Newsweek, October 12, 1998

Coming Apart

THE DEBATE: You say you want a revolution? As economies crumble, the comfortable old certainties are under fire. Unregulated markets are no longer seen as the only possible path to utopia.

By Michael Elliott

"Modern industry has established the world market. All old-established national industries have been destroyed. They are dislodged by new industries, whose introduction becomes a life and death question for all civilized nations, by industries that work up raw material drawn from the remotest zones; industries whose products are consumed, not only at home, but in every quarter of the globe. In place of the old wants, we find new wants, requiring for their satisfaction the product of distant lands and climes. All fixed, fast-frozen relations are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last compelled to face, with sober senses, his real conditions of life, and his relations with his kind."

Forget the sober senses (too many good parties for that) and you could imagine a particularly eloquent banker spouting all that at this week's annual meetings of the World Bank and International Monetary Fund in Washington. Within the last 18 months, the solid hope of a world marching in lock step toward sustained economic growth and political liberalism has indeed melted into air. A financial crisis that started on the banks of Thai klongs has spread from Asia throughout the world. It has claimed one of the world's most long-lasting regimes (Indonesia); violently divided a society that boasted of its modernity (Malaysia), and reintroduced rulers with an affection for communist economics--and perhaps politics--into a nuclear superpower (Russia). If this is the real condition of life we are compelled to face, we're in for interesting times.

Which is just what the authors of the first paragraph thought when they wrote it 150 years ago. For Karl Marx and Friedrich Engels, from whose Communist Manifesto we quote, globalization of the economy was a prelude to revolution (note for our Marxist readers--to the charge of reordering the Manifesto's sentences, we plead guilty). The global bourgeoisie, they argued, would produce "above all, its own gravediggers." It's unlikely that many in Washington think things have got that bad; what's undeniable is that the conventional wisdom is under threat. The political and economic climate of globalization is changing.

At the heart of current thinking about the world economy is "the Washington consensus"--a set of aphorisms shared by the leaders of the World Bank, IMF, United States Treasury, Washington think tanks and their friends around the world. To mainstream economists, the consensus just means getting the fundamentals right. So countries that aspire to sustained development and economic growth should avoid large or long-lasting budget deficits; bear down on inflation; resist the temptation to expand the public sector, say, by wasteful subsidies; open their economies to free trade, and build up "human capital" by sustained investment in education. That's about it.

So far, so unthreatening, unless you think protectionism and inflation good, and education bad. But the Washington consensus is now under attack on both a narrow and a broad front. Narrowly, it is said to have encouraged the flow of gazillions of dollars of short-term capital around the world--hot money, to you and me--with devastating consequences for developing countries. Second, the conventional economic wisdom is blamed for underpinning a distinct political credo, variously dubbed neoliberalism in Latin America, Thatcherism in the United Kingdom and the natural order of mankind by American conservatives. At least in the eyes of its critics, neoliberal politics implies a strict limit on the remit of government, advances the interests of private business and dismisses an unequal distribution of wealth with the helpful observation that life is tough.

Here's a curious thing: many of those now challenging the conventional wisdom live in Britain and America. For the Washington consensus is one of those rare commodities in the world that really deserve the tag "Anglo-Saxon." Of course, plenty of its advocates come from elsewhere--for example, Michel Camdessus, the head of the IMF, is French. But undeniably, "classical" economics, on which the consensus rests, is a discipline that was very largely invented by the British, and whose most distinguished modern practitioners are American. That has important consequences. In dominant intellectual circles in Britain and America, for example, the virtues of free trade are taken to be a revealed truth. In much of the rest of the world, by contrast, free trade is an interesting economic theory, often promoted by those who have most to gain from it, but required to take its place alongside other desirable outcomes of policy--like national grandeur, or the protection of domestic industries. So nobody bats an eye when, say, a French intellectual argues that EuroDisney pollutes the culture, or when a Russian economic plan says "Businesses will have to vie for the right to export and import raw goods with the Russian government" (that's last week's plan, not one written in Soviet times). Similarly, few are shocked when a German Finance minister advocates semi-fixed exchange rates (that's Oskar Lafontaine, who isn't Gerhard Schroder's Finance minister yet, but soon will be). But when, as is happening now, British and American intellectuals scratch their heads, and wonder if the theory and practice of globalization is all it's cracked up to be--that's news. "The ice floes are breaking up," says John Gray, of the London School of Economics, "in the very place where the project was initiated."

Start with the attack on the unlimited mobility of capital--a short 18 months ago, an article of faith among globalization's boosters. No more. Partly, that's because free movement of capital came late to the party. John Williamson, the British economist (and now World Bank official) who coined the phrase in the 1980s, briskly says, "I never put capital mobility in the Washington consensus; I never believed in it." Mainly, however, the attack on short-term capital has come from an analysis of the Asian crisis. In an article in Foreign Affairs this year, Jagdish Bhagwati of Columbia University pointed out that "In 1996, total private capital inflows to Indonesia, Malaysia, South Korea, Thailand, and the Philippines were $93 billion, up from $41 billion in 1994. In 1997, that suddenly changed to an outflow of $12 billion." In the jargon, that's called an overshoot--the endemic tendency of capital markets to swing wildly from one "good thing" to another. But such overshoots make sensible economic management all but impossible: "The claims of enormous benefits from free capital mobility," wrote Bhagwati, "are not persuasive."

