicle for Mitterrand’s presidential ambitions (before winning in 1981, he ran unsuccessfully in 1965 and 1974). Mitterrand always hoped to supplant the communists as the leading force on the French left. But he understood that electoral success depended on an alliance with the PCF. Unlike the communists, he also understood that he would be the key figure in, and main beneficiary of, such an alliance.

    In 1972, these considerations led to PCF and PS to negotiate an electoral agreement known as the Programme Commun, or Common Program. In retrospect, it’s clear that Mitterrand and the socialists were the primary beneficiaries of this agreement. As Martelli notes, the Common Program was “the end of the Communist Party’s dominance in the French left, but at the time we didn’t know it.” Politically, the Program reflected the left’s radical reformist turn during the 1970s. That reformist turn did not necessarily imply a full-scale assault on the foundations of capitalism, but a significant deepening of the institutional restraints on the market. Thus, while calling for a transition to socialism, the Common Program actually centers on a series of measures to modernize and restructure French capitalism, using many of the tools French planners had employed for decades. As Martelli points out, this was fundamentally a radical Keynesian program. It rested on a strategy which promised to use state intervention to maintain employment, and kickstart economic growth by increasing disposable income and thus consumer demand. Le Pors notes that the Program reflected the PCF’s single-minded focus on nationalization as the cure for all of French capitalism’s problems, of which he is highly critical. “The Socialists only agreed to nationalize because they saw it as a condition of preserving the Union of the Left,” he says. “They were ideologically overpowered.”

    The Common Program did not survive the growing tensions between the PCF and PS, whose alliance would collapse in acrimony in the late 1970s. But it would later become the template for Mitterrand’s 1981 electoral manifesto. Introduced at a time when French capitalism was being devastated by another global economic slowdown, that manifesto laid the groundwork for a renewal of communist-socialist unity in 1981, on the basis of joint support for Mitterrand and a common electoral front for parliamentary elections. While the Keynesian program Mitterrand adopted during his first year in office prevented France from sinking into an even deeper recession, it also contributed to double-digit inflation and a ballooning trade deficit. Mitterrand’s reforms, which gave a substantial boost to real wages and household income, fueled the growth of prices and increased imports of everything from cars to household appliances. Meanwhile, rising public expenditures, driven, in large measure by the cost of subsidizing unprofitable firms, especially in the recently nationalized industries, exacerbated the state’s fiscal problems.

    By 1982, these considerations were leading influential voices within the administration to call for a retreat from Keynesianism. The interviews only briefly describe the battles this provoked inside the government, which pitted those who advocated continuing with the government’s reform agenda, even at the cost of exiting the European Monetary System, against those who counseled restraint and the need for austerity to restore fiscal stability. Presented with the option of either reversing course or leaving the EMS, Mitterrand at first vacillated, and then decisively chose the former option.

    Mitterrand’s about-face inaugurated forty years of economic liberalization and trade union decline. After 1983, the government never quite recovered from the internal divisions or loss of public support that ensued. In subsequent years, a series of cabinet reshuffles would see the communist ministers and the left depart, and more moderate figures take their place. But these changes did not save it from suffering a defeat in the 1986 parliamentary elections, leading to two years of “co-habitation” between Mitterrand and his conservative Prime Minister, Jacques Chirac.

    In many ways, the Mitterrand experience is a microcosm of the fate of the entire social democratic left in Western Europe since the 1970s. As inheritors of this history, we are left wondering whether a different outcome was possible—in France and throughout the continent. None of the interviewees hold out much hope for the left to continue down the path of Mitterrand’s first year in office. Martelli notes that timing of the government’s election intensified its isolation: “At the very moment that the left gained power in France, it was defeated everywhere else.” Economic globalization, and France’s dependence on foreign trade for many essential goods, meant that this unfavorable political situation had very direct, material consequences. For instance, because the governments of the United States and West Germany refused to take steps to reduce the value of their currencies relative to the Franc, imports of items denominated in dollars and deutschmarks became increasingly costly.

    Adding to these difficulties was the growing power of finance after the collapse of the Bretton Woods monetary system. Morin points out that “as long as global markets were able to attack the currency, we would not be able to carry out the reforms.” By March 1983, Morin says, “the continued speculative attacks led the party to take budgetary measures to reign in public finances and regain monetary credibility in the eyes of the global economy.” France’s vulnerability to financial speculation was also compounded by its membership in the European Monetary System (EMS). By tying the value of the franc to the German deutschmark, the EMS limited the government’s ability to steer domestic economic policy. Since they had to keep the value of the franc high enough to maintain the peg, French officials were under pressure to control the growth of wages and domestic consumption. All of this meant, Le Pors concludes, that “we were faced with a capitalism that was so financially internationalized that we had no leverage to change the course of things. If you combine the influence of the US, UK, and Germany, there was not much France could do.”

    Fundamentally, however, it was not globalization that doomed Mitterrand’s Keynesian economic strategy. The underlying issue was that, no matter how many companies the government nationalized or how much it spent subsidizing ailing industries, French producers remained unprofitable and uncompetitive. Companies that had traditionally been highly-favored “national champions” now became a drag on the economy and a drain on the state’s coffers. As losses in the nationalized industries mounted, government officials struggled to manage their growing portfolio of state-owned enterprises. The lack of private investment, the high levels of unemployment, and the growing costs of social welfare all meant that the government had to do more with fewer resources. Mitterrand thus found himself in a bind: the weaknesses of French capitalism, which brought him to power on the basis of his left-wing reform program, also limited his ability to carry out that program.

    In light of these realities, it is unsurprising that Mitterrand chose not to continue down the difficult and risky road of reformism. Under enormous pressure from forces inside and outside the government to reverse course, he abandoned the 110 Propositions for France in favor of austerity. Given the deep divisions within his government this was unavoidable. Whether or not he was correct, the experience of his administration exemplifies both the fate of Europe’s social-democratic left in the 1970s, and more fundamentally, the inherent dilemmas of reformism within a shrinking economic pie.

    Traditional demands for wage equality, full employment, a robust social safety net, and greater workplace democracy have always depended on the existence of a favorable economic climate. The problem, however, is that merely by pursuing its reform agenda, a left government can simultaneously undermine the conditions necessary for its own success. In part, this is due to the reforms themselves: nationalizing unprofitable firms, for instance, saves jobs and keeps important industries intact, but it also forces the state to bear the cost of financing them. It’s also due to the structure of power within our societies. Since business, regardless of how well organized or coordinated, can exert leverage over the state, merely by halting investment, it has an enormous political advantage over other groups.

    The degree to which these constraints prevent structural reforms varies: not every country that elects a left government faces the same circumstances as France in 1981. What the Mitterrand experience demonstrates, however, is that the more ambitious the left’s reform plans, and the more dire the situation in which it takes power, the more quickly it will run up against the limits of what capital will accept. Overcoming those barriers requires a high level of organization and internal unity on the left, a strong social base, and the active support of labor. But it also requires the right circumstances—something that didn’t exist in France in the early 1980s.

    At the same time, Mitterrand shows that if the path of radical reformism is challenging and uncertain, the alternative has been disastrous. The three interviews conclude on a pessimistic note about the future prospects for the French left. Despite sometimes impressive mobilizations over the past three and a half decades, it has never recovered from Mitterrand’s course-reversal. In this sense, it is still paying for the failure of his brief experiment in radical social democracy.

