Essay 1 Final

Prévia do material em texto

PG COURSEWORK COVERSHEET 
School of Politics and International Relations 
 
 
 
 
 
 
STUDENT NUMBER: 200806503 
MODULE TITLE & NUMBER: POLM059-APPROACHES TO POLITICAL ECONOMY 
PROGRAMME: MSc International Business and Politics 
NUMBER OF WORDS: 3.206 DATE SUBMITTED: 14/11/2021 
 
Late Submission only: What was the original due date? 
Have you submitted an EC Claim Form for an extension? (YES or NO) NO 
 
 
See the School‟s postgraduate marking criteria for detailed explanation of these categories 
 Distinction 
 
Merit Pass Fail 
Task fulfilment 
Research 
Quality of Argument 
Structure 
Presentation 
Representation of Sources 
 
STRENGTHS: 
 
 
 
 
 
 
 
WEAKNESSES: 
 
 
 
 
 
 
 
 
HOW TO IMPROVE: 
 
 
 
 
 
 
 
 
 Provisional Mark: ___________ 
 Please check this box if you decline for your work to be used as an exemplar for future students. Your work will remain anonymous and will be 
used for guidance only 
1. Use your 9 digit student number only: do NOT use your name anywhere on your coursework 
2. Work must be submitted by QMPLUS by the stated deadline date and time. 
3. By submission of this coversheet, you: 
i) Declare that the writing-up of this coursework is your own unaided work and that where you have quoted or 
referred to the opinions or writings of others this has been fully and clearly acknowledged. 
ii) You understand that plagiarism is the use or presentation of the work of another person, including another 
student, without acknowledging the source. 
iii) Understand that your coursework will be submitted to the anti-plagiarism software Turnitin. 
 
In this essay, I will compare and contrast the theories of Adam Smith and John Maynard Keynes in the context of 
the global financial crisis of 2007/8. 
 
The economic crisis marked the world between 2007and 2009, and we can still feel its effects to this day; it can be 
considered as the most severe in the history of modern capitalism. This financial crisis brought two sovereign 
states, Greece and Iceland to the brink of bankruptcy, brought 1 million homes in the US to foreclosure, cost 3.6 
million jobs in the US alone, and wiped 7.3 trillion dollars of the Dow Jones Wilshire 5000. 
 
For the origin of the 2007/08 crisis, the analysis should begin in the post-world War II era. It is important to point 
out the deregulation of the economy that occurred between 1970 and 1980, as it was the moment when Keynesian 
theory suffered its greatest defeat, with the end of the Bretton-Woods agreement. The mid-1970s is a decade in 
which a neoliberal or fundamentalist market ideological wave began to form. This new configuration of the 
international economy came after more than 40 years of Keynesian and interventionist policies, which supported 
the interference of governments in the market, with the aim of avoiding crises such as the one of 1929. 
 
After a period of stagflation in the 1970s, the United States showed an economic rise that made possible a new 
global economic restructuring. This new structure was characterized by increased use of technologies and the 
creation of advanced information systems that helped to accelerate the entire process of globalization and union of 
international financial markets. The volume of transactions between countries increased considerably in the last 50 
years, bringing great interdependence between them, along with greater interaction between economic actors. 
 
Over the 1980s-1990s, there was a long process of financial deregulation in the U.S. economy and in several other 
countries. The main features of this process were the gradual elimination of market segmentation and the 
expansion of the degree of financial openness between countries. For instance, in the United States and the United 
Kingdom, Ronald Reagan and Margaret Thatcher, respectively, started to implement private sector deregulation 
policies, particularly in the financial sector, which increased the supply of credit. 
 
It is worth mentioning the euphoric way that the market reacted with the economic emergence of countries such as 
China, Brazil and India. The high savings rate in China created large surpluses. These surpluses along with low 
interest rates, and lax credit policy led to increased lending. That euphoria of the markets had infected the 
regulators policies as well. The entry of China into global economic dynamics has been transformative and helped 
establish this growing financing model. This economic growth was based on financialization, low wages, 
precarious working conditions and consumption based mainly on credit. 
 
Between 1995 and 2000, the shares of dot.com enterprises showed high growth prospects with expectations of high 
profits in the future. Because interest rates in the United States were low, companies took advantage of this growth 
to develop bold projects and sell them to investors who were confident in earnings without assessing possible risks. 
However, in the 2000s, the collapse of the internet bubble began and is considered an important moment to 
understand the housing bubble of the United States in the years 2007/8. That crisis led to a redirection of capital to 
the real estate sector, leading to greater real estate speculation. 
 
