Has the democratization of European societies given rise to anti-democratic institutions? Joseph Vogl reflects on historical processes and problem areas of the current Euro and European crises in his search for answers to this pressing question.
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The subject of my reflections is the emergence of modern finance. This process has produced expanding financial markets, the systematic accumulation of financial capital, and strong state apparatuses. Three or four phases can be distinguished in a rather schematic way.
Initially, there was a symbiotic relationship between highly indebted states and private creditors. Problems with state financing, such as high military costs, led to wealthy financiers becoming involved in governmental decision-making. This resulted in the emergence of the modern financial state, in which private lenders profited from the taxation of the general population.
Conversely, private companies and financial consortia were granted state privileges. Prominent examples of this include Genovese bankers since the end of the Middle Ages and the Dutch East India Company since the 17th century.
Para-democratic institutions emerge
A significant step was taken with the establishment of national banks. The most notable example is the establishment of the Bank of England in 1694. This guaranteed long-term state financing and offered investors legal certainty and stable interest rates on government loans. A private company became a government institution. This was made possible by the Glorious Revolution, which legally bound the English royal family to Parliament and made the king a reliable contractual partner.
Conversely, the Bank of England was granted sovereign powers – for example, the king had no access to the bank’s negotiations and decisions. In other words, the democratization of political rule led to the creation of a quasi-sovereign banking institution. Even then, this provoked heated debates about the increased power of such institutions.
Another step was taken with the establishment of central banks in the 20th century under the dogma of independence or central bank autonomy. Examples include the Federal Reserve System in the US (1913), the German Bundesbank (1957), and the European Central Bank (1999). These banks’ purpose was less to finance the state than to secure the extremely unstable financial and monetary system. This also led to radical independence. For example, the ECB cannot be controlled by national or European government bodies or parliaments. It is sovereign in its decisions and accountable only to the financial markets.
In this context, there has also been talk of a ‘fourth power,’ which can be described as para-democratic. The decision-making processes during the last financial crisis demonstrate how such institutions directly intervene in national government policies. Since the financial markets were liberalized in the 1970s, a transnational executive has emerged. This executive’s political power stems from the close cooperation between central banks, international organizations such as the IMF, and powerful capital market players.
Who is the creditor of last resort?
Against this backdrop, a financial regime emerged with the participation of indebted princely and royal houses, absolutist state machines, and modern welfare states, as well as private investors ranging from Renaissance trading houses and bankers to current big banks and investment companies.
However, three things seem essential to the current situation and the logic of the financial regime. First, the financialization of recent decades has led to the dominance of financial markets over all other market forms. This includes the alignment of corporate structures with capital market-generated variables, the transformation of social welfare programs into financial products, and the proliferation of financial instruments, such as derivatives. This has caused the volume of financial markets to explode.
Second, this has gone hand in hand with the dominance of market liberal doctrines such as the ‘efficient market hypothesis,’ which states that an unregulated financial market is the ‘most liquid,’ or the best and most perfect, market dynamic. For this reason, the market should be protected from arbitrary political intervention. Monetary policy decisions were taken away from governments and transferred to independent central banks, and fiscal policy was dictated by market conditions.
Against this backdrop, the processes of creating money have ultimately migrated to the financial markets, and financial industry players have successfully positioned themselves as lenders of last resort. In critical cases, such as in 2008 or during the recent Eurozone crisis, the interests of private creditors are prioritized over all others. The reasoning is that this is the only way to guarantee the preservation of private pension reserves, such as pension funds, and prevent the collapse of the economic system. However, the measures taken to stabilize the financial system have also created a mechanism for automatic enrichment.
Governments become private companies
The situation is aptly described by the phrase, “the tyranny of the random majority of a popular assembly.” Coined by the Swedish economist Knut Wicksell at the end of the 19th century, this phrase is now often used out of context in connection with the warning that we should rely less on voting behavior via ‘ballot papers’ and more on decisions made via ‘stock market listings.’ In other words, democratic majorities cannot be trusted with some issues, such as fiscal policy, and the relevant decisions and assessments must be left to a minority: the financial community.
