Guiding global markets
Dear Paul,
Nothing demonstrates the virtues of free-wheeling, unfettered global financial markets better than the current crisis in Asia.
George Soros recently renounced the system which made him rich, arguing that "the untrammelled intensification of laissez-faire capitalism and the spread of market values into all areas of life is endangering our open and democratic society." And in the light of market turbulence in Asia, many have been expressing similar sentiments.
But hedge funds (such as Soros's Quantum Fund) which can move markets with their well placed bets, have in fact all done rather badly out of the Asian turmoil. This has not prevented Mahathir Muhammad, the Malaysian prime minister, from blaming "speculators" for his woes. But there is nothing new in that. In 1993 the French government blamed Anglo-Saxon speculators for a second bout of turmoil in the Exchange Rate Mechanism which put the franc under pressure. As long ago as 1967, Harold Wilson blamed the Gnomes of Zurich for the devaluation of the pound.
When those at the centre of a crisis blame mysterious outside forces for their troubles, you can be sure that the problems lie much closer to home. Asia's difficulties are internal: the region's financial markets have at last blown the whistle on decades of economic mismanagement, high-level corruption and autocratic politics.
The trouble is that financial markets behave like vigilantes rather than policemen. Theirs is a rough justice. So long as the tottering edifice of the Asian economies continued to deliver rapid GDP growth, there were quick bucks to be made; so investors continued to make them. Even when everyone knows months in advance that a currency is going to collapse-as with the Thai baht before it tumbled in July-it makes sense to keep ploughing in money for high returns until the last possible moment. When that moment arrived, overseas capital flooded out.
But the markets have delivered a just verdict. You should also remember that the people behind this judgement are not irresponsible speculators. People like George Soros only make up a tiny part of the global financial markets-their power is grossly exaggerated. It is not even the overpaid young traders who call the shots; the real power lies with cautious, anonymous, middle-aged men and women running the big pension and mutual funds. Speculative hedge funds might score a few hits, but the heavy bombing is done by these long-term investors.
What these powerful grey unknowns did last year was to withdraw their support from political and economic systems which no one should even want to defend, no matter how much they have been dressed up in the finery of "Asian values." The common factor in the crashes, which moved from one former tiger to another, and eventually to South Korea and Japan, was rapid growth based on cheap bank credit. This cheap credit was available because politicians pressed their cronies in the banks to make uncommercial loans to other cronies and family friends in industry. Their industrial projects have included genuinely productive investment, but a lot of them were simply schemes of classic autocratic self-aggrandisement and financial skimming. Need I mention the Pergau dam?
So if you want to argue that the financial markets have misbehaved in Asia, you are defending some pretty unsavoury economic regimes. I do not have such a strong case regarding crashes of share prices in New York and London-but I do not need one. The little upsets outside Asia do not really deserve the name-shares are still well above the levels of one year ago. Even the 1987 crash was not a real crash. The markets soon made up lost ground, and there was no noticeable impact on the British and US economies. Very few people suffered any long-term financial damage.
There is a bubble inflating Wall Street at the moment; and bubbles burst. It is always a shock when this happens, but I doubt whether it will have a significant impact on most people. The markets' punishment for minor misdemeanours in policy-a government budget deficit slightly too big, or interest rates so low that they trigger a rise in inflation-is correspondingly light.
To sum up: the damage inflicted by the financial markets is often exaggerated. When it is not, as in Asia this year, it is richly deserved.
Yours,
Diane Coyle
2nd December 1997
Dear Diane,
You are not quite as heretical as you try to make out. I am not going to disagree with all you say. Of course markets are not driven by speculators alone-it would be suicide to sell short unless you were sure that most institutions and company treasurers would follow. Of course the stock market and exchange rate crashes in Malaysia and Thailand will have administered corrective shocks, curbing unsustainable speculative booms and making their manufactured goods more competitive in export markets. Of course the crisis in Asia has local roots; and Asian values do not transcend economic logic.
You might reinforce your points further-the IMF and US-orchestrated rescue packages, like the one for Mexico, shift the costs of unscrambling the mess from investors to OECD taxpayers. You could argue-if you were a true believer in free markets-that countries, like companies, should be allowed to go bottom-up.