In the United States, there were types of credits available for mortgages with different risk ratings: prime (A-
paper), Alt-A (Alternative-A paper) and subprime, the latter being the category with the most risk. During this 
period, the number of loans in the subprime category was stimulated to maintain the housing boom impetus. 
Undoubtedly, there was an egalitarianism and inclusion about sub-prime. Its origin dates back to the 1970s, in the 
Community Reinvestment Act passed in 1977 under the Carter administration. This law required banks to offer a 
credit line to low-income families. Demand for subprime loans had doubled in approximately 20 years. Property 
prices had increased considerably. Consequently, with the increase in demand, the market value of housing assets 
grew rapidly. Real estate speculation was also common practice. People bought a house, renovated it and then 
resold it for a higher price. Then, the new owner repeated the action, demonstrating how profitable the real estate 
sector was. 
 
Investment funds began to distribute these loans everywhere, selling a group of loans of the same kind to other 
financial institutions around the world. This was known as securitization, and was nothing more than turning 
illiquid assets into liquid ones. With globalization and interdependence in the financial system, banks, investment 
funds and pension funds all around the world had bought these products. In 2007, mortgage backed securities 
accounted for 39% of all loans in the U.S. market. 
 
However, in 2007, as part of a general monetary correction, the United States government decided to raise interest 
rates and subprime debtors could not afford to pay their debts if interest rates increased. The consequence was that 
the number of homeowners defaulting rose to record levels in 2006 and 2007 in the US. In a scenario where these 
loans were distributed across all parties in collateralised debt obligation form, the consequences of defaults were 
catastrophic. 
 
 
 
A series of disastrous events began to unfold. Several banks and investment funds began to have financial 
problems, declare bankruptcy, reducing their workers in half, such as New Century Financial. Lehman Brothers, 
one of the oldest banks on Wall Street, on September 14, 2008, filed for bankruptcy. The Northern Rock was 
forced to apply to the Bank of England for emergency financial support and was nationalized in February 2008. 
Bear Stearns, the fifth largest bank on Wall Street, was acquiredby JP Morgan Chase for a fraction of its pre-crisis 
valuation. Twenty five banks in the US, five in the UK, and numerous others all over the world ceased 
operations. 
 
In the attempt to help companies recover, central banks around the world began to intervene. Injecting liquidity, 
financial aid plans and credit conditions were strategies to overcome the crisis. Besides, banks began to make their 
own decisions to try to save their own business, and what was seen was a loss of confidence and trust in the 
financial market, (impossible not to think of the concept of Keynes of uncertainty and market confidence, but first 
things first) culminating in the decrease in loans and credit in the market. 
 
One of the strategies for dealing with the crisis used by the Federal Reserve became known as 'Credit Crunch' 
which was an aggressive use of monetary policy to reduce the price of credit and to inject more funds into the 
market. Its main interest rate was cut in September 2007 by half until reach the zero per cent mark by the end of 
2008, a policy based on the Bernanke doctrine. The intervention of the public sector in the private sector was 
seen with a certain aversion at the beginning of the crisis. Neo-liberals believed that it was not the role of the 
state to intervene in private business and that it could make things even worse. Moreover, this intervention 
would be a signal for the market that things were bad. 
 
To sum up, the result of the crisis was the nationalization of many banks, unemployment, inflation and protests 
around the world and an unprecedented bailout of financial institutions undertaken in the name of protecting 
ordinary people rather than rethink the foundations of the system that produced the crash. 
 
Adam Smith 
 
Adam Smith was born in Kirkcaldy, Fife, in 1723. He is known as the main theoretician of classical theory that 
emerged in the eighteenth and nineteenth centuries, with the Industrial and Scientific Revolution, which eventually 
transformed the whole way of thinking and turned economics into a science. It is worth mentioning that he lived in 
a historical moment marked by mercantilism and physiocracy, therefore, his thoughts were essential for the new 
view of political economy, especially the theory of value, which in the future would be adopted by others thinkers 
such as Marx. 
 
Adam Smith believed that the economic world is governed by natural laws, which, if left to function freely, will 
have the best possible results. Thus, the basis of the economic policy preached by him was liberalism, that is, the 
market should be self-regulated, without any influence of the State. Commodity prices and wages are always 
flexible and the currency is not used for hoarding purposes. The first assumption allows full employment to be 
guaranteed without any government intervention. There is a balancing force behind this, which explains that from 
the moment there is a drop in aggregate demand, which will cause unemployment to rise and economic activity to 
fall, wages, and commodity prices would be reduced, production and demand increase, and full employment would 
be re-established (Bresser-Pereira, 1976). 
Smith also analyses the division of work as a category to classify the wealth of a nation. For Smith the division of 
labour emerges as a need to explore and improve individuals' natural abilities, brings time savings and 
technological progress. According to Adam Smith, the wealth of a nation should be measured by the standard of 
living of its citizens. This standard of living depends on two factors: the share of citizens employed in productive 
labour and the productivity of their labour; both will be directly proportioned to the size of their markets. 
 