  7. Transitions

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    It’s been some time since the term “transition” was fully incorporated into day-to-day usage in contemporary Spanish. It refers to the process of political change that began during the second half of the 1970s, a process which transformed Spain from the Franco dictatorship to the parliamentary monarchy that governs the country today. The term was coined in the midst of the dictatorship, as if in its invocation it could foreshadow the horizon of its disintegration. It succeeded in connoting the way in which one regime gave way to another—not a violent cut, nor a democratic breakdown in the strict sense. Instead, it was a process negotiated by the leaders who had inherited the state apparatus of the dictatorship, and the leaders of the parties of the democratic opposition. While the first aimed to assert the weight, however trivial, of an obsolete and precarious power structure, the second aimed to channel the democratic impulse of a significant section of Spanish society.

    That latter section was composed of men and women who resisted through illegal parties and organized social movements (worker’s movements, neighborhood associations, student unions, and feminist groups) capable of breaking the public order and revealing, between the cracks of the regime, the new alternatives.1 In their day to day, they developed forms of political participation, experimentation, and cultural innovation which themselves detracted from Franco’s hold on the popular imagination. In many ways, these early experiences were much more profound than the institutional restructuring later termed the transition. From this angle, the transition can be understood as a sfumato, that is to say, not only the fading of dictatorship into democracy, but as a sum of experiential layers each contributing to its atmosphere and offering a depth that we’ve yet to fully grasp.The interviews with Felipe González, Begoña San Jose, and Héctor Maravall contained in this book capture the texture of this historical moment.

    On the other side of this politically active reality stood another very diverse and wide sector of society, predisposed to the consensus they were socialized into under Francoism. They were motivated by a timid desire for change, as well as by a deep fear of its consequences. Under- standing the Spanish transition requires gaining an awareness of these inherited social habits which were highly structured by authoritarianism, and the survival of its repressive legal, bureaucratic, and media institutions. It also requires acknowledging an international framework in which any action on the margin of society was limited by the areas of political influence that defined the Cold War period.

    But understanding the transition also requires capturing that organic crisis in existing relations of power, the intuitive and automatic social responses which enhanced the appeal of new cultural attitudes and expanded the scope for political action. The much cited phrase of Manuel Vázquez Montalbán—which explains the negotiations behind the changing regime as “an alignment of weaknesses”—is useful if we recognize that, in moments of crisis, any alignment of forces is unstable and fragile. Understood through its underlying estatism, “an alignment of weaknesses” is a declaration that the transition happened in the only way that it could have. It’s an argument in which the real is transformed into the rational, the rational into the optimal, and the optimal into the venerable. But we know that narratives of the past tend to perform this argumentative transposition in the opposite direction: it is from the veneration of the present that earlier events are arranged in a way that inevitably leads towards some determined destiny.2

    The story of the Spanish transition was written in such a way during the 80s and 90s. Through an invention of tradition, the Spanish transition as we know it is actually a product of these decades. And in this process of invention, the very real and visceral criticisms which abounded during the early years of democracy were left out of the narrative.3 In these interviews we see that the more successful the interviewees were in the eighties and nineties, the more pleasant is their memory of the process that led to their ascent.

    The interview subjects describe inverse trajectories during the process of transition. Begoña San José and Héctor Maravall were members of the Partido Comunista de España (PCE), the largest, best organized, and most influential party in the fight against the dictatorship, which nevertheless reached the end of the process in pieces. Felipe González was a member of the Partido Socialista Obrero Espanol (PSOE), a party that played a minor role in opposition to the Franco regime, but won the elections 1982 with an absolute majority, ruling the country without interruption until 1996.

    Several factors account for the difference in these trajectories. Among other reasons, the crisis of the PCE at the end of the transition can be explained through the general stigma that Francoism and the culture of the Cold War had cast upon it. It can be explained by the focus on tactics rather than a vision for long term strategy, by the aging leadership, the frustration with a militancy that was not rewarded electorally, or the conflicts that emerged within that militant base once unity in the fight against dictatorship gave way to ideological divisions fueled by the desire for party control.

    By contrast, the success of the PSOE can be explained by the external support of social democratic parties all over Europe, by the historical weight of the party, memories of which survived latently throughout the dictatorship and resurfaced during the transition, or by its calculated oscillation which enabled it to compete both on the left and the right. The success of the PSOE against the PCE can also be explained by the proliferation of popular media and its crucial role in mediating public debate. The image of González then was that of a young married man, with whom both younger and older generations could identify. It was the image of a labor lawyer, simultaneously appealing to the professional class of lawyers and accountants, as well as the interests of workers. It was the image of a socialist, with Christian beliefs, temperate manners, charismatic speech and little ideology. This image fit the ideals that many had adopted or constructed during the transition.4

    The term “transition” has undergone such semantic expansion that it came to describe every aspect of Spain at the time—from the economy, to culture, and the society. The most interesting accounts manage to articulate the different spheres of activity which did not always align, and occasionally came into explicit conflict. In an attempt to characterize this complex reality, one might be tempted to speak instead of “transitions.” We are concerned with two different transitions which the interviews clearly bring to light. Internationally, the degradation of Keynesian growth models which seized much of the West during the 1980s. And domestically, the personal development of protagonists of the Spanish transition in response to this shift. The international shift can be conceptualized in Polanyian terms as another “great transformation.”5 The evolution of agents of the Spanish transition can be understood through Gramsci’s notion of transformismo.

    Spain built its new political architecture on ground already shaken by the global crisis. In its most popular form, the transition was primarily aimed at integrating Spain into European and North Atlantic institutions. Effectively, it was a transition into a world in transition. This particularly constrained the PSOE’s “historical mission:” to build the welfare state that Francoism had denied the Spanish public even during years of growth and development. The great postwar social pact, which European workers had begun to question because of its benefits to employers, and employers began to dissemble because of declining profits, had never been sealed in Spain. Rather, this fight to change the rules of the social game was fought just as the rules were being redefined.

    The PSOE came to the government in 1982 in the midst of this battle. It did so on the back of a social impulse for change, including very broad moderate sectors, and with the approval of an important part of the country’s economic elite. It did so in an economic context of stagnation, inflation and unemployment very different from that of the “golden years” of the welfare state. In this context of crisis, the development of a strong redistributive policy required not only fiscal progressivity, but also a fundamental restructuring of the relations of power and property. But the PSOE arrived in government after having accelerated an ideological transition from rhetorical radicalism to a social liberalism, con- strained within pragmatic and technocratic borders. This project was generically named modernization. It symbolically combined all those illusions, doubts, debts, limitations and interests which the Party had to confront. In practice, the economic policy of the González government complied with the orthodoxy that was beginning to prevail on the international stage. It opted for anti-inflationary measures which focused on a reduction in aggregate demand, wage cuts, increased tax rates, investment stimuli and extensive deindustrialization. It managed to reduce inflation and restore economic growth, but wages lost purchasing power, unemployment erupted and the labor market grew precarious. To compensate for this very apparent decline, the PSOE combined a language of entrepreneurship with intensified disciplinary practices and a minimal net of social policies. With excessive economic adjustments and facing renewed social pressure, the government built a timid welfare state, with important achievements in health, and more ambiguous ones in education.6

    The opposition to these policies came from many directions. Students mobilized for public education, for a good scholarship system and against the privileges preserved by the private system. The environmental movement matured in the struggles against the maintenance of pre-existing nuclear power plants and the creation of new ones. In a time of nuclear rearmament and an escalating Cold War, those struggles were tied to a strong antimilitarist spirit, from which arose a movement against Spain’s participation in NATO. The pacifist movement deployed in resistance to conscription. The feminist movement gained momentum around the claim to the sexual and reproductive rights of women, barely covered by the abortion law of 1985. The most concerted response to the policies of the PSOE came from male and female workers organized in large trade unions like the CCOO. Labor unrest in Spain was among the highest in Europe during the eighties. Despite these activities, PSOE managed to revalidate its victory at the polls.7

    The protagonists of these three interviews—whom anti-Francoism had brought together, and whom the transition had placed in competition with one another—now engaged in open confrontation. Felipe González was the president of the government. Héctor Maravall and Begoña San José were active members of the CCOO and entered Izquierda Unida (IU) in one way or another. But the ideological worlds of the PCE and PSOE, which at times repelled one another, have also frequently coalesced around the stronger pole. Thus, Héctor Maravall participated in Nueva Izquierda, a current of IU more prone to under- standing with the socialists. Begoña San José recalls the frequent cooperation with socialist women in many organizations and institutions.8 All three make fairly generous assessments of the transition. Their autobiographical testimonies offer a foundational contribution to understanding the history of neoliberalism.

