“Patriotism is the last refuge of a scoundrel”

Martin Wolf in conversation with Łukasz Pawłowski · 4 January 2018

There’s a famous line in English which says that «patriotism is the last refuge of a scoundrel». A lot of it is just flag waving which really disguises the desire of uncompetitive industries and groups to get everybody else in the country to look after them”.

Łukasz Pawłowski: Robert Reich’s Saving Capitalism, Wolfgang Streeck’s How will Capitalism End?, Paul Mason’s Post-Capitalismthese are only a few examples of books predicting either death or a major change in our economic system. Is capitalism on the road to self-annihilation?

Martin Wolf: It depends on what you mean by “capitalism”, which is not a very well-defined term. Was the economic system most Western European countries ran during the 1950’s and 1960’s a capitalist economy? It was clearly more controlled than it is today but was still largely driven by private companies responding to the profit motive, meeting demands of their consumers, going in and out of business depending on how well they did it. At the same time, banks and financial markets played a smaller role and finance was predominantly internally generated. But I would argue those were capitalist economies too. They were just differently configured.

If we accept this notion – that there are different types of capitalist economy which evolved over time – it seems to me we’re definitely not seeing the death of capitalism because quite simply nobody has propounded, or operated an alternative. It does not exist.

The debate properly defined can only be about forms of capitalism, not about its death. That strikes me as an empty proposition because nobody has put forward an alternative economic system that actually works. And the only people who actually tried an alternative – the Soviets and for a short time Mao Zedong – eventually abandoned it. So I think the notion of the death of capitalism does not make any sense at all. But the reform of capitalism is a perfectly plausible idea. It happened in the past and it could easily happen again.

One could argue that precisely because there’s no alternative to it, capitalism may self-annihilate. It is quite often said that during the Cold War major welfare reforms in Western Europe were introduced because political elites were afraid of the appeal Soviet communism might have to the working class and wanted to contain it. Now, when there’s no alternative economic system they may not be willing to make similar concessions. In other words, capitalism may become a victim of its own success.

Let us suppose that capitalism was never reformed and did not work very well, or as well as it should. That’s not death. Something dies only when it disappears and is replaced with something else.

Capitalism may need a reform and the absence of a credible alternative might mean that it would continue but will not be as functional and effective as it should be. That is, however, a completely different proposition from the idea that capitalism will die. It is a proposition which says capitalism will remain highly suboptimal.

I guess the line of thinking here is that at some point capitalism ceases to be what it actually is. It’s no longer an economic system which promises to optimize productivity via free exchange of goods but is either gradually or abruptly replaced by something else.

The question is what it would be replaced by. You could imagine a highly corporatist economy emerging. That is to say, markets being sliced up by agreements between major firms and producer organizations keeping out competition and new entrants. This sort of economy generates quite a hierarchical political system and over time it ossifies. I suppose that is a conceivable, long-term direction for capitalism, in our societies. If that is what people mean by the death of capitalism, then I can understand the logic behind their thinking. But what we are really talking about here is a world of slower growth and less dynamism.

In your book “The Shifts and the Shocks”, you write something that, surprisingly, is still contested by many economists, namely that crises which appear in a capitalist system are not caused by external forces but are inherent to the way the system works. If that’s the case, where do you see any incentive to actually reform it?

The incentive to prevent another crisis from happening is that the recent crash was a pretty devastating event for everybody, including the people running the system. A lot of businesses involved in financial activities became discredited. That is one, obvious reason why they would like to reform the system.

I defined the changes that have occurred so far as essentially conservative in the sense that they put the system back together again with quite a large number of tweaks of various kinds but without fundamentally transforming the nature of it.

Is it enough?

Because it was a conservative reform it reduced the probability of a crisis but it certainly did not eliminate it. Our financial systems remain fragile and another crisis at some point is virtually inevitable. We can reduce the probability of a crisis but it can’t be reduced to zero.

Furthermore, as time passes the worries about the possibility of a crisis will fade, while the belief that this was far in the past and has no longer any relevance will grow. The longer things go well, the more risk people will be willing to take on and we’ll have another crisis. That’s a very likely outcome.

Our financial systems remain fragile and another crisis at some point is virtually inevitable. We can reduce the probability of a crisis but it can’t be reduced to zero.

Martin Wolf

What form might the next crisis take?

All financial crises have fundamental characteristics in common but they always have slightly different triggers, because financial systems change and often it’s the innovations which cause the crisis. So when you ask me what the financial crisis of 2050 might look like, almost by definition we don’t know, because it will be a system that in detail has changed very profoundly. The key factor that will cause the crisis is, however, pretty clear.

In times of boom intermediaries – which can be single institutions or hierarchies of institutions connected to each other – generate enormous credit expansions. The people who hold claims on these intermediaries trust them with their money. The system as a whole transforms risk. There are risky assets at one end but after they go through the intermediaries, at the other end of these structures are people who think that what they are holding are safe assets. That’s a fundamental characteristic of bank-type intermediation, although institutions involved in it do not necessarily need to be called banks.

