Don't follow us, we're lost too

One positive development of the current global financial crisis could be the recent election of Barack Obama as President of the United States of America, in the opinion of economist Professor Panicos Demetriades of the Economic and Social Research Council's (ESRC) World Economy and Finance (WEF) Programme, who is today speaking at the 'Politics of Macro-Adjustment and Poverty Reduction Conference. "The theory that, to promote financial growth, the role of government has to be a limited, hands-off approach is probably gone forever. The new US administration could and should liberate financial institutions from these views. It will not be easy but less ideologically biased advice to LDCs would help promote global growth" says the Professor of Financial Economics at the University of Leicester. "What it should not do is to continue protecting the narrow interests of the US financial lobby."

Policies, such as financial liberalisation, bank privatisation and non-intrusive/passive regulation, have been prescribed to Less Developed Countries (LDCs) by the US Treasury through the International Monetary Fund (IMF) and the World Bank. These policies, the root cause of the current crisis across developed nations, have sometimes been forced on LDCs through structural adjustment programmes.

The crisis has forced governments in developed countries to once again take a leading role in finance, albeit reluctantly in some cases, by taking over major banks. It has highlighted the serious dangers of passive financial regulation.

"Developing countries should therefore take stock, as should the IMF and World Bank, who have been the key institutions promoting this set of policies." said Panicos "My research has shown that the role of government in finance has been pivotal from the beginnings of financial systems in Europe and Asia."

"Assuming the new US administration succeeds, we should see better, less ideologically biased advice to LDC's, to help to promote growth worldwide, even if it does not protect the narrow, short-term, interests of the US financial lobby in LDC's."

What about the UK?

Looking at the future for the UK, Panicos says. "I expect that, eventually, politicians in Europe and the US will realise that investing billions in banks and running them at arms length will not work and we will see a much more 'hands on' approach in future."

Individual banks, acting in their own self interest, will not address the massive market failures that currently exist. In a downturn, repossessions may be good for the bank but not for the economy, as they push prices lower and deepen the recession. However, a nationalised bank can be instructed to re-structure loans in arrears instead of repossessing. This course of action may be less profitable in the short term for an individual bank but it could be profitable for the banking system as a whole in the medium term. More importantly, if all banks do the same, it is good for the economy.

Research suggests that nationalising the greater part of the banking system and running banks in the interests of the country rather than the shareholders may be the only way forward. As Panicos points out "In many cases, the shareholders have been more or less wiped out so nationalisation may be the only way forward if we are to come out of this recession sooner rather than later. Governments must become more hands-on. After all, they have invested billions of our money in the banks, we will not forgive them if we see no return."

Source: Economic & Social Research Council