    The memory of historical periods often comes from a position of power. Power constructs memory with sophisticated resources, simulating a benevolent distance with the past and reproducing anecdotal dialogues which flatter oneself. Power knows how to count and above all to be silent. The void that it leaves between the profiles it draws ends up constraining the slender silhouette of itself. But power sometimes also relaxes, it floods the story and ends up revealing something we already knew.

    However, memory, of the kind collected in oral history, is also built from other places—from the desire to rescue a life experience, to the search for who one was and for a time that is extinct. The authenticity of the past is glimpsed when many of the voices of then and many of the memories of today are heard, and especially when they are multiple and replicate each other.

    Between the 1970s and 1980s, Spain lived through its unique transition to democracy just as the world began its transition (linearly and uniformly) into neoliberalism. The country’s recent history appears to be traversed by many contradictory moments: anachronistic, accelerated, syncopated, out of step. Without impinging on the democratic changes underway, the transition left intact the elite institutions and practices of the dictatorship. Others were cloaked in the new language of modernization, revealing with time the grotesque nature of these hybrid forms. The monarchy acts like a metaphor for the country’s peculiar trajectory. The king emeritus was hailed as the leader of the transition in the 1970s. A few months later, he fled to the Persian Gulf. In 1969, he was named successor to the King by Franco. And in the 1980s and 1990s he was hailed as “the best Spanish ambassador abroad.”

    Hybridization was the peculiar form of that decade from the beginning of the eighties to the beginning of the nineties, where the opening of health centers coincided with the legalization of contratos basuras, and the festivities in the streets with the law of patada en la puerta: a mixture, in turn, of the old authoritarianism with the disciplinary measures of the new global order. The weakness of the social state that arose in Spain in that critical decade explains the speed with which it was dismantled. The neoliberal side of the two-faced Janus ultimately devoured its opponent. In the new millennium, a financialized and poorly diversified economy prevailed. Society grew more unequal, with a precarious mass and segments thrown into social exclusion.

    With this baggage Spain faces today a global pandemic, which has torn it at the seams and which has thrown it into the historical gallery of mirrors. The image reaffirms itself immediately: segregated neighborhoods for the poor, consumerism for the rich. A lack of investment in medicine, and overinvestment in the police force. If we move without fear through the gallery of mirrors, the memories of all men and women, we will see the multidimensional image: wrinkles and scars, but among the atrophied sections some parts that can still be exercised. Therein lies the utility of the memories of these transitions, in which a powerful public health and social coverage system was fought for, community support networks were built, and civic virtues were deployed without coercion.

    1. On the labor movement, see Doménech, X., Political change and the labor movement under Franco, Barcelona, ​​Icaria, 2011; Babiano, J. and Tébar, J., “Class unionism in the transition to democracy”, Gaceta de Estudios syndicados , n. 30, 2018; On the student movement: Hernández , E. , Ruiz, MA and Baldó, M., Students against Franco (1939-1975), Madrid, La Esfera , 2007 and Carrillo, A., “The opposition to Francoism in the university”, CIAN , Vol. 23, n1, 2020. On neighborhood movements: Bordetas , I., We made this city: Neighborhood self-organization and mobilization during the late Francoism and the process of political change, Unpublished doctoral thesis, 2012 and Radcliff , P., The construction of democratic citizenship in Spain, Valencia, UV, 2019. On feminism: Martínez, C., Gutiérrez P ., and González, P. ( eds ), The feminist movement in Spain in the 70s, Madrid, Cátedra, 2009 or Gil, Silvia, New feminisms. A history of trajectories and ruptures in the Spanish state, Madrid, Traficantes de Sueños, 2011. On counterculture: Labrador, G., Guilty for literature. Political imagination and counterculture in the transition, Madrid, AKAL, 2017.  ↩
    2. On these presentist narratives, Fontana, J. The History of Men, Barcelona Crítica, 2002. ↩
    3. On narratives of the transition, Pérez, J., “Historical experience and social construction of memory: the Spanish transition to democracy”, Past and Memory, n. 3, 2004; Godicheau , F . (coord.), Innocuous Democracy. What post-Francoism has made of us, Madrid, Post metropolis, 2015; Pasamar, G., The Spanish transition to democracy yesterday and today, Madrid, Marcial Pons, 2019. ↩
    4. The reasons for this trajectory is developed in Andrade, J., PCE and PSOE in ( the ) transition, Madrid, S . XXI, 2012.  ↩
    5. Polanyi, K., The great transformation, México, FCE, 2007. Gramsci, A., Antología , Madrid, AKAL, 2013, pp. 283-284. ↩
    6. Different readings of this period in Soto, A. and Mateos, A. (Eds.), History of the socialist era in Spain: 1982-1996, Madrid, Silex, 2013; Petras, J. “The Petras report. Fathers and sons. Two generations of Spanish workers,” and Vega, R. “The streets are burning: Radical mobilization and struggles for employment in Naval Gijón,” Sociology of Work, n. 90, 2017. ↩
    7. Gálvez, S., “The Great General Strike, the Unions Against the ‘Socialist Modernization’,” Madrid, S. XXI, 2017.  ↩
    8. San José, B. “Feminism and syndicalism during the Spanish democratic transition,” in Martínez, C., Gutierrez , P. and González, P. (eds.), Op . cit. ↩

  8. The Italian Left After Keynesianism

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    In 1977, Eric Hobsbawm published a book of interviews with Giorgio Napolitano, a leading figure in the Italian Communist Party (PCI)’s gradualist wing, the miglioristi. Hobsbawm proclaimed himself a “spiritual member” of the PCI and intended this book to depict the path it was beating in between Leninism and social democracy. Yet his efforts appeared rather frustrated by Napolitano’s vocabulary. Though calling for the “reconstruction and renewal” of Italian society and insisting on the PCI’s “democratic commitment,” Napolitano did little to convey any clear socialist worldview. As he extolled the “perspective of the continuous, organic, balanced development of the Italian economy” and the “retailoring of [Italian] production for the foreign market,” Hobsbawm interrupted him, as if to draw him back on topic:

    Hobsbawm: All this is very useful and positive…
    Napolitano: But what does it have to do with the advancement of socialism?
    Hobsbawm: That’s exactly what I wanted to ask you.
    Napolitano: That’s a question whose answer is less simple than it may seem.

    Napolitano’s elusive response expressed a contradiction not limited to the miglioristi. In Cold War Italy, the PCI never took up the reins of national government, yet strongly identified with republican institutions and a cross-class interest. The meaning of this ambiguity in terms of economic policy was highlighted at a 1962 Gramsci Foundation seminar on “Tendencies of Italian Capitalism,” as well as the 1966 PCI congress, where leading migliorista Giorgio Amendola clashed with the left of the party. Despite the “economic miracle” of the 1950s, Amendola emphasized the backwardness of Italian capitalism, and asserted the PCI’s role in “modernization,” “democratic programming,” and “structural reforms”—less planning than Gaullist dirigisme. The PCI left’s leader Pietro Ingrao instead emphasized the fight to increase workers’ living standards—a line which other PCI leaders saw as sectional and “economistic.” It was Amendola’s perspective that prevailed in the PCI into the 1970s, though it was Enrico Berlinguer and not he who became the new general secretary in 1972.