His second thesis discusses about the social link. This link is not the result of a social pact, as Hobbes, Locke and 
Rousseau suggested, but rather a harmonious product of sympathy and self- interest. To his understanding, market-
oriented behaviour are formulated through „empathetic‟ interpersonal relations. Smith seems to trust in human 
beings, and their ability to control their actions and to regulate themselves away from excesses 
 
Other important concepts in Adam Smith's theory are: the surplus, value in use and value in exchange. The surplus 
is equal to the part of the product that exceeds what is necessary to reconstitute the initial investments of the means 
of production and the subsistence of workers. This surplus should be used to improve working conditions, increase 
the number of workers. In other words, this surplus should be used productively. Value in use is a prerequisite for 
value in Exchange. 
 
For Smith, the role of the state is, above all, to ensure the safety of its citizens, to administer justice, and maintain 
certain works and public institutions. Such institutions should never serve the interests of a single individual or a 
specific group. It is important to note Smith‟s liberal position on the markets. Perhaps contradicting some, once he 
embraces the idea of a political and economic freedom, he also makes it clear that this freedom must be made 
within rules supported by public institutions. Smith also warned about financial discipline and in his theory of 
moral hazard, where he suggests that if an institute or person will be protected against failure, the markets agents 
would not act responsibly. 
 
John Maynard Keynes 
 
John Maynard Keynes was born in Cambridge in 1883. He was an economist and considered that classical 
economic theory was not consistent with the reality of the world economy of the 1930s. In this period he published 
his most famous work, The General Theory of employment, interest and money in 1936, which would be a 
milestone in the economic thinking of the time. In his works, Keynes criticized the lasseiz-faire. He sought to 
understand and correct the flaws of the capitalist system, studying the capitalist economics and their cycles as well 
as the reasons that lead to instability and periodic economic crises. In addition, he believes that crises happen 
because of insufficient regulations by governments. 
 
Keynes also developed a series of measures to be adopted in an attempt to reverse an economic crisis. These ideas, 
known for their protectionist character, were widely used in the world after World War II. For example, Keynes 
was one of the authors who had his ideas used in the Bretton Woods conference, helping in the recovery of Europe 
after the war. He was responsible for the resumption of economic growth in the United States and United 
Kingdom. 
 
Keynes realized that the capitalist system cannot, by itself, ensure full employment and its development without 
going through chronic crises with periods of indeterminate duration. The production crisis of 1929 was a clear 
example of this. Unlike Adam Smith, who believed that market freedom could ensure, almost organically, 
maximum production efficiency. 
 
For Keynes the market behaviour has three stages: euphoria (expansion of credit), uncertainty and panic to the 
recession. Economic cycles, according to Keynes, are phases in which economies move between growth and 
recession and the duration of these periods cannot be predicted. Furthermore, crises are part of the nature of the 
market, and therefore they cannot be avoided. 
 
Keynes said that at the first sign of the crisis, the state has to intervene in the economy. However, this intervention 
has to be for a limited time, because if it spreads the State can become indebted and the consequences can be even 
worse. The role of governments is to keep income circulating and provide production growth. These attitudes help 
to increase individuals' confidence in the market, which would consequently increase the level of investment. The 
regulation of markets by the State is justified because the State is larger than the market and representsthe 
collective. 
 
The key word for Keynes seems to be "confidence". He believes that uncertainty in the economic environment can 
put the economy at risk. The government must focus its actions on resuming the confidence of agents, ensuring 
policies that provide greater productivity, generating jobs and increasing income and all these variables are 
extremely poorly driven by the private the sector. 
 
Therefore, in times of crisis, the state seeks to maintain employment, so that consumption continues, and as a 
consequence, the payment of taxes and fees. These payments help the government cover the deficits created when 
the government has allocated money to cover the reduction in investment. Another important measure is to 
maintain a relatively stable interest rate, so that entrepreneurs have an idea of their future returns, and thus have 
confidence in maintaining their investments. 
 
Approaches: differences and similarities 
 
It is interesting to note that the theories of these two great economists were shaped by significant crises that they 
experienced - in the case of Smith the Ayr bank crisis, and in the case of Keynes the Great Depression of 1929. 
Although he has been widely associated with laissez faire, Smith, just like Keynes, actually advocated for the 
regularisation of banking activities by the State, focused mostly around the circulation of money with the adoption 
of the real bills doctrine. This though is where the similarities between the two great thinkers end. 
 