Bhagwati's paper was enormously influential, not only because it was trenchantly argued but because on the matter of trade in goods he is a notorious free-market purist--no pussyfooting around with exceptions to protect the environment or labor conditions. And his is not the only loud voice questioning the value of capital mobility. Last month Paul Krugman, of the Massachusetts Institute of Technology, similarly concluded that the instability caused by huge capital movements required some policy response. Options include taxes designed to discourage short-term capital flows, like those Chile has employed, or rules prohibiting local banks from exporting funds at the first sign of trouble. Similar suggestions have been made by officials from France, Germany, and--though hedged in bureaucratese--Britain. The United States is still skeptical; last week Treasury Secretary Robert Rubin said, "My own view is that these very short-term speculative capital flows have played a relatively small part... in the current crisis." Even Rubin, however, conceded that "on an individual day in individual currencies, [the effects of such flows] may have been significant." And in Washington this week, the World Bank and IMF meetings will likely encourage debtor nations to constrain their own banks from borrowing short-term funds in foreign currencies. How they will do so in practice--Chile, which has some of the cleverest economic officials in the world, was forced to scale back its controls this summer--remains a bit of a mystery.

In fact, a lot that will come out of Washington this week is in the realm of the mysterious. The meetings, depend on it, will call for better regulation of debtor-country banks, voluntary guidelines on best practice for debt rescheduling, more money for the IMF and less corruption. But in a globalized economy in which billions of dollars move at the stroke of a computer key, ensuring that nice things happen (and that nasty ones don't) is difficult. The perfect proof of that proposition was offered last week by Alan Greenspan, the chairman of the U.S. Federal Reserve Board, in congressional testimony on the recent bailout of a large hedge fund, Long-Term Capital Management. "Given the amazing communications facilities available virtually around the globe," said Greenspan, "trades can be initiated from almost any location... Any direct U.S. regulation restricting their flexibility will doubtless induce the more aggressive funds to emigrate from under our jurisdiction."

Think about that statement for a minute. The most experienced financial regulator in the world's most advanced economy just said that he can't control a few hundred bond traders and mathematicians living (for the moment) in Greenwich, Connecticut. To the question "Who's in control of the global economy?" we now have an answer. Nobody.

It's at that point that the narrow attack on the conventional wisdom of globalization mutates into a broad one. A world without controls--rules--is a world without security. An insecure world is one in which people facing what they fear will be anarchy may retreat into the blanket of the past. That, shortly put, is the message of the LSE's John Gray, whose recent book, "False Dawn," is a scathing critique of globalization. Like Bhagwati, Gray is interesting partly because of his background--20 years ago he was one of a group who provided the intellectual underpinnings of Thatcherism. But those who unleashed the neoliberal revolution, says Gray, "underestimated the revolutionary nature of global capitalism." In an unconscious echo of Greenspan's lament on LTCM, he adds: "Nobody anticipated the power of the new technologies." In Gray's view, global capitalism wrecks social cohesion, endlessly churning nations and communities, removing what was once familiar--a job, a store, a career--and replacing it with a set of constantly changing fixes.

That's a message with political resonance--and in Moscow, it's been heeded. "Russia," says Gray, "has already left the neoliberal consensus." True; the economic czar of Yevgeny Primakov's new government is a former chief of Gosplan, who has just proposed vast increases in subsidies to industry and Soviet-era controls on foreign exchange. The small middle class--in Moscow and a few other urban centers--who bought into Russia's flirtation with the Washington consensus are unemployed, shellshocked or both. The vast majority of Russians to whom neoliberalism gave nothing of value have been promised greater social support--though how this will be paid for remains another of 1998's mysteries. The best outcome to which Russia's global capitalists can now look forward is that they will inherit an economy wrecked by hyperinflation some time in the next decade.

Western Europe, too, may be seeing a backlash against neoliberalism. With the victory of Schroder's Social Democrats in last month's German elections, all major European countries apart from Spain are now controlled by the left-of-center. Sometimes, the distinctly left-of-center--the party that most improved its position in the recent Swedish election was the aptly named Left Party. Schroder may have preached a modern form of social democracy to the German electorate, but with Lafontaine at the Finance Ministry, and in a likely alliance with the Greens (no global capitalists they), it's hard to see the new government choosing a neoliberal path. In France, Lionel Jospin's Socialist government, it has been said, wants a market economy without a market society--in other words, one that tempers the imperatives of neoliberalism with the protection of social cohesion. Tony Blair's British government is shiftily moving the same way. In key areas, like labor relations and privatization, it will not roll back the neoliberal reforms of Thatcherism. But at last week's Labour Party conference, Blair's left wing made more noise than it has for four years, and in any event, Blair is no less concerned than Jospin at the effect on communities of tumultuous economic change--hence his much-ballyhooed recent musings on "The Third Way."

Where all this goes is anyone's guess. An optimist would hope that the world is not on the verge of a recession, that Russia doesn't collapse, that all the fine words in Washington are matched by action, that hot money is cooled down, that Asia grows again, and that the American presidential election is not dominated by a trade deficit that the IMF estimates will be a record $390 billion next year. Hey, you never know. The pessimist sees a world slump, heightened misery in Asia and Latin America, hyperinflation in Russia and a turn toward protectionism--and slightly xenophobic politics--in Euroland. What's plain is that the old order has changed; unregulated markets are not seen any longer as the only path to global prosperity and political freedom. "We're all casting around for new things," says the World Bank's John Williamson. "Plainly, there are some areas in which governments need to play a more active role than people would have said 18 months ago."

Marx and Engels, of course, had a different prescription.

With Bill Powell in Moscow and Rich Thomas in Washington.