June 19, 2007
Unfettered finance reshapes the global economy
“In Rome everything is for sale.” – Prince Jugurtha in Sallust’s Bellum Jugurthinum “Yes to market economy, no to market society.” – Lionel Jospin, French Socialist ex-prime minister It is capitalism, not communism, that generates what the communist Leon Trotsky once called “permanent revolution”. It is the only economic system of which that is true. Joseph Schumpeter called it “creative destruction”. Now, after the fall of its adversary, has come another revolutionary period. Capitalism is mutating once again. Much of the institutional scenery of two decades ago – distinct national business elites, stable managerial control over companies and long-term relationships with financial institutions – is disappearing into economic history. We have, instead the triumph of the global over the local, of the speculator over the manager and of the financier over the producer. We are witnessing the transformation of mid-20th century managerial capitalism into global financial capitalism.
The remainder of Martin Wolf’s article can be read here (FT.com subscription required). Discussion from our guest economists is free.
Dani Rodrik: This is a great article and I think Martin is spot on. He has identified the nature of the transformation we are undergoing better than I have seen done anywhere else. But the piece ends on an inconclusive note, and Martin is uncharacteristically glib about the bottom line in all of this. It’s all “on the one hand, on the other hand” at the end. Come on, Martin, we are used to stronger stuff from you!
Perhaps the glibness is because Martin sees where his argument is leading, but he is too worried about putting it in words. The fact is that it is pretty easy to identify all the risks that this new global financial capitalism has created (and Martin lists them all), and quite difficult to identify the benefits it has generated. Martin makes a valiant effort on the latter score, but it rings hollow.
As Martin acknowledges, the new financial capitalism has had a first order impact on worsening inequality in the rich countries, while the beneficial effects on productivity and growth are speculative (and even if they exist, they have obviously made a difference only to those at the very top of the income distribution). The disappointments in poor and middle income countries are if anything even greater.
Capital is flowing in the wrong direction (from poor to rich nations) and there is scant evidence that the increasing sophistication of financial markets has allowed these countries to smooth consumption and reduce volatility. If anything, the opposite is the case.
The problem, at its root, is the incompatibility between global finance and fragmentation of political sovereignty at the national level. Domestic finance could be tamed in the previous century through national institutions (regulation, legislation, central banks, and so on). Global finance, to work well and safely, requires institutions similarly global in scope. The chance that these global institutions can be created is, well, nil - at least in our time.
So those who like and want to live global financial capitalism owe the rest of us an explanation: how exactly will this new global regulatory order be created to take care of global finance?
Posted by: Dani Rodrik | June 19th, 2007 at 3:23 pm | Report this commentMartin Wolf: The reason that this piece does not come to a stronger conclusion is that it is supposed to be a piece of analysis, not a column, and so is not supposed to express my personal opinions too strongly. I agree that the questions these developments raise are huge ones. Dani’s comment spurs me on to address them. Wait for my column next week!
Posted by: Martin Wolf | June 19th, 2007 at 4:40 pm | Report this commentRobert Wade: Some comments on the stability of “our brave new capitalist world”.
First, the “financialization” of rich country economies,
especially Anglo-American, goes with the erosion of the industrial sector. I keep wondering about the present-day, post-IT revolution empirical evidence on Kaldor’s growth laws, especially the one which says that the rate of growth of productivity in non-manufacturing (including services) is a positive function of the rate of growth of manufacturing output. The law implies that - contrary to Terence Burns’dictum, “If we can’t make money by manufacturing things we’d better think of something else to do” - industry is the engine of (sustained) growth. Which suggests that rich-country governments should not simply cheer on the increasing dominance of finance over the rest of the economy.
Second, the combination of financialization in the West and galloping industrialization in East Asia, in the context of huge differences in unit labour costs, results in big trade imbalances. The response to these trade imbalances produces the global money glut - a looming source of economic breakdown. On the one hand, the US finances its deficits by essentially printing money, and is able to do so because its currency is also the dominant international currency. On the other, the East Asian surplus countries’ central banks buy up the dollars entering their countries in order to prevent currency (and wage) appreciation - by creating the equivalent in their own currencies. In turn, they invest the dollars back in US assets, fuelling asset price rises, fuelling increased consumption and imports - which feed back into the East Asian cycle. The result is rapidly rising global financial fragility. ( I am siding here with Richard Duncan’s “money glut” theory, as distinct from the “savings glut” theory.)
