Martin Wolf makes my day

Martin Wolf has written the best thing I have seen in a very long time on the momentous transformation the world economy is undergoing.

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.

Yes, global financial capitalism. Its defining feature is "the triumph of the trader in assets over the long-term producer" in Wolf's words. 

What does Wolf make of it?

How then should one evaluate this latest transformation of capitalism? Is it a “good thing”?

Powerful arguments can be made in its favour: active financial investors swiftly identify and attack pockets of inefficiency; in doing so, they improve the efficiency of capital everywhere; they impose the disciplines of the market on incumbent management; they finance new activities and put inefficient old activities into the hands of those who can exploit them better; they create a better global ability to cope with risk; they put their capital where it will work best anywhere in the world; and, in the process, they give quite ordinary people the ability to manage their finances more successfully.

Yet it is equally obvious that the emergence of the new financial capitalism creates vast new regulatory, social and political challenges.

....

Pessimists would argue that monetary conditions have been so benign for so long that huge risks are being built up, unidentified and uncontrolled, within the system. They would also argue that the new global financial capitalism remains untested.

....

The regulatory challenges are big enough. But they are far from the only ones. Lionel Jospin’s hostility to what he called a “market society” is widely shared. Powerful political coalitions are forming to curb the impact of the new players and new markets: trade unions, incumbent managers, national politicians and hundreds of millions of ordinary people feel threatened by a profit-seeking machine viewed as remote and inhuman, if not inhumane.

Last but not least are the challenges to politics itself. Across the globe there has been a sizeable shift in income from labour to capital. Newly “incentivised” managers, free from inhibitions, feel entitled to earn vast multiples of their employees’ wages. Financial speculators earn billions of dollars, not over a lifetime but in a single year. Such outcomes raise political questions in most societies. In the US they seem to be tolerable. Elsewhere, however, they are less so. Democratic politics, which gives power to the majority, is sure to react against the new concentrations of wealth and income.

In the end, Wolf does not seem to have made his mind about what he thinks of it, and where he would like to see this new system going. 

I am among those who see the future risks as being substantial.  I think there is a fundamental incompatibility between unfettered global finance and a fragmented system of political sovereignty at the national level.  I am also not convinced that this new international financial capitalism has actually lived up to its promise: it has on the whole not been beneficial to developing nations, and it has created great inequality in the rich countries (as Wolf acknowledges). So we need a substantial rethink.

All the potential Keynes's out there: we need your ideas!

UPDATE: Here is the comment I submitted to the FT website as a member of the FT's expert panel.

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?

UPDATE2: Martin Wolf responds on the FT site:

Martin 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!

I look forward to it.

Comments

[Kenji]

To be a devil's advocate for the moment---Isn't the solution to all of these related problems more shareholder ownership? If everyone became a true capitalist, what would be the problem?

[Kalle]

I can't agree more. Wolf really has produced a very well written (as usual) article that nails down many of the most dificult issues we need to grapple with. I also agree with the plea for new Keynes's, but I would argue that what we need is not just a rethink of how international economic policy can become more potent in a globalized economy. Politics in general needs to become "globalized" if it is going to be able to respond to the challenges of today.

This is of course no easy thing, and the nation-state is far from obsolete, but a shift towards new ways of approaching the different problems governments face is needed. More of an analysis within politics that starts with the region/globe rather than with the nation-state is arguably a cruical first step.

[David]

Rodrik

As a non-subscriber of FT, is it possible for me to get my hands on the answers from mr Wolf?

Is it possible for you, as a member, cut & paste al the comments of his article here?

[kharris]

"I am also not convinced that this new international financial capitalism has actually lived up to its promise: it has on the whole not been beneficial to developing nations, and it has created great inequality in the rich countries..."

"Promise" starts with the letters PR, but we should not let that confuse us. There are not the same things. Financial and economic elites have, at times, promoted developments that led to a general improvement in welfare. Public education. Public sanitation. Public transportation. Public nudity. There are, however, counter-examples. There is no reason to expect that a development fostered by financial and eocnomic elites will increase welfare in general, even if a story to that effect is floated as part of the PR campaign. Post-WWII social safety nets were put in place at least in part because the elites of that generation were afraid the rest of us would go nuts again and commit ourselves to another slick-talking murderer. That generation is gone, and the self-interest that looked like altruism is gone with it. The new batch of rich guys in suits are clear on why members of a well-ordered society should enjoy the benefits of the good order they foster.

Short version - the "promise" of global financial sophistication was never really a promise.

[terence]

My guess: your new Keynes will be a political scientist not an economist. The true challenge being to foster forms of international institutions that are bearable to all the groups identified above, and which cajole capital into behaving in ways more productive than destructive.

The alternative, I guess, is a globalisation that leaves sufficient space for domestic institutions to function fully. But I'm not sure whether, in a political economy sense, this is at all possible.

[dissent]

This is of course no easy thing, and the nation-state is far from obsolete, but a shift towards new ways of approaching the different problems governments face is needed. More of an analysis within politics that starts with the region/globe rather than with the nation-state is arguably a cruical first step.

