A new era of accountable capitalism

T he current financial and econ-omic crisis is apparently sweeping aside many established ideas of how societies should run their economies. In Germany, the crisis has ballooned into the worst recession in postwar history. By way of diagnosis, some say we are observing the end of the financial world as we know it. Not so long ago some had heralded the era of Alan Greenspan, former US Federal Reserve chairman, as the realisation of a new economic paradigm. By way of therapy, some have called for the renaissance of state-monopoly capitalism, sometimes labelled "new capitalism". The crisis should have a cathartic impact on the financial sector but there is a risk that responses to it will overshoot.

We already have the conceptual approach we need to set up intelligent rules to which all market actors have to adhere and that will foster transparency, credibility and trust. We know how to pursue stability-orientated monetary policies. We need to revive a culture of stability and responsibility in business. Individual incentives should reward long-term success, prevent short-termist excesses and punish inordinate risk-taking. We know that sticking to rules on competition, state aid and trade shelters the long-term gains from competition and trade from short-term protectionist and interventionist reflexes. Our social systems should shield market participants from the consequences of market upheaval - but not at the expense of market flexibility. These principles are the leitmotifs of the social market economy model on which Germany's economic rise after the second world war was built.

For both short-term crisis management and long-term decisions, it is imperative that policymakers, bankers, investors and voters understand clearly what went wrong with the world economy. Some elements of the build-up of the housing and financial bubbles have been clearly identified: loose monetary policy; the wrong kind of incentive in the housing markets; a lack of regulation of financial institutions, which allowed the creation of a shadow banking system; inadequate incentive and risk-management systems within banks; and a failure of rating agencies and of financial market supervision.

Some have also referred to the breathless search for profits, euphoria in a new, "risk-free" financial world and lack of understanding of the new financial instruments. Preventing a recurrence of the serious systemic risks that arise from these inherently human phenomena requires rules that set strong and clear incentives.

As the bubbles have burst and the financial market crisis has spilt over into the real economy, central banks and governments throughout the world have adopted measures to restore trust in the financial markets and mitigate the recession. In my view it is essential to focus on measures that enhance long-term growth and to maintain fiscal responsibility. The German stimulus packages - the biggest in the European Union - have thus combined additional government spending on infrastructure with reductions in taxes and social security contributions. At the same time, the federal government has agreed to a tightening of its deficit rule, enshrined in the constitution, in order to guarantee the long-term sustainability of public finances.

It is vital that the crisis does not become a cover-up for ad hoc protectionism and interventionism or, worse, lead to a spiral of interventions or a fully fledged revival of industrial policy. Therefore, all stimulus measures should be at the very least non-discriminatory and rule based. European competition rules as an integral part of the European economic constitution have served Europe and Germany well for 50 years. It is now all the more important to strike the right balance between sticking to the rules and necessary flexibility. Intervention as a last resort on the basis of systemic risk and public control must be restricted to the financial sector. Since the government usually lacks the necessary expertise and personnel to run companies on a large scale, we should work on exit strategies before intervening.

Boom-and-bust cycles are inherent in market economies and cannot be prevented completely. Governments now need to work on reducing systemic risk in the financial sector without unnecessarily restraining financial innovation. One way would be to take account of the global economic dimension of the crisis hitting the financial sector. The other way is to reform rules and establish new ones for the sector.

Three principles should guide this overhaul: first, risk management within banks and risk supervision by rating agencies and financial authorities must be strengthened on a global level to prevent the build-up of systemic risk. Second, to prevent an increase in moral hazard there must be a blueprint for the treatment of failing systemically relevant banks that ensures that it is the management and shareholders who are held most accountable. Third, rules made in future must attempt to cover all systemic actors in the financial sector and to avoid regulatory gaps.

Economic crises usually polarise the political debate. Using taxpayers' money to save financial institutions whose bankers receive bonuses while letting victims of the crisis fail in the real economy will be challenging for politicians to explain. Explaining econ-omic policy, finding credible long-term solutions and providing equal econ-omic opportunities for citizens are preconditions for a good future for market economies in both their continental European andAnglo-Saxon variants.

The writer is the German economics minister.