The impact of free-flowing capital on democracy

It helps to look both backwards from 1944 and forwards into the post-war era, and then to come to where we are now. The architects of the Bretton Woods monetary system, who met in New Hampshire in 1944, included John Maynard Keynes and the principal American negotiator Harry Dexter White. Keynes thought that if you wanted to have democracy in the post-war world, then states needed to be able to control the flows of capital. He looked back on the interwar years, particularly what had happened in the 1920s and into the early 1930s during the years of the gold standard, and he thought that international capital flows, the free movement of capital across national borders, had been incredibly destructive to democracy.

Keynes said that if we wanted a post-war world in which it would be possible to have political contest over matters about taxation and the distribution of wealth, and if we wanted to be able to set interest rates at a level low enough to allow full employment (which he thought would be a necessary condition of democracy surviving), then states needed the right to control capital flows. The Americans, led by Harry Dexter White, were willing to accept that. They may not have agreed with all Keynes’s analysis, but they accepted the relationship between democracy and capital flows during the interwar years. And they had some of their own motives for agreeing that, under the Bretton Woods provisions, states would have the right to stop capital moving out of their national borders. That is what they agreed.

In practice, in the Bretton Woods years (from 1944 to 1973) it turned out to be much more difficult than Keynes had thought to be able to control capital flows. There was lots of movement in what was called the eurodollar markets that undermined the capital controls that governments put in place. But it did mean that the Bretton Woods years were three decades that were relatively free of financial market instability, compared with what had happened previously in the interwar years and what would happen from the 1970s onwards.

In the 1970s, beginning with the United States, states got rid of capital controls and capital started to flow in massive quantities around the world, often via financial markets, but not only. We see a return of some of the difficulties that governments got into during the 1920s and 1930s. In the 1970s and 1980s, capital flows did not end up having the catastrophic consequences of the 1930s, particularly not in Western democracies, but they caused significant difficulties and made it harder to pursue the kinds of economic policies that had been more common in the 1950s and the 1960s.

In the 1990s and even into the early 2000s, there was optimism in believing that somehow the world had found a way to not tame international capital flows but make sure that they were used for productive purposes. The idea was that even if you had to accept the excesses of financial markets, there was still a net benefit to enough economies and enough citizens across the world that sustained economic growth. The movement of investment capital into China and into India from the 1990s, in particular, allowed millions of people to be taken out of poverty.

But if we look at the 2008 crash, we see the case of international capital flows in regard to banks. Banks were borrowing money, particularly in dollars, and then buying foreign assets. There were European banks buying mortgage-backed securities with dollars that they borrowed, or German, French and British banks borrowing money to lend to southern European governments, or to southern European corporations and banks. That was the world which caused both the financial crash and the eurozone crisis. We could see once again how dangerous international capital flows could be in terms of producing not just financial market instability but economic instability. And that had disruptive political consequences.

Before, and especially after the crash, it became clear, particularly in regard to big tech companies, that this world in which capital could flow so readily across national borders made it relatively straightforward for big multinational corporations not to pay a great deal of tax. That has had important implications for democratic politics. Although you could argue in the 1980s that the opening up of international capital markets did not lead to states being able to tax less effectively, whether that be corporations or the very wealthy, it is a lot harder to make that argument now. And if it is not possible to have a serious political contest about who should pay taxes amongst the very well-off, or to ensure that corporations pay the corporation rate taxes set by the government, it is quite hard to have democratic politics in the way in which we understand it.

During the gilets jaunes protests in France, President Macron said he was going to have the great national conversation. When he was visiting town halls, talking to people, the only thing that he said could not be discussed was “more taxes for the rich”. What is the dynamic in the world economy that has taken that possibility away from democratic politics?

There is a paradox. On the one hand, governments in democratic states have made themselves more dependent on international capital flows than they were prior to the crash because they now borrow so much more. That is going to be even more pronounced in response to the COVID-19 emergency. Governments that finance expenditure, including expenditure on their own citizens, by borrowing money in international capital markets are structurally dependent on international capital markets.

If we compare governments in the 1980s who were borrowing in international capital markets with governments today, we can say that governments are less constrained now than they were then, because the 1980s was an era of high interest rates. Any time that governments did things that financial markets did not like – for example, pursuing policies that were more left-wing than investors were keen on, like what happened in the early Mitterrand years in France – they would end up U-turning away from those more radical economic policies and doing things to calm financial markets back down again. They would need to do that in order to get interest rates, the rate at which they could borrow, to fall again.

The world of zero interest rates and quantitative easing that emerged after 2008 took that away. Democratic political imagination was given a new lease of life, because it seemed more possible than before for states to borrow large sums of money in international capital markets, without the constraining consequences of the past. At the beginning of Jeremy Corbyn’s leadership, there were people in the Labour Party in the UK who were keen on the idea that there could be what they called a people’s quantitative easing.

The idea was that instead of money being borrowed and spent on the kinds of things that it was being spent on after 2008, it would be used, for example, to increase expenditure on the welfare state. It seems likely that there will be greater democratic demands for quantitative easing to be used to sustain more radical economic purposes than we have seen for a long time. You can see this in the kinds of political positions that are being taken on the left of the Democratic Party in the United States: we have had quantitative easing for bankers, and now we need quantitative easing that is going to support ordinary citizens. In that sense, it is possible that there will be some escape from international capital market constraints, because the constraining factor primarily came from the rate of interest. And that is much, much lower now.

Nonetheless, quantitative easing and the monetary environment in which we are living have all kinds of deleterious consequences that are going to catch up with us at some point. When that will be is incredibly difficult to know. In early March 2020, when the financial market crash happened, and as lockdowns were beginning in most of the world, many people, myself included, thought this a real turning point. Central banks cannot keep propping up all this debt in the way they have done since 2008.

But in the matter of a few months, we have gone back to something that looks like 2009 or 2010. We have financial markets that are largely detached from what is going on in the real economy. So long as that is the case, we are still going to live in a world of incredibly low interest rates, or in the case of the eurozone, negative interest rates. What we are witnessing is a political phenomenon in which who gets to decide whom all that debt supports, and what the state spends borrowed money on, are going to be the crucial political questions. There may be more space for the left in that than there has been for some time.