Smith believed in the ability of markets to achieve equilibrium through the mechanism of supply and demand. 
State intervention would only interfere with that mechanism with distortive effects. In essence, private investment 
acting in self-interest would be more productive. Keynes on the other hand believed that economic growth is 
driven by the demand end of the equation and that demand has to be stimulated through government spending in 
cases where the economy is not operating under full employment. That spending would increase GDP by a higher 
amount than the amount spent. State was not merely an arbitreur but rather intervened as an actor, and arguably the 
most influential one. 
 
It is clear that neither of the two approaches was actually fully implemented on the onset of the financial crisis of 
2007/8. Smith would have complained that no real bills doctrine was in place, the Gold standard and Bretton 
Woods had been long abandoned, the economy was rife with tariffs and subsidies. Speculation had taken over 
prudent self-interest. In the fine balance between sympathy and self-interest, the latter was prevailing. Perhaps one 
could go as far as to argue that despite low interest rates, the granting of subprime mortgages could be considered a 
form of usury. 
 
Keynes would argue the opposite, that the State had reduced its role. The economy and the financial sector had 
been significantly deregulated in a process that started in the 80s. The State was not interfering enough - 
expenditure was more or less stable and deficits were marginal and decreasing. The speculation in which a great 
percentage of the population was engaging was increasing uncertainty in a way that could damage market 
confidence. 
 
Despite the macroeconomic backdrop, arguably, the catalyst, if not the reason for the financial crisis, was 
somewhat more specific –the aggressive speculation in real estate that the public engaged in and the financial 
system enabled by providing cheap leverage. 
 
 
https://fred.stlouisfed.org/series/MSPUS 
 
Smith would have identified this exuberance as challenging the ability of the supply and demand mechanism to 
achieve a new equilibrium. Whilst prices were galloping in the trend demonstrated in the graph above, three to 
three and a half million excess housing units were produced during the boom of 2000 to 2006. 
Further, Smith would also question the ethics of a financial system that continued funding the boom and surely 
seeking wealth through speculative investment in real estate would have fallen under his definition of unproductive 
labour. 
https://fred.stlouisfed.org/series/MSPUS
 
Keynes would notice the difference in balancing aggregate demand and aggregate supply. He would point to the 
increased uncertainty that would happen from the speculation and the subsequent loss of confidence. And he would 
certainly not be able to find a better example of his marginal efficiency of capital theory than the repeated and ever 
increasing investment if real estate. 
 
Conclusion 
 
Both Smith and Keynes base their theory on certain actors acting with prudence and employing good sense. In the 
case of Smith, this expectation has to be fulfilled by all market participants including the general public, in the case 
of Keynes by the State. However, the financial crisis confirmed that neither can ever be taken for granted. 
 
Because I have more affinity with liberal thinking, I would really wish Adam Smith's principles were put into 
practice. But, I would say that Smith‟s proposal of minimum interventionism can never succeed in a representative 
democracy in which voters elect leaders to take action, take back control, making their country great again. In 
addition, in a system where financial institutions are making strategic choices driven mostly by self-interest and 
investors that easily change from property speculation to Bitcoin. 
 
As for the State interventionism, proposed by Keynes, he believed that our leaders will have the ethics and know-
how to do the right thing at the right time and in the right dose. All this whilst being lobbied by the banks, looking 
for returns for the pension deficits and making sure that voters will achieve the dream of home ownership. 
 
The current system, both pre and post crisis, tends to oscillate between Smith and Keynes theories, in different 
measures, dictated by the social-economic and political climate. Therefore in my view, they are both imperfect. 
There is no one approach more convincing than the other. What we have are attempts and viewpoints. But 
certainly a financially educated public can be in a position to act more prudently and to hold all market participants 
accountable thus moderating the magnitude of the next crisis. 
 
 
 
BIBLIOGRAFY 
Bieler, Andreas, Lindberg, Ingemar and Pillay, Devan. 2008. "The future of the global working class: an 
introduction", in Bieler, Lindberg, Devan (eds.), Labour and the Challenges of Globalization: What Prospects 
for Transnational Solidarity? London: Pluto Press, pp. 1-22. 
 
