What’s going on, then?

Jenny Stewart, University of Canberra

John Braithwaite, Regulatory Capitalism: How it Works, Ideas for Making it Work Better Cheltenham, Edward Elgar, 2008 (264 pp). ISBN 9-78184720-002-0 (hard cover) RRP $192.95.

As an economic system, capitalism is definitely not for the faint-hearted. Even in its most civilised forms, it is prone to cycles of boom and bust. In its less civilised forms, it leads to savage levels of social inequality. The problem is, no one has been able to come up with anything better.

The recent turmoil on world financial markets, however, has shaken the system to its foundations. A number of investment banks have collapsed or been taken over. Governments worldwide have been forced to guarantee deposits in retail banks, and to recapitalise a good number of them. Stock-markets madly plunge and surge, and recession has either hit, or is about to.

The crisis had led many to wonder whether, this time, capitalism as we know it might really be finished? Admirers of Karl Marx are dusting off their volumes of Capital. Political economists are recalling the work of Paul Baran and Paul Sweezy, whose Monopoly Capital (1966) identified the growing tendency of finance capital to overwhelm the productive economy. From a quite different perspective, the legendary George Soros has blamed governments for failing to understand the growing risks posed by unregulated markets based on exotic financial instruments (Soros & Woodruff 2008).

British Marxist historian Eric Hobsbawm describes the issues with his usual clarity. Globalisation, he observed in a recent BBC interview, was implicit in capitalism. Yet at the same time, globalisation is inherently unstable, operating through a succession of crises, some big, some small. Hobsbawm believes that the present crisis, like the Great Depression of the 1930s, signals the end of an era (Hobsbawm 2008). Whatever form the new capitalism takes, it will be different from the old. For the foreseeable future, the ideology of the free market, at least in its fundamentalist forms, will have run its course.

Capitalism is definitely not an economic system for the faint-hearted.

Some form of regulatory renaissance seems inevitable. But regulation of what kind? It is just beginning to dawn on many people that globalisation does not simply mean that everything is made in China. It also means that other people’s regulatory systems impinge directly on our own. In other words, globalisation means everything is connected to everything else. I don’t know whether the butterfly moving its wings in the Brazilian Amazon really does produce a hurricane somewhere else. But a sub-prime mortgage crisis in the United States certainly does spread speedily (and unpredictably) across the world.

How so? Well, the originators of these dodgy loans quickly pass the risk onto someone else, by securitising the debt. This means that they can lend more money to even more financially-strapped clients. Because good assets are packaged with bad, buyers of these collateralised securities (many of whom are managing other people’s money) think they are safe. But the value of the security depends, critically, on house prices continuing to rise. Once the game of pass the parcel stops, and lenders attempt to exit the market by selling assets at fire-sale prices, it speedily becomes apparent that major losses are inevitable. If they decide to hold on, they have to write-down these assets—unless, of course, a friendly government somewhere decides to bail them out.

Because there is so much credit about, asset price-bubbles develop, burst and then re-develop. The Asian financial crisis of the 1990s, while it played out differently in different countries, first manifested itself in rapidly-rising asset prices and unconstrained borrowing. The Americans, with their exceptionally exuberant form of capitalism (I am trying to put it nicely), are particularly prone to these events. The savings and loans debacle of the early 1980s was an earlier version of the much bigger crisis that hit Fannie Mae and Freddie Mac in 2008. Even the land of Oz is not immune. The financial system almost collapsed in the 1980s, as a result of over-hasty financial deregulation.

On the other hand, when everything is booming, how we love it! Easy credit fuels massive consumption. We buy bigger houses and more and more stuff to put in them. Clive Hamilton keeps telling us we should stop, but we take no notice (Hamilton & Denniss 2002). But then, like recovering junkies, we have to weather the bad times, when the credit dries up, and businesses stop investing, and the grim spectre of recession (or worse) hangs over us.

So, what should be done? There is general agreement that once the dust has settled, markets that have been more or less unregulated will have to be reined in. But this is easier said than done. Whatever governments do, they create opportunities for some of the cleverest boys and girls in the world to outwit them. Like generals, governments always seem to fighting the last war or, sometimes, the wrong war. There is moral hazard at every turn, because the knowledge that they will be saved leads the entrepreneurs of risk into even more daredevil schemes.

‘De-regulation’, according to Braithwaite, is a myth.

Does John Braithwaite, who has been a long-time student of regulation, have some answers for us? Over many years, Braithwaite and his colleagues have developed the concept of regulatory capitalism to describe the current state of capitalist evolution, at least in the Western industrial democracies. There is, according to Braithwaite, a kind of symbiosis between the capitalist system and the states that attempt to regulate it. While capitalist expansion creates new challenges, so does the regulatory apparatus grow in power and flexibility to meet those challenges. ‘De-regulation’, according to this author, is a myth.

Clearly, Braithwaite is an optimist. He believes that new types of governance are emerging, based on networked forms of private, public and hybrid power. He makes the very useful proposal that regulators should try to create ‘markets in virtue’. By this, Braithwaite means mechanisms for encouraging those who want to do so, to act honourably, rather than creating forms of hypercompetition that force everyone who wants to stay in business, to engage in (for example) aggressive lending practices. (We get his point but still, ‘virtuous markets’ might be a better term than ‘markets in virtue’. And ‘vicious markets’ might be a better term than ‘markets in vice’, which sounds a bit like prostitution, gambling and illicit drugs.)

