How have arguments about the long-term advantages of the Anglo-American finance and banking system, compared to its rivals, been affected by crisis and recession since 2008?
Ever since the ‘economic miracle’ of Japan post-WW2, the world has transfixed itself on the relative benefits of the Anglo-Saxon, Rhineland – and up until recently – the Chinese financial systems. After the 1990s collapse of the Japanese and stagnation of the German economies – countries which make up the heavyweights on the Rhineland side – debate has re-emerged on the comparative benefits and drawbacks of these systems. This proved to be more complex than would otherwise be expected. Major differences could be observed between countries using similar financial models. Industries within similar financial systems often operate in diverse ways, and within those industries companies are also varied in their approach, activities, business strategy and employ distinct corporate structures.
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From a macro view, the Anglo-Saxon financial system exhibits economical superiority as compared to its adversaries. Its benefits include ease of access to liquidity by encouraging free trade, promote risk-taking with the promise of high reward as an engine of innovation, and securities markets abetting dispersed ownership and corporate financial self-sufficiency. A series of financial mishaps, not the least those leading to the 2007/08 global recession, have called into question the system’s declared economic case. The negative impacts from the latest recession will likely rattle the prevalent orders for years to come, with major economic and possibly socio-political reforms proposed to correct the imbalance. This comes at a time of post-modernist humanism bringing renewed legislative focus and popular scrutiny regarding social, economic and environmental sustainability issues.
The financial crisis of 2008 has been traced back to the U.S. sub-prime mortgage markets, whereby low U.S. interest rates between years 2004-2006 sharply increased from 1% to 5.25% – leaving those who had hardly been able to afford mortgages to begin with unable to repay the banks. This lead to a surge in loan defaults, creating pools of ‘toxic’ debt whereby the ‘diversified portfolio’ risk approach had spread rather than offset the problem [Mason, 2009]. This in turn decreased bank confidence in lending, as each bank questioned the validity and health of the financial instruments other banks were offering – causing a “credit crunch”; a contraction in the credit banks make available for lending.
Mortgage debts are asset-backed securities, and non-payment allows the banks to recoup potentially expensive loss of value through a legally protected right to acquire those mortgaged properties. However, this crisis was insinuated with dramatic property price depreciation because people were in effect demanding what they could not afford, thus artificially marking prices upwards and creating a housing price “bubble”.
This explanation of the financial crisis is just that: a descriptive explanation of how it happened. There remain deeper questions regarding why this happened, and what factors, institutional or otherwise, have contributed to the crisis. The recurrent themes to dominate the debate have since centred around; the predominant financial and banking systems, the risk and speculative nature of business, corporate governance and accountability, and legislative regulation (or the lack of it). In trying to explain the why questions, Marxist economists have contested the notion that the current problem’s roots lie in some shortcoming of the credit market [Roberts, 2011]. Rather, it is argued that the latest recession is part of a prevalent pattern in which a tendency towards diminished rates of profit is occurring [Dumenil & Levy, 2011]. In explaining what factors contributed to the systemic crisis (and in how to resolve these issues), it is Keynesian economics which has garnered resurgent interest. John M. Keynes’ fiscal and monetary remedies were adopted in healing economies worldwide, with some of the largest ‘quantitative easing’ measures to date taking place in the Anglo-Saxon systems.
The rise of the large-scale enterprise also brought with it the ascendance of dedicated management [Chandler, 1962], and thus loosened the link between control and ownership. In the U.S., this gave corporations a competitive edge, eventually leading the U.K. to import U.S. managerial practices [Dore, 2001] (U.K. business had been suffering from family-owned and undereducated management). These changes lead to a new era in corporate governance for both nations. These changes gave rise to the ‘neoliberal’ finance and corporate governance system – at about the same time China was deregulating its economy and Japan was exiting its economic ‘miracle’.
