‘Managing’ global disorder requires the right balance between market and government forces argues Bernie Fraser.
It is an honour for me to participate in this special lecture series. I hope that what I have to say will be of interest to you.
I am billed to speak on “Managing Global Economic Disorder”. It is a challenging topic. It is also quite a well pitched topic. We could perhaps debate whether the ‘disorder’ in question is more regional than global – and more financial than economic – but it would be rather pedantic to do so. Clearly, there is a good deal of economic and financial disorder in the world these days.
Indeed, we could be forgiven for thinking that we are living in truly tumultuous times, with the media trumpeting a succession of ‘crises’ over the past couple of years – in South East Asia, in Russia, in South America, and in the near collapse of a major hedge fund in the United States. All this has created a broad perception of a global crisis, which has been reinforced by abundant predictions of a global depression to rival that of the 1930’s.
But, to me, global ‘disorder’ more accurately describes recent developments than do alternatives like global ‘crises’, ‘depressions’ and ‘meltdowns’. I have tended to discount the possibility of such dire outcomes, largely because of the underlying strength of most of the major industrial economies, along with a certain amount of faith in the capacity of policy makers to avoid a global depression.
And so it has turned out – at least to this time. That is an important qualification, because the risks are on-going. It is therefore appropriate to speak in terms of ‘managing’ global disorder as best we can; eliminating that disorder altogether is not a practical option, partly because a degree of instability is inherent in the global capitalist system, and partly because the national and international mechanisms available for dealing with the instability are, at best, imperfect.
These issues will be explored a little further this evening. In the process I want also to develop the argument that the current balance between market forces and government forces in determining our economic and social fortunes has swung too far in favour of the market – on both national and international planes – and that better management of global economic disorder requires some reversal of these trends.
The recent eruptions in Asia and elsewhere had multiple causes but financial markets have figured prominently in their ignition and transmission. When the troubles started the currencies of several SE Asian countries were effectively pegged to the US$$ and as the US$$ appreciated their currencies were thought to be over-valued, leading global investors to withdraw their funds. Between the first and second halves of 1997 private capital flows to South East Asia swung from an inflow of $US50 billion to an outflow of $US100 billion. Not surprisingly, Asia’s currency and equity markets collapsed, confidence evaporated and interest rates sky-rocketed.
Russia and Brazil were caught up in the backwash of Asia’s problems, but with debt servicing, weak banks and other home-grown problems thrown in. The US hedge fund – Long term Capital Management – almost collapsed after losing close to $US42 billion in the financial panic which followed Russia’s debt default. What is it that makes financial markets – especially the markets for currencies, equities, bonds, property and ‘derivatives’ – so prominent in triggering and transmitting global economic disorder? Several factors are worth noting:
First, financial markets are the closest thing we have to truly global markets. Capital flows for all manner of investments are subject to fewer restrictions than the markets for most goods and services.
Secondly, the pool of investible funds which fuels the financial markets is rising all the time. In part this reflects the increasing wealth and longevity of people around the world, and their quest to earn better returns on their savings than those traditionally available on bank deposits (which leads investors to venture further out along the risk spectrum into bonds, property, equities, and so on).
Thirdly, financial markets are quite efficient in performing their important functions of mobilising and investing savings. Modern technologies furnish market participants with copious quantities of information on everything that moves, and permit billions of dollars to be shifted around the world at the press of a few keys on a computer.
Fourthly, and partly for the reasons mentioned already, financial markets are inherently volatile, and prone to ‘overshoot’ in both directions. Contrary to textbook models, they do not always ‘self-correct’: they can develop a momentum of their own which often has more to do with short-term political and other expectations (which might or might not be soundly based), than with longer term economic ‘fundamentals’. When this electronic herd of global investors suddenly decides to charge off in the same direction, it can dramatically alter the landscape. We have seen how, virtually overnight, Asian countries went from being the darlings of global investors to hotbeds of ‘crony capitalism’. The tendency for fund managers to be assessed on their relative – rather than their absolute – performances also encourages a herd-like behaviour; there seems to be some protection in being a member of the herd, where ever the herd might be heading.