Bohlat, David (209), 'How Would Adam Smith Fix the Financial Crisis?‟ Challenge, 52(6): 60-78 
 
Bresser-Pereira, L. C. A crise financeira global e depois: um novo capitalismo? Novos Estudos CEBRAP, v. 86, 
pp.51-72, março 2010. Disponível em <HTTPS://www.scribd.com/document/33916394/A-crise-financeira-global-
e-depois-um-novo-capitalismo> Acesso em 17 jun. 2018 
 
Bresser-Pereira, L. C. Da macroeconomia clássica à macroeconomia keynesiana. Versão revisada em 1976 de 
apostila publicada. Originalmente em 1968. EC-MACRO-L-1968 (E-. 73). 
São Paulo, abril de 1968. Revisado em maio de 1976. Disponível em HTTPS://ufrr. 
br/economia/index.php?Option=com_phocadownload&view=category&download=135:7&id=17: textos-
macro&Itemid=234> Acesso em 17 jun. 2018. 
 
 
Clark, Chris (2016), Ethics and Economic Governance: Using Adam Smith to understand the global financial 
crisis, London, New York: Routledge, Introduction. 
 
Fine, Ben (2010), 'Looking at the crisis through Marx - of is it the other way about?‟ in Steven Kates 
(ed.), Macroeconomic Theory and its Failings: Alternative Perspectives on the Global Financial Crisis, 
Cheltenham: Edward Elgar, pp. 51-64. 
 
Gamble, Andrew (2009), the Spectre at the Feast: Capitalist Crisis and the Politics of Recession, New York: 
Palgrave, Chapters 1 and 6 
 
Hermann, J.From liberalization to the American financial crisis: the announced death arrives in Paradise. Political 
Economics Magazine, vol. 29, n. 1 (113), pp. 138-141, January-March 2009. Available in 
<http://www.rep.org.br/pdf/113-8.pdf> Access in 17. Jun 2018. 
 
Heilbroner, R. (2000) lhe Worldly Philosophers. London: Penguin. Pp. 249-287. 
 
Keynes, J. M. A teoria geral do emprego do emprego, do juro e da moeda. São Paulo: Nova Cultura, 1996. 352 p. 
 
Kripper, Greta (2011), Capitalizing on Crisis: The Political Origins of the Rise of Finance, Cambridge, M.A.: 
Harvard University Press, Introduction 
 
Milanovic, Branko. 2020. “The Clash of Capitalisms: The Real Fight for the Global Economy‟s 
Future.” Foreign Affairs 99 (1): 10–21. 
 
Mussa, Michael (2009), 'Adam Smith and the Political Economy of a Modern Financial Crisis', Business 
Economics, vol. 44(1): 3-16 
Roncaglia, A. (2001) The Wealth of Ideas: A history of Economic Thought. Cambridge: Cambridge University 
Press. Pp.384-415 
 
 
Skidelsky, Robert (2011), 'The relevance of Keynes', Cambridge Journal of Economics, 35 (1), pp. 1-13. 
 
Smith, Adam. Wealth of Nations, Electric Book Company, 2000. ProQuest Ebook 
Central, https://ebookcentral.proquest.com/lib/gmul-ebooks/detail.action?docID=3008435; Book One, Chapter 
III, That the Division of Labour is Limited by the Extent of the Market, pp. 35-40. 
 
 
Watkins, John P. (2017), 'Financialization and Society's Protective Response: Reconsidering Karl Polanyi's 
Double Movement', Journal of Economic Issues, 51 (1), pp. 98-117. 
 
https://www.govinfo.gov/content/pkg/BUDGET-2010-TAB/pdf/BUDGET-2010-TAB.pdf 
 
https://www.statista.com/statistics/200410/surplus-or-deficit-of-the-us-governments-budget-since-2000 
 
(https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr556.pdf) 
 
(https://strathprints.strath.ac.uk/67808/1/Grieve_DPIE_2008_adam_smiths_concept_of_productive_and_unproduc
tive_labour_an_interpretation.pdf) 
 
(https://www.jonesday.com/en/insights/2009/02/the-year-in-bankruptcy-2008) 
 
 
 
 
 
. 
 
https://ebookcentral.proquest.com/lib/gmul-ebooks/detail.action?docID=3008435
https://www.govinfo.gov/content/pkg/BUDGET-2010-TAB/pdf/BUDGET-2010-TAB.pdf
https://www.statista.com/statistics/200410/surplus-or-deficit-of-the-us-governments-budget-since-2000
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr556.pdf
https://strathprints.strath.ac.uk/67808/1/Grieve_DPIE_2008_adam_smiths_concept_of_productive_and_unproductive_labour_an_interpretation.pdf
https://strathprints.strath.ac.uk/67808/1/Grieve_DPIE_2008_adam_smiths_concept_of_productive_and_unproductive_labour_an_interpretation.pdf
https://www.jonesday.com/en/insights/2009/02/the-year-in-bankruptcy-2008