This idea has been elevated to a liberal raison d’état for several decades. The argument goes as follows: In budgetary matters and questions of economic and financial policy, democratic governments depend on majorities and are therefore inclined to take risks with popular measures, such as increased spending on social benefits or combating unemployment, even if it leads to inflation, in order to be reelected.
This leads to what economists call ‘dynamic’ or ‘time inconsistency,’ a contradiction between a long-term commitment to price stability and low inflation rates and an incentive, motivated by election cycles, to stimulate the economy and labor markets in the short term, combined with the corresponding social costs. This is why these powers should be transferred from democratically elected governments to central banks, which are responsible for monetary and fiscal policy.
However, this logic goes one step further, as we saw in the wake of the euro crisis. According to this logic, government budgets should be treated like those of private companies. Their creditworthiness is then assessed by the markets, particularly by rating agencies. This led to a competition among Eurozone countries for a good reputation and made the debts of debtor countries even more expensive. The financial community was only appeased by the usual austerity measures, privatizations, cuts in social benefits, and changes in labor law.
Remaining permanently unaccountable
The close intertwining of the state and finance that led to the modern financial regime has not always been in the spotlight. This is likely due to the theoretical and conceptual frameworks that influence our views on political and economic issues. Political theories largely understand the state as a closed system of legal and administrative practices, while dominant economic theories are guided by the systemic nature of the market.
This has likely led to the prevalence of liberalist doctrines – a well-rehearsed mode of thinking animated by the juxtaposition of politics and economics, state and market. This created a clearly divided landscape in which one could hope for a restriction of state power through the spontaneous mechanisms of markets or the regulation of markets by state authorities. In this polarization, which is part of the ebb and flow of politics and science, the question of the government’s role in economic processes and institutions was not widely discussed.
With a few exceptions, such as the Stamocap theses, which referred to the intertwining of the imperialist state and the economy, there are hardly any systematic studies on the genesis of financial power that emerged from alliances between state apparatuses and finance capital. For instance, there is no political theory of central banks. Michel Foucault once remarked that the opposition between the state and civil society, with which political theory has grappled for over 150 years, is not useful for describing modern governmental power.
Another reason for the reduced visibility of these phenomena is likely the amorphous nature of the interfaces between the state and finance. This has been evident since 2008. The most important decisions were made by informal bodies or committees of experts (‘institutions’) and through informal channels, such as quick agreements between government representatives, central bankers, and major investors. The informal nature of this decision-making process poses a theoretical difficulty because it is difficult to grasp with the systemic, formal, or structural concepts of economic and political theories.
Strengthening democratic space
The current financial system has a few obvious flaws that limit or complicate its participants’ scope of action. Central banks have lost control over the money supply, and liquidity creation largely takes place on the markets. The usual servo mechanisms, such as discount rates and reserve formation, have lost their effectiveness. This presents a particular dilemma for central banks in terms of economic policy.
According to the prevailing dogma, economic growth should be financed by low interest rates and cheap money. This process has been pursued for several years through instruments ranging from a zero interest rate policy to quantitative easing at the ECB, for example. However, the successes have been modest thus far, with little or no growth in most Eurozone countries and a minimal increase in the inflation rate. This accumulates future risk potential, as evidenced by the boom in the capital and real estate markets.
Financing growth also means financing the next financial crisis. This dilemma is further complicated by political issues that affect political decision-makers. They must manage divergent and ultimately incompatible interests relating to the democratic electorate and the voting behavior of a powerful minority: the financial community. This creates a line of conflict that is also shaping political debates from Greece to Spain to Portugal.
At the same time, it establishes the conditions for changing political perspectives. First, public budgets must be restored to a state where they can be used for targeted investments. The ruined municipal infrastructure in Germany is a suitable area for this. Second, market mechanisms cannot be allowed to manage public goods. The privatization of public tasks, or governance, marks a deliberate self-restraint of democratic government. Third, governments and economies must reduce their dependence on the dynamics of financial markets. This dependence has consistently worsened in recent decades. Debt brakes, austerity programs, and inter-state competition for reputation exclusively serve the interests of finance. They have successfully transferred entire economies into the “prison of the market” (Charles Lindblom).
Editor’s note: This article is based on an interview conducted by the BG editors with Joseph Vogl about his book “The Sovereignty Effect.”