For these and other reasons – including the vested interests which some market players have in perpetual volatility – we can expect on-going and occasionally substantial disruption in global financial markets. And this applies not only to markets in emerging countries; currency, equity and bond markets in the United States, Australia and other developed countries are also subject to frequent and sometimes violent fluctuations. Arguably the most serious threat to the global financial system in recent times was the near collapse of Long term Capital Management in the US, which had to be rescued by a bailout organised by the Federal Reserve.
Finally – and quite importantly for the purpose of this evening’s discussion – it is worth remembering that financial markets function primarily to deliver the best possible returns to the owners of capital. Portfolio investors – as distinct from many longer term direct investors – are not really concerned about the broader community implications of their investments. Sometimes the correlation is inverse; the price of bonds, for example, tends to rise (yields tend to fall) when unemployment rises because this is taken as a sign that inflation (a critical concern to bond investors) will be lower in the period ahead.
In short, most players in the financial markets are not burdened by concerns about the broader rights or wrongs of their actions. The pursuit of profit transcends all other considerations or, as George Soros has said – and he could be expected to have some relevant insights – ‘in financial markets, the principle of expediency takes precedence over moral principles’.
Perhaps non of this would matter too much if financial markets were discrete appendages to the ‘real’ economies. In that situation non-players could stand back and marvel at how efficiently – if sometimes quirkily – financial markets enriched some investors at the expense of others. But in practice, of course, swings in equity and currency markets, for example, do affect spending, production, employment and so on. Financial markets and the ‘real’ economies are constantly interacting with one another.
This is pretty obvious. When private capital poured out of Asian countries on the scale that it did in the second half of 1997, it was not just the currency and equity markets in those countries which collapsed, but also banks, property developers and many other businesses, leading to hefty cutbacks in production and employment in 1998. Many of these countries continue to struggle, with the prospect of little or no economic growth in 1999.
When markets are integrated as closely as they are today, problems in one region readily spill-over to others. The problems in Asia quickly infected other emerging countries and – so called flight to quality effects notwithstanding – rattled equity and other financial markets in developed countries. The spread of share ownership through pooled fund vehicles and privatisations is increasing the potential for sharp fluctuations in share prices – if they are sustained long enough – to affect spending, production and employment through wealth and confidence effects. There are also the direct trade linkages, with negative growth in many Asian countries; for example, impacting on exports from Australia and elsewhere.
In the event, and excluding the mainly emerging countries in the eye of the hurricanes, the damage caused to the world economy has been less than had been feared by many observers. In large part this can be attributed, somewhat fortuitously perhaps, to their occurrence at a time when the US and many European economies – we can add Australia – were in quite good shape. Some deft handling of monetary policy – particularly in the US – also helped to cushion their impact.
Even so, the costs in terms of lost production, unemployment, social misery and political instability in many countries have been substantial. A few signs are emerging that economic activity in Thailand and South Korea could move into positive territory as 1999 progresses, and I am also hopeful of some improvement in Japan’s performance over the same time-frame. But non of this can be taken for granted, while countries like Russia and Indonesia face seemingly intractable problems, and doubts persist about the viability of current stock prices in the US, particularly in the hi-tech sector. In short, storms could reappear suddenly on any number of fronts, and the countries which escaped their full force this time might not be so fortunate next time.
The wake up call from the recent turmoil, coming after a less than glorious history of performance of global capitalism during the preceding decade or so, has sparked considerable talk about how things might be better managed in the future. The underlying assumption – which we basically have to accept – is that the process of globalisation, with all its pluses and minuses, will be on-going. In other words, we have to live with it and find ways to better come to terms with it.
These talks are focussed mainly on financial markets but they really need to be broader than that. Although markets for most goods and services are less open than markets for capital and financial services, they are subject to similar influences. It is the increased mobility of capital, information and entrepreneurship across all sectors that is driving national economies to integrate. Competition and profitability are the hallmarks of the globalisation process in al its guises. Like investment managers in financial markets, managers of large publicly owned corporations in manufacturing or whatever are assessed and rewarded on their ability to make money, to add shareholder value. To that end their attention is concentrated on matters like consolidation and downsizing, not on how to create more jobs. These maters too, of course, can be sources of economic and social disorder.