When the assets start looking riskier, when their values look exaggerated and their prices start falling, such a structure is vulnerable to panic. And once the panic starts, you get a crisis. Given the structures we have such crisis remain immensely likely.

You know the people we call financial elites. You regularly meet the most influential politicians, top economists at the European Central Bank, British banks, IMF, Federal Reserve. What is the mood in these circles?

These are people who at the core are committed to the system and have always been. Partly because they can’t see the alternative and partly because the political resistance to making more radical changes is just overwhelming. Short of a complete breakdown of the system, they can’t imagine a complete transformation.

It’s important to remember that even after the Great Depression the essential nature of the system remained intact. At that time a group of distinguished economists in Chicago put forward the so-called Chicago Plan. It would abolish the fractional reserve system and impose 100% reserves on demand deposits which would clearly transform the financial system in a pretty big way. Yet, although the Plan was supported by some of the most important American economists of the time it was basically shot down by the banking industry, backed by congressmen. Even after the Great Depression – which was a much bigger crisis than the one we experienced in terms of its shock value – it proved impossible to change the system fundamentally.

Yes, there was Glass-Steagall Act – which separated commercial and investment banking – and many restrictions on financial operations were introduced. But all this eroded progressively in the 1950’s and 1960’s and over further decades. It’s not that the liberalization of the 1990’s was suddenly transformative. It was a whole long series of liberalizations.

What have we done this time?

Essentially we’ve had the same response to the one we had after the Great Depression but, since it was a smaller event, the reaction was somewhat less radical. There has been an enormous increase in the regulatory interventions in the banking system. And when you talk to bankers they will all say their business models have changed as a result. And that is actually correct.

My expectation is that all these actions have reduced the probability of the crisis but have certainly not eliminated it because there was never enough will or fear to achieve this goal.


Because the interventions you would have to make to eliminate the fragility of a financial system with very large and complex intermediaries are enormously radical.

In what way?

One thing it would involve is the creation of a world without banking and nobody has been prepared even to contemplate the world without banks.

I’m one of those people – although some of my colleagues here at the “Financial Times” disagree – who think that it’s not a good idea to have a currency union without a government. That’s why I’ve always said Britain should never join the Euro.

Martin Wolf

Some left-wing economists – for example, Wolfgang Streeck – claim that there’s hardly any incentive to radically reform the current economic system because the profits of the financial sector do not really depend on how the rest of the economy is doing. And once we experience a crisis like the one in 2008, the states just print out more money to put out of the fire. Paul Mason argues that capitalism is now on a life support from the states.

This argument – as many of these sorts of arguments – is true up to a point. And one must be very careful about how far one pushes it. Recently I’ve read a set of data which said that the profitability of banking as an industry has diminished substantially since the crisis. The profitability of many banks has never recovered. As a result, the banking industry is in a very slow process of shrinkage. It would not be accurate to say that the crisis has had no effect on the banking sector.

It is fair, however, to say that governments have worked very hard to maintain the financial sector in being. They did so because they believe – and I think they are right – that there’s a link between the financial sector and the real economy. A lot of transactions which are real economic transactions are related to the ability of banks to fund them.

The aim of state actions was to get back the economy into some sort of reasonable shape. You might well think that the financial sector is too large and that it needs reform. But I think you cannot argue that supporting the financial sector has no bearing on how strong the economy is.

The question is what you spend your money on. In your book you clearly say that some economies – Greece for example – may not return to their pre-crisis shape for a very long time.

First of all, prior to the crisis, huge disequilibria had emerged in the Eurozone. Greece had three major problems – financial, fiscal and a massive uncompetitiveness.

Then the crisis hits. One of the standard adaptive mechanisms – the exchange rate – does not exist. So in order to regain competitiveness, one has to reduce the nominal costs in euros directly. That can’t be done without a huge recession. Wages are never easily flexible downwards. The only alternative would be to agree on policies to push the inflation much higher in core countries of the Eurozone, like Germany or the Netherlands, and they certainly would not let that happen.

For the Greeks, these were more or less inevitable consequences of being part of a monetary system that had incomplete political and economic institutions and which had allowed enormous and highly destabilizing booms in the private sector, or public sector irresponsibility, before the crisis. Those were very big policy mistakes.

What should have been done differently?

Debt reduction for Greece should have been more significant and introduced more quickly. And monetary policy in the Eurozone should have become more expansionary much sooner. From 2008 to 2012 the Eurozone did not respond to the crisis very effectively. But the fundamental weakness of the system lay in the fact that Greece had become completely dependent on decisions made by other governments. And those governments were accountable to their own electorates. Inevitably this meant Greece had very little freedom of manoeuvre. This was not an economic policy mistake but rather a fundamental consequence of creating such monetary system.