Third, Martin says that regulatory co-operation between nationalauthorities has improved, and that “reports, such as the International Monetary Fund’s Global Financial Stability Report and its national equivalents, provide useful assessments of the risks”. Producing reports is one thing; having people read them and react sensibly to them is another. The IMF’s Independent Evaluation Office finds that the Fund’s operational staff tend not even to read the global stability reports, let alone integrate findings into their bilateral work. Only 14 per cent of senior staff said that the IMF’s findings from its “multilateral surveillance” were discussed with national authorities. Conversely, bilateral (that is, Fund-country) surveillance reports show little discussion of policy spillovers even from systemically important countries such as Germany, Russia, and even the US.
Further, it seems that on the whole, financial market participants pay rather little attention to the data provided through “transparency” exercises - even though they would presumably no longer be “misled” by the data (as they upposedly were before the Asian crisis). A recent independent evaluation of the IMF’s Financial Stability Assessment Program (FSAP) concluded that “while many authorities identified the ’signalling role’ to markets as one of their motivations for participating in the FSAP exercise, the impact of FSSAs [Financial Sector Stability Assessments ] on the views of financial market participants appears modest”.
Again: “Our interviews with a wide range of market participants indicate that most have limited knowledge of the contents of FSSAs, a conclusion reinforced by the results of the recent survey conducted in connection with the internal review of the standards and codes initiative. Use of FSSAs by credit rating agencies appears to be somewhat greater, but they have used them only selectively.”
To the extent that markets do pay attention to the information made available through transparency exercises the effects may be to make financial markets less stable and more prone to crisis. Why? Because these developments, by homogenizing the data about economies and reducing the diversity of opinion on the near future, may accentuate the tendency to pro-cyclical herding behaviour - bankers and investors buying what others are buying, selling what others are selling, owning what others are owning.
In short, for all the talk, post-Asia crisis, of the need for a “New International Financial Architecture”, nothing much has changed on the regulatory front, even as risks have multiplied. If one asks why the crisis of 1929 resulted not in a (short-term) crisis but in a Great Depression, a large part of the answer is lack of agreement on rules of economic behaviour - such as on how to operate the Gold Standard, a lack of agreement which resulted in all the pressure for adjustment being placed on deficit countries to deflate and not on surplus countries to expand. The lack of agreement on rules of economic behaviour was a function of, in part, the lack of international organizations; and of pervasive security jitteriness in the relations between European states, itself a reflex of the refusal of the US and Britain to exercise security leadership. In this context, quite small crashes could have, and did have, deeply destabilizing effects. (Here I am drawing on an argument of LSE professor Robert Boyce in a forthcoming book about the Great Depression.) Compared to 1929 the framework of rules of economic behaviour and international organizations looks to be much more robust. Yet the above findings of the IMF’s Independent Evaluation Office throw up a question mark. And we should not ignore the feedback from today’s
Posted by: Robert Wade | June 25th, 2007 at 9:45 am | Report this commentpervasive security jitteriness - especially around West Asia - to economic fragility.
Martin Wolf: Robert has produced thoughtful comments, which I have enjoyed. Let me react briefly to his points.
First, is industry still the engine of sustained productivity growth? I strongly doubt this. In fact, I think it is a form of commodity fetishism. I accept that countries need to be able to produce tradeable goods and services and many of these will indeed be goods. But the evidence among the industrial countries is no longer that the highest productivity growth is in the countries with the most successful industrial sectors.
Second, as Robert knows, I don’t buy the “money-glut” thesis he extols. I believe the money glut is a product of the savings glut, not the other way round. I certainly don’t accept that differences in unit labour costs guarantees trade imbalances. Is Japan running large current account surpluses because of its cheap labour? Anyway, there is nothing the US can do about China’s cost competitiveness, so long as the latter persists with its mercantilism. The alternatives are either be to accept a deep recession at home or to attack the mercantilism directly, by imposing massive protection on exports from the region, particularly from China. Would Robert really recommend this?
Third, I am sure Robert is right that people pay only limited attention to these various reports on financial stability. But it is a fallacy to believe that everybody needs to be aware of all information for the market as a whole to work efficiently. Widely dispersed information is used better by markets than by any other social institutions. This is one of Friedrich Hayek’s most important points.
Finally, do we now suffer from deep disagreements on the rules of the game? Yes, I think we do. A large part of the world is trying to operate liberal capitalism with freely-floating exchange rates, while the most dynamic parts of the world are trying to operate tightly controlled capitalism with pegged exchange rates at undervalued levels. That is a recipe for conflict, if not chaos, as I have argued many times (more times, I imagine, that many readers can bear). But what is one to do? We can only do the best we can in what looks increasingly like another interregnum, as the 1920s and 1930s were.
Posted by: Martin Wolf | June 25th, 2007 at 8:46 pm | Report this comment