    Berlinguer’s leadership, lasting up till his death in 1984, was nonetheless marked by a substantial shift in his party’s economic thinking, embracing a strong critique of Keynesianism and even “statism.” Yet this also happened as a Socialist Party (PSI) increasingly hostile to the PCI was moving from what former Prime Minister Giuliano Amato calls a “schizophrenic” party to more recognizably social-democratic positions. While in the 1970s Italy had Europe’s most militant labor movement, profound changes in both the PSI and PCI’s culture beginning in this decade would radicalize them in a position which rejected any “sectional” blue-collar interest. It would be an exaggeration to present even the period of PSI leader Bettino Craxi’s premiership from 1983 to 1987 as the onset of Italian neoliberalism, given both the lack of any general design to liberalize the economy and the limits on incipient moves toward privatization. Yet the crisis of Keynesianism following the 1973 oil shock would mark a major reordering of the workers’ parties’ priorities, laying the bases for their transformation into a neoliberalized “center-left” in the early 1990s.

    The PCI had, from the period of the Comintern Seventh Congress in 1934 and then the antifascist alliance of World War II, always proposed some variant of “popular frontism,‘ transcending the sectional interests of blue-collar workers. Ever since the failure of the biennio rosso of land and factory occupations in 1919-20, Antonio Gramsci had recognized the need for the working-class minority to hegemonize broader masses rather than just assert its own industrial might. Since the factory proletariat was small in that early period of communist organization (around 2 million), even a fairly narrowly defined working-class force would have to integrate all manner of artisans, small traders, the casual workforce and unemployed, as well as rural laborers and farmers. But under Palmiro Togliatti’s leadership, this outlook was radicalized into a search for alliance with bourgeois parties on antifascist grounds, and indeed to appeal to the broadly defined “Catholic masses.” After Fascism, the important thing was to advance democratic reforms that could put the working class in the heart of national life, rallying broader layers around it, in a series of stages which would precede the fight for socialism proper.

    Reaching its height in the Resistance period, such a position faced obstacles during the Cold War era, in which the communists (and to a lesser degree, in the 1950s, even the socialists) were subject to a kind of anathema, which they sought to overcome by demonstrating their loyalty to republican institutions. The logical endpoint of this strategy came in Berlinguer’s leadership and the “historic compromise” from 1976 to 1979, in which the PCI gave outside support to Christian-Democratic (DC) cabinets. Indeed, while the PCI was now at its electoral high watermark—winning 34 percent support in the 1976 general election, bringing it closer than ever to overtaking the long-dominant DC—Berlinguer was aware he could never build a stable government just by cobbling together a “50+1 percent” coalition of the left. Recent events in Chile as well as the fact that Italy was a NATO country pointed to the need for a more mediated approach. In Berlinguer’s outlook, the PCI had to demonstrate its loyalty to democratic institutions and commitment to serving the broader national interest, thus earning it the right to hold executive power.

    This was the spirit in which it tolerated DC stalwart Giulio Andreotti’s third government after the 1976 elections (the abstention known as the non sfiducia, i.e. “not-no-confidence.”) This compromise, in which the PCI still had no ministerial roles, owed much to the efforts of DC party president Aldo Moro, who had already in the 1960s eased the PSI into the first “center-left” governments and now spoke of rapprochement between the DC and the PCI. His murder in May 1978 by Red Brigades terrorists would greatly set back such a cause. Yet beyond this apparently unnatural union, this period of “national solidarity” raised wider obstacles for the PCI, especially on the terrain of economic policy. For all its historic theoretical titans, the PCI had no experience in national government and a correspondingly weak layer of party economists—instead being driven to rationalize Andreotti’s crisis-response measures, in order to pull along its own base.

    Indicative in this regard was the package of austerity measures announced by Andreotti in October 1976, three months after the PCI’s non sfiducia had allowed him back into power. Alongside sharp fuel price increases, Andreotti proposed a two-year freeze on the scala mobile, a measure established in 1945 (from 1975, as a single reference point for all workers) to index wages to inflation. While the shop-floor mobilizations of the last decade had driven strong wage rises—thus achieving a more equitable sharing of postwar growth, just as it was coming to an end—faced with 17 percent inflation, the Andreotti government sought to impose a tighter wage discipline. But responsibility for such a turn now also lay with the PCI, considering not only its 12 million strong electorate but its massive hegemony among organized labor. Indeed, this revised outlook was most famously defended by Luciano Lama, leader of the General Italian Workers’ Confederation (CGIL) union and a veteran PCI militant, in an interview with La Repubblica.

    Speaking with its editor Eugenio Scalfari, Lama explained that he did not just stand for a sectional interest. Rather, “if we want to be consistent with the goal of pushing down unemployment, clearly the improvement of employed workers’ conditions has to come second.” Asked what this meant concretely, he explained, “Wage policy in the coming years will have to be very contained, any improvements we can ask for will have to be staggered.” Also put into question was cassa integrazione, the mechanism which paid out wages to redundant workers: “We can no longer oblige firms to keep on the books a number of workers beyond their productive capacities, or continue to demand that cassa integrazione means permanent assistance for surplus workers.” In a policy later known as the “svolta dell’EUR,” Lama made clear that the CGIL would accept a policy of “sacrifices” in the interests of rebooting investment and resisting runaway inflation, which had by 1977 reached 20 percent.

    The year in which Berlinguer first ventured the language of “austerity” as a “lever to transform Italy” was also 1977. With this he both pushed back against a consumerist vision of progress and insisted that short- term sacrifices would ultimately serve the general interest. Berlinguer’s comments did not portend a permanent fiscal austerity such as Italy would undergo in the 2010s; rather, they sought to present the PCI as a responsible party of government, while counterposing its record to the corruption of the ruling parties, shown in the first oil crisis of 1974. This change was not simply an artifact of the historic compromise with the DC, but a theme on which Berlinguer expanded even after the turn back to opposition in 1979, including in a 1981 interview with Scalfari on the “moral question” in politics. The PCI now advanced policies to handle the immediate crises facing the economy, rather than simply pointing to its ills as malign effects of capitalism or supporting mobilizations to shield workers from their effects.

    I’ve noted that even by 1945, PCI leaders had abandoned any notion of a 1917-style revolution: from the Stalinist Pietro Secchia to migliorsti or more social-movement-oriented figures like Ingrao, PCI leaders raised the banner of broad popular alliances, defense of republican institutions, and compromise with Catholic Italy. Yet if each had different conceptions of how this connected to the socialist “end goal,” Berlinguer’s turn relegated any such program of transformations to an intangible future. This also allowed the PCI to draw closer to the ideas of MIT economist Franco Modigliani, a brand of post-Keynesianism in fact based on marginalist ideas. In 1976 he was feted at a conference of the PCI-linked Centro Studi sulle Politiche Economiche, at which party economists embraced even such a pillar of neoliberal doctrine as NAIRU. This was the same vision reflected in Lama’s comments on the competing interests of employed and unemployed workers, which accepted that wage rises, not an exogenous shock, were driving inflation.

    For historian Guido Liguori, a gap was opening up between the PCI base and the values being imported from other political cultures. But equally striking were developments in the PSI. Ridding that party of its Marxist residues, in 1983 Bettino Craxi became Italy’s first socialist premier, in a five-party alliance mostly based on DC MPs. Where in the “national solidarity” era the CGIL had swallowed a pause on wage demands, in 1984 Craxi legislated to lower the scala mobile index by three points. In this, he had the consent of the CISL and UIL union federations, who signed the “Valentine’s Day agreement” on February 14, though not the CGIL. Berlinguer opposed this, and even after his death on June 11, the PCI pressed on with its bid to force an abrogative referendum. While the “yes” (pro-abrogation) camp far exceeded the PCI’s own base, it ultimately lost the vote 46 percent to 54 thanks to the common front among the PSI, DC and the smaller liberal and centrist parties. As Giuliano Amato hints, for a PSI, now strengthened by rising white-collar layers, the PCI’s defense of a rigid scala mobile showed it to be stuck in the past.

