The perils of moderation

Willem Buiter is arguing for full nationalization of the banks. One argument in particular caught my eye:

Costly partial state ownership and the fear of future state ownership (partial or complete) are themselves discouraging banks from lending…if the state’s financial assistance is priced punitively or has other painful conditionality attached to it, existing shareholders and management will do everything to avoid making use of these government facilities…Such a bank will therefore be reluctant to take any risk, including the risk of lending.

This is a particular form of a more general argument, modelled by Herschel Grossman (such as this pdf), Roland Benabou (section 4 of this pdf) or Jess Benhabib and Aldo Rustichini (pdf).
These papers show that the threat of future taxes or other forms of appropriation can reduce capital accumulation and economic growth.
In such circumstances, it’s theoretically possible that full-scale revolution might be more economically efficient than gradualist social democracy. This is because social democracy exposes the capitalist class to the threat of future full or partial expropriation - thus depressing current economic activity - whereas sudden revolution does not. Instead, by restoring secure property rights, revolution can stimulate investment.
The gut instinct that social democracy, gradualism or progressiveness is more sensible than outright revolution can therefore be false. Sometimes extremists can be rational and hard-headed, whilst moderates are woolly-headed economic illiterates.
Buiter’s argument is that this is true for banking nationalization.
The question is: does the argument have wider applicability (more likely in developing economies), or is it merely a textbook possibility?

Comments

[Luis Enrique]

I also liked the bit about contradictory messages from the authorities. I think what Buiter says makes sense; a couple of posts down I worried about the politicisation of lending under nationalised banks, but nationalisation may still be the least worst option now (I'm less sure about long-term).

Does the argument have wider applicability? Well arguments like this lay behind "shock-therapy", Jeff Sachs in the USSR and the-privatize-everything at once bastardized version of the Washington Consensus. That didn't work out too well.

In the case of banking there may be arguments for an all or nothing approach, but in most contexts - certainly development economics - the merits of gradualism and experimentation* look pretty strong to me.

And Lord preserve us from any attempted revolution to overthrow capitalism. Chris Dillow do you honestly believe for a moment that any such attempt would stand a significantly-different-from-zero chance of a happy ending? Who's going to run the show? The S.W.P?

* This is one of Rodrik's themes. The chapter on China (I forget by who) in a book he edited "In Search of Prosperity" is worth reading.

[kinglear]

Woolly headed economic illiterates, describes the present government fairl well, I would have thought.

[John Scots]

Although RBS shares have fallen considrably today, the UK government will own 70% of the company soon which means share prices will increase, if anyone has any sense they should buy into RBS, not only will they make money but it will help save the bank itself.

[D iversity]

The problem - often noted in past crises - is that bank managements tend both to have short memories and to be slow learners. The message that thas to get through to the bank managers - as in past crises - is that gathering into a frightened huddle and all hoarding cash is behaviour that brings on the evils that they fear.

Put another way, bankers have forgotten the lesson of J.P. Morgan's doing the opposite of huddling in fear. That stopped the 1907 crisis; even if he could not mange a similar single handed solution to the 1929 crash.

[Bob B]

The reluctance of the government to nationalise the banks is not based on either their timidity or ideological objections IMO.

The looming potential problem is that every business or person agrieved by a refusal of their nationalised bank to grant (or extend) loan facilities will see that as a political issue and lobby accordingly or rush to their MP. MPs will jolly up ministers to ensure that nationalised banks finance their pet projects - and even if that doesn't happen, we can be pretty sure that some parts of the press will claim that it does.

Besides that, the French experience with Crédit Lyonnais, a state-owned bank since 1945, is an object lesson in demonstrating that state ownership of a bank guarantees absolutely nothing about keeping the bank out of trouble:

"By July 1997, French finance minister Dominique Strauss-Kahn could admit that the bank had probably lost around Ffr100 billion, or around $17 billion, in its colossal spending spree. Independent commentators have suggested that the debacle will end up costing the French taxpayer between $20 and $30 billion."
http://www.erisk.com/Learning/CaseStudies/CreditLyonnais.asp

At one stage, in pursuit of the vaunting ambitions of its appointed managers, the bank came to own the MGM studios in Hollywood in the 1980s.

Btw Dominique Strauss-Kahn is now MD of the IMF. Prior to his political career, he was a professor at École nationale d'administration (ENA) through which most of France's political elite - like Delors, Michel Rocard, Chirac, Giscard d'Estaing, Jean-Claude Trichet, Dominique de Villepin, Edouard Balladur, Ségolène Royal, François Hollande, Alain Juppé, . . passed as students. There have been a few exceptions, such as President Sarkozy and Martine Aubry, Delors' daughter and the newly elected leader of the Socialist Party in France. Note: in Britain, Oxbridge has nothing like the grip on career progression in politics and public administration that ENA has in France or the Tokyo Law School in Japan. What can be argued is that access to those elite institutions is strictly on performance in the daunting entry exams - Delors came from very humble origins.

[diogenes1960]

can the UK afford to nationalise RBS etc? Why is there no mention of attenpting to segregate the UK from the non-UK debt exposure?

[Alex]

Buiter is an ass, a left-over IMF hawk from the 90s who was practically cheerleading for a sterling crisis three weeks ago - and suddenly he wants total bank nationalisation, at the same time as he becomes David Cameron's best mate? I doubt his good faith; I suspect he probably sees the NHS, public education etc as prime targets for a firm smack o'structural adjustment.