Markets Run Into Old Foe
In 1992, Francis Fukuyama optimistically forecast that the “end of history” was at hand. The collapse of Soviet communism and the demonstrated failures of command economies, he contended, had led to universal acceptance of market-based, capitalist democracies. The Manichean struggle between the two systems was winding down.
Fukuyama’s optimism was premature.
Once again, the shortcomings of markets and the crisis of global capitalism are being sung by a politically diverse choir, including prime ministers Mohamad Mahathir in Malaysia and Yevgeny M. Primakov in Russia, Finance Minister Oskar Lafontaine in Germany and international speculator George Soros. This “resumption” of history has been spurred by a series of financial crises in international markets, Asia’s financial turmoil, Russia’s default on $15 billion of dollar-denominated Soviet debt and current pressures on Brazil’s debt-ridden, but otherwise promising, economy.
At bottom, critics have focused on “untrammeled” (i.e., unregulated) markets as the principal cause of all this turmoil, though they have diverged in their diagnoses and remedies. Mahathir blames global hedge funds for his country’s plight, and he has acted, accordingly, to insulate Malaysia from international capital markets by governmental screening and control of capital movements into and out of the country. Primakov and his aides have proposed to reverse Russia’s economic decline by imposing selective price controls, restricting foreign-currency transactions and retaining a large state-enterprise sector in the economy. Lafontaine advocates larger government spending programs, while insulating German and European Union markets from import competition and international financial volatility. Soros proposes setting up an International Credit Insurance Corp., funded by the G-7 governments (hence: their taxpayers), to protect economies and investors from excessive financial volatility.
On closer examination, these views are more reflective of the predilections of their protagonists than the reputed imperfections of market-based economies.
For starters, there are no untrammeled free markets, nor does the canonical free-market system presume that effective markets function without restrictions. For markets to operate effectively, clear and explicit rules of the game are essential. These include protection of property rights, legally binding and enforced contracts, established and reliable modes of resolving disputes, and free and open competition among producers, consumers, lenders, borrowers and investors. Without these rules, markets will malfunction.
Second, Asia’s financial turmoil stems not from the operation of free markets but from a capitalism colored by personalistic or governmental excesses. In many of the affected countries, for example, there were excessive amounts of short-term lending and borrowing, and protracted support for overvalued exchanges rates underwritten by the assumption that governments or multilateral agencies would prop the currencies up if they came under attack.
Third, the story is similar in Russia. The absence of legal and other institutional restraints required for the smooth operation of markets, widespread fraud in the privatization of state-owned assets and an associated flight from the ruble all help explain Russia’s economic predicament. Underlying and contributing to the Russian debacle has been a “moral hazard” stemming from International Monetary Fund lending practices. Since the IMF bailed out Indonesia with a $40-billion package, lent $60 billion to South Korea and lesser amounts to Thailand and the Philippines, should not Russian policy-makers expect more than the niggardly $15 billion to $20 billion that the IMF offered?
To blame the vagaries of free-market systems for these problems is to confuse the free market with aberrations from it.
Although the European Union, reinforced by its monetary union and single euro currency, differs from these cases, it, too, shows distinct signs of veering away from free, open and competitive markets. Having apparently rediscovered the attractions of Keynesian economics as a possible remedy for their chronic high-unemployment problems, the EU’s finance ministers recently agreed on measures to insulate the union from potential external shocks by restricting outflows of capital and limiting import competition. If Lafontaine becomes the head of the European Commission, the executive arm of the EU, these trends are likely to be reinforced. Along this path lies a slower rate of growth in the EU’s real gross domestic product and a depreciated value of the euro relative to the U.S. dollar.
Finally, what about the destabilizing effects of large, short-term speculative capital movements? To be sure, there is a need for greater transparency and timely disclosure to avoid the enormous and excessive leveraging by such ill-fated hedge funds as Long-Term Capital Management. Nevertheless, on a list of the five or six major contributing factors to the international financial contagion of the past year, the destabilizing effects of large hedge funds, including Long-Term Capital, Tiger Management and Soros’ Quantum Group, probably ranks seventh or eighth. For example, when the Malaysian ringgit was rapidly declining in August and September 1997, the 10 largest hedge funds appear to have been buying the currency, not shorting it.
Whether some form of controls on large movements of short-term capital is desirable, in addition to more timely disclosures of how and how much hedge funds are leveraged, is worthy of debate. On the one hand, some type of control, such as the Tobin tax or a Chilean type of capital deposit, each of which would raise costs of short-term capital transactions, may contribute to increased financial stability and reduce currency volatility. On the other hand, controls designed to ward off financial volatility may instead generate a contagion of additional controls, leading to corruption, evasion and favoritism in their application.
However this argument may be resolved, the struggle between markets and governments, despite Fukuyama’s forecast, is not history. It is more likely to follow a cyclical pattern, sometimes emerging, then submerging, over time. History rarely succumbs to initial attempts to end it.