    Decisive, here, was the idea of sacrifices now for payoff tomorrow: Craxi’s focus on combating inflation appeared in the guise of a crisis-resolution measure. But rather less understood were the structural shifts also taking place in these years, both unravelling gains made by the 1960s–70s labor movement and codifying rules which conditioned all political decision-making. Particularly important, in this sense, was Italy’s entry into the European Monetary System (EMS) in 1978. The PCI had from the onset of the Cold War opposed the European integration process, and before Italy’s entry into EMS even a relatively pro-European figure like Napolitano criticized its likely negative effects on workers in countries with weaker currencies. Yet over the 1980s EMS (later, EMU) became the framing of all economic policy discussion in Italy, a process formalized by the independence of the Bank of Italy in 1981. As opposed to the elected government setting monetary policy, including via frequent recourse to devaluations, Rome would have to fix wage policy and public borrowing with reference to a money supply whose most immediate conditioning factor was the interest rate set by the Bundesbank.

    Already from 1980, public debt began to spike, driven not by government profligacy or wage rises so much as the effects of the oil shock and, more specifically, the paralyzed institutional response which resulted from the central bank’s “divorce.” With the lira effectively pegged to the mark, and the Bank no longer forced to buy up government bonds, public debt ballooned from 57 percent of GDP in 1980 to over 100 percent in 1992. Becoming premier that summer and faced with unbearable pressure on the lira (the ‘Black Wednesday’ that also forced Britain out of ERM) PSI man Giuliano Amato announced a “blood and tears” budget, while also putting an end to wage indexing. This administration would slash 93 trillion lire (50 billion euro) from the public budget. In the name of emergency response (and as Amato notes on sharing meager resources equitably) this austerity program was backed by both the leadership of the CGIL and the post-communist PDS (Democratic Party of the Left), accepting sacrifices now in the interest of keeping Italy in EMS. When, faced with the deepening crisis in the PSI, former Bank of Italy governor Carlo Azeglio Ciampi took over as premier, the PDS offered its support.

    The PDS did not directly join Ciampi’s administration—when parliament voted against prosecuting Craxi on corruption charges, the party withdrew its own proposed finance minister. The PSI’s first premier would ultimately flee to Tunisia, evading trial and pushing his party toward outright destruction. Yet the changes that had taken place during his premiership would have a lasting impact, especially when considered as part of a shift in the entire left which had begun already in the mid-1970s. Whether in the leadership of the trade unions or through their participation in government, the two main parties of the Italian workers’ movement had already in this period begun administrators of the “battle against inflation,” pushing into the background not only their past visions of social transformation, but even the immediate defense of sectional working-class interests.

    Over the course of the 1990s, the center-left’s bid to guide Italy into the eurozone “on time” in 1999 radicalized it in this direction, as former PCIers now unbound from the communist past could assume European liberalism as their new ideal horizon. As the PCI turned into the PDS, there were splits—a Communist Refoundation took form, and there were also sharp divisions in the base of the CGIL, with even general secretary Bruno Trentin resigning after signing up to the abandonment of the scala mobile. Yet if there have been some moments of revolt against the particular measures promoted by Italian neoliberalism, this has never amounted to a nationwide political force with an alternative governmental program and different set of priorities, such as the PCI represented at least until the late 1970s.

    That the European country with the largest communist party now has a neoliberalized center left and a small and politically inert left-wing milieu raises the question of the “paths not taken.” Especially important, in this regard, is the way we understand the relationship between changes in the leadership in the PCI—especially the passing of the Resistance generation, as even Berlinguer embodied, and its replacement by younger figures like Massimo D’Alema, Walter Veltroni and Pierluigi Bersani—and their ability to impose such a dramatic shift in the party’s identity and fundamental social referents. Bersani would refer to the continuity ex-communist leadership as la ditta (“the firm”), and clearly some of the explanation for the left’s political weakness lies in the subjective choices it made. Yet a frank reckoning with the left’s weakness would also have to point to broader cultural failings in the PCI (and even more so, the PSI). A story of betrayals by leaders is certainly unsatisfactory in explaining the behavior of a political force supposedly based on the masses’ own protagonism.

    In his fascinating 1981 study on the Italian Communist Party, Grant Amyot offered insights into its left wing through a local-level analysis (in Bari, Modena, Naples, Perugia, Turin), rare even among Italian researchers. He identified not only a failure in the historic compromise propounded by Berlinguer, felled by the assassination of Moro, but a wider crisis in the Popular Front model inherited from the Togliatti era, and accepted by all wings of the party. But building on this observation, one could say the left’s weakness owes not to the alleged “disappearance” of the working class—in what is, after all, still the continent’s second most industrial power—but the fact that the islands of industrial organization that still exist no longer suffice to cohere wider “popular classes” politically. Schematically, if in the 1970s the 60,000-odd FIAT workers at Turin Mirafiori symbolically represented the labor behind industrial modernity, the muscle behind the anti-fascist revolt, and a visible expression of the power of numbers, one could hardly ascribe a similarly obvious “cohesive” role in 2020 to Italy’s 1.6 million mostly low-paid tourism employees. The PCI always represented more than just industrial workers; the problem, after the loss of the identity and cohesion the party itself offered, is how to federate different types of workers, unemployed, precarious, small-proprietor groups under any common set of demands.

    Thus emerges the role of the state and institutional-level politics in cohering an agenda that stands above the workplace-level bargaining power of individual groups of workers. It is, decisively, the Italian left’s weakness in proposing achievable reforms at this state level—visible even in the PCI’s 1970s response to stagflation—which has made it particularly suffer the effects of the decline of the mass workplace. This problem is further complicated by an ambiguous attitude toward the hollowing-out of national sovereignty in recent decades. Since 1989, even forces more radical in their rhetoric than the neoliberalized center-left have tended to focus on social “resistance” against various disliked reforms rather than advancing an agenda for government and state intervention. This is also why the dissolution of the old workers’ parties led not to their replacement by some superior alternative, or the masses now organizing free of bureaucratic party hierarchies, but rather a general atomization and desertion of the political terrain.

  9. Inflation, Specific and General

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    Until 1980, the annual rate of change of the Consumer Price Index (CPI), the weighted measure of the cost of a basket of core consumer goods, increased at an accelerating pace in every business-cycle expansion, reaching double digits during the 1940s and 1970s. Inflation—its causes and consequences—was at the heart of economic debates throughout this period, when the discipline of macroeconomics took its current form. While we understand individual industry price changes in terms of supply, demand, and market power, our conceptual tools for understanding inflation remain weak. Neither monetarist attention to the “money supply” nor the institutionalist focus on the Phillips Curve have provided a reliable guide with which to construct macroeconomic policy: the relationship between the price level and the unemployment rate has attenuated with the decline of collective bargaining, and a more than eleven-fold increase in the sum of checking deposits, savings deposits, and cash on hand in the US since 1980 (the standard M2 measure of the money supply) has seen the annual increase in the CPI fall below four percent for all but a handful of the past forty years. Even the phenomenon implied by the term is the subject of confusion: Does it refer to the amount of money or debt in circulation, or to a rise in price and values? If the latter, which prices or values?