So far the talks have not progressed very far. Personally, I’m sceptical about their likely progress, not least because many of the more powerful participants are committed to bolstering market systems and market values, rather than pursuing changes which would give greater weight to people and social values. But I am getting ahead of myself.
One obstacle to better managing the globalisation process is the widening gap between the global scope of economic and financial activities, and the mostly national sovereignty of politics and policies. The global economy, as someone has observed, can be likened to the Internet, where everyone is connected but no one is in charge. There is no global political or social system to exert influence over the global economy; there is no global central bank or financial regulator. The international organisations that we do have clearly line up to their tasks with a lot of lead in their saddle bags. That said, they need to do better than they have done of late.
The International Monetary Fund (IMF) can no doubt point to its successes, but its track record has deteriorated recently. In today’s world, when a country is perceived to be in economic difficulty it is unlikely to be very long before that difficulty (almost regardless of its underlying causes) is reflected in an outflow of capital. Unless this liquidity is replaced promptly, the country concerned could be obliged to push its interest rates sky-high, a situation which no country can live with for very long. One of the IMF’s main functions is to provide emergency support and while its desire to attach some conditions is understandable, it defeats its purpose when those conditions include long-term structural changes and corporate governance issues (as appears to have been the case with Indonesia’s recent rescue package).
The IMF also appears to have a one policy fits all approach. Some South East Asian countries came to grief mainly because of unregulated investments and other problems in their private – not public – sectors but the Fund nonetheless adhered to its orthodox prescriptions, which include sharp cut backs in government spending (along with steep rises in interest rates) to help prop up the confidence of global investors. Other mistakes appear to have been made in Russia and Brazil. To me the Fund’s orthodoxy betrays excessive faith in market forces, and downplays community interests in its policy making; on occasions, by heightening political uncertainty, its prescriptions could actually increase market instability.
Some soul searching about its future is presumably underway within the Fund. It is losing credibility, which is essential to any institution charged with restoring market confidence, and it suffers from limited resources. Time will tell how serious it is about developing more relevant and flexible approaches to the problems posed by globalisation, including a greater appreciation of the impact of its policies on the lives of ordinary people in the countries it seeks to help.
Perhaps it could start by being less insistent in future in pushing monetary and fiscal policy discipline to the point where it virtually guarantees severe economic recessions. It could also acknowledge that volatile short-term capital flows do more harm than good, and set about devising some acceptable controls, rather than viewing all such options as unwarranted interferences with market forces. Can we expect to see such changes? I doubt it, particularly while economic orthodoxy is so entrenched within the organisation, and while it remains so beholden to the governments and major banks of its most powerful members, who are also the strongest supporters of the market system.
Shortcomings in bank lending and risk management procedures have contributed to the recent troubles in several countries, as they did in earlier episodes. These shortcomings persist not only in emerging countries but also In developed countries, notwithstanding the efforts of the Bank for International Settlements (BIS) to raise the level of bank supervision in those countries through minimum capital ratios and other standards. For every reckless borrower in Thailand or Russia or Brazil there is a reckless lender somewhere in the United States or Japan or Europe. Hedge funds, which are notable mainly for speculating with borrowed funds, are also the creations of capital rich developed countries.
More effective controls over certain activities of banks, hedge funds and other large ‘derivatives’ could help to reduce market volatility but national governments are reluctant to cede the necessary powers to international organisations. This probably explains why much of the work in train in the BIS and elsewhere appears to be aimed at improving market disclosure and transparency (or openness). There is no harm in trying to make markets work better, but it is difficult to see how additional information will significantly reduce the inherent instability of global financial markets, or alter their narrow profit maximising focus.
