You have highlighted multiple macroeconomic implications having to do with the end use of credit. Let's start this conversation with the link between the purpose of credit and the pace of economic expansion.

That is a very good starting point. As early as Schumpeter, we've known that bank credit and other forms of financing are essential ingredients for launching and expanding economic activity, as well as for its long-term evolution. The role of entrepreneurs is to reform or revolutionize the ways we produce; the role of banks is to provide credit to support their projects. Today, however, many loans are not used for this purpose but are used to acquire pre-existing assets in the real estate and financial markets. The crowding out of credit for business innovation and development affects the trajectory of productivity and, in the long run, has a negative impact on the pace of economic expansion.

You also mention that bank credit is related to economic stability/instability. How does this link work?

I base my opinion on research by Professor Richard Werner and on the key distinction mentioned between loans earmarked for the asset markets (real estate and financial —stocks, derivatives and so on) and those flowing to the so-called real economy of production and consumption.

Keynes had already spoken about money and credit in real circulation and in financial and real estate circulation. It is clear that if we allocate more of our credit resources to the acquisition of real estate and financial assets, there will be less to finance production innovation and development. If in the real sector the reduction of these types of loans become a constraint on economic expansion —and there are solid theoretical arguments and empirical evidence that this is so— in the financial sector the abundance of credit fuels instability and the risk of facing recurring crises. The explanation is relatively simple. A greater flow of resources raises asset prices. Agents in these markets are quite prone to excessive optimism and leverage. Credit becomes the fuel for a price spiral and, as expectation about price developments can change from one minute to the next, there is fertile ground for the formation and subsequent bursting of speculative bubbles. Since the great financial crisis of 2008, there has been a proliferation of studies that, with some variations, look back on the trajectory described here as well as the serious effects on modern society.

The world is facing a severe economic crisis. What role should credit play at this juncture?

The government of the Netherlands and also those of many other nations have made an exemplary effort to keep the economy afloat in the face of the public health and economic crises. Recent interventions are a testament to the ability of governments —or rather, States including central banks— to intervene selectively in markets to ensure that priority activities maintain an appropriate flow of resources and continue to operate. Without such interventions, economies would indeed have collapsed.

So, in this crisis, we have seen multiple opportunities provided by selective resource allocation policies. I should add that this is only part of the story. The other part has to do with the support the European Central Bank, the Federal Reserve and other central banks continue to provide to asset markets. 

For some segments, 2020 was a fantastic year despite multiple distortions in production activities, which is paradoxical and shows the deep disconnection between the financial circulation and the real circulation of money and credit.

Considering its many macroeconomic implications, the end use of credit seems too important to be decided solely by the markets. What do you think? 

I completely agree, and this has been known for a long time. Credit markets do not naturally tend toward equilibrium and often fail due to information problems. Joseph Stiglitz and other well-known economists have been busy explaining this behavior. Interest rates do not adjust to ensure that credit is allocated to the most productive uses. Nor does the growing importance of shadow banking and the proliferation of derivatives and synthetic instruments help in this regard. In light of the externalities of credit, but also of the distortions in its market, there is a strong case for the State to participate actively in this market, either with reasonable regulations or through selective resource allocation policies.

In your study you outline several cases of successful credit allocation. Which ones would you highlight? 

This is a really interesting story. From the end of World War II until the 1980s, selective credit allocation policies were the norm rather than the exception in much of the world. We know this supported the turnaround of several Latin American economies in the 1950s and 1970s. Later, several more lasting successes were achieved in Asia with the so-called Asian tigers and more recently, in Vietnam, China and India.

In my research with colleagues at University College London, we documented the long tradition of selective credit allocation policies and their usefulness for developing priority activities and sectors. This has never been a story of free markets. It is, in fact, a story of markets and governments working together to promote the development of strategic activities. Sometimes agriculture was chosen, and credit channeled to the food sector was instrumental in raising productivity and ushering in a true green revolution. With some variations, the same happened in the successful shipbuilding industry, automobile manufacturing, electronics and other activities selected to accelerate industrial development in Asian countries.

There are those who discourage the use of credit allocation policies due to the distortions they generate. What is your position on this?

That is, of course, a completely valid criticism. History not only records cases of success but also a considerable number of failures. Governments make mistakes, and that is a risk that any political strategist or academic analyst must bear in mind. Hence the importance of having the backing of an industrial policy that sets clear timeframes and goals, guides public and private efforts, and maintains a dynamic of constant evaluation and adjustment.

Would discouraging lending for the acquisition of real estate and financial assets ensure that resources flow to activities with greater impact on social progress?

There are two problems here. Disincentivizing or suppressing the flow of credit to real estate and financial asset markets in a timely manner reduces the likelihood of speculative bubbles; this is a plus. But there is no evidence that, with these measures, the flow of credit is automatically redirected to sectors or activities of greater social impact. This is why two distinct and independent strategies should be planned. On the one hand, prudent measures to avoid overheating the asset markets and, on the other, selective credit allocation policies to strategic sectors previously identified within the scope of an industrial policy.

What do you consider a good starting point for incorporating selective credit allocation policies? 

There is no general rule. It depends on the position of each country. What is important is that policymakers start by rethinking credit targeting as a powerful ally of their productive development strategy. With the advent of the Washington Consensus and its prescriptions for a minimal State, industrial policy became anathema. Today, the challenges posed by climate change, the major financial crisis of 2008 and more recently the covid-19 crisis have given new impetus to State involvement in the economy, to industrial policy and, with it, to the selective allocation of credit. 

Each country must analyze its strengths and weaknesses, rethink its socio-economic objectives and decide how to use its credit system to contribute decisively to achieving its development goals. After three or four decades of neoliberalism, we have discovered that the most intelligent way to do this is not to leave all the initiative to the market. The State can and should play a leading role in the strategic allocation of resources as well as in the selection and promotion of activities that contribute most to development. Besides managing the consequences of the crisis, the State should lead the transition to a sustainable economic model, invest in renewable energy generation and, in the case of the Netherlands, channel a good deal of resources to water management.

What do you consider to be the most significant challenges of such a far-reaching transformation?

There are two types of challenges. The first is to overcome vested interests. This is not a conspiracy theory or anything like that but a sober description of reality. Companies in the financial sector regularly enjoy considerable influence in the countries where they operate and may not, in principle, be convinced by the idea of sharing some of their most profitable activities with the government or another public entity. So the first challenge is to build an environment of collaboration and permanent dialogue that favors coordinated efforts. An environment where the common interest prevails and all the experience and energy of the private sector are harnessed. 

The second challenge lies in the realm of ideas. A challenge to the minds and hearts of political and business leaders to abandon the idea that the economy is a system that reaches some kind of equilibrium with the participation of private actors and where government intervention only distorts. We know that markets fail. So the assumption that any serious development challenge, including the damage caused by the covid-19 crisis, can be met without an active role for government is a fantasy. After so many years of free-market thinking, it is time to draw some lessons from history on how governments were able to encourage development by building greater productive capacities. Industrial policy and selective credit allocation are part of this repertoire.