    In the decade-long recovery from the 2008 financial crash, Federal Reserve and Treasury officials began to reconsider their models of the inflationary process, as well as the priority of price stability among macroeconomic objectives. The coronavirus pandemic has accelerated both trends. Synthesizing the lessons of the Obama-Trump era, Federal Reserve Chairman Powell noted that “You can have 3 or 3.5 percent unemployment for a couple of years, and really, you see modest moves in wages and almost invisible moves in inflation.” His comment reflects the emergence of an entirely new understanding of the structure of the economy, with potentially significant policy consequences. Reflecting concern over the place of price stability in the public scale of values, the Federal Reserve announced in August of 2020 that it would keep interest rates near zero until the annual rate of increase in the CPI is “moderately above two percent for some time,” while a growing number of international organizations and now senior leaders of the Democratic Party, victorious in the executive and with a slim majority in the legislature, are urging a historic step up in the level of government spending.

    Understanding the causes and consequences of inflation is crucial to grasping patterns of distribution and investment. Investors evaluate their portfolio decisions on the basis of the expected future value of returns, a task only possible in relation to future prices. Deflationary expectations tend to postpone investment decisions in physical capital, while rising prices accelerate them. Historically, capital income has increased much faster than wage income and capital’s share of total income rises during the first half of business expansions in the US, as profits swell from a greater volume of sales much faster than employers raise wages.

    Managers and owners are unwilling to reduce money profits when workers do succeed in raising wages; inflation is the mechanism for redistributing real income when money claims exceed capacity. Anti-inflationary policies thus have dramatic consequences for workers. The customary solution is to raise the unemployment rate until workers are weak enough to moderate wage demands. But when raising employment is a top priority, that solution moves off the table.

    The signals of auspicious policy shifts therefore have some investors concerned. Warn the chief forecasters at Blackrock, the world’s largest asset manager: “Domestic workers could gain greater bargaining power on wages… especially in places where the political pendulum is swinging toward addressing inequality. This may take the form of higher minimum wages and taxes. That would make wages more sensitive to domestic slack and pricing pressures.” Already, logistics prices are rising as Amazon, FedEx, and UPS have raised their margins in a consumer economy increasingly organized around home delivery and weak labor standards. Even older industries such as iron and steel are seeing prices rise, with the spot price of coiled sheet steel more than doubling since August lows.

    For the majority of people, for whom wages are income rather than a cost of production, devising alternative anti-inflationary policies is critical. But the attention of macroeconomic theory to the general price level has prevented this thinking from taking place. While the low price of commodities, driven by the massive expansion of global manufacturing capacity, has kept the CPI down since the 1970s, the price of services, which make up two-thirds of the cost of living for US workers, have been rising on a secular trend. Price rises that previously signaled struggles over real income or excessive demand have not passed beyond four percent per year since the 1980s, but the collapse of manufacturing prices has been replaced with a rising price of services. These price increases are structural and, if they accelerate, should not be met with fiscal-monetary contraction.

    If governments take seriously their professed commitment to sustaining full employment by expanding fiscal policy in the post-pandemic recovery, wages at the bottom of the labor market are bound to rise. However, given that the cost of services has been rising independently of average hourly wage trends, rising wages at the bottom should not be a reason to slow the recovery. When wage increases do begin to shift production costs, the response will need to move beyond the monetarist and institutionalist approaches to inflation developed in the 1960s. These theories of inflation, which stress the likelihood of a “wage-price spiral,” and the importance of the “natural rate of unemployment” or the “non-accelerating inflation rate of unemployment” (NAIRU), were based on the political economies of the 1950-70s, in which domestic experiments in industrial planning and income policies—and the price controls and wage guidelines they entailed—were chucked aside as impossible projects in social engineering. But today such planning is an urgent necessity. Standing in the way are fundamental misinterpretations of how the last inflationary crisis was finally overcome.

    NAIRU & the wage-price spiral in an era of globalization

    The theory of inflation advanced during the 1960s and 70s held that the general price level has a vertically asymptotic relationship to the level of employment: as unemployment falls below some level (which can only be determined empirically after the fact) workers will demand higher wages, employers will compensate with higher prices, and investors and savers will respond by requiring higher interest rates or profits. Once this spiral begins, a greater volume of spending will be required to maintain the existing level of employment and output, causing price increases to accelerate. Steady inflation will break into a gallop, unraveling long term business planning in the face of higher price expectations, and producing arbitrary windfalls or bankruptcies until government authorities raise the unemployment rate back to its natural level. Because it is consumer spending which determines private demand for labor, the entire mechanism is set into motion by the government’s manipulation of the level of demand.

    This model is an artifact of a world in which a much larger share of manufacturing supply chains were located within single countries and in which services were a much smaller share of GDP. In the US economy circa 1950, rising prices had a direct and observable relationship to wage bargaining, with industry-wide unions representing hundreds of thousands of workers across the entire nation—between 80 and 100 percent of workers in transportation, coal, metal mining, steel, automobiles, meat packing, and rubber; over two-thirds of all production workers in manufacturing.1 Bottlenecks could be found where price pressures persisted through multiple business cycles; breaking bottlenecks to overcome rising prices depended on entrepreneurs entering the market or government planning to restructure industries. Economic policy advice depended on ones’ evaluation of a given market, on the relative costs and benefits of restructuring an industry by entrepreneurs as opposed to public regulation or state enterprise, and on the political coalitions that could be found within Congress for each alternative.

    This no longer describes the world today. Globalization has restructured product markets so that domestic wage costs comprise only a small portion of manufacturing costs. Global commodity prices increasingly depend on wages in Cambodia, Thailand or Mexico—or on the geopolitical threat of US military intervention, as Saddam Hussein and Ali Khamenei learned. Whereas the domestic manufacturing industry of old protected profit margins through oligopoly pricing, today the explosion of global manufacturing capacity keeps these prices highly competitive. Profit centers are legally removed from many employers who increasingly invest in asset speculation rather than operations, with a long-term depressive effect on labor demand. In the disorganized and highly unemployed society that followed the collapse of the manufacturing economy, wage structures are finely gradated by employer-determined categories. Increases in one part of the structure may not increase the entire wage bill.

    Stagflation of the 1970s

    The interpretation of the stagflation of the seventies that has survived this transformation is startlingly ahistorical. As the major OECD study on stagflation (written by Nixon CEA chairman Paul McCracken) reported in 1977, “the immediate causes of the severe problems” of the seventies could “largely be understood in terms of conventional economic analysis [and] avoidable errors in economic policy.” Or as Larry Summers writes, “The first attempts to contain inflation [during the seventies] were too timid to be effective, and success was achieved only with highly determined policy. A crucial step was the abandonment of the idea that the problem was structural in nature rather than driven by macroeconomic policy.”

    The real cause for the inflation was structural—as political as it was economic. Rising prices are an index of social tension: whether between consumers for a given quantity of goods or services, between the working class and employers over the income of production, or between nations over the terms of trade. In each case, rising prices reflect rival income claims between groups. In the 1960s, the economics profession understood this. The Kennedy and Johnson administrations’ full-employment program entailed a formal bargain of wage restraint from unionized workers in exchange for sustained full employment and an expansion of the social safety net: Secretary of Labor (and former chief counsel of the CIO) Arthur Goldberg, together with the CEA, secured a national wage policy from the AFL-CIO and won from Congress an increase in the minimum wage and the Medicaid program. It was Lyndon Johnson’s failure to move toward a controlled economy that set off the wage-price spiral; after five years of rising corporate earnings, organized labor demanded price and profit controls in exchange for continued wage restraint.