The Anglo-Saxon system has its historical and cultural roots – it is safe to assume that the lower a country scores on the uncertainty avoidance index of Hofstede, the more it will be market-oriented [Koen, 2005]. The individualistic mind-set prevalent in the U.S. and U.K., as well as the emphasis of society on materialism and Financialisation, meant the Anglo-Saxon system was dominated by a shareholder theory approach. This resulted in extensive securitisation; a catalyst to the economic crisis because of the complex risks such securitised financial instruments created. In contrast, the Confucianist culture prevalent in some South East Asian nations – which promotes humanity (Ren) and righteousness (Li) – in conjunction with a Productivist mind-set, has allowed a more coordinated market to spawn. Likewise, the German ‘Gemeinde’ – or communalism – has lead to a similar financial system, whereby various stakeholders play a much more important role than is true of the Anglo-Saxon system. In Japan, the ‘Sha-in’ (enterprise community members) are of overwhelming importance to managers [Dore, 1994].
The Anglo-Saxon model is one based on a stock market capitalist system, and as such it enforces short-term horizons on corporations. Ownership of corporate shares is mostly vested in institutional investors (mostly in pension and investment funds) resulting in comparatively low cross-shareholding, and financial institutions hardly own any shares at all. Venture capital remains the only major long-term investment in the Anglo-Saxon system. The resources made available in this system are flexible and mobile – thereby making it easy to get rid of the old and easily market the new. This capital also allows for a comparatively larger risk appetite, thus allowing investments in innovation with relative ease and flexibility – an aspect considered by Porter (1991) as essential for national competitiveness. Competition requirements and anti-trust legislation have limited companies from coordinating between activities between each other, their customers, and stringent legislation separating corporate control and ownership [Koen, 2005]. This runs contrary to the Rhineland and Chinese transitional economic systems; bank-financed, long-term relations-based business strategy which legally (Germany) or socially (Japan) obliged that wider interests are accounted for [Whittaker & Deaton, 2009].
Societal expectations of business within these systems meant that corporate governance systems in the Rhineland system were more comprehensive than their Anglo-Saxon counterparts. However, this has also limited the flexibility of their decision-making process, with many sometimes conflicting interests to be considered. Long-term obligations also meant that sometimes unprofitable business was kept due to trust-based relationships, further demeaning their competitiveness (sometimes done to preserve their reputation) [Dore, 2001]. Whereas profit-maximising oriented business in the Anglo-Saxon model usually disregarded external effects of their businesses. A summary of the benefits and weaknesses of these two systems is presented below.[Blackford, 2008]
Historical and theoretical differences between these models, in the past and present, have not always been able to explain comparative performance. In the 2008 recession, Japan entered a period of freefall recession. On the other hand, the German recession patters were more closely aligned to those of France than with Japan. Germany has emerged from its brief stint in recession as the back-bone and driving force of the EU economy, whereas the same cannot be said of Japan, who’s annualised GDP rate regressed by almost a tenth in one quarter. Furthermore, up until 1993, the Japanese did not have the ‘universal’ banking system as Germany did. Differences between the U.S. and the U.K. meant that varying implications were levelled against them as a result of the recession. The U.S. allowed for the collapse of Lehman Brothers, and other failing banks were acquired by competing businesses (Merrill Lynch was acquired by Bank of America), whereas the U.K. preferred to nationalise and bailout its banks.
The U.K.’s lack of diversification, as in the U.S., and their heavy reliance on the services sector meant that the top 8 U.K. banks had to bailed out at exceptional costs. Even same-industry success has been attributed to different economic systems. In the U.S., the vast availability of capital and heavily privatised healthcare system are credited with the success of the U.S. pharmaceutical industry [Blackford, 2008]. However, in theory the impatient nature of funds and the short-termism of investment should have challenged as opposed to reinforcing this industry [Dore, 2001]. On the other hand, the success of the pharmaceutical industry in the U.K. has been traced to the National Health Service – which provides corporations with a large and stable customer. These reasons are completely contradictory, with one citing privatisation and the other nationalisation as sources of success.
The Chinese finance system proved adequate in riding out the financial crisis. Its economy was not exposed to any major threat during the recession, as compared to other major nations, because it had limited exposure to foreign markets. In 2008 China remained largely unaffected by the impending recession, and by 2009, when the crisis was at its peak, growth rates halved to +6.2% while other nations experienced contraction. For example, FDI in China is usually only allowed in partnership with Chinese firms. If anything, China helped absorb the full impact of the recession; at one point the government announced its own stimulus package (valued at just under $550 billion) even when its economy was thriving on strong growth. The financial crisis could be argued to have caused a process of temporary Anglo-Saxon convergence towards the Chinese model, especially in the U.K. which nationalised multiple major banks, thus consolidating the banking system [Bottiglia, 2010]. Due to institutional investments made by banks in other businesses, this act of government control has implications which reverberate throughout the whole financial and banking system.
