Fiat Chief on the Global Finance Crisis

VENICE, June 10, 2008 — The Italian-Canadian chief executive of Fiat, the leading Italian industrial enterprise, Sergio Marchionne, speaking about the present economic crisis last weekend, mentioned the well-known argument first made by the Austrian-American economist Joseph Schumpeter about the function of “creative destruction” in modern capitalism. The financial disaster of recent months has provided plenty of destruction. Whether creation follows depends not only on reforms but the restoration of responsibility in financial and corporate circles, Marchionne suggested.

He was speaking to the annual workshop in Venice of the Council for the United States and Italy. Marchionne is the man who brought Fiat back from what a few years ago seemed its deathbed to become today one of the leading global automobile companies, bigger and far more successful than General Motors.

Schumpeter’s argument says that capitalism proceeds through a process of replacing obsolescent or outmoded and fading corporations, institutions and processes, under the pressure of new and more efficient actors in the economy.

It is a convincing argument, confirmed by observation of what goes on in today’s globalized economy, as well as in technology, manufacturing, and the organization of work and production.

It is particularly appealing to a modern society possessing an all but universal conviction, or faith, in the inevitability of progress. If destruction is indeed the way society progresses, this is highly reassuring to those who might be tempted to think that catastrophes are bad things. Events such as the outbreak and devastation of the first and second world wars might seem steps backward by humanity, rather than forward, as many, if not most, people thought at the time. The wars were considered — in a phrase often heard — as “reversions to barbarism.”

However, Schumpeter’s argument concerned capitalist economics, not politics. Others have applied, or misapplied, his ideas. Some American neoconservatives thought, erroneously, to their surprise, that deliberate destruction of undemocratic regimes in the Middle East would cause democracy to spring forth spontaneously.

The Canadian writer Naomi Klein last year published a best-selling book (“The Shock Doctrine”) arguing that certain leaders in the capitalist economy deliberately foster disaster for the political as well as material profit that can be gained as a result.

It is hard to argue with Schumpeter’s argument about the capitalist economy’s workings. His main argument was that the dynamic and innovative entrepreneur is the principal agent of this progress, although scientific or technological innovation, or even the work of the intellectual — like Schumpeter himself — can have profound effect on the economy. (Schumpeter foresaw the eventual downfall of capitalism when it fell into the hands of the intellectual class, who would sacrifice dynamism to egalitarian goals!)

Sergio Marchionne brought Schumpeter’s thought to his analysis of the current financial crisis (summarizing his critique of how financiers think with the song title “Money for Nothing” by Dire Straits, an international hit in 1985).

The hunt now is on for whom to blame for all of the destruction of wealth during recent months, and also for those guilty of letting it happen. He finds an allusion to Schumpeter in a recent working paper from the International Monetary Fund that describes “the recent experience in the subprime market [as] a case study in the cost and benefits of financial innovation in an environment of shifting asset price dynamics.”

The benefits cited in that effort to find the “creative” aspect of the present destruction (one would like to think this ironical) are the expansion of homeownership due to the fall in the cost of high-risk mortgages, “especially among minority groups,” and the dispersal “of the default risks away from core depository institutions to the capital markets.”

The most destructive aspect of the failure of the system was that this whole universe of subprime loans, plus “securitization” with validation by the rating agencies, “flew under the radar screen of the regulators.” Over half the U.S. mortgage loans were made by independent lenders without federal supervision.

Marchionne quotes Edward M. Gramlich, a member of the board of governors of the Federal Reserve, as writing that “this is the way laissez-faire ideologues ruling Washington, including Alan Greenspan, wanted it . … They were and are the men who believe that government is always the problem, never the solution, and that regulation is always a bad thing.” Fortunately, Marchionne said — speaking as a European executive — “the damage to the real economy is going to be limited to the U.S., and the contagion risk is limited.”

The Fiat CEO concluded that the problem has been unregulated lending, and that no regulation meant tragedy. He said, “There is not a single doubt that the U.S. must increase its consumer protection mechanism,” and should restore the equivalent of the Glass-Steagall legislation of 1933 that segregated financial institutions according to their function, so as to prevent banks from owning asset management companies. This protects bankers from themselves, and everyone else from the illusion that money can be spun from nothing.

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