About 32 years ago, mainly out of frustration with the approached of international institutions like the IMF and BIS, I proposed the establishment of a new institution to promote closer cooperation among central banks in the Asian region. Its functions were to include the sharing of information and experiences on matters like interest and exchange rate policies and bank supervision. Contingency planning and possible emergency support mechanisms to respond to the destabilising effects of short-term capital outflows were also envisaged.
The proposal attracted considerable interest at the time and made some early progress, notwithstanding the usual battles over turf between rival agencies within some regional countries, and general disparagement from organisations outside the region. Lately, of course, most central bankers in the region – or at least those who have kept their jobs – have been preoccupied with more immediate problems. Perhaps the initiative could be revived when current pressures recede; regional approaches will not solve global problems but practical regional approaches could help to better manage the disorder associated with global markets. A strong regional voice might also have a better chance of being heard – alongside strong American and European voices – in the on-going dialogue to bolster international support and regulatory agencies.
Australia should support sensible endeavours to strengthen existing international agencies, and to explore possible new facilities which might minimise the destructive effects of free markets in future. For the reasons suggested, however, we should not hold our breath for dramatic reform of international arrangements. The developed countries mostly believe in the system as it presently exists, and while they have had a few frights recently, they have not suffered catastrophic damages. The odds, therefore, are that the international reform process will drift along with, at best, marginal adjustments to the way global capitalism currently works.
This prospect puts the onus on national governments to pursue policies which best manage the fall-out from globalisation. They, in any event, bear much of this responsibility and possess most of the necessary powers. They decide, for example, whether to have a fixed or a floating exchange rate, or perhaps a currency board. Each has its own problems; with the recent breakdown of fixed exchange rates in some Asian countries having disastrous consequences. On the other hand, although its occasional ‘overshooting’ has been unsettling, Australia’s floating exchange rate – backed up by sound macro-economic policies – has been mainly responsible for Australia riding out the global economic disorder as well as it has. In my view, the decision to float the currency in December 1983 ranks as Australia’s single most significant economic policy measure of the past two decades.
Banks and most other financial institutions are generally well supervised in Australia, and this too has stood us in good stead through the banking troubles of the early 1990’s and more recently.
National economic policies will, in part, determine how well we manage the consequences of global markets. I emphasise ‘in part’ because too often these policies serve narrow economic functions and are assessed on narrow economic criteria. The ultimate test of economic policy should be not whether it makes for a better economy, but whether it makes for a better society. Economists who ignore, discount or assume away the social dimension do their profession and everyone else a great disservice.
This point is quite central to my argument tonight. I have said already that global capitalism is all about maximising monetary values (investment returns, profits) and promoting self-interests, with little concern for social values and community interests.
Markets are not communities, least of all global markets. I do not object when investors and corporate manager advocate a free rein on market forces in pursuit of their self-interests. But they go too far when they attempt to dress self interests in community interests garb, or assert that they are the same thing. Usually they are not.
It is the old issue of the balance between market forces and government intervention re-emerging in the new context of a global economy. I would suggest that the spread of the influence of global markets over our daily lives – as well as the inherent instability of global markets – gives extra significance to this distinction between self interests and community interests. It means that if notions of fairness, compassion and other social attributes which are not given adequate expression in the market-place (such as concern for jobs, health care, education, law and order, the environment) are to flourish within the constraints of the global economy, then they will have to be consciously nurtured from outside the system – which means by governments. Appeals to businesses to be more charitable and community spirited are not enough. A prominent but deft hand of government has to wrestle with the invisible hand of the market.
I am talking here about striking a balance between social and market values – between people and profits – not about replacing one ideology (market forces) with another ideology (government intervention). I have always had considerable respect for the market, not because it is perfect –it is far from that – but because it does deliver acceptable outcomes in many areas. It does, however, also have considerable dowsides, and I referred to some of these earlier. Experience suggests that we should be wary about turning too readily to governments to solve all or problems; but we also know that problems like unemployment, poverty, dissemination and the like will not solve themselves.
Where this balance should be struck is largely a matter of individual bias. My bias is towards that balance which stands the best chance of making Australia, in my particular short-hand, a competent and compassionate country; we need to be productive and competent if we are to prosper in today’s competitive world, and we need fairness and compassion if we are to live in a decent society.