Virtuous markets seem worth pursuing, although given the behaviour of some, administering a little old-fashioned punishment first seems well in order. Beyond that, there is the vexing problem of somehow taming the raging capitalist system that is, obviously, seriously out of control. Here, we need a more muscular and comprehensive theory than Braithwaite is able to provide. Such a theory would give some guidance for establishing a new order that combines improved national-level regulation, with some kind of new (or re-newed) form of international regulation. To do this, we need a theory of regulation that somehow reconciles the political and the economic.

Does ‘responsive regulation’, reprised in the current volume from earlier work with Ian Ayres (Ayres & Braithwaite 1992) and with Val Braithwaite (Braithwaite & Braithwaite 1995) fill the bill? Responsive regulation means presuming (and rewarding) good behaviour. The theory is based on what actually happens when (for example) we try to regulate the standards of care in nursing homes. Clearly, there are multiple values to be conjured with here: such as the extent to which regulation privileges individualised attention for residents at the expense of efficiency in a home’s operation; and the degree to which rules are flexibly rather than rigidly enforced. Good ways of dealing with shortcomings must be sensitive to place and context. Braithwaite discusses the ways in which ‘responsive’ inspectors can effect improvement while not creating antagonism. Somehow, though, I do not think the model of the good regulator in the nursing home (or even school) would last very long in Wall Street.

Another approach to take in the current crisis is to try to understand where we went wrong, or at least, what forces have produced the current predicament. Does ‘regulatory capitalism’ give us the necessary traction? In other words, do Braithwaite’s ideas help us to chart a course towards more effective regulation? It is true that parliaments the world over are busy passing laws. The problem is, in a world where resources flow as freely as they do, regulation at the national level is very difficult to implement. As with policy to combat global warming, the fundamental difficulty is: how do we get nations to work together? Here, without any over-arching authority to mandate virtue, it seems that Braithwaite’s ideas are on much less certain ground. Braithwaite and Drahos have (rightly) criticised intergovernmental institutions such as the World Trade Organisation for limiting virtuous markets in information by imposing US intellectual property law on others (Braithwaite & Drahos 2000). But, while imperfect, the regulation of trade has, arguably, been strengthened in the post war period. Meanwhile, international financial order has languished by comparison. Bretton Woods, the framework of collaboration between nations based on the ideas of John Maynard Keynes, has been largely superseded by widespread financial deregulation, with (so far at least) little sign of the international institutional development that is needed to deal with the resulting problems.

History tells us that we humans rise to the occasion, if at all, only when we are hit between the eyes with a really big crisis. If we survive the immediate cataclysm, we are able to summon the political energy that is needed for change. Currently, we have the crisis. We do not, however, have any country or even group of countries that is prepared to take any sort of moral leadership in constructing a new world economic order.

Parliaments the world over are busy passing laws.

In the short term, I see only two possible leaders of this kind—the European Union, and the United States itself. If your initial response is ‘you must be mad, the Americans got us into this mess’, I would have to agree. On the other hand, the Americans beat both the fascists and the communists. Yet, in many ways, their ideological success has been their undoing, and now they need our help.

Countries of goodwill should aim to implement mechanisms to regulate financial flows. National action will be needed; for example, to supervise more closely financial entities that are currently unregulated. But international understandings are also necessary because without them, countries with poor supervisory environments will have an advantage over those with sound ones. This occurs because the task of complying with regulation imposes additional costs on the regulated businesses.

The result of more restrained credit-creation will be slower growth, but perhaps more sustainable growth. In the past, capitalism’s worst excesses have been mediated by the welfare state and by regulatory forms that have given working people reasonable jobs to do, and have prevented robber barons from monopolising markets. But the regulatory state has yet to catch up with globalisation.

If it is to do so, there must be some acknowledgment of the downside of global capitalism. Markets do not know best, because at least in the West, the limits to consumption have probably been reached. (It is a different story, of course, in developing countries.) Global trade gives us cheap goods, but it also means that in the world’s powerhouse economy, the United States, there are many millions of people who do not have the sort of job that would give them access to credit on realistic terms. They have not been compensated for this, and most are excluded from gaining the kind of education that they would need to take their place in the so-called knowledge economy. These are challenges, not just for the regulators, but for the entire world of public policy.


Baran, P. & Sweezy, P. 1966, Monopoly Capital: An Essay on the American Economic and Social Order, Monthly Review Press, New York.

Ayres, I. & Braithwaite J. 1992, Responsive Regulation: Transcending the Deregulation Debate, Oxford University Press, New York.

Braithwaite, J. & Braithwaite, V. 1995, ‘The politics of legalism: Rules versus standards in nursing home regulation’, Social and Legal Studies, vol. 4, no. 3, pp. 307–341.

Braithwaite, J. & Drahos, P. 2000, Global Business Regulation, Melbourne University Press, Melbourne.

Hamilton, C. & Denniss, R. 2002, Affluenza: When Too Much Is Never Enough, Allen & Unwin, Crows Nest.

Hobsbawm, E. 2008, Interview on Today, BBC Radio 4, British Broadcasting Service, 18 October [Online] Available: http://news.bbc.co.uk/today/hi/today/newsid_7677000/7677683.stm [2008, Oct 29].

Soros, G. & Woodruff, J. 2008, ‘The financial crisis: An interview with George Soros’, New York Review of Books, May 15, pp. 8–10.

Dr Jenny Stewart is Associate Professor of Public Policy at the University of Canberra. She is the author of The Lie of the Level Playing Field: Industry Policy and Australia’s Future (Text Publishing, 1994) and (with Grant Jones) Renegotiating the Environment: The Power of Politics (Federation Press, 2003).