Meanwhile, Germany has emerged from the recession as the heavyweight European economy, outperforming all its peers. Germany went into a year-long recession, but bounced back in force. It is now carrying the rest of Europe, whereby a recent increase of 2.3% in its economic growth has lead to a 1% increase in the EU growth rate. The Germans have viewed this economic crisis as an external problem, as opposed to a structural or institutional problem at home. It is rationalised that, as an export-driven economy, the negative effects of its economy were unavoidable. There are certain aspects on which the Anglo-Saxon system thrived on, but which ultimately espoused conditions which would determine its own downfall.
It is now clear that due to the internationalisation of the stock-market capitalist system, and the relative success it has brought its practitioners (up until the 2008 recession), has forced convergence of some German and Japanese companies towards the Anglo-Saxon model. It is true that Japan and Germany have seen some continuity in their models, however large enterprises in both countries are slowly converging towards a self-financing strategy by tapping into the international securities markets [Schroter, 2005]. Meanwhile, SMEs remain traditionally funded – thus a part-hybrid system is evident. The economic difficulties brought about in the 1990’s in both Japan and Germany has meant that banks turned to SMEs to sustain their businesses. With Japan’s bank reserves drying up, SMEs found themselves in between a hard place and a rock: unable to turn to the bond markets due to low interest rates, and simultaneously faced higher bank restrictions.
A critical difference in corporate governance and ownership obligations between the Anglo-Saxon and Rhineland models still remains. The former places regulation and supervision of business on market forces, with weak and ineffective governance systems [Dore, 2000]. The former places supervisory functions in the dual-board system, and still largely depends on long-term, cross-shareholdership [Kono & Clegg, 2001]. Ownership in the Anglo-Saxon system is more price-oriented (fluctuations in share price in the stock market has big effects on demand for such shares), whereby this is not true of the Rhineland and Chinese systems. Indeed, just as the Anglo-Saxon systems have experienced a capitalist-managerial revolution, a counter-revolution may be in the making. Managers are now paid in performance-related bonuses, percentage of profits and stock options.
This pattern indicates a trend back towards the owner-management era – albeit in a more reformed sense of the concept. It is no surprise that management inclinations are exclusively aligned to owners – after all, they could be considered as such. Post-recession, the U.S. found itself abandoning free-market principles, with all its supposed benefits, in favour of a “quantitative easing” policy on par with socialism. Post-bailout, U.S. society is arguably split between those who ‘cannot’ fail – a socialist system supported by the expectation of government backing during crisis – and a capitalist system for everyone else. Management greed has been cited as the main culprit [Kothari, 2010]. The banking crisis which ensued also highlights the relative importance of banks in the Anglo-Saxon system, which have usually been relegated in imperativeness in comparative analyses. The extent to which the stability of these economic systems lie on the stock market as opposed to the banking system is not very clear – however, the dot.com bust in 2000 did not have the severe ramifications that the 2008 recession had.
A very likely contributor to the recession has been the state trend towards deregulation of the financial system. A trend towards financial deregulation in the late 1970s – following through into the 1990s – may have contributed to the 2008 financial meltdown. The 1986 financial services ‘Big Bang’ followed deregulation by the Thatcher government in the U.K. This was due to a falling share in financial services from 40% in 1955 to 15% by the later 1970s. Similarly, Jimmy Carter’s DIDCMA of 1980, followed by the Reaganomics era, as well as the changes taking place in China within this same period, pointed towards the deregulation of the financial systems in those countries, respectively.
It is not clear how important a role national finance and banking systems really play in a globalised, interdependent world . National boundaries have become decreasingly significant. The increased relevance of transnational corporations, and the decreased sovereignty of nations over corporate activities, would seem to suggest that managerial and institutional inefficiencies, rather than those of the financial system, are to blame for the recession. Indeed, the root of the problem may have been the deregulation process in the U.S., or in the failed ‘diversified portfolio’ risk approach of Anglo-Saxon-based corporations, but the interconnectedness of financial interests has meant that no truly international financial system is able to escape the systemic crisis, as the negative effects spill over into peripheral markets not directly involved in the problematic area of business to begin with.