How do we determine whether or not we are moving towards this (or any other) preferred balance? Pragmatically, through trial and error, I would suggest. Although mistakes were obviously made, Australia has achieved solid economic progress over the past decade and half. Social progress, though evident in some areas, has been less noteworthy overall; unemployment, in particular, has remained persistently high. What, however, is especially disturbing from my perspective is that, in the past few years, the balance has been shifting more towards market outcomes, and away from people outcomes. This does not augur well for the future.
We see this shift towards the essentially selfish culture and expediency of the market place in several policy areas, including labour market deregulation, privatisations, budgetary priorities, and tax reform. I will be offering some comments on the Government’s tax proposals on another occasion, but a couple of brief observations now might help to illustrate the theme of tonight’s talk.
In all the hundreds of pages of material the Government has released on its proposed tax changes, virtually no space has been devoted to debating the proper role of taxation in a civilised society, or to forming judgements about whether more or less tax revenue will be needed to adequately fund government responsibilities in the years ahead. Instead, the Coalition have simply assumed that public spending and government involvement in economic and social affairs should continue to decline.
This is the ideological track the Coalition are following. Relative to GDP, budget outlays have declined form 27 per cent in 1995-96, to 25 per cent last year; they are projected to decline further, to under 23 per cent by 2001 -02. But is that the read to a productive, fair and socially cohesive county? Are the projected declines in outlays consistent, for example, with the provision of roads and other physical infrastructure necessary to improve Australia’s productivity and competitiveness? Or with the requirements for increased investment in education, research and training programs to help reduce youth and adult unemployment, and to help make us the clever country we need to be to hold our own in global markets? Or with the increased expenditures on health and other community services needed to tackle current backlogs and prepare for the additional demands of an aging population?
In my opinion, current and projected trends in outlays are not consistent with meeting these and the other aspirations of the Australian community. I believe those trends need to be halted and, over time, cautiously reversed if Australia is to grow at a good rate, create more jobs, and maintain a decent society. To help with all that the tax system may well be called upon to generate more – not less – revenue relative to GDP. How that might most fairly be done is a very big topic but the clear priority in my view should be to repair the direct (or income) tax base, not to switch to regressive consumption taxes.
I have made a few detours this evening, but I think you will have picked up the drift of what I wanted to say.
Looking ahead, Australia has no real option but to live with the competitive pressures and sometimes disorderly consequences of global capitalism. The challenge is to manage that accommodation as best we can, both nationally and internationally. Ultimately it comes down to managing market forces better – not replacing them, but acknowledging their shortcomings, limiting their operation in some areas, and cushioning and compensating their effects in others. The resultant balance of market and government forces is our best chance of combining a productive, wealthy economy with a fair, cohesive society.
In my opinion these objectives will be mutually reinforcing more often than they will be conflicting. Globalisation itself requires Australians t make frequent changes to their work and life styles but these changes are likely to be more readily achieved and sustained if their benefits are seen to be spread fairly across the whole community. Where conflicts do arise, the interests of the community should, in my view, overrule the interests of the market.
That, unquestionably, calls for a certain amount of courage on the part of our political leaders. But less, I suggest, than even they might fear! In my view, governments are often too easily bluffed by ‘the market’. Financial markets to tend to take short-term and sometimes irrational positions, but for all that they will generally fall in behind policies which are sensible and can be portrayed as such – any policy which helped to make Australia a more competent and compassionate country should pass that test.
All this might seem a touch naive to some people – not, I trust to members of this audience, but to dull-eyed people who can’t envisage Australia as a uniquely competent, fair and caring society. For my own part I see nothing naive about aspiring to such a society, or acknowledging that not everything that is important in life can be bought in the market place.
So there you have it. To borrow a line from Oscar Wilde: “I have blown my trumpet against the gate of dullness”.
Speech by Bernie Fraser. Whitlam Lecture in association with The Australian Fabian Society, 25th February 1999, YWCA, Melbourne.