    The trend accelerated under Richard Nixon with the 1973 OPEC oil-price increases. The alternatives to the oil and gasoline rationing that followed was, at most, nationalization of the industry, at least, administration of the controls by someone sympathetic to their success—which Treasury Secretaries George Shultz and William Simon were not. A public option to force down oil corporation profits, proposed by Senators from Oklahoma’s Fred Harris to Massachusetts’s Ted Kennedy, represented a middle path. Instead, the Ford and Carter administrations hobbled through six years of rising oil prices, urging wage and price restraint on industry, and attributing their failure to the “excess demand” of the government budget. In his ethnography of working-class Brooklyn during the seventies, sociologist Jonathan Rieder recorded how obvious the alternatives to stagflation were to the public. “I’d go for public ownership of the oil companies,” an Italian-American Nixon loyalist told him after Watergate, “if I didn’t think the national politicians were a bunch of thieves.”

    The politics of inflation today

    The experience of the sixties brought many US liberals—those favorable to the expansion of the welfare state, usually members of the Democratic Party—to embrace the ideas of conservative economists like Friedman. But to fret about the risks of rising labor costs entailed by fiscal expansion today is to misunderstand or deny the wage-price dynamics of the service economy and the role the state and its budget must play in restructuring core service industries. Rent (or “owners equivalent”) alone constitutes over thirty percent of the CPI, utilities and transportation comprise 9 percent, medical care another 9 percent, food away from home 6 percent, and education 3 percent. Whether private services sustained by federal subsidy, or state-level public programs that have turned to tuition and fees with the retrenchment of state funding, the industries that comprise the core of the US services sector have converged in the past four decades on a sort of decelerated Baumolianism. Financed by some combination of philanthropy, public subsidy, subscriptions, and user fees, operations costs in these industries represent the ballooning pressure of workers who must compete with elaborate managerial bureaucracies and vestigial private financing over their share of industry revenues.

    Within the service sector, prices for medicine and education have grown faster than average hourly wages in the entire nonfarm business sector in every recovery since 1975. The result is that in 2019, average health-insurance premiums for employer-based group policies with family coverage were around $20,000 per year; average college tuition in the US for public institutions granting four-year degrees was $11,800 in the 2015-6 school year, the most recent available from the National Center for Education Statistics (total annual cost of public higher education—including room and board—was $26,900). These service prices represent tenfold increases since 1975, when the average hourly wage increased less than half as much. In the most recent recovery, rent joined the group of service prices pushing up the total cost of living, outpacing the rise in hourly wages from 2015 to 2020. These rising prices are structural in nature, and if they are pushed up further by rising wages fiscal-monetary restraint will do nothing to lower them. Full-employment should not be sacrificed in an attempt to lower prices. Instead, anti-inflation policy must pass out of the hands of general employment policy and into specific programs for problem sectors that, as the situation requires, restore tax financing, eliminate monopoly profits, and level cost structures.

    During the final years of the Obama-Trump boom, the wages that rose quickest were at the bottom of the labor market. Between 2015 and 2020, wage growth in the first quartile—those earning around $600 per week, or $15 an hour for a 40-hour week, in 2019—outpaced the other three-quarters of the labor market. This layer of the workforce is largely below the bulk of workers in the high-cost service industries today burdening the workers’ budget. Median weekly earnings in education were about $1000 in 2019; in healthcare they were around $800. Expanding the labor market to bring warehouse and food service workers up to the level of teachers and nurses may raise some prices, but they will not be those prices weighing most heavily on workers’ budgets.

    What if higher employment does result in wage increases above the bottom of the service sector? Until public control of these industries expands from its current partial financing toward broad restructuring—to ensure existing revenues in education and healthcare are distributed downward toward the provision of services, for example, and away from administrators and stockholders—the relationship between these industries’ prices and wages in general will continue to be unreasonable for most workers. The alternative to public control in these industries is already at work, whether in the downward wage pressure of “Uber”-izing more professions or in the spread of telehealth and MOOCs in healthcare and education. Such technologies allow employers to expand access to their services and lower prices with less labor—the question is whether this is how we want to manage our core social institutions. But so long as we are concerned about generalized inflation caused by rising wages, such questions will be off the table.

    1. J.B.S. Hardman, “The State of the Movement,” in J.B.S. Hardman and Maurice F. Neufeld, eds., The House of Labor (Prentice-Hall, 1951), p. 63. Cf. Sumner H. Slichter, The American Economy: Its Problems and Prospects (Knopf, 1948), who calculated that “Two thirds of the workers in manufacturing, four fifths in construction, four fifths in transportation, and four fifths in mining are organized,” p. 34. ↩

  10. Supercomputer

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    In March 1976, Deputy Secretary of the Department of Defense (DOD), William “Bill” Clements invited William “Bill” C. Norris, CEO and Chairman of the supercomputer producer Control Data Corporation (CDC), to a closed-door meeting at the Pentagon. Secretaries and undersecretaries from the United States Army, Navy, and Air Force were to attend, as well as a selection of spokespersons from the public university system and private sector. Clements requested Norris come prepared with “any important aspect of Defense management or posture that… warrants perspective” and to be candid in his comments.

    Preparing for the meeting, Norris wrote a note. The subject was “East-West trade.” The DOD was not giving enough attention to export administration, the CEO wrote. The Department of Defense’s “inconsistent” approach to reviewing export applications for computer technology to Central and Eastern European countries, Norris continued, was fostering an “unhealthy,” “adversarial” relationship between the military and private industry.

    A rival of IBM, CDC was a leading supercomputer producer in the mid-1960s and 70s. In 1976, the firm had a capitalization of $1.82 billion, annual revenue of $1.21 billion, $41.5 million in annual profits, and over 100 subsidiaries stretching from Australia, to South Africa, and across Europe. Due to the high valuation of its machines, CDC was ranked eighty-fifth on the Fortune 500 list for assets in 1976, just above Kraft, Coca-Cola, Singer, and Boeing.

    Since the dawning of the US-Soviet détente, CDC had internationalized some manufacturing operations behind the Iron Curtain. The firm entered into licensing agreements with communist states to lease out the rights to produce computer peripherals, such as disk packs and printers. By 1976, CDC opened a subsidiary for this purpose. ROM Control Data, in the Socialist Republic of Romania, was one of the first US subsidiaries in the Eastern Bloc, or Comecon (The Council of Mutual Economic Assistance).

    The DOD’s resistance to CDC operations in the Eastern Bloc was relatively new. Following the so-called Halloween Massacre in November 1975, in which Gerald Ford reorganized his cabinet to appease the ascendant neoconservative wing of the Republican Party, the upper echelons of the US government began to challenge business engagements in Central and Eastern Europe. In particular, Donald Rumsfeld’s appointment to lead the DOD ushered in a new era in defense. Adopting a “hardliner” position towards the Soviet Union, détente under Rumsfeld was reconfigured to mean increased defense expenditure, arms buildup, and a cordoning off of the flow of strategic technologies to the Soviet Union and Eastern Bloc. In other words, the DOD’s new position reprised containment1 and foreshadowed Reagan’s Star Wars, while explicitly clamping down on the flow of potentially strategic technical knowledge.

    Two incompatible American visions of managing the flow of technical knowledge around the globe emerged. CDC built its export strategy around ad hoc licensing agreements and the maintenance of intellectual monopolies. The DOD, on the other hand, increasingly sought to police, but not stop, the flow of potentially strategic knowledge in its own bid to legitimize itself in the lull between the Vietnam War and Star Wars. A struggle ensued between the firm and the federal agency over who would be the final arbiter of global technical knowledge flows. Their struggle speaks not simply to the domestic dynamics informing the United States’ trade relations in the mid-1970s, but also the political-economic motivations undergirding globalization more broadly.

    “Eastern European Strategy”

    CDC’s Eastern European strategy sought to transform the Eastern Bloc into a regional factory producing computer peripherals—like disk drives, tape readers, and printers—to be sold on the world market.

    The project had two phases. The first—called “limiting indigenous development”—consisted of obtaining restrictive licensing agreements with communist states, confining their ability to sign contracts with other computer firms for peripherals as well as discouraging independent research and design (R&D) and manufacture of these products. The goal was to position the company as the most favored supplier of peripheral technologies (and later, of computers) to these states.