But I do not accept your radical version of the wisdom of markets. You say that "markets behave like vigilantes rather than policemen." But their job is punishing their own crimes; the odd twist is that those punished are not international market makers or national ?tes-they are the small savers and workers in the countries concerned. Indeed, most Asian countries are so corrupt that they will avoid necessary institutional reforms if possible. So the benefit of market punishment may be short-term.
Capital mobility is a double-edged sword for most developing countries. Asia may be following Latin America on a switchback course of growth and collapse, driven by cyclic international capital flows. Asian countries such as South Korea developed most effectively when growth was mainly driven by domestic capital formation and they enjoyed the benefits of protection as well as access to western markets. Now that option is not available. Short-term capital flows and longer-term foreign direct investment (FDI) are going to a small minority of developing countries, often overheating and damaging their economies. The rest, like much of Latin America and most of Africa, are left out in the cold.
Free-wheeling, unfettered markets are hardly achieving balanced global development. Why is the IMF trying to prop up South Korea? Why are the other G7 countries pleading with the Japanese government to rescue its unsound and corrupt banking system? Why will the US probably bail out the Russian government bond market? Why do most western bankers and securities dealers support these moves? Because they are afraid of inter-related shocks which could lead to a collapse of the financial system and a protracted slump. These fears may be exaggerated, but they are not absurd. Better to be safe with some public intervention than to be sorry without. This is particularly so because today's post-Keynesian, anti-public spending ?tes would probably handle a slump worse than they did in the 1930s-not least because a rearmament programme to kick-start national economies is unlikely.
The case for extended national and international re-regulation of the global financial markets almost makes itself. Imagine that the present system of international financial trading continues to grow unchecked and that it renders obsolete the present weak forms of (mainly nationally based) regulation and corporate governance. Imagine the derivatives market growing to the point where the current outstanding positions are multiplied several-fold, where the range of actors includes banks owned by the Russian mafia. Then try to imagine this system remaining stable, except for the occasional mild correction.
If you want an open economy and free trade in goods and services, but wish to avoid a lurch towards protectionism, then the case for regulating the international financial markets is a strong one.
Yours,
Paul Hirst
3rd December 1997
Dear Paul,
Your reply falls back on the old argument that if home-grown capital was what made Japan and South Korea strong, newly industrialising countries would do better to follow their example than to sup with the devil of the global capital markets. They do not have the choice of opting out-nor should they want to.
South Korea and Japan had no choice. In the postwar Bretton Woods era, the wide and deep pool of inter-national funds simply was not available. Developing countries had to save on their own in order to invest. It is impossible to rule out the possibility that the early developers would have grown even faster with access to more finance at lower cost. For all their current difficulties, the Asian tiger economies have reached a high level of average income; they installed an extensive infrastructure of power and transport much faster than those first off the starting line. Indeed, Japan and Korea only built their infrastructure as fast as they did thanks in part to what you might call cold war spending by the US.
I certainly agree with you that only a minority of developing countries currently enjoy access to global capital markets. But is it a solution to regulate those markets so that even fewer have access to them? Or would you propose to regulate the markets into investing "fairly" in the neglected African and smaller Latin American economies? This makes no sense at all. The moral for those countries which find themselves left out in the cold is to examine why it is that investors refuse to touch them. The answers are usually obvious: atrocious economic policies and banana republic governments.
The answer to your question-why there is widespread support for IMF-led rescues for countries such as Mexico or Thailand or Korea which are hit by a market-induced crisis-is precisely that nobody wants to see the shocks spilling over from certain countries into the rest of the world. The machinery for these bail-outs is obviously cumbersome and unsatisfactory; but it will improve. It will have to. Nationally based regulation is already obsolete. I'm afraid that the Russian mafia is already deep into the market; it has been for some time. But the system is nevertheless proving reasonably stable, and it continues to lubricate trade and physical investment. The markets not only work-they work well.
Yours,
Diane
4th December 1997
Dear Diane,
I think you miss my point about Japan and South Korea growing mainly by domestic capital formation. My comparison with Latin America pointed out how openness to and heavy dependence on the international financial markets produces uneven development and unsustainable growth. Countries relying on FDI and international financial cycles will find it much more difficult than Japan to develop to an advanced economy status. I agree that Japan enjoyed an important boost from US cold war spending, mainly during the Korean war. This kick-started several key sectors and boosted Japanese domestic demand.
