Fault Lines: How Hidden Fractures Still Threaten the World Economy Read Online Free PDF

moral hazard in this crisis. The worrisome reality is that it could all happen again.
    Put differently, the central problem of free-enterprise capitalism in a modern democracy has always been how to balance the role of the government and that of the market. While much intellectual energy has been focused on defining the appropriate activities of each, it is the interaction between the two that is a central source of fragility. In a democracy, the government (or central bank) simply cannot allow ordinary people to suffer collateral damage as the harsh logic of the market is allowed to play out. A modern, sophisticated financial sector understands this and therefore seeks ways to exploit government decency, whether it is the government’s concern about inequality, unemployment, or the stability of the country’s banks. The problem stems from the fundamental incompatibility between the goals of capitalism and those of democracy. And yet the two go together, because each of these systems softens the deficiencies of the other.
    I do not seek to be an apologist for bankers, whose hankering for bonuses in the aftermath of a public rescue is not just morally outrageous but also politically myopic. But outrage does not drive good policy. Though it was by no means an innocent victim, the financial sector was at the center of a number of fault lines that affected its behavior. Each of the actors—bankers, politicians, the poor, foreign investors, economists, and central bankers—did what they thought was right. Indeed, a very real possibility is that key actors like politicians and bankers were guided unintentionally, by voting patterns and market approval respectively, into behavior that led inexorably toward the crisis. Yet the absence of villains, and the fact that each of these actors failed to bridge the fault lines makes finding solutions more, rather than less, difficult. Regulating bankers’ bonus pay is only a very partial solution, especially if many bankers did not realize the risks they were taking.

The Challenges That Face Us
     
    If such a devastating crisis results from actors’ undertaking reasonable actions, at least from their own perspective, we have considerable work to do. Much of the work lies outside the financial sector; how do we give the people falling behind in the United States a real chance to succeed? Should we create a stronger safety net to protect households during recessions in the United States, or can we find other ways to make workers more resilient? How can large countries around the world wean themselves off their dependence on exports? How can they develop their financial sectors so that they can allocate resources and risks efficiently? And, of course, how can the United States reform its financial system so that it does not devastate the world economy once again?
    In structuring reforms, we have to recognize that the only truly safe financial system is a system that does not take risks, that does not finance innovation or growth, that does not help draw people out of poverty, and that gives consumers little choice. It is a system that reinforces the incremental and thus the status quo. In the long run, though, especially given the enormous challenges the world faces—climate change, an aging population, and poverty, to name just a few—settling for the status quo may be the greatest risk of all, for it will make us unable to adapt to meet the coming challenges. We do not want to return to the bad old days and just make banking boring again: it is easy to forget that under a rigidly regulated system, consumers and firms had little choice. We want innovative, dynamic finance, but without the excess risk and the outrageous behavior. That will be hard to achieve, but it will be really worthwhile.
    We also have to recognize that good economics cannot be divorced from good politics: this is perhaps a reason why the field of economics was known as political economy. The mistake economists made