    The second, never fully-realized phase planned to push these products out of the so-called Second World and into the Third, thereby creating global dependencies on CDC hardware. The firm’s licensing agreements were intended to be scaled to produce a surplus that would exceed domestic need. From there, in an almost Hobsonian supposition, it was thought that Central and Eastern European countries would sell the excess to buyers beyond their borders, particularly in the Third World.

    The company saw the balance of payments as directing this circulation somewhat automatically. In particular, Comecon states lacked hard currency—i.e. US dollars. Central and Eastern Europe underwent economic stagnation and currency crises in the 1970s, a situation compounded by the 1973 Oil Crisis. Given the lack of convertibility for currencies in the Eastern bloc, it was difficult to pay the firm for licensing fees. Thus, CDC was banking on the prospect that communist states would sell the computer peripherals in the Third World to generate revenue, a portion of which would then flow back to the parent company in US dollars.

    This elaborate tactical-strategic commercial system was conceivable because the Eastern Bloc’s balance of payments with the Third World was positive. Moreover, the US’s continued suppression of nationalist movements and support for anti-democratic strongmen in the Global South meant that many countries in the Third World did not want to be seen dealing with a company that could be construed as part of the US national security apparatus. As the CEO Norris said, “Presumably, some of the Third World markets may be better accessed by our Socialist partner[s].”

    But CDC’s “Eastern European strategy” was overall a failed project. Although the company was successful in exporting a portion of its manufacturing abroad to Central and Eastern European states, like Romania, the grander vision of harnessing the global economic system to proliferate its trademarked products never came to fruition. This failure was in no small part due to the heavy-handed and blinkered manner in which the firm had carved up the world and its dealings. Central and Eastern Europe was not the monolith the firm supposed.

    Romania, for example, primarily dealt with CDC not to gain technical capacity to produce peripherals, such as low-grade disk drives and printers, and sell them on the world market, but to build a working relationship with the firm. The Romanian government thought this relationship would help the state eventually buy a newer, powerful supercomputer (a CDC CYBER 80), to be used in oil exploration, thus hopefully giving the country greater autonomy from Moscow. (Neither the Department of Commerce nor State Department, however, would get behind the sale of a CYBER 80 to the state, to say nothing of the DOD.) Marketing peripherals to the Third World was not a top priority for the subsidiary. As a State Department assessed ROM Control Data’s status in 1977, the joint venture was “proving to be a money loser for the firm.” The cable continued: “Costs at the Romanian operation were relatively high… and Romanians had proved also totally unable to sustain their own marketing effort.” Unable, meaning, unwilling.

    But the hostility on the part of the Defense establishment also contributed to stymieing CDC’s plan. Although the DOD was not wholly successful in gaining a stranglehold over US export controls, they were successful in shifting the terms of the discussion. Critically, the Export Administration Act of 1979 adopted the suggestion that export applications be reviewed on the basis not of the technology’s intended use abroad or availability on the world market, but its potential strategic applications, a key position supported by the DOD. As a result, CDC’s export license applications, and in particular its applications to transfer technology for low-capacity disk drives, came under increased scrutiny.

    The clincher for CDC’s “Eastern European strategy,” however, was the breakdown of CDC itself. In 1978, the Department of Justice (DOJ) brought litigation against the company for mail fraud and illegal foreign transaction reporting two years earlier. In 1979, the firm was sued by its shareholders for failing to disclose these corrupt practices, paying out over $1.3 million in damages. Furthermore, the firm was over-leveraged. By 1986, it was selling off many of its ventures. The Eastern European Strategy was a market-access strategy, and an unprofitable one at that. It was abandoned soon after.

    CDC, proto-global value chains, and a first wave of globalization

    What then is to be learned from CDC’s failed Cold War-era venture in Central and Eastern Europe? Although CDC’s dealings with Comecon states in the late 1960s and 70s were certainly particular, they were not singular. Looking at the supercomputer producer’s relations with Central and Eastern European states during this period one can find features of globalization—meaning, narrowly, global financial integration and the internationalization of production—in the era between the first and Second Cold War.

    The standard narrative of globalization is that in the early 1990s, with the breakdown of the Soviet Union, the international system was restructured as a global system to support the liberalization of both trade and finance. This was seen in the expansion of the International Monetary Fund (IMF), the World Bank, Organization for Economic Cooperation and Development (OECD), multilateral (‘free’) trade agreements like North American Free Trade Agreement (NAFTA), and the making of the World Trade Organization (WTO). Capitalism won out. History had ended.

    There have been many correctives posited to this narrative. Quinn Slobodian argues that the desire to construct a supranational system to protect international capital against nationalist economic interests can be seen as early as the interwar period. Others have sought to push the timeline of globalization back from the Washington Consensus of 1990s to the 1970s, before the final days of the Cold War, to acknowledge the earlier growth of international finance. This was seen through the rise of international capital markets and subsequent debt crises seen in Eastern Europe, Sub-Saharan Africa, and Latin America in the 1980s, and the early decades of the OECD, whose membership hinged on the lifting of capital controls, allowing for hotter money flows.

    The case of CDC aligns with the lattermost studies, demonstrating that neoliberal globalization was quite tangible as early as the 1970s. But CDC’s activities in Central and Eastern Europe reveal the other side of globalization—not global financial integration, but the internationalization of production. The development of globalization ran through not only the realms of ideas and finance, but also through Romania’s national computer industry.

    A study of CDC’s ventures in the Eastern Bloc helps us consider the economic imbalances inherent to internationalized production. In fact, the geographic dispersal of the firm’s commercial relations abroad could be seen as a kind of proto-global value chain (GVC). The supply chain CDC was hoping to construct for computer peripherals in Central and Eastern Europe adhered to a smile curve—meaning, the so-called higher value stages of production (i.e. R&D, design, and trademarking) were largely located in the United States, while the lower ones (i.e. parts and components and assembly) were outsourced to low-wage countries, such as Romania. The higher value stages of production were effectively governed by an intellectual monopoly: technical knowledge was enclosed and thereafter leveraged to create global commercial dependencies.

    CDC’s activities in the Eastern Bloc challenge the image of a standard global value chain; the firm was not explicitly scouting cheaper labor, but more distinctively market access. The firm was, thus, advancing intellectual property rights for computer technology in tandem with the geography of the Cold War to gain a global market advantage with political ramifications, ones that the State Department found highly favorable during the Nixinger-era and less so under Ford. This Cold War context helps to magnify the geopolitical embeddedness of internationalized production—a dynamic with new relevance today. Just look at Trump’s “war” on Huawei. Arguably, there isn’t a more striking contemporary example of the geo-politicization of technology transfers.

    In turn, returning to the contest between CDC and the DOD, this competition throws the open secret about globalization into sharper relief: globalization is just as much a political project as an economic one. This is perhaps somewhat obvious regarding the DOD, whose attempts to insert itself as a supervisory power over “intangible,” high-tech global knowledge flows proves inextricable from the ambitions of a newly emboldened Cold War national security state. However, CDC’s efforts to globalize production likewise look eerily imperial in its efforts to leverage the ownership of technical knowledge to create global dependencies.

    In other words, CDC’s ventures behind the Iron Curtain reveal that globalization was never really about making ‘free’ markets. The fight over trade terms was, and increasingly is, an embittered one, inextricable from the explicit interests of ad hoc international actors—ranging from firms and domestic agencies to states and economic blocs. Technology transfers, although often framed as a mechanism to share or ‘democratize’ information, instead should be understood as fine-tuned instruments deployed exclusively to benefit the arbiter.

    1. John Lewis Gaddis, George F. Kennan: An American Life, Penguin Random House, 2012.  ↩