Second, I don't think it will do to say that some countries are off the map simply because investors will not touch them. They cannot merely be left to aid agencies and NGOs. One idea is a modest levy of, say, 0.5 per cent on FDI between OECD countries, creating a fund for investment. Companies which currently find an African country too risky, for example, could apply to the fund for up to 50 per cent of an investment. This has the advantage of encouraging corporate investment, not merely aid. It also requires companies to add capital to the fund. We need more ideas of this kind to encourage wider and more adventurous investment.
You are very optimistic that the machinery for bail-outs to prevent systemic crisis is adequate and will improve. Not if markets remain unfettered (as you desire), it won't. Saying that markets work well at the international level, when regular rescue packages are needed from international agencies and leading states, strikes me as rather odd. The markets are relying on the government cavalry to ride in to clear up their mistakes. This will not make them either more responsible or more stable.
Yours,
Paul
5th December 1997
Dear Paul,
Your proposal for a tax on profitable investment in some countries, to be used for unprofitable investment in other countries, sounds like old-fashioned corporatism. Why should the developing countries which have got their house in order see foreign investors discouraged by a tax which would create a fund-to be run by an international bureaucracy, I guess-for the benefit of other countries which have not undertaken the hard work needed to make themselves attractive to overseas companies? I find this an extraordinary proposal.
Certainly there are market failures, on top of the policy and political failures which you agree exist, making it hard for some African and Latin American countries to compete for international funds. However, there are already very successful agencies which raise private capital to try to overcome these hurdles-without the benefit of a cross-national tax requiring a panoply of treaties and bureaucrats. The International Finance Corporation, an arm of the World Bank, is a shining example.
I stick to my point that if some countries are off the map, this is mainly because they have put themselves there. The OECD governments have no business taxing their own successful companies in order to bail out rotten politicians in poor countries. The relief of poverty in such countries is indeed best left to aid agencies and NGOs. Does my approach mean that all developing countries are condemned never to achieve developed country levels of prosperity? Not at all. Their obstacles are not financial but institutional and political. If the Malaysias really want to make it into the high-income league, they will have to ditch their Mahathir Muhammads and develop more open socio-economic institutions.
As for the international rescue packages, my point was merely that they are a step on the way to the creation of an orderly system of market supervision and management. We already have the national institutions in our central banks and securities regulators. The inter-national institutions are in their infancy, which is why we have this rather panicky air of crisis whenever they step in. I would never argue that markets need no supervision or rules-simply that taxation and regulation are the worst ways of going about it.
Yours,
Diane
6th December 1997
Dear Diane,
Corporatism is the ultimate bogey word of the moment, but it doesn't scare me! We can argue about the rather impressive record of post-1945 corporatist institutions at another time. The purpose of a levy on FDI is precisely to create a distribution of investment which the markets cannot and will not achieve unaided. Current conventional wisdom-that if a country can achieve political stability and make the right macro-economic adjustments, development should follow through capital inflow- is na? in the extreme. Moreover, if today's international agencies are doing such a good job of providing development finance, why are the poorest parts of the world in such a mess?
Your reply is "rotten politicians." But most successful non-OECD recipients of FDI have execrable regimes-like Indonesia's. You argue that developing countries will have to "ditch their Mahathir Muhammads and develop open socio-economic institutions." I find this proposal quite extraordinary. What if democratic, accountable governments attempt to achieve things which investors do not much like-such as trade union rights, land reform, income redistribution and environmental protection? Rotten politicians do not spring from the void, but from economic backwardness or from too much contact with big business which is itself corrupt.
My proposal for a new fund is designed to encourage business investment, not to create bureaucracy. Business can contribute to development; my proposal is intended to give companies an incentive to take risks in unstable environments and add capital to the funds generated by a levy. But the basic difference between us is the degree of belief in the efficiency of markets. I think they need a stronger guiding hand than implied by your meek "supervision."
Yours unrepentantly,
Paul
