Rethinking the global market economy

More regulatory oversight and a remuneration system that promotes less risky behavior are only the first steps. A reshuffle of the whole economic system is urgently required.

“The liberal market philosophy that the individual should enjoy unbridled freedom has become subject of critical scrutiny as a result of the credit crisis,” says Professor John Groenwegen, speaking in his office at the Faculty of Technology, Policy & Management (TPM). Groenewegen, an authority on institutional economics, says the exorbitant remuneration system for CEOs that helped compel the current crisis is a marginal issue. The root of the problem, he says, lies in the make-up of the economic system. Groenewegen holds leading positions at various research organizations: he is the secretary general of the European Association for Evolutionary Political Economy, as well as a research fellow at the Tinbergen Institute, which is named after Jan Tinbergen, the first Dutch Economics Nobel Laureate.

What went wrong?
“Perverse incentives were introduced into the economic system. However, the key problem is the liberal economic belief that it’s best for society to give individual economic actors unbridled freedom. The problem with such a system is that its outcome is opaque. Nobody can predict the aggregated outcome of uncoordinated economic activity of individual actors. Nevertheless, the belief that what’s good for the individual is by definition good for society is widely accepted. The credit crisis is exemplary in how severely things can go wrong if this liberal economic belief is implemented in the real world.” 

Which perverse incentives were introduced? 
“The latest wave of liberalization resulted in the adoption of Anglo-Saxon competition and corporate law by Dutch authorities. The thinking was this institutional reform would promote innovation and efficiency. In contrast to the past, shareholders became the most important stakeholder. These Anglo-Saxon type shareholders were, in addition, shareholders who focused on short-term profits and not long-term growth. The remuneration system that came along also provided the wrong incentives: manager’s strategies and objectives were reduced to obtaining ever-increasing turnover and profit figures. It’s not very hard to imagine that such incentives can lead to Enron-like cases.” 

But according to you the main problem is: unbridled economic freedom.
“The intention to enhance regulatory oversight and alter the remuneration system as declared at the recent G20 summit is a good first step, but not enough. Authorities should judge ex-ante the possible consequences of a certain innovation for the entire economic system. And the thinking should be: don’t allow something you don’t understand. The measures announced by the G20 are intended to enhance the functioning of the market, not to control the market.”

What do you mean by, ‘don’t allow something you don’t understand’?
“The subprime mortgage derivates – a financial innovation – that were constantly sold and resold, with nobody really understanding the associated risks and benefits, wouldn’t be allowed in such a system. A double safety net is proposed. First, a particular authority judges the merits of an innovation, and if the authority believes the innovation does not pose a threat to the economy as a whole, the authority allows the innovation. In such complex cases in which it’s virtually impossible to judge the consequences an innovation could have on the economy, the authority should block the innovation. This is a completely different philosophy about the composition of the economy than the liberal economic one. Currently, the policy is that everything that is innovative should not be monitored and not judged, because they are essential for our progress. In the system I’m proposing, popular in France and Japan, what is best for the system and the prevention of a system breakdown is the guiding principle for authorities.”

But this economic model posses a threat to innovation.
“That’s right. Every kind of configuration of the economy comes at a price. Before allowing a particular innovation, authorities should ask themselves specifically: should I, by allowing this innovation, risk a system breakdown? In the real world you obviously try to go for the best of both worlds: promote innovation and prevent a system breakdown.” 

In a global economy, organizations like the IMF and World Bank could best prevent a system crash?
“Yes, but first these organizations must become more democratic than they currently are, and get more authority subsequently. However, this won’t be easy. The European integration process is exemplary in this regard: nobody wants to transfer too much power to Brussels. In the system that I’m proposing, the IMF could demand the USA to reduce its national deficit or that it should spend less, or else there will be sanctions. The latter would be the most preferable solution, but a powerful upper and lower house or congress and senate in countries around the world are also good candidates for this role.”

Do you agree that the current merger and acquisitions regulatory framework has made it impossible for authorities to do anything else but to save, in effect, failing banks?   
“This is indeed a big problem, but we have possibilities to intervene. The Europe Union’s commissioner for competition, Neelie Kroes, can take appropriate measures. However, the problem is that she judges such initiatives on whether they do or do not restrict competition. In the economic system I’m proposing, she would also judge whether the resulting organization becomes so important for the economy that government oversight is imperative.”

Many have blamed the ‘greed is good’ mentality among bankers for fuelling the global credit crisis. Do you agree?
“Greed refers to a genetic human feature. My fundamental belief is that the behavior of an individual is, by and large, defined by his environment and not his genes. This environment consists of laws and rules and informal institutions such as norms of behavior and codes of conduct. To promote welfare this complex of institutions should constrain greed and promote altruistic behavior. The credit crisis shows that along with the introduction of perverse regulatory incentives, the informal institutional framework also started to crumble. Twenty years ago a CEO in the Netherlands was judged by his peers on his ability to restructure his company with the minimum number of lay-offs. To earn their respect he didn’t have to announce at the golf club the many millions he was going to make.”