Now the idea is to tighten the cooperation between Eurozone members, to introduce new institutions and share the risk…

It’s not clear how it all is going to end up. There’s a limit to what they can do because it’s not a federal union, it doesn’t have a federal budget and it will not have one for a foreseeable future. So people in charge focus on narrower tasks. They created the European Stability Mechanism which means they can help smaller countries in the crisis much more effectively than they could have before. The problem is they still cannot help big countries. They can deal with Portugal, but not Italy. The ESM is not big enough.

Because of that, they also created the Outright Monetary Transactions programme announced in July 2012. It allows the European Central Bank to make purchases, under certain conditions, of bonds issued by Eurozone member-states. It is designed to help big countries. But we don’t know yet whether it will work. We can say that, institutionally and politically, improvements have been made. It’s probably not enough to avoid another crisis and it’s not clear how it would all work if another crisis actually broke out.

I’m one of those people – although some of my colleagues here at the “Financial Times” disagree – who think that it’s not a good idea to have a currency union without a government. That’s why I’ve always said Britain should never join the Euro.

What about a country like Poland with a smaller economy and at the same time both politically and economically more dependent on the EU?

From the economic point of view, I believe Poland should not join the Euro. I put aside profound political questions that are now evidently being raised in Poland.

Poland’s economy is quite large and properly managed it should grow faster than the rest of the Eurozone. Up till now, Poland’s monetary policy has been well-managed by the national bank. The floating exchange rate has helped – it seems to me – to cushion shocks pretty effectively.

Of course, if Polish monetary policy is now going to be completely politicized and used to support irresponsible fiscal policy, or if confidence in Poland declines and you start generating economic crises within the country, this view might change.

Protectionism is a tax on domestic citizenry which is transmitted to producers. It’s a subsidy. Putting it under the banner of America or Poland is just a way of disguising it.

Martin Wolf

The financial crisis has been one of the reasons behind the rise of populist parties throughout the West. And one of the main claims made by these politicians, including those in Poland, is that they are going to “take back the control” of their nation states, make them more powerful and less dependent on external forces. Is it possible? We hear the same rhetoric in very diverse countries like the US, UK, Poland or even Hungary.

There are several different dimensions of “taking back control”. A lot of it is essentially a rhetoric of interest group politics. Let’s suppose you’re in an industry that has done badly in global competition. It’s not easy to say: “We’re just very inefficient and uncompetitive and we think our fellow citizens should subsidize us.” That doesn’t go rhetorically very well, does it? So instead you can say: “We’re a victim of a foreign plot to destroy sacrosanct national industries and deprive decent, honourable Americans/Brits/Poles of the jobs they should have. Therefore we must «take back the control» from these beastly foreigners who insist on selling us cheap goods”.

A lot of this rhetoric simply conceals sectional interests. You might think that some of these sectional interests are the ones you really care about. But no-one really answers the question why should we care about these people as opposed to other groups of people who also lose jobs, but don’t happen to work in an industry subject to foreign competition.

There’s a famous line in English which says that “patriotism is the last refuge of a scoundrel”. A lot of it is just flag waving which really disguises the desire of uncompetitive industries and groups to get everybody else in the country to look after them. Protectionism is a tax on domestic citizenry which is transmitted to producers. It’s a subsidy. Putting it under the banner of America or Poland is just a way of disguising it.

The point is, can it actually work?

No nation state, no national economy, even the US, and certainly not the smaller ones can be in any sensible way autonomous or self-sufficient. They depend on one another. Think of the number of imported goods and services Poland could not generate for itself because it simply lacks the ability to do so. It’s certainly true for Britain. If it was not for trade, we would have no smartphones, we wouldn’t have most of our computers and many other goods. The fact that market economy has gone global generated a wider range of goods and services, and therefore prosperity that we could have never created on our own. In that profound sense, the nation cannot be sovereign.

Does it mean citizens have very little choice over the trade policy their countries pursue?

You could say a nation makes a sovereign choice to open up and that’s true. And we’ve done so together through organizations like the WTO, or the EU because we felt it was beneficial to the country. It’s a trade-off. We can achieve a higher standard of living and therefore in some sense the most important objective of sovereignty. Why does a country want to be sovereign? So that its people can enjoy a decent life – freedom and opportunity. The same argument I made during the campaign before Brexit referendum.

The idea behind the EU and the WTO is that we all gain more from cooperating than we do if we all pursue narrow versions of sovereignty, particularly as they tend to lead to wars. The Americans understood this, until Trump came along and most of the British understood it until some point. But, in the case of countries of Central and Eastern European countries, I find it absolutely bewildering why they would not understand it. Because if there’s one lesson from history – it’s true for all of Europe, but it’s certainly true for a country like Hungary or Poland – is that their sovereignty is indefensible without the help of others. Being embedded in wider alliances in which countries share mutual responsibilities is the only way to have sovereignty at all. Otherwise, it becomes completely empty and empty sovereignty seems to me completely pointless.

Then, what’s the point of sovereignty?

Ultimately the sovereignty of the nation is not the objective, for me. The objective is to provide an environment in which individuals, families and voluntary groupings can pursue their respective objectives freely. That’s sovereignty worth having.

That’s liberalism.

And I’m a liberal.