This is mildly amusing mush. And it's also the kind of thing one hears from globalization advocates, who don't really admit the problem exists.

The place to start is not handwaving about "new approaches" -- which is less than useless -- but with the mechanics of representation in making equitable policy decisions at the global scope. What are the institutions? What do they control? What is their carrot and what is their stick? How do they develop and then enforce their policies? What can be globally regulated, given differing political systems?

Obviously the challenges these questions pose are not difficult, they are insurmountable. Look what crises were required to produce the League of Nations and related institutions, all of which utterly fail to be adequate to our challenges today. We need more powerful global institutions, but what we have is a prez who thinks the UN is a p*ssing post.

My major fear is that globalization as we know it is subject to disintegration and catastrophic failure. It is primarily a set of ad hoc relationships that are built only for profit and not for durability, sustainability (political or environmental) or equity. It is much more fragile than it appears.

[alex]

dissent: "My major fear is that globalization as we know it is subject to disintegration and catastrophic failure. It is primarily a set of ad hoc relationships that are built only for profit and not for durability, sustainability (political or environmental) or equity. It is much more fragile than it appears."

Don't worry - 1914 will be the best year yet!

[Andrzej]

"the triumph of the trader in assets over the long-term producer" is the source of our trouble with the creation of the environmentally sane, sustainable society. Local and organic might as well be from Mars in this world of financial capitalism. It is green after all.

[Justin Rietz]

Dani -

I read your paper "Feasible Globalization" and I believe the premises and therefore the conclusions of the paper (and hence your post) are flawed.

In your paper, you state that many non-market institutions are needed in order for markets to work effectively. You then provide examples of current non-market institutions that supposedly play this role. First, I would argue that institutions that protect the right to private property are hardly “non-market” and there are many examples of private property being protected without government involvement yet with the agreement of the private citizens involved. Moreover, one may just as well argue that markets have worked in spite of many of these institutions, and that many economic problems blamed on unregulated markets should in fact be blamed on government interference (the Federal Reserve is a prime example, but to be debated at another time).

Moreover, few of the institutions cited could not be replaced with market mechanisms. Consider that court rooms are being unilaterally "privatized", evidenced by the significant growth in private arbitration. Many have found it to be as fair, more efficient, and in the end, less costly than the government legal system.

The paper points out that China did not take the neoclassical approach a western-trained (Washington Consensus?) economist would have recommended. Yet scant attention is paid to the major capitalist reforms that have taken place in China, and no mention is made of those who support transition to truly free markets but at a measured pace. Also overlooked is the fact that the Chinese government is still an authoritarian regime that inhibits the economic potential of a large percent of its population and has forced entire cities to relocate for the benefit of industrial growth. Unless we choose to embrace the idea of cultural relativism, this trouncing of individual rights is hardly a development path to emulate.

In fact, cultural relativism permeates the paper's argument to a disturbing extent. You state that "diversity in national institutions serves a real and useful purpose. It is rooted in national preferences, sustains social compacts, and allows developing nations to find their way out of poverty." Beyond the sweeping generalizations that this statement requires the reader to take for granted, it is also at odds with another claim in the paper. Specifically, the inadequate protection of private property is offered up as an example of the “international boundaries” that are the result of national institutions. It is hard to justify the lack of property rights as having some overriding societal benefit. In fact, it is usually, if not always, the results of a corrupt authoritarian or mercantilist government that benefits a few elite at the expense of everyone else.

In regards to the arguments about democracy, it should first be clearly stated that a democracy is defined as a government elected by the people that it serves, and does not necessary imply limitations on the power given to that government. However, the paper claims that the limitations put on a government’s policy options by free global trade causes the "crowding out of democratic politics." This claim is supported by the argument that free markets by definition prevent government action in the economy. Such an argument would also allow us to claim that a government with absolute economic power would truly be democratic. In fact, democracy is often positively viewed as the best political structure for limiting government power, and hence limiting the ability of the government to enact policies and regulations that interfere with the decisions of private citizens.

Ultimately, the paper tries to justify the support of protectionist policies by turning the issue on its head. Given the pre-existing conditions we find in much of the world, the move towards global free trade will be long and arduous, mistakes will be made, and those in power will continue to attempt, some times successfully, to shape policies that will benefit their constituents at the expense of others. But isn't this exactly the reason we want free markets - to wrest control of our economic future from inefficient, self-serving, and corrupt governments and instead allow consenting individuals and private parties to engage in mutually beneficial exchange?

We should not denounce free trade because it is incompatible with nation-states, but rather denounce the corrupt, authoritarian, and mercantilist governments that are incompatible with free trade and hence free society.

[sst]

I don't think all the answers will come from economics or that we will find a Keynesian silver bullet but an idea I intend to flesh out is that we need a Post-Cold War Reconstruction - as a framework for institution building just as many of our current inadequate ones came out of the post WWII reconstruction. It could also serve as a device for reframing the concept of security to include all those important things that tend to land in blindspots, e.g., ecosystem services.
And since my trackback didn't show up - this comment is from a post about this post on The Post-Normal Times, (permalink here).